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Protect poor by creating jobs in formal sector

The government has introduced a scheme providing a lower tax rate only to new manufacturing firms.

Published: 08th May 2020 04:00 AM  |   Last Updated: 08th May 2020 07:59 AM   |  A+A-

Workers hailing from Rajasthan who were employed in shops in Sowcarpet and Broadway seen boarding into a bus bound to Jodhpur. (Photo | R Sathish Babu/EPS)

The health and economic crisis we are currently in is giving us insights into what is and isn’t working well in India, and how we should prepare for a better tomorrow. Yes, we have been able to reach India’s marginalised population better using our public distribution system and direct benefits transfers through the digital infrastructure we built over the last decade. But at the same time, the plight of the migrant worker and the huge economic setback of the urban and rural daily worker is also becoming painfully transparent.

As we come out of the crisis, we will need to make some big changes. More than 80% of India’s labour works in the informal sector. This percentage needs to come down drastically. This would require removing the incentive to stay in the informal sector and creating powerful incentives to move workers to the formal sector.

The informal sector provides many advantages for businesses. Pay is flexible, businesses have complete flexibility in hiring and firing workers, and in reorganising the production processes swiftly to suit changing business conditions. The regulatory cost and burden of hiring workers is also low. For example, no provident fund (PF) contributions are made, nor are other benefits provided. After all, this would increase the cost of hiring each worker, which neither the business owners nor the workers—by accepting lower wages in exchange for these mandatory benefits—are willing to bear. Currently, the employer is required to contribute 12% of the worker’s salary and the employee also deducts and contributes another 12% from their salary towards PF.

What if the government were to bear this cost instead? For example, the government can offer to contribute the entire 24% of workers’ salaries, up to a maximum limit of say Rs 500 to Rs 1,000 per month. The Pradhan Mantri Rojgar Protsahan Yojana (PMRPY) made a step in this direction in a limited way by offering to contribute 12% of the employer's portion for three years (with some conditions). Since the PF contribution is a future liability, there will be no immediate budgetary impact for the government and as the economy grows, so would the tax revenues collected by the government that would allow it to fulfil these obligations in the future. The government can also contribute a small amount per month towards health, accident, disability and life insurance provided through mandatory group insurance plans. That India has a large population in the workforce that is young would make this plan feasible.

This would greatly alter the incentives to provide jobs in the formal economy, away from the informal sector, if labour laws for hiring and firing were also relaxed—something that economists have been advocating for decades. The spillover effects of the transition to a formal workforce are immense.

First, it has become increasingly transparent that it is jobs in the formal sector that provide better economic security to workers. China managed to increase the per capita income of its workforce multi-fold after the 1980s, not by microfinance or entrepreneurship in small informal sectors, but by creating hundreds of millions of jobs in the formal economy.

Second, workers in the formal sector acquire marketable skills due to their jobs and importantly, create a record of it that is credible, verifiable and portable. They can carry this with them to other jobs—even if they get fired at one business. Workers in the informal sector, on the other hand, struggle to update their skills and have no verifiable credentials that are useful beyond their small limited circle, impeding their mobility and security. Some innovative solutions in the gig economy are trying to address this market failure by creating a verifiable, digital “skill passport” that will also go a long way towards creating more jobs in the formal economy.

Third, because the worker is more protected with jobs in the formal economy, due to better health, disability and life insurance and with a cushion of savings in his or her PF account against which he or she can be allowed to borrow in emergencies, the labour laws can be relaxed to make hiring and firing easier and simpler. Firms could be provided further incentives, for example a lower tax rate—which would be partially offset by income taxes paid by employees—if they create and add jobs as measured by their total PF contributions.

The government has introduced a scheme providing a lower tax rate only to new manufacturing firms. We recommend that tax incentives be broadened to all firms if they add to employment as verified by increased PF contributions linked to Aadhaar. Similarly, relaxation of labour laws could be initially tied to job creation in the formal sector. This will allow the firms to grow to an economically efficient scale and size rather than stay as “pygmies” as the Chief Economic Advisor (CEA) Krishnamurthy Subramanian said in his 2019 Economic Survey. We now have plenty of international evidence that suggests that engines of economic growth roar only after the small innovative firms grow large, creating prosperity for the rich and the poor alike. Wealth creation and protection of the poor go hand in hand.

Bhagwan Chowdhry and Prasanna Tantri

The authors teach Economics and Finance at the Indian School of Business (ISB)

(Email IDs: bhagwan@isb.edu, prasanna_tantri@isb.edu)      



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