Labor Regulations, Employment and Wages: Evidence from India's Apparel Sector

• Published date: 01 January 2017
• Date: 01 January 2017
• Author: Aashish Mehta,Rana Hasan,Asha Sundaram,Nidhi Kapoor
• DOI: http://doi.org/10.1111/aepr.12160

Labor Regulations, Employment and Wages:

Evidence from India’sApparelSector

Rana HASAN,

1

†Nidhi KAPOOR,

1

Aashish MEHTA

2

, and Asha SUNDARAM

3

1

Asian Development Bank,

2

Universityof California, Santa Barbara,

3

University of Auckland

While India is amongthe world’s largest producers and exporters of apparel products,the sector has

not performed to itspotential. This study analyzes whythis might be so from the perspective of the

structure of production in the sector, the most striking aspect of which is a firm size distribution

heavily dominated by small firms. Using nationally representative firm-level and labor force survey

data, we argue thatthe dominance of firms operatingat scales too small to apply modernproduction

and managementtechnologiesis one proximate reason for India’srelative underperformance.Further,

we note that India’s labor regulations and the associated enforcement regime are important policy

drivers of Indian firms’tendency to avoid placing “too many workersunder one roof”.

Key words: Apparel industry, firm size distribution, formal and informal sectors, inclusive growth,

India, labor regulation

JEL codes: J3, J46, J48, L11,L67, O14, O17

1. Introduction

It is widely acknowledged that India’s success in creating productive and well-paying

jobs will be central for meeting the objective of inclusive growth. Where will such

jobs—commonly referred to as “good”jobs—come from? Do certain sectors and types

of firms hold the key? What has been the record of these sectors and firms in job

creation so far? To the extent that their track record has been lacking, what

holds them back? What types of policies and interventions will spur the creation of

good jobs?

We are indebted to Arvind Panagariya for his insights on the links between regulation and

firms’decision-making and for encouraging us to use survey data to uncover these links. We

thank Rajesh Bheda, Ashish Dhir, and Rahul Ahluwalia for detailed background analyses

and discussions on various aspects of the apparel industry. Finally, we are grateful to David

Birnbaum, Luke Jordan, Mudit Kapoor, Partha Mukhyapadhya, and Meenu Tewari for a

wide-ranging set of discussions on Indian apparel and the policy environment in which it

operates. These discussions have greatly improved our understanding of different aspects of

the sector, including the constraints that may be operating on it. Of course, any errors are

our responsibility. The views presented here are thoseof the authors and not necessarily those

of the Asian Development Bank, its executive directors,or the countries that they represent.

†Correspondence: Rana Hasan, Asian Development Bank, 6 ADB Avenue, Mandaluyong City 1550,

Metro Manila, Philippines. Email: rhasan@adb.org

doi: 10.1111/aepr.12160 Asian EconomicPolicy Review (2017) 12, 70–90

70 ©2017 JapanCenter for EconomicResearch

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One sector which holds considerable promise is manufacturing. India has been

successful in establishing a diversified manufacturing sector and has developed fairly

advanced technological capabilities in some subsectors (for example, chemicals,

pharmaceuticals, and auto components). However, the sector as a whole has been an

underperformerrelative to a number of its neighbors in East and Southeast Asia. The share

of the manufacturingsector in gross domestic product(GDP) has been around 24%-35% in

countries such as Malaysia, Thailand, People’s Republic of China (PRC) and Indonesia—

considerably higher than the 12%-15% or so in India.

Moreover, manufacturing sector growth in India has been driven more by relatively

capital- or skill-intensive industries, and not labor-intensive industries as one would expect

given India’s labor abundance (Kochhar et al., 2006). The manufacturing sector’s

contributionto employment in India has thusalso been limited. In comparison to countries

such as PRC and Malaysia wherethe manufacturing sector accounts for between 20%-35%

of total employment, the corresponding share in India has fluctuated between 10%-15%.

While India’s employment share is not too different from countries such as Thailand

and Indonesia (14%-16%), the quality of employment in Indian manufacturing appears

to be significantly lower. This may be seen in terms of the dominance of micro and small

(and informalsector) firms in India. Asnoted in ADB (2009), 84% of India’smanufacturing

employment in 2005 was estimated to be in firms with fewer than 50 workers. The

corresponding shares were 25%–47% for economies such as the PRC; the Republic of

Korea; Malaysia; and Thailand. The concentration of small firms is a problem because at

small scales ofoperation, firms often get caughtin a vicious circle of relianceon traditional,

low-productivity technologies with limited earnings and low wages.

Explanationsfor these features of India’s manufacturing growthexperience typically fall

in three categories: those that emphasize deficiencies in infrastructure (especially energy

and transport/logistics), thosethat focus on over-regulation,and those that focus on market

failures. While virtually all analystsagree that India’s infrastructure imposes a large burden

on its manufacturing sector, opinion is more divided on the relative importance of

regulation related constraints on manufacturing performance versus those imposed by

market failures.

Regulation related explanations typically include concerns with labor regulations (e.g.,

Krueger, 2007 and Bhagwati and Panagariya, 2013); other industry-related regulations that

govern entry and exit (for example, World Bank, 2013; OECD, 2007); some remaining

restrictions on trade and foreign investments, notwithstanding the dramatic trade

liberalization of the 1990s; a complex system of taxation that can limit inter-state

commerce; land related regulations that restrict the availability and/or increase the cost of

land for industrial purposes; and the policy, until the mid-2000s, of “reserving”entire

product lines, especially labor-intensive ones, for firms with plant and equipment values

below a given threshold. Significantly, some analysts emphasize the adverse effects

associated not so much with the regulations themselves, but administrative processes and

institutions associated with implementing regulations.

As regards market failure related explanations, most analysts typically focus on credit

market imperfections as a constraint on the expansion of small and medium-sized firms

Rana Hasan et al. Labor Regulations and Indian Apparel

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