Labour market institutions in India: Their impact on growth and employment

This paper examines the impact of labour regulations on employment and output growth. It reviews the evidence from past research on the subject in India, and draws lessons on the relationships between institutions, regulations and employment.

The lack of flexibility in the labour market in emerging economies is often cited as the reason for poor performance of the labour market in terms of employment generation and productivity growth. The success of labour institutions in these markets and in India has been measured by the effect they have had on generating jobs rather than whether they have enabled the use of more flexible forms of work organization that are supportive of lean production systems. Job security regulations are often seen as a source of rigidity and resulting in rents for organized labour. This paper argues that these regulations often emerged as a response to the threat of unemployment and income insecurity and were intended as a form of social insurance rather than being the result of rent seeking. It demonstrates that markets if left to themselves will not be able to device contracts that provide an efficient level of employment security. In a temporal world if workers trade-off working with shirking, employers can similarly trade-off honouring a contract with termination of the service of employees. In labour markets both firms and workers are susceptible to opportunism and verifying breach of contract is difficult. A meaningful way to get workers to invest in a job and employers to honour contracts is to legislate employment protection. The difficult task, of course, in reality is to ensure that employment protection does not become protectionist.