Wednesday, July 21, 2010

More on the need for labor market flexibility

Much of the discussion about economic reforms remain confined to financial markets, infrastructure and agriculture. Labor market reforms tend to get overlooked, both because they are politically sensitive and there is a lack of understanding of its potential impact.

This is especially important given the widely acknowledged positive role that flexibility with labor migration across geographies and industries can play in promoting economic development. I have blogged about the need for labor market reforms in India here, here and here.

Our labor market suffers from numerous distortions both due to absence of appropriate incentives and presence of disincentives - lack of incentives for migration in search of better opportunities and disincentives against hiring and movement across jobs. In fact, these restrictive labor market regulations play no small role in the development of the massive black economy in the country. The challenge for policy makers will be to structure reforms that unshackles the market while providing some form of cushion to the workers against the uncertainty created and vulnerabilities introduced by these reforms.

Consider this example. Wages, for both unskilled and skilled labor, in Kerala are amongst the highest in the country. In fact, the unskilled labor wages are 3-4 times higher and skilled ones 2-3 times more than in neighboring Tamil Nadu. This is an absolutely staggering situation and highlights attention on the huge inefficiencies and rigidities that bedevil the labor market across the country.

Even though there are no legal restrictions on migration within India, internal labor movements remain sub-optimal within the country. Apart from the cultural and social issues that inhibit migration there are several institutional factors that come in the way of internal migration.

Fundamentally, migrants cannot access any of the welfare and other government benefits that the local residents enjoy. This is true not only of commonplace subsidies like rations, pensions, weaker section housing etc, but also of more critical benefits like access to local government employment openings, educational scholarships for children, health insurance, and self-employment scheme benefits. (In fact, another advantage of the UID/Aadhar is that it would provide portability of benefits and thereby help overcome many of these institutional obstacles to increased migration).

It is a reflection of the institutional bias against such internal migration that many state governments have policies in place specifically intended at discouraging migration. Further, the well-intentioned actions of state governments on various issues like housing end up with unintended adverse consequences. I have already blogged about the unintended incentive distortions caused by provision of housing units (linked to bank loans) in anchoring potential migrants to their villages thereby generating inefficient labor market outcome.

In this context, it would be interesting to study the role of NREGS in "crowding-out" beneficial rural to urban migration. It is possible that the NREGS will have disincentivized migration by a number of potential semi-skilled rural-to-urban migrants whose migration would have generated more efficient long-term labor market and economic outcomes. For example, rural-to-urban migrants would have a much greater chance of deploying their skills and even upgrading them, besides being a source of skilled labor supply for industries, than those who choose to remain in their villages.

In many respects, states like Kerala should learn from the bitter experiences of PIIGS economies in Europe who too face the formidable challenge of higher wages lowering their economic competitiveness in relation to their EU partners. Kerala's labor market is surely a major handicap for the state in its efforts to attract industrial investments, in the face of competition from other states, due to its uncompetitive labor rates.

Lack of adequate labor market integration across Europe means that the PIIGS economies have to take regulatory measures to address the issue of high labor wages. This naturally comes up against considerable political opposition and stands less chance of success. A more practical and efficient method to address this issue is to design policies that promote internal migration that arbitrages away such labor market distortions.

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