Adopt Formalisation to Power Productivity Growth in India’s Manufacturing Sector

Syllabus: Economy

Source: TH

Context: A recent study based on ASI data (1999–2019) shows that contractualization in India’s formal manufacturing sector has risen from 20% to 40.7%, primarily driven by cost-avoidance rather than flexibility or skills, thereby harming long-term productivity growth.

About Adopt Formalisation to Power Productivity Growth in India’s Manufacturing Sector:

Core Issue:

India’s formal manufacturing is experiencing an informalisation within formal structures, where contract labour is increasingly used not for enhancing efficiency or acquiring skills, but to reduce wage costs and bypass labour laws.

Key Findings from the Study:

• Rising Contractualization: Contract labour in manufacturing doubled to 40.7% by 2022–23. This trend cuts across all sub-sectors, including large firms.

• Contract labour in manufacturing doubled to 40.7% by 2022–23.

• This trend cuts across all sub-sectors, including large firms.

• Wage Disparities and Exploitation: Contract workers earn 14.47% less on average than regular workers. In large enterprises, wage gaps widen to 31%; overall labour costs are 24% lower for contract workers.

• Contract workers earn 14.47% less on average than regular workers.

• In large enterprises, wage gaps widen to 31%; overall labour costs are 24% lower for contract workers.

• Severe Productivity Gaps: 31% lower productivity in contract labour-intensive (CLI) firms than regular labour-intensive (RLI) ones. Gap widens to 42% in small labour-intensive CLI firms. High-skill or capital-intensive CLI firms (only 20%) show minor productivity gains (5–20%).

• 31% lower productivity in contract labour-intensive (CLI) firms than regular labour-intensive (RLI) ones.

• Gap widens to 42% in small labour-intensive CLI firms.

• High-skill or capital-intensive CLI firms (only 20%) show minor productivity gains (5–20%).

• High Turnover, Low Training: Use of short-term contracts reduces workforce stability, discourages skilling and innovation, creating long-term productivity losses.

• Use of short-term contracts reduces workforce stability, discourages skilling and innovation, creating long-term productivity losses.

Structural Issues in Contractualization:

• Misaligned Incentives in Contracting: Third-party contractors often have no stake in long-term outcomes, leading to a principal-agent problem where firms and contractors pursue conflicting goals.

• Erosion of Work Discipline and Quality: Short-term job contracts reduce worker accountability, encouraging shirking behaviour and poor-quality output—classic manifestations of moral hazard.

• Deliberate Bypass of Labour Protections: Contractualization is misused to evade the Industrial Disputes Act, 1947, excluding workers from safeguards on retrenchment, layoffs, and fair dispute resolution.

• High Turnover and Training Disincentives: The transient nature of contract work increases attrition, discouraging firms from investing in on-the-job training, innovation, or skill upgradation.

• Weak Social Security and Welfare Gaps: Contract workers are often denied access to EPF, ESI, or maternity benefits, worsening economic insecurity and perpetuating informalisation within formal enterprises.

Policy Challenges in Regulating Contractualization:

• Stalled Execution of Labour Codes: The Industrial Relations Code, 2020—meant to formalise fixed-term hiring without middlemen—awaits state-level adoption, delaying systemic reform.

• Unregulated Expansion of Non-Permanent Jobs: By enabling flexible hiring, the new labour codes risk institutionalising precarity unless complemented by robust regulatory oversight.

• Union Pushback and Political Resistance: Labour unions fear that increased hiring flexibility will erode collective bargaining rights, stalling reforms through political opposition and litigation.

• Premature Withdrawal of PMRPY Incentives: Schemes like PMRPY (2016–2022), which subsidised EPF contributions to promote formalisation, were discontinued before achieving sectoral saturation.

• Poor Monitoring of Contractual Norms: Labour inspections remain weak, especially in MSMEs, allowing rampant misuse of contract labour without accountability or employer penalties.

Policy Recommendations:

• Implement Labour Codes Carefully: Ensure fixed-term contracts include basic benefits and rights to prevent disguised informalisation.

• Incentivise Longer Tenures: Offer social security contribution waivers or priority in government tenders for firms adopting longer fixed-term contracts.

• Revive PMRPY with Enhancements: Reintroduce the scheme with stronger accountability to promote formal hiring and reduce cost-based contractualization.

• Link Formalisation with Skilling: Provide subsidised access to skilling schemes (like PMKVY) only for firms with formal, stable employment contracts.

• Disincentivise Excessive Contractualization: Levy productivity-linked penalties or audit triggers if CLI usage exceeds thresholds in low-skill industries.

Conclusion:

In the long run, cost-driven contractualization undercuts labour productivity, innovation, and industrial stability. India’s journey toward higher economic growth must therefore adopt genuine formalisation, skill-based hiring, and long-term workforce development. A balanced approach that combines labour market flexibility with job quality assurance is critical for transforming Indian manufacturing into a globally competitive sector.