Unlocking Employment Growth in Indian Manufacturing: A Fresh Perspective on Labor Laws and Economies of Scale.

Over the past five years, India has been positioned to leverage its demographic dividend. Unfortunately, significant progress remains elusive. Government policies aimed at skill development and employment growth have seen limited success. Approximately 65% of the population still lives in rural areas, primarily relying on agriculture. However, family land holdings have become increasingly fragmented across generations, making them insufficient to support livelihoods. To tackle this challenge, India must create employment opportunities beyond agriculture, with a focus on non-agricultural sectors such as industries and services.

Despite a growing GDP, employment growth remains sluggish. Since 2000, the service sector has driven India’s GDP, benefiting educated youth in urban areas. Yet, rural youth face challenges due to limited education and skills. While the Construction Industry absorbs some workforce, manufacturing struggles to provide adequate jobs. Manufacturing’s contribution to GDP declined from 17% (2000) to 13% (2022), impacting overall economic growth.

Informal jobs, comprising 90% of employment, suffer from stagnant real wages. At this critical juncture, it is imperative to foster an environment in the country that incentivizes entrepreneurs to invest and create substantial employment opportunities within organized manufacturing, with a specific focus on labor-intensive industries. The emphasis should be on generating ‘Formal Jobs’ rather than low-quality contract or informal positions.

The export sector holds substantial potential, particularly considering the ‘China Plus One’ strategy embraced by the USA and EU. India has an opportunity to reclaim its position in labor-intensive product exports.

India has experienced a significant decrease in the growth of its merchandise exports over the last twenty years. In the period from 2014 to 2024, the Compound Annual Growth Rate (CAGR) dropped to 4%, a stark difference from the strong 17% growth seen in the previous decade (2004-2014).

Analyzing the top five export sectors reveals a significant shift, with labor-intensive conventional manufacturing exports (such as Textiles & Clothing and Gems & Jewlery) experiencing a decline in their market share.

Stringent labor regulations pose challenges for investors in India. The Industrial Disputes Act of 1947, specifically ‘Chapter VB,’ introduced during the 1976 ‘Emergency’ period, restricts downsizing for large industrial units with over 300 workers. Employers require government permission even to lay off a single worker, hindering business flexibility. These illogical regulations deter new investors. While entry into manufacturing faces no barriers, exit processes demand government consent.

Recent studies reveal that contract labor constitutes a significant portion of organized sector employment. Employers choose contract workers despite additional costs (10% contractor margin and 18% GST) due to their flexibility in adjusting the labor force. Unfortunately, contract workers receive lower wages (approximately 70% of formally employed workers), lack job security, and miss out on social benefits like PF and ESI. Paradoxically, labor laws meant to protect rights have inadvertently pushed workers into informal employment.

In labor-intensive industries, stringent labor laws discourage factories from employing large workforces, hindering their ability to benefit from economies of scale. While China’s largest manufacturing units may employ up to 30,000 workers and Bangladesh around 10,000, India rarely exceeds 1,000 workers per factory.

Indian entrepreneurs seeking growth often choose to establish multiple small factories across various locations, resulting in fragmented production capacity. Unfortunately, this approach has drawbacks. Due to small factory sizes, Indian manufacturers miss out on economies of scale. Financial constraints further limit investments in capital-intensive technologies to improve quality and productivity. Consequently, India becomes a costlier and less reliable supplier, requiring longer lead times. In the international market, India faces competitiveness challenges.

A minor adjustment to labor laws could be effective without causing discord with labor unions. Amendments to Sections 25-M (Layoff), 25-N (Retrenchment), and 25-O (Closure) of Chapter VB in the Industrial Disputes Act of 1947 should shift from a permission-based approach to a compliance-based one. Removing the need for prior permission to lay off, retrench, or close a factory would enhance flexibility. Factories should adhere to established rules regarding worker dues and severance pay, reporting their compliance to government authorities. Non-compliance by employers should be strictly penalized.

Interestingly, before the ‘Emergency’ period until 1976, no factory—regardless of size—required prior permission for layoffs, retrenchment, or closures. The law was then based on compliance rather than seeking permission.

The government should engage with stakeholders to highlight that permission-based labor laws have led to a decline in formal, high-quality jobs in the country. Currently, over 90% of the workforce is engaged in low-quality informal jobs without social security benefits, benefiting only the labor contractors disproportionately. To encourage large-scale manufacturing revival, flexible laws are essential. This approach would create substantial formal job opportunities, enhance productivity, and boost international competitiveness. Ultimately, India must prioritize fundamental competitiveness and incentivize economies of scale to succeed in global markets—subsidies alone won’t suffice.