What lies behind India's Jobless Growth?

Many people think that manufacturing should take greater responsibility of job-creation in India as agriculture already employs over half of the country’s workforce, and services can’t absorb a million youths a month who are entering India's job market. Modi’s Govt. is trying its best to push manufacturing through 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 7% plus growth rate, yet jobs are not growing as fast as GDP. China added over 13 million jobs in 2015. India, in contrast, could add only 91000 jobs in the first 6 months (April -Sept) of 2015. In the previous 6 months i.e. Oct 2014 - March 2015, India's record was better with 181,000 new jobs added. But even that is not sufficient.

What needs to be done to address the problem of jobless growth that if not addressed, has the potential to turn India’s demographic dividend into demographic disaster? 

Many think that lowering the cost of capital increases investment and that in turn automatically creates jobs. Unfortunately, that’s not how it works in reality.

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. Raising minimum wages without any commensurate rise in productivity does the same and kills jobs. It hurts exports as well.

A prolonged period of low-interest rate regime cause asset price bubble by inducing investment in riskier assets like real estate. Worse, it penalises retirerees/pensioners, and discourages savings and in turn an economy's capacity to make future investment. 

In fact, India’s rigid and often confusing labour laws enforced by a myriad of agencies have done irreparable damage to the cause of labour by creating two classes of workers - those who work for informal sector comprising 90% who’re paid low wages and have no job security, and well-paid workers with secure jobs in formal corporate sector comprising 10% of total. Worse, roughly 50% of the workers working for India’s corporate sector are now contractual.

Nevertheless, investment remains an important determinant of job creation. However, the investment is influenced more by whether the investors will be able to recover their money with some profit for taking business risk. The cost of capital is thus an important but only one variable in taking investment decision. 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% flows into equity and mutual funds. Roughly 50% goes into low risk fixed deposits and small saving 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 demand side as consumption demand accounts for 60% of aggregate demand. It will also induce more savings being diverted into gold and real estate.

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.

India's domestic market is flooded with competitively priced imports (often subsidised by countries like China), that reduces 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.

Some of the reasons may be internal that have to be dealt with by private sector internally. But, the government can’t escape 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 starting from steel to textile are bleeding.

Indian 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 latest rank 178) that adds to transaction cost. It implies 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 but has serious implications for many manufacturing industries e.g. cement and steel.

India’s ill-conceived trade pacts have resulted in a situation of what is called 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 its raw material –manmade fibres attract an import duty of 10% 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 the conclusion of MRAs, in FTAs such as India-Japan CEPA that hurts exports. Again, exportables like textile 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 40% compared to India’s 5% 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 so low in developing countries, they fail to recognise that productivity is also very low in developing countries. Pushing wage 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. Govt. should focus on productivity-enhancing skill upgrade measures rather than fixing minimum wages. Rise in labour productivity will increase labour-demand and push wages up automatically.

Cross-subsidization of coporates by savers à la China will not work in India as India is not China and the world has changed a lot for China model to work anymore.

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

I rest my case. 

Please share your thoughts even if you differ from me. Humans should differ because we're all unique in our own ways. If we're not connected, it's time to get to know each other. You can also get in touch with me on Twitter @RiteshEconomist and@DSmartConsumer

A version of this post has been published in The Hindu Business Line

Image Source: http://joblessyouth.com/about/

You may like to check this Indian Express Article for a different perspective on the subject. Another relevant piece about India's jobless growth by Madan Sabnavis is here. Some other interesting reads: 

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Low wages are both a cause and consequence of low productivity