Simplifying labor regulations and the introduction of the GST could spur India’s formal economy.

There is no doubt the Indian economy has been growing since liberalization took place in 1991, with latest figures suggesting a 7.3% gross domestic product (GDP) growth rate for 2014-15. Despite the country’s high GDP growth rate, India consistently ranks poorly in the World Bank’s Doing Business surveys, coming in at 142 out of 189 countries this year.

Firms in India continue to face two major constraints: tax administration and labor regulations. For example, in the 2014 World Bank Enterprise survey for India, 12.2% of firms reported tax administration as a major constraint, while 11.3% of firms indicated that labor regulations were an impediment to growth.

The Industrial Disputes Act (IDA) of 1947 governs labor regulations in India. It covers various aspects such as hiring and firing workers, closure of establishments and the resolution of industrial disputes through tribunals and labor courts. The IDA also provides regulatory guidance on strikes and lockouts in the formal sector.

As labor is a subject in the concurrent list of the Indian Constitution, both the center and the state governments have made numerous changes to the IDA. Over time, these amendments have made states either more employer-friendly or worker-friendly.

But some of these laws are extremely onerous and have hampered firm growth in India. For example, Sections V-A and V-B of the IDA, which cover layoffs and retrenchments for firms with more than 50 and 100 permanent workers, respectively, make it expensive and difficult for loss-making firms to layoff workers or to close down.

Labor regulations in India have been a topic of active academic study, with most researchers agreeing that more pro-worker labor regulations have resulted in lower output, employment, investment and productivity in formal manufacturing. The pro-worker regulations also lead to lower sensitivity of industrial employment and higher use of contract workers by firms in response to local demand shocks.

In response, the Indian government has taken steps in the right direction for industrial development by proposing amendments to many labor laws as part of its “Make in India” and “Shramev Jayate” campaign.

The other big constraint faced by firms relates to the complex tax structure; some of these are imposed at the central level, while others are at the state and product level.

Despite this plethora of taxes, the central government has been successful in helping some of the smaller and industrially backward states grow with the help of tax incentives. For example, the government initiated the New Industrial Policy for the states of Uttarakhand and Himachal Pradesh that gave central excise tax and central income tax exemptions to new and existing firms if they expanded in size.

The result was an increase in the number of new firms entering the two states, as well as the growth of existing firms. This tax exemption scheme successfully led to a massive increase in industrial employment, number of factories, fixed capital and industrial output.

The simplification of the complicated web of state and central taxes can go a long way toward spurring industrial development in India. One major initiative in this respect is the proposed introduction of the Goods and Services tax (GST), which is expected to start in April 2016. The GST is supposed to subsume a majority of central and state taxes and make tax compliance and tax structure much easier for both firms and individuals.

Reforms on labor regulations and tax are clearly moving in the right direction and will most likely help both the manufacturing and services sector grow in India.

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

Photo Credit: ARTEKI / Shutterstock.com

We bring you perspectives from around the world. Help us to inform and educate. Your donation is tax-deductible. Join over 400 people to become a donor or you could choose to be a sponsor.