Impact of Labour Laws in India: Informal Employment, Contracts, and Wage Inequality

Over the years, there has been growing debate among economists and policymakers about the relevance of labour laws in India for job creation. Some argue that entrepreneurs have adapted to these laws, rendering them less important. However, we feel that the disconnect between how these laws are written, interpreted, and enforced has led to significant toxic transmission losses. The consequence has been that a substantial 93% of India’s workforce is trapped in informal employment, with over 30% employed under fixed-term contracts. This trend of informal and contractual employment at such extreme levels should not be accepted as the norm—it’s a problem that reflects deep systemic issues rather than positive economic progress.

While fundamental issues such as fair wages, safe working conditions, and social security, are non-negotiable in any debate on labour law reform in India. Other issues that need to be addressed are the politicization of unions, fixed-term contracts, and wage inequality. Trade unions in India often oversimplify these complex and nuanced issues. Let’s delve into each of these matters.

The first issue is the politicization of unions. This problem is closely linked to the multiplicity of unions and raises a philosophical question: how much influence should outsiders have in a company’s internal affairs? As Mancur Olson’s insights on interest groups highlight, over time, unions’ interests can diverge from the greater good. When trade unions in India are led by non-employees, their leadership often becomes a stepping stone for political ambitions, which can skew their priorities away from worker welfare. As a result, unions can evolve into platforms for building political constituencies rather than addressing labour rights. This politicization creates a toxic environment that hampers meaningful labour negotiations. To ensure that unions genuinely represent the interests of workers, they must be led by the workers themselves, not by outside political actors.

The second issue is the rise of contract employment. Trade unions, along with the outdated labour laws in India, often view employment contracts as permanent. This rigid approach discourages formal hiring, which in turn fuels the growth of informal employment. Employers are hesitant to commit to permanent contracts and often prefer automation or outsourcing to minimize risks. Moreover, changes in the global economy, such as technological advancements, globalization, and project-based work, have fundamentally altered employment relationships. Today, both employers and employees favour short-term, flexible contracts over lifelong commitments.

In the past, companies like IBM embodied the model of lifetime employment. However, recent data from IBM shows that 50% of its employees have been with the company for less than two years, 40% work remotely, and 30% are women. This shift towards flexibility and diversity in the workforce is being hindered by India’s labour laws, which are akin to marriage without the option of divorce. The rise of fixed-term contracts is a rational response to these outdated laws. As long as contract workers and permanent employees are paid above the minimum wage, there should be no requirement for complete wage equalization. Employers should retain the flexibility to pay based on factors like experience and job responsibilities.

It’s important to remember that without employers, there would be no employees. India’s economic environment is already challenging for job creation. Recognizing and legalizing contract employment would help reduce the heavy reliance on informal and contractual employment, allowing for a more stable job market in the formal sector.

The third issue is wage inequality, which remains a highly complex and contentious topic. The American automobile industry faced severe setbacks when it began paying workers above-market wages solely based on seniority. It was only through the adoption of differential wages—where younger workers accepted lower wages while older employees maintained higher pay—that the industry avoided collapse. Employers who navigate various challenges such as generating their own power, providing transport and even training to employees must be allowed the flexibility to negotiate differential wages based on the value added by the worker. In the absence of such flexibility, the rigid and outdated labour laws in India are being manipulated by politicized unions that cater to a small labour aristocracy at the expense of the larger workforce. Such gross transgressions against large employers discourage job creation which is evident in the country’s inability to reduce low-productivity agricultural employment, which still accounts for 54% of the labor force but contributes only 18% to GDP. We must revise labour laws to cater to the needs of changing times if we wish to enhance formal employment opportunities in the manufacturing and services sectors.

The devastation witnessed in a city like Kanpur, once a booming centre of India’s textile industry, is a stark reminder of what happens when labour issues are mishandled. Today, Kanpur struggles with limited power, high unemployment, and a declining industrial base. A similar collapse of industries in other cities like Kolkata and central Mumbai further highlights that while factory closures may not have hurt employers in the long term, they have caused immense suffering for workers.

Trade unions in India have an essential role to play in advocating for workers’ rights, but their current focus is misguided. Rather than pushing for confrontational agendas, unions should focus on crucial issues like improving employability, ensuring workplace safety, and retraining workers for the evolving job market. The concerns of unorganized labour, women, and the younger workforce must be prioritized. If the current trajectory continues, more regions like Gurgaon risk suffering the same fate as Kanpur or Kolkata, which is an outcome neither employers nor workers can afford to ignore.

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