How should India reform labour laws?

Feb 26, 2015

Manish Sabharwal

Chairman, Teamlease Services

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Changing the ways that India’s benefits regimes are funded would be the most impactful way to reform the country’s labour market. It is not changing the law to make it easier for companies to hire and fire employees.

When people think of labour law reform in India they tend to think of the laws around hiring and firing; specifically, reforming Chapter 5B of the Industrial Disputes Act.

But there are many other reforms possible:

collapsing the 44 central labour laws into five clusters;
fixing our dysfunctional benefits regime;
making trade unions more representative.
making compliance for employers frictionless;

I would also argue that the most impactful labour law reform would be fixing our benefits regime. Under this regime, the mandatory deductions to gross wages are 45% for an employee with a Rs5500 monthly salary but only 5% for an employee on a Rs55,000 monthly salary. Making matters worse, this 45% deduction from low wages goes to programmes that give poor value for money; 55 million of 100 million Employees’ Provident Fund of India (EPFO) accounts are dormant. Additionally, EPFO’s administrative costs of 440 basis point make are one of the most expensive in the world for a government securities mutual fund.

Even more painfully, most of the employer contribution to EPFO now goes to the bankrupt Employee Pension Scheme (EPS) whose $8billion hole is being balanced by reducing benefits. Furthermore, the Employees’ State Insurance (ESI) has India’s worst health insurance claims ratio, paying only 49% of contributions as benefits. It is also sitting on $5billion of idle financial investments.

I would propose the following reforms, which would create three choices for employees in how their salary is paid:

Choice 1; Paying or Not Paying the 12% EPFO employee contribution
The 12% employee contribution is an unaffordable salary deferment by low wage employees who have no savings. Employees should be allowed to opt out of this contribution at joining, pay this into their individual National Pension Scheme (NPS) or continue the status quo by paying to EPFO.

Choice 2; Paying the 12% employer contribution to EPFO or NPS
Currently most of the employer contribution to EPFO goes to the Employee Pension Scheme (EPS). Employees must be allowed to choose between EPS or diverting their entire employer contribution to their individual National Pension scheme individual account.
Choice 3; Paying health premiums to ESI or an Insurance company
Employees should have the option to pay their monthly health insurance premium to ESI or buy a policy from any IRDA-regulated health insurance company.

It is well known that India’s labour laws have negative consequences. The country suffers from poor productivity, poor working, conditions lower taxes and a large number of small, informal firms. Indeed manufacturing comprises just 12% of employment and 85% of manufacturing comes from firms with less than 50 employees.

Nevertheless, the country has finally begun to fix this regulatory cholesterol that has been holding back formal job creation. In the last year the new government has already amended the apprentices act, revamped the labour inspector regime, given employers and employees unique numbers, and is moving to online compliance. Most importantly the central government now allows state governments to diverge their labour laws from the national norm. This means Rajasthan’s reform lead is now being followed by seven other states.

But changing the rules of the benefit system would be the most impactful reform that the government could now undertake.

This article was first published by the World Bank’s Jobs and Development blog. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Manish Sabharwal is the Chairman of Teamlease Services, based In Bangalore.

Image: Women labourers work at the construction site of a road in Kolkata January 8, 2015. REUTERS/Rupak De Chowdhuri.

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