There is a three-way stalemate with labor market reforms in India. The government is committed to the achievement of the following
1. Expand the coverage (both benefits and target group) of social and other protections for labor and increase the level of existing protections.
2. Lower the cost of doing business by reducing various regulatory compliance costs - compliance filings, maintenance of documents and registers, periodic renewals and licensing, recurring payments.
3. Limit discretionary transactions in the interface with the government so as to reduce harassment corruption.
But public provision of social protections runs into the fiscal constraint very quickly. In the case of the private sector, it increases the employee cost to the company. This, in turn, runs counter to the second objective, thereby necessitating direct trade-offs. Similar trade-offs, albeit of a lower degree, arise between the first and third objectives since greater protections (basic facilities at the workplace, freedom to exercise basic rights, decent wages and other benefits, safeguards against exploitation and abrupt retrenchments etc) invariably demand more interfaces. But in a deeply corrupt system, more interfaces merely exacerbate the harassment. So what gives?
The fiscally cheap and politically easy challenge is the third one. Modern IT systems - involving integrated work-flow automation and Aadhaar linkage, complemented with high quality data analytics - have the potential to dramatically reduce harassment corruption. But the quality of implementation most often detracts from the achievement of the desired objective. And the vast entrenched vested interests committed to its failure are powerful. But, to the extent that harassment corruption can be crippling on new and smaller firms, its mitigation can be a big nod for firms to start formal.
It also lays down the platform for effectively balancing the first two objectives. Apart from reducing harassment corruption, with its attendant costs, work-flow automation also lowers compliance costs significantly. A combination of lower compliance and harassment costs eases the burden on firms from a gradual increase in labor protections. But even these, on their own, would only offer marginal attraction for firms. In this mileu, targeted and structured public support for labor protections, also made possible by the IT systems, has the potential to dramatically increase the attractions of formality.
For example, the insurance and pension deductions and contributions for all new employees of a firm (with a small negative list to exclude the largest firms) earning below a certain income could be subsidized for a period of ten years, with a progressively declining phase-out schedule. Assuming a maximum support of 15% of salary and for employees with monthly income below Rs 20,000, and a steady state of 1 million workers, the net annual outflow would be just Rs 36 billion.
Even assuming a steady state of five times as many workers, it would be far lower than the generous subsidies given to capital. Once the costs of formality are lowered and benefits raised, it may even no longer be necessary to be so generous with the public support. But even if the political economy makes a benefits reduction difficult, the overall economic and social benefits would far outweigh the financial costs.