The challenge with "bolder" labor market reforms

Labor market reforms run into several challenges. The OECD Economic Survey of India advocates "bolder" labor market reforms. It writes,

Bolder reforms would further promote quality employment and reduce income inequality. Work on OECD countries suggests that reducing labor market dualism by narrowing the gap between the protection of permanent and temporary jobs lowers income inequality by reducing both wage dispersion and unemployment. In India, the large unorganized and informal sectors, which leave many workers with low income and virtually no social protection, contribute to labor market segmentation. Reforming labor regulations should aim at providing a minimum floor of pay and social and labor protection conditions for all workers irrespective of the status, size and activity of the firm. This would require introducing a comprehensive labor law which would consolidate and simplify existing regulations. In turn, this would reduce uncertainty surrounding regulations as well as compliance costs for manufacturing companies. Barriers to formal employment should also be reduced, in particular by abolishing the most restrictive provisions of the Industrial Dispute Act that require prior government permission for employment termination and exit decisions. At the same time, the new law should consider providing better training and assistance in job search. 

While the argument is appealing, I am not sure whether it will stand the test of scrutiny, even on simple logic, leave alone political economy considerations.

Currently, starting and remaining small and informal enables firms to keep costs down (by paying lower wages and avoiding social protections and certain taxes) as well as escape regulatory requirements. In a country where more than 90% of business enterprises are small and informal, any reform involving minimum pay and social protections, as suggested by the OECD, would be a massive, even impractical, exercise of public intervention. This cannot be done by consolidation and simplification of existing regulations but would require direct executive fiat, whose enforcement poses its set of challenges and distortions.

So here is the fundamental challenge with labor market reforms. On the one hand, the vast majority of businesses in the informal sector barely manage to make ends meet even after paying far lower than minimum wages and offering no social protections. On the other, any formal regulation, even in the most liberalized form, cannot not insist on a reasonable minimum wage and social protections . 

The only way to reconcile this dilemma is to acknowledge the reality that a major part of the market will have to remain outside formal minimum wage and social protections, thereby accepting the informal sector. In short, "bold" reforms involving state of art labor regulations and elimination of the informal sector may be a difficult balancing act. This leaves us with the next best reforms like consolidation and simplification of existing regulations.  

The alternative, as this blog has long advocated, is to provide certain basic universal social protections - and the recently launched triptych of programs on life and accident insurance, and pensions is a step in that direction - and use its cushion to roll-back the dual-price market in labor wages. The public subsidy inherent in such programs can potentially provide the cushion, atleast to some employers, to support employer-employee financed health insurance and pensions. 

However, for this to make any meaningful dent, the public subsidy accruing to these programs will have to be of a much higher magnitude. But it is clear that currently the country does not have the fiscal space to support a large enough universal social safety net.