Tuesday, November 25, 2014

Reforming the dual-price market in labor wages

Mainstream debates on labor market reforms in India focus on easing hiring and firing regulations. In an excellent column Manish Sabharwal points to another important labor market distortion - the massive difference between gross and net pay. He writes,
Current labour laws... require employers to confiscate 45 per cent of the salary of employees whose wages are under Rs 1.8 lakh per annum and hand it over to various programmes and agencies like the Employees’ Provident Fund Organisation (EPFO), Employees’ Pension Scheme, Employees’ Deposit-Linked Insurance Scheme, Employees’ State Insurance Corporation... government data is clear that employees with wages this low do not have any savings. It is impossible, or at least very difficult, for them to live on half their salary... divergence between what employees call chitthi-waali salary (gross pay) and haath-waali salary (net take-home pay)... - part of the difference is funnelled into schemes that offer poor value for money, bad service and are humiliating — breeds informal employment. In the case of informal jobs, gross salary is equal to net salary. 
And about the inefficient deployment of these hard earned savings,
There are 55 million dormant accounts, more than half the total number of accounts, in the EPFO. Hard-earned money is abandoned by employees because they are frustrated with the organisation’s incompetence, corruption and inefficiency. Additionally, the EPFO’s charge of 440 basis points makes it the world’s most expensive government securities mutual fund — other mutual funds charge 25 basis points for gilt funds. The Employees’ State Insurance Corporation has India’s worst health insurance claims ratio — it only pays 49 per cent of contributions as benefits — and offers rotten care, while sitting on Rs 28,000 crore of idle financial investments. 
I agree with Manish that instead of the controversial hire-and-fire reforms, the next round of labor reforms should involve addressing this dual-price market in labor wages, though the details may vary. This is one more in the long list of dual-price markets in India - market and registration value for property transactions, market and subsidized price for essential goods, MSP and market price for food-grain harvest, production cost and tariff for utility service, etc - that need to be urgently dismantled.

But there is a fundamental problem with the issue which is likely to surface when discussion starts on its reform. Employee social protection is typically financed either through a combination of employees and employers contribution. But at these low wage levels, it is difficult for the employees to contribute their share and any employer's share is generally a transfer involving a reduction in employee pay-check. Any reform that dispenses with the social protection is not only undesirable but also unlikely to pass muster.

The only option available may be some form of publicly funded social protections - pension and insurance. But such protections comes with fiscal burden. However, it can be mitigated by limiting them to salaries below a certain level or certain sectors or types of employment, with a gradual phase out of the same over a 10 year period. The Hartz reforms in Germany embraces these principles for low and mid-level jobs. In any case, instead of frittering public resources on unproductive indirect subsidies and incentives, this may be a more effective and less distortionary approach towards encouraging small enterprises into becoming formal. 

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