Tuesday, April 5, 2016

Cleaning up construction - sub-contracting and resource misallocation

The tragic collapse of the flyover in Kolkata which killed 26 people should be the right opportunity to focus on the role of sub-contracting in India's largest employment generating sector outside of agriculture. It has been reported that the main contractor, IVRCL, had sub-contracted out the affected stretch and there have been allegations of negligence by both the original contractor and sub-contractor.

Construction, especially its labor market, operates largely in the informal sector. All large construction contracts are typically executed through several sub-contractors. But regulatory layers discourages formal sub-contracting, thereby pushing it into the informal sector. Further, since informal sub-contracting helps evade many statutory obligations, apart from minimizing tax liability, it boosts the margins for both the original contractor and sub-contractor. It is no surprise that the share of construction in the total unorganized sector employment has doubled to 11.33% in the five years to 2009-10.

The vast majority of sub-contractors are local political leaders, like municipal councilors and sarpanches. Far from any engineering and construction expertise, their valued core competence is in being able to navigate the local land, labor, social and political markets at the lowest cost. Most often, they are predominantly labor contractors, leveraging their local influence with officials and in the society to supply labor and ease practical execution problems. Needless to say, the labor is overwhelmingly informal. 

In fact, a neat rent-seeking chain exists within the construction industry. While the local political leaders dominate the sub-contracting business, the bigger contractors are likely to be state level legislators, and the largest ones more likely to be national level politicians. Andhra Pradesh, with its out-sized share of infrastructure contractors among its national level political leaders, is the best example of this eco-system. 

This role of construction industry potentially presents a two-fold resource mis-allocation problem. On the one hand, capital (and entrepreneurs) is likely to find it far more attractive to invest in land-related construction-intensive infrastructure (real estate, roads, airports, power plants, ports etc) than in manufacturing. Why invest in establishing industrial units - with all the attendant labour, electricity, and regulatory problems - when you could potentially make many times more in much less time and with even less effort from construction and infrastructure? On the other hand, labor finds plentiful jobs in construction (in areas with lower living costs) and with limited incentive to exert the extra 'deferred gratification' skilling efforts required to succeed in manufacturing.

These trends square up with recent research on resource misallocation which finds labor misallocation towards financial sector and away from manufacturing etc in developed countries associated with the higher financial wages in the former.

No comments: