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And Now to Enter the Exit Policy

Arvind Panagariya

            Moving steadily ahead with its reforms agenda, the Vajpayee-Sinha combine is entering an area of policy that promises to be most fruitful but is also politically difficult: labour laws that effectively deny enterprises with 100 or more employees the right to exit and workers many of the basic benefits.

            In the heyday of the license raj, any entrepreneur lucky enough to obtain an investment license was guaranteed a handsome stream of profits.  Because the entry of new firms was tightly controlled and imports were subject to strict licensing, poor buyers had nowhere to go.  As late as 1980, the Hindustan Motors could produce the Ambassador car that had been discarded everywhere else in the 1950s and expect a queue of customers extending to two or more years into the future.

This cosy arrangement, covering the entire organized sector, did not escape the watchful eye of labour unions representing the workers.  They demanded similar privileges and were readily obliged by socialistically inclined governments of the time.  Provisions that effectively outlawed layoffs were introduced, giving the workers the same protection in the labour market that the privileged industrialists enjoyed in the product market.

The key change in labour policy came in 1976 when the then Prime Minister Indira Gandhi introduced a provision requiring enterprises with 300 or more employees to obtain prior permission from the state government before any worker could be retrenched.  In 1982, this limit was lowered to cover enterprises with 100 or more employees.  Due to its obvious political ramifications, state governments almost never give permission for retrenchment, effectively prohibiting an orderly exit of firms.

The ban on retrenchment has produced few winners.  Under the threat of strikes, it has forced firms to tolerate extreme inefficiency and grant wage hikes that often render them unprofitable.  The ban also discourages entrepreneurs from seeking entry into labour-intensive sectors and employing labour-intensive techniques.  Growth of labour-intensive industry, in which India enjoys a comparative advantage, has been scuttled.

The ban has also proved harmful for workers.  By discouraging firms from entering into labour-intensive industries, it has suppressed the demand for labour.  From 1981 to 1991, despite an annual growth in output of 5 percent, private-sector employment in the organized sector remained unchanged at 8 million.  Following the removal of investment and import licensing, which forced some discipline on labour unions, this number grew to 10 million in 1995-96 but it remained substantially below its true potential.

Paradoxically, even many of the workers for whom the provision on retrenchment was introduced have been hurt by it.  Since firms are not permitted to close down their operations officially even when faced with persistent losses, they have found a backdoor exit: lockout.  This is accomplished by missing payments on the monthly electricity bill, which leads to a loss of the electric connection and renders the firm technically inoperable.  The firm owner then locks the factory and in many cases moves the management and assets out of the state (except land which is immovable).

The workers employed in such firms are, thus, left without hope of recovering unpaid wages or redundancy benefits.  The government often takes over these firms declaring them “sick” and refers them to the Board of Industrial and Financial Rehabilitation (BIFR).  The BIFR must either rehabilitate or liquidate these firms, giving the workers their due if the firm’s assets so permit.  But the BIFR process itself is extremely slow and takes several years.

The plight of these workers was recently aired by Sanat Mehta, a Member of Parliament.  Speaking in the Lok Sabha on May 14, 1997, he bitterly complained about the losses borne by 80,000 workers belonging to 42 textiles mills closed down in Gujarat between 1983 and 1995.  “These units [were] closed down without any rules and regulations,” lamented Mehta, “and the most tragic part of the story is that these 80,000 workers…were not paid any of their legal dues. No notice pay and no retrenchment compensation [were] given to them.”

The only beneficiary of the ban has been a tiny minority of elite workers in the public sector units.  In many cases, while these workers draw their salary and perks, factories are run on contract labour.  Ironically, contract labour itself has no protection under the law and is subject to constant harassment by contractors.

If we are to reap the full rewards of the reforms to-date and protect the rights of all workers, labour-market reforms are crucial and urgent.  As a recent report entitled “Unshackling Indian Industry,” and submitted to the Prime Minister's Council on Trade and Industry by industrialists Nusli Wadia and Ratan Tata argues, with these reforms, we will see the Old Economy move in unison with the New Economy.

The reforms must address three key objectives.  First, the firm’s right to retrench must be restored irrespective of its size.  Analysts often view the need for this provision in the context of exiting firms.  But this is short sighted.  Healthy firms, large and small, also need this flexibility to adjust to changing market conditions and technology.  From the available details, the current proposals of the government fall far short of addressing this objective adequately since they focus only on firms with 1,000 or more employees.

Second, approximately uniform rights, conforming to the international practice, should be established for all workers irrespective of whether they are employed in small, medium or large firms.  This must include the establishment of appropriate retirement benefits and severance pay based on the number of years worked.  Outsourcing and the status of contract workers must be formally recognized, ending the tyranny of contractors.  Any discrimination against female workers should also be eliminated.

Finally, to give substance to these provisions, proper enforcement mechanisms must be instituted.  This means creating time-bound procedures.  Strict timetables must be imposed on the BIFR proceedings with workers awarded their compensation in a timely fashion.  Justice delayed is justice denied.

Economic Times, July 19 2000