To make a ‘leap’ forward

Vidya Mahambare | Updated on March 12, 2018

Labour market reforms will have a beneficial effect on employment generation and farm output. — K. Pichumani

Labour, education, agriculture and physical infrastructure are critical factors in India’s economy.

“What you discover in running these companies is that there are limits that are not cash. There are limits of recruiting, limits of real estate, regulatory limits…. There are many, many such limits. And anything that we can do to reduce those limits is a good idea.” That was Google Chairman Eric Schmidt’s response recently to a query on why his company was hoarding $50 billion in cash, instead of investing it into long-term innovation projects.

Clearly, the problems businesses face in the US, in India and elsewhere are not very different. Taking forward what Mr Schmidt says, if the Indian economy, especially corporate investment, has to take a giant leap forward in the medium term, it has to overcome numerous such limits.

The most critical of them, in addition to regulatory clarity and certainty on issues such as taxation and land acquisitions, are those related to India’s LEAP – labour market, education, agriculture, and physical infrastructure. Reforms in these areas will improve our growth prospects and make it more inclusive by raising job creation, lowering inflation and fiscal deficit, and reducing volatility in interest rates.


The ‘L’ in LEAP refers to the labour market. A flexible labour market is of fundamental importance in any economy not only for employment generation, but also for the quality of jobs. To put it crudely, workers are the sellers in the labour market and employers are the buyers. Employers hire workers only if they are expected to bring in more than they cost. This is true even for household support service providers that we employ.

Do we, as individuals, employ household helpers on a permanent basis? No, we don’t. We need the flexibility to terminate the services of a person if he/she is not productive relative to their pay or we no longer require their services. However, as long as we use their services, we are generally happy to help him/her out with extra cash for family functions, education expenses, or medical bills. Such a flexible arrangement gives us the ability to adapt to a constantly changing personal situation and, in the process, create a job that might not exist if this flexibility is taken away. The same flexibility is important at a company level for the same reasons.

One of the lessons in economics is never to judge a policy by its intentions, but rather by the results it produces. The laws that hinder labour market flexibility such as restrictions on layoffs are a good example of this. When the costs of employing a new worker are higher than the benefits, employers choose to hire lesser number of workers or replace workers with machines. This is especially true in India’s manufacturing sector. If India is to achieve the target of creating 100 million additional employment by 2021-22, as laid out in the National Manufacturing Policy, removing rigidities in the labour market will be crucial.

Only in situations where skilled workers are in short supply will employers find it worthwhile to offer wages higher than those justified by worker productivity. This appears to be the case in India’s high-skill sectors such as certain segments of financial and information technology services. We also have a shortage of sufficiently skilled vocational trained workers. The problems associated with wages being consistently above productivity are well-known -- prices of goods and services begin to rise at a faster rate.

High wages of skilled labour and unavailability of sufficient jobs for low-skilled workers will only increase social tensions, going forward, and, in turn, strengthen the dependence on public income transfer schemes to the relatively poor to avoid such a backlash.


The average productivity of people has to, clearly, go up and that requires an appreciable jump in the teaching quality of average schools and colleges. As soon as the economy begins to recover from the current slowdown, these limits would again become visible and raise wages in sectors facing skill shortages. So, sorting out E – education – in LEAP should become one of the top priorities.

If issues relating to the labour market and education are sorted out, improving A - agriculture productivity - in LEAP will become easier. With fewer people dependent on agriculture and moving into truly sustainable jobs in manufacturing, it would be easier to integrate small landholdings and increase mechanisation of farms.

This is the fastest way to enhance farm productivity, along with an improvement in irrigation facilities. Sustainable job creation will free government resources from social sector schemes to productive investments in areas such as agriculture. History suggests that agriculture productivity grew faster in countries such as South Korea and Taiwan, before the take-off in overall GDP growth.

Why is improving agriculture critical for a sustainable increase in corporate investment? It is because the failure of agriculture supply to keep pace with growing demand has resulted in double-digit food inflation – year-on-year changes in prices -- in the past several years.

This, in turn, increases pressure to raise wages and, thus, cost of production. As inflationary pressure becomes more widespread, the central bank is left with no choice but to raise interest rates, raising the cost of credit for businesses. As inflation rises and changes in interest rates become more frequent, business certainty reduces, thereby making it difficult to take investment decisions.


The ‘P’ in LEAP stands for physical and fuel infrastructure, and its importance in ensuring sustainable corporate investment, especially manufacturing, need not be repeated here. Solving the LEAP issues will go a long way towards reviving private sector growth, which will determine India’s economic success in the medium term. If we don’t succeed in carrying out such an ambitious reform process, then we should be prepared for more volatile and relatively low growth in the coming years.

Needless to say, fixing India’s LEAP is easier said than done. Enduring short-term pain, which is inevitable when a series of major reforms are undertaken, for long-term gain is not what most of us prefer.

(The author is Principal Economist, Crisil.)

Published on August 27, 2012

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