Decoding India’s jobless growth

Ritesh Kumar Singh | Updated on January 20, 2018

Under pressure It's a teeming market without possibilities SUBIR ROY

Lowering the cost of capital does nothing to increase investment, not does it boost employment

We often say that manufacturing should take greater responsibility of job creation as agriculture already employs over half of India’s workforce, and services can’t absorb the million youth who are joining it every month. The Centre is trying its best to push manufacturing through the Make in India initiative. But that doesn’t seem to be working, at least when it comes to job creation.

India is the fastest growing large economy, posting a growth rate of over 7 per cent, yet jobs are not growing as fast as GDP. What needs to be done to address the problem of jobless growth which, if not addressed, has the potential to turn India’s demographic dividend into demographic disaster?

Killing jobs

Many think that lowering the cost of capital increases investment and that in turn automatically creates jobs. Unfortunately that’s not how it happens. Making capital artificially cheaper promotes its sub-optimal use in a labour abundant economy like India. It may induce adoption of labour-saving production technologies especially if labour laws are not business friendly; so does raising minimum wages without commensurate rise in productivity. That kills jobs.

In fact, India’s rigid and often confusing labour laws enforced by a myriad agencies have done irreparable damage to the cause of labour by creating two classes of workers — contractual workers comprising 90 per cent who’re paid low wages and have no job security, and well-paid workers with secure jobs comprising 10 per cent of the total. Roughly half the workers in India’s corporate sector are contractual.

Nevertheless, investment remains an important determinant of job creation, but investment is influenced more by whether the investors will be able to recover their money with some profit for taking business risks. Cost of capital is thus important, but it’s only one variable. Another but more important determinant is availability or lack of sufficient demand.

In India, one-fourth of household savings goes into financial channels. Of that, less than 5 per cent flows into equity and mutual funds. Roughly 50 per cent goes into low-risk fixed deposits and small savings instruments. The balance goes into gold and real estate.

Pruning interest rates on savings either invested in FD or small savings instruments — EPF/PPF — will lead to lower purchasing power (via negative wealth effect) of working class households, and hurt business prospects from the demand side as consumption demand accounts for 60 per cent of aggregate demand. Lower interest rates will not necessarily lead to increased private investment if there’s insufficient demand — either in domestic or export markets. It will only improve business margins without increasing real investment or add new jobs.

The domestic market is flooded with competitively priced imports (often subsidised by countries such as China) that reduce the market size for indigenous manufacturers. This is not to argue that imports should be banned. But it certainly calls for a serious examination into why domestic businesses are not able to compete with imported products.

Contract enforcement

Some of the reasons may be internal that have to be dealt with by private sector internally. But, the government can’t escape the responsibility for external mismanagement that adversely affects manufacturing cost competitiveness. Given India’s high cost manufacturing model and ever-increasing competition from competitively priced imports, most Indian manufacturing companies, from steel to textiles, are bleeding.

Domestic businesses, especially SMEs and first-time entrepreneurs, are not able to compete with imported products because of high transaction cost arising out of inefficient logistics and India’s overall poor record on ease of doing business.

Discussion on ease of doing business has largely escaped any discussion on ease of contract enforcement (India’s rank is 178) that adds to transaction cost. It implies that bidders in a contract have to account for risks in enforcing terms of the contract in the form of higher (bid) prices that’s extra cost for procuring firms. A good example of poor contract enforcement is real estate: though not exactly related to manufacturing, it has serious implications for many manufacturing industries, such as cement and steel.

India’s ill-conceived trade pacts have resulted in inverted duties — higher import duties on raw material/components and lower duties on finished products. That discourages value addition and job creation within India.

Apparels can be imported into India duty-free while raw material — manmade fibres — attracts an import duty of 10 per cent that doesn’t make any sense but persists. Similarly, finished products such as laptops or cell phones can be imported more cheaply than all their parts (imported) separately because of duty inversion.

India’s trade pacts have failed to extract real market access for its exports as they are not able to address concerns on non-tariff barriers. There is slower or no progress on conclusion of MRAs in FTAs such as India-Japan CEPA that hurts exports. Again, exportables such as textiles and clothing are not included for duty reduction in India-Mercosur PTA.

Most of India’s merchandise exports — agriculture or manufactured — are commodities in nature and operate on thinner margins. Thus, even a small cost disadvantage either because of duty, power or logistics cost, makes export uncompetitive. That largely explains why Chinese global export share in apparel is 35 per cent compared to India’s 5 per cent even if we produce most of the raw materials while China imports them.

Advances in 3D printing and robotics will further take away India’s comparative advantage derived from possessing cheap labour.

The way forward

When trade negotiators from developed countries say wages are low in developing countries, they fail to recognise that productivity is also very low in developing countries. Pushing wages up without a corresponding increase in labour productivity will induce businesses to go for labour-saving production technology that will kill jobs. Their insistence on minimum labour standards is nothing but a disguised form of trade protectionism that needs to be resisted by developing countries.

More employed workers even at lower wages are a better option than less employed workers at higher wages. This is not to argue that wages shouldn’t be allowed to go up. The Government should focus on productivity-enhancing skills upgrade measures rather than fixing minimum wages. Rise in labour productivity will increase labour demand and push wages up automatically. Cross-subsidisation of corporates by savers à la China will not work in India as India is not China and the world has changed too much for the China model to work anymore.

Realistic interest rates reflecting the scarcity value of capital along with a prudent macroeconomic policy will bring in more FDI that will aid job creation if major concerns on the demand and supply sides are addressed. Unfortunately that’s not seeing much action.

The writer is a corporate economic advisor based in Mumbai. The views are personal

Published on April 26, 2016

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