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India has been remarkably successful in boosting economic growth: its economy has grown at about 6 percent per annum since the 1990s, with growth accelerating to 9 percent over the past two years. Absolute poverty has been cut in half, and the country seems set to achieve middle income status soon.

Among all this good news, some puzzles remain. Despite recent growth, India’s manufacturing sector still accounts for less than 15 percent of GDP and employs less than 15 percent of the work force. This is in stark contrast to the fast-growing East Asian countries such as Korea, China and Thailand where rapid expansion in manufacturing has generated large scale employment that has lifted millions out of poverty.

For most Indians, especially the poor and marginalized, labor is the principal asset. If India is to sustain its current levels of growth and reduce poverty, it has to provide jobs with good wages for the vast majority of its people, as well as for the 80 million new entrants who are expected to join the work force over the next decade.

Yet most manufacturing jobs in India are in the informal sector which is characterized by low productivity and wages and to which labor laws do not apply. This is disproportionately large compared to East Asia: in India, small informal firms employ a sizeable 40 percent of the country’s workers compared with only 4 percent in Korea. On the other hand in 2003, India’s organized manufacturing sector employed only about 1.3 percent of the total labor force of over 450 million, most of it in the private sector. Even more unfortunately, employment in the formal manufacturing sector declined between 1996 and 2002.

What is preventing manufacturing in India from becoming the engine for mass employment it has been in East Asia? Take the textiles and clothing sector which accounts for a fifth of India’s exports. It employs almost 10 percent of India’s workforce, or some 35 million people, and has the potential to add another 12 million new jobs --dwarfing the 1-2 million jobs created by the much-heralded IT and BPO sector. The sector was expected to boom after the multi-fiber agreement was abolished in 2005. While in the first year of quota-free exports, textiles and clothing exports jumped 23 percent, similar to China’s, growth slowed to about 10-12 percent the following year (2006). Not only was this slower than China, it was also slower than Bangladesh, Pakistan, and Vietnam.

The sector is clearly facing constraints that are hindering its expansion. China’s remarkable success – with exports of 20 billion finished garments or roughly 4 for every person in the world - has largely been explained by its state-of-the-art factories and efficient transport infrastructure. While huge infrastructure bottlenecks have undoubtedly kept India’s textile and clothing industry small and fragmented, what is perhaps less well-known is how India’s archaic labor regulations are hurting the sector’s growth.

Anecdotal evidence suggests that Indian manufacturers often set up several plants instead of a single large one to get around labor laws. This, however, limits their flexibility to meet seasonal variations in demand. They also lose out on economies of scale and investment: on average, Indian textile and clothing firms have only 10-20 percent of the machines that a typical Chinese plant does.

Of course, labor laws are needed. Workers need protection. But labor laws should protect workers, not jobs. In India, current regulations end up doing more harm than good. In international comparisons, India stands out as having one of the most rigid labor laws in the world. A recent study estimated that in 1997, India could have had more than 1 million more jobs in the textiles and clothing sector alone if its labor regulations had been less restrictive. Overall the country could have had 2.8 million more good quality formal sector jobs - a startling 45 percent of existing employment in the organized manufacturing sector on that date.

Not all of these losses are due to the difficulty of retrenching workers: more than half are a result of the complexity of laws and the difficulty of resolving disputes. There are currently 47 central laws and 157 state regulations that directly affect labor markets. These are often inconsistent and at times overlapping. It is impossible for either firms or workers to be aware of their rights and obligations when rules and regulations are spread over such numerous national and state level Acts.

It is clearly possible to do much better. Active labor market programs and policies (ALMPs), as recommended by the International Labour Organization and other bodies internationally, are starting in India and may need to be strengthened. ALMPs can be sub-divided broadly into three categories: direct job creation, labor market training, and job brokerage (improving the match between job seekers and vacancies). For now, the rural employment guarantee program is an important start. If implemented well, it promises to provide an important form of job security for the rural labor force. More is possible and could include effective information and employment exchanges, social insurance mechanisms for informal sector workers, and strengthened technical and vocational education programs. Amending the plethora of existing labor regulations is itself an integral part of the job-creating ALMP strategy for India.

The Government of India has been seeking to spur manufacturing growth by setting up Special Economic Zones (SEZs). Although the program has been put on hold till the land acquisition and social safety net issues for rural land-owners have been resolved, it is important to note that the international experience on SEZs is mixed. Tax packages alone are often not enough to attract investment. Moreover, they are often costly. Their role in employment generation is usually marginal. SEZs may be useful in testing new approaches, in policy as well as governance structures. They can be catalysts for reforms as the China case suggests. But SEZs cannot be a short-cut to development, and should not detract from the overall reform effort in India.

An improvement in labor regulations, perhaps spurred at individual state level within a central enabling framework, will provide an opportunity to accelerate manufacturing growth and especially employment in key labor-intensive sectors, including the crucial textiles and clothing sector, within the next decade.

Source:Economic times and World BankMore