India’s government liberalized the economy in 1991, but did not implement the International Monetary Fund’s (IMF) recommended labor and tax reforms. Since 1991 the economy has improved significantly with an average annual growth of seven percent until the worldwide financial crisis in 2007.
But, in 2012, India’s economic growth hit a breaking point with a 4.9 percent growth rate, the lowest in a decade. Labor and tax reforms are now necessary to destroy the numerous barriers to business development.
The economic growth since 1991 has reduced poverty and increased the number of people apart of the middle class, but due to labor laws, a large number of working age adults are either unemployed or underemployed in low-productivity tasks.
The Industrial Disputes Act dictates what employers can and can’t do. Businesses employing more than 100 can’t hire or fire workers without government permission. This means that workers can’t be fired unless the business is about to go bankrupt.
This also limits the size a business can become. According to the World Bank’s 2013 World Development Report, larger firms are more productive and thus more likely to be innovative and competitive in export markets. This would create a huge boost in wages that is currently being prevented by the labor laws.
Tax laws make it equally difficult for businesses to thrive. Rates are high and provisions are incredibly complicated. This encourages businesses to develop convoluted strategies to maneuver around the tax laws or to bribe the tax man. As a result of tax evasion, approximately 4 percent of Indians pay 70 percent of the total tax in India.
Tax laws have also trapped 90 percent of the Indian work force to work in the informal sector in which laws are irrelevant and taxes can be evaded. Problematically, workers in the informal sector are deprived of social safety nets and government training schemes that could increase their productivity and wages.
The government should use labor and tax reform to persuade informal businesses to enter the formal sector as it would broaden the tax base, and this increased revenue could be used to extend the social safety net beyond the 8-9 percent of the workforce that is currently covered.
But, deregulation is a hard sell in India. Currently, India is ruled by the Congress party-led coalition, United Progressive Alliance (UPA) that has been forced to include innumerable parties that oppose reform in order to stay in power.
Other opponents include: trade unions protecting job security in the formal sector, legal businesses avoiding competition from new entrants, and corrupt bureaucrats preying on the informal sector are adamantly opposed to labor and tax reform.
One strategy for disarming popular oppositions for further reform is to try it in individual states. India’s 28 states could serve as mini-laboratories to test what works and doesn’t and make reforms accordingly.
If this strategy is not employed, another must be tried, as labor and tax reform are two of the last steps necessary before India’s economy can skyrocket.
– Kasey Beduhn
Photo: The World Bank