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Thursday, January 17, 2008

Job creation and Government policies

The Indian Prime Minister's Economic Advisory Council (EAC) today called for lowering indirect taxes, so as to boost consumption and thereby sustain the high econommic growth in the face of weakening external demand. The EAC has also asked for a relief package for labour intensive industries, so as to tide over the rising rupee. But are these suggested measures the most ideal fiscal policy measures to sustain economic growth, while at the same time facilitating job creation?

The failure of the "India Shining" campaign of the BJP in the 2004 elections, is an excellent example of how high GDP growth do not automatically translate into increased individual welfare. In other words, India may be shining, but were Indians doing great? While there has been a great deal of debate about the issue of job creation, statistics paint a picture of job creation not being proportional to economic growth.

The forces of globalisation and liberalisation have changed the character of the employment markets and more importantly of jobs themselves. We live in an age when the job market is undergoing rapid transformation. The fixed time, fully insured, jobs are being replaced with McJobs. These McJobs are characterized by their temporary and flexible nature, and have fewer promotions or raises and fewer benefits. While the uncertainty associated with jobs have been increasing, the compensation has stagnated and for many categories even declined in real terms.

NYT contributor, David Leonhardt, has written about how the American economy has been experiencing a slowdown in job creation in recent years. He describes the job market thus, "The biggest problem with the job market isn’t the jobs that are being eliminated, shipped overseas or filled by temporary workers. The biggest problem is on the other end of the equation. There are far fewer jobs being created by new or expanding companies than there were throughout the 1990s." Drawing on recent job statisitcs, he argues that job elimination and creation in the US are at its lowest in many decades.

For long, it has been part of economic orthodoxy that economic growth would automatically take care of jobs also. Numerous studies and the post-1990s econommic growth have shown that this may not be the case, and there is the possibility of "jobless growth". Traditional explanantions for jobless growth like linking it to productivity does not stand the test of close scrutiny. All models link productivity growth to investment, and private sector investment has been declining since 2004. Has the time come for reevaluating our economic policies, keeping in mind the specific job creation objective? Has the time come to concentrate on better targetting of fiscal policies?

Many economists argue for the need to concentrate government stimulus in areas that produce a high number of well-paying jobs. These include capital spending and many Government programs, from education and health care to infrastructure, as well as the tax concessions given to different income groups to stimulate growth.

Many people criticized President Bush's "growth" policies - mostly tax cuts on income and dividends weighted toward the well off - for providing too little bang for a buck's worth of stimulus. Such policies, weighted towards the rich and towards boosting consumption growth, has been found to be less likely to create jobs. The objective of the policy should be to create more jobs, if necessary by boosting consumption, and not the other way round.

The NYT reports about a study by Harvard economist, James Medoff, about the job creation potential of different categories of investments. Mr. Medoff created a measure that included the number of jobs produced by a dollar of spending and the level of pay and benefits those jobs provided. Combining the two resulted in a labor market 'score.' He then examined how highly capital investment, consumption and various government spending programs scored by adding good jobs to the economy.

Mr Medoff found that while private investment in durable goods did very well in creating jobs, investment in education did even better. As the report says, "It created many more jobs per dollar spent, and they paid fairly well, if not as well as jobs derived from capital spending. Government health care spending also produced many well-paying jobs. Other government spending programs conducive to good job growth were for highways, water and air facilities, and police and firefighters. Military spending also added good jobs, but not at an equivalent rate."

It found that the weakest job creation spending was consumption, which the Bush tax cuts stimulated and which has been the undoubted engine of recent economic growth in the US. In fact, given the overwhelming role of Chinese and other imports in consumption, a tax stimulus ends up transferring American tax payers wealth to China and other emerging world exporters.

The NYT article's recommendation is simple, "A sensible new economic program, therefore, would reject individual tax cuts and emphasize government spending that creates jobs. This could include adequate transfer of money to the states - as much as $100 billion. It could also include seriously financing the president's new education bill, which has been neglected; a drug prescription plan for Medicare that is more generous than what Congress is considering; new ideas about providing health insurance to those who have none; and innovative investment in transportation infrastructure."

The findings of the Medoff study and the trends from the US economy, has clear learnings for other economies. This assumes much significance for India, especially at a time when its economy is expanding rapidly, and an important objective is to ensure that this growth is inclusive. The aforementioned studies underline the importance of health care and education investments, apart from basic infrastructure investments. Fiscal policy has to lay more emphasis on Government spending as opposed to individual tax cuts, that spur consumption, so as to optimize job creation. All this is of critical importance in developing countries like India, where double digit economic growth which do not translate into large number of jobs, may not be sustainable and win elections. India's economic growth has to positively rub off on Indians!

Update
Arvind Panagariya has an interesting explanation about why Indian manufacturing sector has not take off as China's and why labor intensive industuries have not made a similar mark in India. He writes, "In the late 1960s, India had also adopted the policy of reserving labour-intensive manufactures for the exclusive production by small-scale enterprises. Even after years of steady relaxation, the small-scale enterprises face a ceiling of 50 million rupees (approximately $1.25 million) on investment in plant and machinery. The small-scale industry list grew over time and by the late 1980s came to include virtually all labour-intensive products. As long as this reservation was in force, high-quality labour-intensive manufactures that could compete on the world markets had no chance of emerging in vast volumes. The bulk of the small-scale enterprises operated in the protected domestic market."

Though the number of reserved items fell from 821 in 1998-99 to 114 in March 2007, the draconian labor laws ahve prevented the de-reserved sectors making much headway. Panagariya writes, "Under these laws, it is virtually impossible for a firm with 100 or more employees to fire the workers even in the face of bankruptcy. It is equally difficult for the firms to reassign the workers from one task to another. These provisions impose very low worker productivity or a high real cost of labour. Large-scale capital-intensive sectors such as automobiles, where labour costs are a tiny proportion of the total costs, can profitably operate in such an environment. But the same is not true of large-scale labour-intensive sectors labour. Few foreign manufacturers are willing to enter India outside of a small subset of capital- and skilled-labour intensive sectors."

He also dwells on two other constraints - expensive power and poor transport infrastructure, "Not only do firms pay a much higher price for power in India than elsewhere in the world, they also face much greater uncertainty of supply. Likewise, despite considerable improvement, the transportation network in India remains unreliable and inefficient. The time taken to clear the goods entering and existing the ports and to move the goods between ports and manufacturing sites, which is so critical for assembly and processing activities, is much higher and more variable in India than in the competing countries such as China."

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