Opinion
Making capital costlier in relation to labour may help generate more jobs
Summary
- One strategy to drive resources towards sectors that employ more people is to lower the ‘wage-rental ratio,’ which broadly measures the relative cost of labour and capital. Raising the real cost of capital may not suffice, but better employment linked incentives and labour reforms could work.
India is the fastest growing major economy in the world. Yet, seen through the lens of employment, the growth story is quite gloomy. While GDP grew at 6.5-7% between 2011-12 and 2022-23, employment grew at only 1.9% annually.
Employment growth need not keep pace with output growth, since a good part of the latter should be attributable to productivity growth. However, employment growth needs keep pace with the growth of labour supply.
Otherwise, the difference will add to the backlog of unemployment. During the period 2011-12 to 2022-23, while employment grew from about 466 million persons to about 577 million, as per Balwant Mehta’s estimates, labour supply grew from 477 million to about 595 million.
Thus, the number of unemployed grew from about 10 million in 2011-12 to over 19 million in 2022-23, an annual growth rate of over 5.6%—not much lower than the growth of output!
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I am ignoring the fact that India’s official surveys employ a very broad definition of employment, wherein all under-employed persons who had any work even for one hour a day for just 30 days during the preceding 365 days are counted as employed.
One strategy to nudge resource allocation in favour of more labour-intensive growth is to lower the wage-rental ratio (which broadly measures the relative cost of labour and capital). This would raise the relative profitability of labour-intensive sectors and resources could gradually be re-allocated towards these sectors, making growth more labour intensive.
Outside agriculture, which is already overburdened by under-employed household labour, there are many labour-intensive sectors which offer large volumes of employment.
A recent NCAER study estimated that in 2022, the top 10 non-agricultural labour- intensive employers, such as construction, trade, land transport, education, other services, food processing, textiles and garments, etc, were already employing around 240 million persons (bit.ly/3Z5ALle). A decline in the wage-rental ratio could lead to a significant re-allocation of resources, including capital, in favour of these sectors.
How can the wage-rental ratio be reduced? Lowering the wage rate, the numerator, is a non-starter since the level of wages is already very low in India.
As per the latest Periodic Labour Force Survey (PLFS), the monthly real wages of regular employees, the best-paid category, was just ₹10,000 per month in 2022-23 (at constant 2011-12 prices). Casual wage labour, the worst form of employment, fetched only ₹4,500 per month.
The self-employed, accounting for over 57% of total employment, had comparable monthly real earning of only ₹7,000 per month. Clearly, since the absolute level of wages (or earnings) remains so depressingly low, the policy goal here has to be not lowering but raising the absolute level of real earnings, based on rising productivity and rising labour demand.
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What about the denominator? In India, where the government is the dominant, pre-emptive, borrower of funds and government-owned financial institutions also the dominant suppliers of funds, the cost of capital is essentially a quasi-administered price that does not reflect the scarcity value of capital in a capital-scarce developing country.
As per our NIPFP Mid-Year Economic Review, the yield on the benchmark 10-year government security has been stationary in the 7-7.5% range for the past couple of years and the short-term Treasury Bill yield has converged with it (NIPFP Policy Brief May 2024).
The yield curve on corporate bonds has also closely tracked the sovereign bond yield with just about a half percent risk premium. Pande and Mehta have estimated that the 10-year G-Sec yield has been at this level or lower during most of the past two decades and the short-term Treasury Bill yield has usually been significantly lower.
With headline inflation hovering around 5-6% for the last couple of years, and higher in many years during the past two decades, it implies that the real interest cost of capital is around 2% at present and was significantly lower, even negative, in many years during the past two decades.
What policies can raise the real cost of capital to incentivize more labour-intensive growth? Depreciating the exchange rate would switch macroeconomic expenditure from imports to exports and simultaneously raise the cost of foreign capital.
However, our trading partners could accuse us of currency manipulation. Moreover, real rates cannot be suddenly raised in a disruptive manner when the private investment cycle is just beginning to recover.
Thus, raising domestic real interest rates, supported by exchange rate depreciation, can at best be part of a larger menu of policies to induce more labour- intensive growth.
A promising policy measure that can significantly lower the wage-rental ratio is an employment-linked incentive scheme (ELI), a concept introduced by finance minister Nirmala Sitharaman in her recent budget. However, the incentives being offered are so limited that they are unlikely to have much impact.
A serious ELI grant scheme linked to additional employment, similar to the present PLI grant scheme linked to increases in production, could be very effective. It would tilt the incentive structure in favour of the employment-intensive sectors listed above and make growth more labour intensive.
Policies to change relative factor prices are necessary to make growth more labour intensive, but may not be sufficient if employment growth is also constrained by non-price factors. The most important factor here relates to structural rigidities in the labour market.
There is a view that it is not the cost of labour, but the rigidities and compliance burden of labour-related Acts, and a maze of other similar laws or rules, implemented by a predatory ‘inspector raj,’ which stands in the way of higher employment.
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As it happens, there are large variations across states in the laws and rules that apply. These variations enable us to look at the actual comparative evidence, instead of just speculating about labour-market rigidities and their impact on employment. This is an important issue which requires careful analysis by labour economists.
These are the author’s personal views.
