Sunday, November 30, 2014

Is skills gap a binding constraint on Indian economy?

Aashish Mehta makes an interesting intervention on skills gap in India. He questions the conventional wisdom that the country is facing a massive skills deficit. He points to two narratives, with the difference being that in one firms "cannot find skilled workers", whereas in the other firms "cannot find skilled workers at wages it can afford". From his joint work with others, he finds compelling evidence against the former and in favor of the latter.

He points to signatures that question the conventional wisdom on "skills gap" - stagnant or falling return on educational investment (or skill price), workers in labor-intensive manufacturing require barely secondary education and pick up skills in 4-6 weeks, textile firms with more than 10 workers pay 30% higher wages than those with less than 6 workers.
Further, the Employment and Unemployment Survey 2011-12 reports that workers in firms with less than 20 workers earned Rs 1581 a week, a third higher than the modest Tendulkar poverty line, whereas workers in firms which employ more than 20 earned more than twice the poverty line. The differential in wages between the two types of firms points to an affordability problem for smaller firms (the larger firms poach from the smaller firms) and a possible unwillingness problem for the larger firms (why should we pay 30% more for the same worker).

In simple terms, as long as the benefits (to workers and employers) from skilling exceed costs, the market (through "skill price" mechanism) and/or government (through skill development programs) can address the skills gap. But evidence, as aforementioned, appears contrary to this inference. However, if the wages are unaffordable for the majority of firms, neither markets nor governments can do much to alleviate the problem.

In India's case (even elsewhere), it is commonplace to hear firms, even in labor intensive sectors, complain of skills deficit. India's overwhelmingly small sized firm eco-system is a likely major contributor to this problem. Consider the scale - firms with less than 20 workers, constituting 73% of all manufacturing workers, produced 12% of manufacturing output in 2010-11. This is even more skewed in labor intensive sectors like textiles.

Small sized firms, being more likely informal, pay far less than larger firms, especially at the starting levels. In fact, the vast majority of these firms would, given the scale and nature of their operations, find it unviable to pay any more. These firms would struggle to retain their employees in the face of competition from medium and larger firms, and are therefore likely to complain of "skills deficit". The sheer numbers would add greater salience to their voices. Further, even among the larger firms, the exorbitant cost of labor related taxes, upto 45% of wages being deducted, limits their ability to pay high enough wages to attract and retain good workers.

A chorus of "skills deficit" is therefore not surprising, though it may be less a "deficit" problem and more an "affordability" one. If, as it appears, it is a matter of "affordability" than "shortage", then it points to other binding constraints facing those firms which need to be relaxed so as to enable them to pay higher salaries to attract workers.

Update 1 (3/12/2014)

A Times article that highlights shrinking educational wage premium in Chile. A combination of massive increase in skill acquisition and its decreasing quality appears to be responsible for this trend. Further, this has to be seen against the backdrop of Dutch disease - Chinese demand for copper boosting exports, causing currency appreciation, and reducing the demand for skilled workers. 

No comments: