'Formalising' the Economy: What's in It for Workers?

The Modi government's attempts to reshape the economy lie entirely in the financial realm; they come on the back of concerted efforts to strip workers of legal protection in not just the informal sector, but also the formal.

A worker dries thread at a textile mill in Agartala. Credit: Reuters/Jayanta Dey

The Narendra Modi government has made two major interventions in the economic sphere, demonetisation and the Goods and Services Tax (GST), with the ostensible aim of expanding the formal sector at the expense of the informal.

Demonetisation failed to achieve its stated goals, at heaviest cost to the poorest; the jury is still out on GST (which, it should be remembered, enjoys cross-party support). Enterprises in the informal sector are clearly struggling to comply with a system that requires computer literate accountants, a luxury most small firms and artisans are unable to afford. The lack of physical infrastructure – such as dedicated offices to accept returns and offer advice on compliance – is entirely characteristic of the Indian state’s propensity to cut costs at the expense of those who need the most help. Meanwhile delays in refunds add to the working capital difficulties of small firms.

Formalising the economy signifies different things depending on the problem under discussion. It might refer to the financial aspect of a business firm – whether or not it pays tax or files paperwork, for example. Or it might refer to conditions of work and the status of workers employed in it. Interestingly, the Modi government’s attempts to reshape the economy lie entirely in the financial realm. Indeed, they come on the back of concerted efforts to strip workers of legal protection even in the formal sector. In other words, they do absolutely nothing to mitigate the informal and precarious existence of labour.

Formalisation in the financial sense does little or nothing for workers in a firm. In the absence of labour formalisation (which involves extending legally enforceable rights to them), the effect is merely to exacerbate the hardships of the informal sector. Its sheer size indicates a basic failure of economic policy: by some estimates, more than 90% of India’s workforce does not enjoy any form of legal protection. The history of labour laws shows how this situation was created, through deliberate choices made by the state.

The first substantial body of labour legislation in India dates from the 1940s and early ’50s, just before and after independence: the division between the formal and informal sectors was crystallised during this period. The economy grew rapidly during the Second World War, when both manufacturing output and the number of small and large-scale enterprises expanded under the stimulus of war demand. An increasing number of workers also began to unionise during this period. After the war, demand contracted sharply, putting pressure on previously abundant profits. Strikes and protests broke out in a range of industries – beedi-making, tanning, handlooms, small engineering workshops, textile mills – and services (transport, sanitation etc.). Workers called for higher wages, trade union representation and welfare measures. Well before this, several commissions, including the Royal Commission on Labour, had criticised working conditions in small industrial enterprises, where most of the workforce was concentrated: women and child workers suffered acutely in particular. The necessity of extending legal protection to them had been under discussion for some time.

The central government dragged its feet, but in states where industrial workers formed a vocal constituency, attempts were made to address their concerns. In the Madras Presidency (comprising modern Tamil Nadu, Andhra Pradesh, and parts of Karnataka and Kerala), the provincial government headed by the Congress party proposed two new bills in 1947 – the Madras Non-power Factories Act and the Madras Shops and Establishments Act – aimed at protecting workers outside large factories. The first general elections based on universal suffrage were around the corner.

The debates in the Madras Legislative Assembly during the passage of these bills, and their progressive dilution in subsequent years, exemplifies a much wider trend – the chronic failure of labour legislation aimed at vulnerable workers because of flaws built into it from the very beginning. The first sticking points in our case comprised the very definition of ‘non-power factory’, ‘shop’, and the ‘worker’ to whom the laws would apply.

It was proposed that a non-power factory be defined as any enterprise employing ten or more workers that did not use electric machinery in the production process. Several legislators pointed out that this would undercut the very purpose of the bills, for owners could simply split up their establishments into smaller units so as to show less than ten workers in each. This was already happening in large beedi-making factories that the Madras government had tried to bring under the purview of the Factories Act of 1934. A committee set up to review the act pointed out that classifying enterprises by number of workers made little sense. Nevertheless the threshold of ten workers was adopted – predictably factory owners immediately began sub-dividing their establishments. Another favoured strategy was to claim that only a fraction of workers came under the definition of the law.

Credit: Reuters

This claim was made possible by ambiguities built into the legislation. Although both bills defined ‘worker’ or ’employee’ in broad terms, their key provisions applied only to those who had worked ‘continuously’ in an establishment for at least six months. This created an obvious loophole, for most workers in small industries (handlooms, beedi-manufacturing, jewellery-making, tanning etc.) were kept on piece-rates. In the case of service industries (such as hotels and shops), where workers were usually hired on daily wages, owners argued the employment contract was limited to a day and therefore continuity of service could not be claimed.

The rights of women workers came under sharp attack. Owners claimed that they lacked skill (except for ‘deft fingers’), only acting as helpers to male workers to earn extra money in their ‘spare time’. Politicians joined them in arguing that labour laws would prevent women working from home, for no one would be willing to employ them. In other words, women were seen as needing protection from labour legislation! The Non-power Factories Act was withdrawn in a matter of months. During the course of the next decade, a series of official exemptions were introduced into the Madras Shops and Establishments Act forbidding its application to family run establishments, shops and firms employing less than three workers, and to all workers employed on piece-rates or short contracts. In the end, virtually every kind of small establishment, whether shop or factory, came to be exempted from it.

A close look at the archival record reveals that behind this systematic dilution lay active lobbying by owner associations and individual legislators. Associations of beedi manufacturers, tannery owners, master weavers, hotel owners etc. and various chambers of commerce demanded exemptions and changes in the legislation. They went to court, obtaining favourable rulings thanks to the opacity of provisions written into law. Chronic delays in court procedure helped maintain the status quo, for trade unions had far fewer resources in terms of time and money to fight legal cases than factory owners.

Both owners and politicians harped on the need to protect small industry. Any attempt to regulate them by improving working conditions and wages was invariably portrayed as a threat to the very existence of these enterprises. Several legislators made this argument when the bills were debated on the floor of the Madras assembly, defending the small entrepreneur and petty trader (and implicitly their right to exploit workers without restraint). It was argued that Madras province, as the home of cottage industry, should safeguard its interests instead of bringing hardship upon ‘small people’, who were, in the words of one fulsome speech, ‘the real backbone of trade, they are the entrepreneurs, they are the agencies of industry and commerce of our Province. They are men of self-reliance and self-effort. I do not know why the government instead of coming to their rescue should propose measures restricting the scope of industry…’

Another reaction was indignation at the idea that the work-places of professionals like lawyers and doctors could be subject to any kind of regulation. Even before the bills were passed, lawyers’ offices, doctors’ clinics and nursing homes were exempted from their provisions.

Ironically, protection for the small entrepreneur and professional was deemed possible only at the expense of the worker. Patently dishonest and self-serving arguments were advanced to justify this viewpoint: workers in small establishments were a happy lot unlike their counterparts in large factories; they were better left to the care of their employers; regulation would cause unnecessary strife. Legislators spent considerable time discussing the right to paid holidays granted by the new legislation. What would workers do with so many holidays? Idleness could only lead to mischief!

Both laws failed the workers they were meant to protect. The salient features in their making – and unmaking – were to be repeated in labour legislation for small/cottage industries all over India. One was the extensive authority retained by governments to provide exemptions and extend or diminish the application of law. Another was the deliberate use of imprecise definitions, open to challenge in court. Together they encouraged lobbying at every level (the multiple slabs and exemptions in GST being but the latest example). A third was restrictive application, providing employers with ready-made loopholes.

Central laws like the Factories Act, Provident Fund Act, Payment of Bonus Act, and so on were even narrower in scope and definition. They proved reasonably effective when applied to the formal sector (comprising large factories and public sector enterprises), where qualifying thresholds could not be evaded. Even there they remained restricted to permanent workers, for the actual interpretation of law ended by excluding temporary, contract, and trainee workers from its ambit. This tiny minority (permanent workers in the formal sector) became the country’s labour aristocracy, enjoying a strong degree of protection until the 1980s, when official anxiety over declining competitiveness prepared the ground for the economic ‘reforms’ of 1991.

The dichotomy in the treatment of labour was partly circumstantial: without outlawing strikes – not easy to do in an electoral democracy – it is difficult to suppress workers in large factories. They formed a small but influential minority, concentrated in major cities, capable of bringing them to a halt; they also tended to dominate in industries considered crucial to the economy (textile mills, engineering works, automobiles). By contrast, workers in small industries were dispersed across a much larger number of enterprises, geographically spread out, and more constrained in terms of resources.

For the second aspect of the failure of labour legislation consists of the refusal of political parties and trade unions to reach out to these workers – despite the fact that they comprised the vast majority of the Indian workforce outside agriculture during the decades after independence. Paradoxically, the 1940s and ’50s represented the high-tide of unionization in this sector. The state’s refusal to implement its own legislation meant that their demands remained unmet; as enterprises became more dispersed with official sanction if not official encouragement, workers’ struggles petered out. Meanwhile the major trade unions turned away from them to concentrate exclusively upon the formal sector.

The justification for restricting the scope of labour legislation has always been the same: that the country cannot afford labour protection if it is to remain economically competitive. During the 1940s and ’50s it was said that India was only beginning to industrialize: protecting all workers would hamper the process and slow it down. Once the economy was better developed it would become possible to expand welfare measures. The enactment of labour legislation for large factories was accompanied by much rhetoric about welfare for all and the hope that workers’ rights would gradually be extended.

But, as we know, precisely the opposite happened. The growth of the Indian economy since the 1990s has been accompanied by ever greater erosion of labour laws and labour protection. The Congress and the BJP (acting even more systematically) have successfully dismantled whatever legal protection once existed for the small minority of workers in large-scale industry. Today when the government speaks sanctimoniously of the need to formalize the economy it should be pointed out that this process is not designed to benefit labour in the slightest. Meanwhile those who champion the cause of small enterprises or cottage industries (through tax exemptions and other forms of protection) might usefully consider what a completely unregulated informal sector has actually meant for workers in it.

Economically, the policy of exempting small industries from labour legislation and providing them with an array of tax breaks meant that businessmen in the most labour intensive sectors of the economy had every incentive to keep the size of their enterprises below the official threshold. But this also meant renouncing economies of scale at a time when Japan, South Korea and Taiwan were aggressively scaling up firms under state direction. The effect was to render most of these industries internationally uncompetitive in the long run. Large factories in the formal sector suffered a similar fate for a different set of reasons – including the state’s refusal to use credit mechanisms to force them to export (a route followed with notable success in east Asia). Chronically low levels of investment in public education and healthcare (essential for improving workers’ skills and productivity), and the lack of effort put into making them effective, dragged down the formal sector and the economy as a whole.

The academic debate over India’s economic policies after independence, and the performance of different sectors of the economy, is extremely complex. All that can be pointed out here is that the contribution small industries were supposed to make to the economy – that of providing unskilled employment – came at very significant cost to workers, who got work, yes, but only in the most insecure and/or dangerous conditions. It is a state of affairs that still prevails, more than seventy years after India became independent.

Karuna Dietrich Wielenga is Newton International Fellow at the School of Interdisciplinary Area Studies, University of Oxford; Shashank Kela is Visiting Scholar, Wolfson College, University of Oxford.