Indian firms are not creating enough jobs and reason is restrictive labour laws

Arvind Panagariya, the vice-chairman of the NITI Ayog, recently said that Indian companies do not invest in industries which have the potential to employ a lot of people or what economists refer to as labour-intensive sectors.
“Here is my charge to you: if I look around, none of you invest in industries, in sectors that would generate lots of employment; all of you just run away from hiring purpose,” Panagariya said.
Every month more than a million Indians are entering the workforce. As Panagariya put it: “Every year, 12 million enter the labour force. What is your plan for the country so that more people are employed? We really need to think. You know the ground conditions; why you are not investing in sectors which are more labour-intensive such as food processing, electronic assembly, leather products.”
The question that Panagariya was asking is why do Indian businesses shy away from investing in labour intensive sectors. This has led to a situation where the growth in labour force in India has been much faster than the rate at which jobs are being created.
As the latest Economic Survey points out: “Regardless of which data source is used, it seems clear that employment growth is lagging behind growth in the labour force. For example, according to the Census, between 2001 and 2011, labor force growth was 2.23 percent (male and female combined). This is lower than most estimates of employment growth in this decade of closer to 1.4 percent. Creating more rapid employment opportunities is clearly a major policy challenge.”
This slow growth in jobs has happened despite the Indian economy growing at a very fast rate for most of the period between 2001 and 2011. One obvious reason, as Panagariya explained, is the reluctance of Indian businesses to invest in sectors that are labour intensive. And there are reasons for the same.

The slow growth of the Indian textile sector is a result of the restrictive labour laws in the country. Reuters

The labour laws in India remain very restrictive. In their book India's Tryst with Destiny Jagdish Bhagwati and Panagariya recount a story told to them by economist Ajay Shah. Shah asked a leading Indian industrialist about why he did not enter the apparel sector, given that he was already backward integrated and made yarn and cloth. “The industrialist replied that with the low profit margins in apparel, this would be worth while only if he operated on the scale of 100,000 workers. But this would not be practical in view of India’s restrictive labour laws.”
Labour comes under the concurrent list of the Indian constitution, i.e. both central and state governments can make laws on it. This has led to a situation where there are a surfeit of labour laws which companies need to follow.
As Bhagwati and Panagariya write: “The ministry of labour lists as many as fifty-two independent Central government Acts in the area of labour. According to Amit Mitra (the finance minister of West Bengal and a former business lobbyist), there exist another 150 state-level laws in India. This count places the total number of labour laws in India at approximately 200. Compounding the confusion created by this multitude of laws is the fact that they are not entirely consistent with one another, leading a wit to remark that you cannot implement Indian labour laws 100 per cent without violating 20 per cent of them.”
This explains why Indian businessmen stay away from labour-intensive businesses. It also explains why Indian businesses start small and continue to remain small.
As Bhagwati and Panagariya point out: “As the firm size rises from six regular workers towards 100, at no point between these two thresholds is the saving in manufacturing costs sufficiently large to pay for the extra cost of satisfying the laws”.
This means many firms that can grow bigger choose not to and in the process don't create jobs that they would have otherwise. The textile sector is a very good example where most Indian firms continue to remain small. As many as 92.4% of workers in this sector work with small firms which have 49 or less workers. Now compare this to China where large and medium firms make up around 87.7% of the employment in the apparel sector.
In fact, even Bangladesh has overtaken India in the textiles sector. As Mihir S. Sharma writes in Restart—The Last Chance for the Indian Economy: “Before the expansion of trade thanks to new international rules in the twenty-first century, India made $10 billion from textile exports, and Bangladesh $8 billion. Today India makes $12 billion—and Bangladesh $21 billion.”
So what happened here? The textile industry, explains Sharma, needs to turnaround big orders quickly and efficiently.
“Really long assembly lines still matter in textiles: in some cases, 100 people can sequentially work to make a pair of trousers in least time. In Bangladesh, the average number of people in a factory is between 300 and 400; in the South Indian textiles hub of Tirupur, it’s around 50,” writes Sharma.
To allow Indian businesses to grow bigger, the government will have to prune down its long list of labour laws. But politically that remains a very difficult thing to do. Further, research shows that new and young businesses create the maximum jobs.
As an OECD research paper points out: “SMEs (small and medium-sized enterprises) account for 60 to 70 per cent of jobs in most OECD countries, with a particularly large share in Italy and Japan, and a relatively smaller share in the United States. Throughout they also account for a disproportionately large share of new jobs, especially in those countries which have displayed a strong employment record, including the United States and the Netherlands. Some evidence points also to the importance of age, rather than size, in job creation: young firms generate more than their share of employment.”
This can only happen in India if the ease of doing business and starting a new business goes up in the years to come. To conclude, Mr Panagariya asked a question for which he already had the answer.