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Hindustan Times

January 29, 2006

Walking on two legs

Arvind Panagariya

If we go by the latest census data, as late as 2001, 77 per cent of India's population lived in rural areas and 59 per cent earned its living from farming. Given farming generates less than a quarter of the national income, it offers a significant proportion of the farmers barely the subsistence income.

I have argued for some time now that if India is to transform itself from this primarily agricultural to modern economy, it must walk on two legs: unskilled-labour-intensive manufacturing and skilled-labour-intensive services. The former, which includes products like apparel, footwear, toys and other light manufacturing products, would generate well-paid jobs for the vast majority of India's unskilled and semi-skilled workers. The latter, which include dynamic sectors like software, business process outsourcing (BPO), communications and banking, would offer opportunities to generate wealth through full utilisation of India's skilled labour force.

Reforms are needed on several fronts to speed up the process of transformation. In the area of international trade, the commitment to continued liberalisation must be reinforced by bringing the highest tariff in manufacturing down from its current 15 per cent level to 10 per cent and cutting tariff peaks such as those applied to automobile imports. On the fiscal front, the annual commitments as set out in the Fiscal Responsibility and Budget Management Act must be met. The small-scale industries reservation list, which has been considerably trimmed over the years, must now be eliminated altogether. In the area of infrastructure, the most critical areas are power, ports and airports. Our goal has to be to achieve as much progress in these areas in the next five years as has done in roads and communications in the last five years.

Two areas requiring special attention, one having far-reaching implications for the unskilled-labour-intensive manufacturing and the other for the skilled-labour-intensive services are labour markets and higher education, respectively.  Whereas in China, foreign investment has poured into unskilled-labour-intensive manufacturing, in India, it has gone into either capital-intensive manufacturing such as auto parts and automobiles or skilled-labour-intensive sectors such as software, BPO, telecommunications and pharmaceuticals.

Even local firms have been highly reluctant to invest in the large-scale unskilled-labour-intensive units on the scale observed in China. Unsurprisingly, the fast-growing exports from India are either skilled-labour-intensive or capital-intensive.  We are virtually absent from the world markets for toys and the vast majority of other light manufactures. Our share in the US market in apparel is fully matched by much smaller Bangladesh and is one- fourth that of China.

The key reason for this poor performance of the unskilled-labour-intensive industry remains high effective labour cost in the organised sector. If there ever was a case of dualistic development in India, it is in this area: elite workers in the organised sector enjoy huge protection while those in the informal sector have virtually no rights.

Much of the discussion on labour reforms focuses on Chapter V.B of the Industrial Disputes Act (IDA), which denies the firms with 100 or more workers the right to retrench workers under any circumstances.  But the problem is deeper. Even smaller firms in the organised sector that do not fall under the purview of Chapter V.B of the IDA find it nearly impossible to retrench workers. The provisions in Section 9A of the IDA also make reassignment of workers to different shifts or tasks extremely difficult, time-consuming and costly. These provisions result in very low productivity of regular workers with the firms having to hire contract workers to perform tasks for which regular workers already exist. Yet, the average level of wages in the organised sector is far higher than would be justified in a labour-abundant economy such as ours. A salaried driver, gardener or sweeper in the organised sector is often paid three or four times the wage available to him in the informal sector.

Simultaneously, workers in the informal sector have virtually no rights. Their wages are low and rarely cover medical expenses or pensions. This has led even firms carrying on important manufacturing activities to rely largely on contract or casual workers and operate in the informal sector. While such operations do manage to contain labour costs, their ability to expand the operations to larger scale is constrained despite high profitability.

If India is to push the growth of labour-intensive manufacturing to the rates comparable to China's and thus provide descent jobs to the vast majority of the workers, a wholesale reform of labour laws is critical. A proper balance must be achieved between the rights and obligations of the workers in the organised sector. Symmetrically, the casual and contract workers must be provided greater protection. The starting point for the reform is evidently Chapter V.B of the IDA, which must be repealed. But that has to be viewed only as a beginning.

Turning to the skilled-labour-intensive services whose growth has distinguished the Indian experience from most of the traditional success stories, our problem is the emerging shortage of such workers. Initially, when the software, BPO and communications sectors began to take off, the extra demand for well-qualified workers at the margin was small due to a small base of these services.  Moreover, the market had some slack due to weak demand for skilled workers in the prior years. But the base of these sectors is now larger with the extra demand for skilled workers by them being larger as well. Simultaneously, the slack has been absorbed as reflected in wage increases at rates ranging from 10 to 15 per cent and annual turnover rates of 20 to 40 per cent.

If India is to maintain the momentum and lead in the skilled-labour-intensive services, it needs to urgently focus on the reform of its higher education. It is the country's misfortune that the HRD minister under neither the NDA government nor the present UPA government has shown any interest in reforming this sector. While highly talented students selected from a nation of one billion people have been able to help the country's top technical institutions such as the IITs and IIMs maintain their reputations, value added at the vast majority of the universities in India has been declining rapidly.

No obvious politically acceptable short-run fixes for higher education are available, but efforts must begin on three fronts. First, the central government must grant entry to private universities. It is remarkable, albeit depressing, that while countries such as China and Bangladesh allow private universities, the Government of India does not.  Private colleges exist but they must affiliate themselves to a public university to grant degrees. Moreover, the government interference in the running of private colleges remains rampant. The government has no resources to achieve the needed rapid expansion of higher education and it is time it took help from the private sector.

Second, it is time to introduce tuition fees to cover at least one- third of the operating costs of the universities. Higher education has private value for those receiving it in terms of the much larger lifetime income they earn. There is no economic case for subsidising this private gain at the expense of the taxpayer. Even those unable to pay the fee should actually be required to borrow from the banks. This is a politically difficult step but a beginning has to be made.

Finally, the stranglehold of the University Grants Commission (UGC) on higher education must be loosened. More than 50 years after Independence, universities should be able to govern themselves without the UGC looking over their shoulders. The entry of private universities, independence from the UGC and the freedom to raise own resources through tuition fees may provide the dose of competition so badly lacking in the current system.

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