Perhaps the greatest problem facing India on the economic front today is the lack of sufficient job growth in the organized sector. Before going any further, let me give you some reasons as to why our focus should be on 'formal' employment in the organized sector of the economy:
- Productivity is far higher in the organized sector. As Brian McCaig, Assistant Professor of Economics, Wilfrid Laurier University, pointed out in a paper1 published by the World Economic Forum:
"Informal firms… often lag in productivity far behind formal firms,... As a result, countries characterized by an abundance of informal firms suffer from low aggregate productivity (Hsieh and Klenow2 2008)…
Overall, our results highlight the importance of policies that promote the growth of the formal sector and consequently draw workers out of the informal sector. Such policies not only provide for occupational upgrading and increased earnings for individuals who switch, but also facilitate gains in aggregate productivity in formalized sectors."
- A higher proportion of the workforce in the organized sector would reduce levels of inequality in society. Quite apart from the imperatives of basic fairness, a growing body of research tells us how important greater equality in income distribution is for sustained economic development. An IMF note3 puts it well:
"It turns out that many of even the poorest countries have succeeded in initiating growth at high rates for a few years. What is rarer—and what separates growth miracles from laggards—is the ability to sustain growth. The question then becomes: what determines the length of growth spells, and what is the role of income inequality in duration?
We find that longer growth spells are robustly associated with more equality in the income distribution."
- Even measuring progress (or the lack of it) in creating jobs within the informal sector is a hit and miss affair. What with full-time employment, partial employment, seasonal employment and disguised unemployment, statisticians seeking to give accurate estimates are just about as likely to succeed as the blind man who goes into a dark cellar at midnight without a light looking for a black cat that is not there!
Let’s come back to the problem of low employment generation in the formal sector that is troubling the country’s leaders and economists (other than the ones of ostrich parentage). Most experts identify the lack of labor reforms and incentives for organizations to employ more people as the twin obstacles to greater job growth in the organized sector. Because of the legislative and other impediments facing meaningful labor reforms (which I have addressed extensively elsewhere), in this column I would like to present a new approach to fiscal incentives that could quickly prompt the organized sector to add jobs.
The Need for Strong Medicine
It may well be asked whether it is really necessary to deprive the state of revenue through one more tax concession. To me this question appears similar to a typhoid patient wanting to avoid antibiotics because they cost more than paracetamol. Here are some reasons fiscal incentives are important for mitigating jobless growth in the short and medium term:
- The Government has already announced plans to bring down rates of corporate taxation. If we agree that economic growth is simply a means of bringing prosperity to as many people as possible, what better way can there be to use this as one-time opportunity provided by the (already committed) tax reduction, and directly funnel a part of the benefit to encourage corporate employment generation?
- The anti-employment pulls exerted on strategic decision-makers by increasing automation, protectionism and 'contractualization' are just too strong to respond to analgesics like preaching and prayers for redeployment in higher quality jobs elsewhere in the economy. In the first place, the potential recruiters in hi-tech have their own plans for staffing and recruitment, in which middle-aged terminees from other industries have little place. Secondly, while the providers of 'upgraded' jobs may not be facing market downturns, they have to cope with exactly the same employment-contracting pressures already mentioned. In the longer term, and most worryingly, many of these high-quality jobs may just not be created in India. In a telling article4 on "The Real Threat of Artificial Intelligence" Kai-Fu Lee, Chairman and Chief Executive of Sinovation Ventures, writes:
"… what about other countries?
They face two insurmountable problems. First, most of the money being made from artificial intelligence will go to the United States and China. AI is an industry in which strength begets strength... It’s a virtuous circle, and the United States and China have already amassed the talent, market share and data to set it in motion…
The other challenge for many countries that are not China or the United States is that their populations are increasing, especially in the developing world. While a large, growing population can be an economic asset (as in China and India in recent decades), in the age of A.I. it will be an economic liability because it will comprise mostly displaced workers, not productive ones."
Clearly, antibiotics are in order!
- Incentives need not be one-way traffic. While not intended as a revenue-generating measure, a higher incidence of tax on organizations that reduce long-duration employment can partially offset the cost of the fiscal incentive.
It is worth reiterating at this stage that a lasting cure will demand repeated and intensive sessions of labor reform therapy.
Incentives need not be one-way traffic — while not intended as a revenue generating measure, a higher incidence of tax on organizations that reduce long-duration employment can partially offset the cost of the fiscal incentive
A New Approach to Making Job Generation Worthwhile for Business
Many people (myself included) have tried figuring out ways to encourage job creation in the formal sector through fiscal means but have floundered against the problem of the incentives just rewarding higher wage costs without raising employment (especially at the lower levels). To my knowledge, this is the first time there is a proposal which, while being flexible about the form the fiscal incentive can take, mandates that it must conform to the following three principles:
- The fiscal incentive should be linked to the change in the average permanent headcount for a business entity. Simply incentivizing wage bill increases could actually mean 'fat cat' packages get more obese while employment goes down. By linking headcount in this fashion we will encourage the creation of jobs at the lower levels of the hierarchy.
- There must be a disincentive for headcount reduction. Apart from making the overall proposal more economical for the Government, this would discourage gaming of the system by adding people in one year only to reduce them in the next. This should also leverage the loss aversion principle (enunciated by Kahneman & Tversky5) which shows that people strongly prefer avoiding losses to acquiring equivalent gains.
- There should be a fiscal cost for 'contractualization' or 'uberization'. The scheme should curb the rapidly growing tendency to replace a permanent workforce with non-permanent employees or (so-called) non-employees.
Given below is just one simple way these criteria could be met. The model has been intentionally kept simple to exemplify the concept. Further refinements can be added to check unintended consequences and misuse.
- Each organization would be required to report its average permanent head-count for a given financial year (the Reference Year) and for the previous year. The extent to which the Reference Year’s average permanent headcount is higher (or lower) than the previous year’s would be computed as a percentage figure (the Head-count Change Percentage or DH% for short).
- An amount equal to DH% of the Reference Year’s Payment and Provisions for (permanent) Employees would then be computed. This amount would be multiplied by a Job Growth Multiplier (JGM). While it would be for better economists than I to work out what the JGM should be, back-of-the-envelope calculations suggest it may have a marginal impact if it is lower than 2.
- The amount computed in step 2 (above) would become the Employment Generation Tax Advantage (EGTA) and be available as an additional deduction while computing Taxable Income for the Reference Year provided the Head-count Change Percentage is positive. Conversely, if the Head-count Change Percentage is negative, the amount computed in step 2 (above) would become the Employment Reduction Tax Increase (ERTI) and an equivalent amount from the Payment and Provisions for Employees would be unavailable as a deduction while computing the Taxable Income.
A couple of further guidelines will be needed:
- Since the Indian Government has no call to subsidize employment in other countries, both the permanent employee count and the wage costs should be limited to employees in India.
- In order that the computation is not unduly influenced by changes in top-level compensation, the payments and count of the costliest employees (say using the criterion specified for reporting employee income under Section 217 of the Companies Act) should be excluded.
As stated earlier, wiser minds than mine can devise more sophisticated and fool-proof (as well as swindle-proof) models without deviating from the three basic principles and put them through a variety of simulations before making a final choice.
There should be a fiscal cost for 'contractualization' or 'uberization' and the scheme should curb the rapidly growing tendency to replace a permanent workforce with non-permanent employees or (so-called) non-employees
Following Shibi’s Sanskara
When I sounded out to economists as well as top-level Finance and HR leaders, most felt this new approach could well tilt the strategic decisions taken by corporates to the employment-positive side. A few of them, however, were less certain about this approach. If I leave out self-interested criticisms (e.g. their companies were embarking on massive downsizing) the main objection was that it was the shortage of adequately skilled people rather than job opportunities that prevented more employment. Now I don’t doubt for a moment the importance of skill building as a prerequisite for employment in the formal sector. But it is far from being the entire story. Unless there is strong demand-side suction, all the massive investment that is underway and planned for skill building will lie fallow. Even this argument didn’t convince objectors who were actually passing a moral judgment on those who could not gain employment (in the formal sector), blaming their lack of skill on a lack of will. Since their 'principled' fundamental attribution error6 proved remarkably immune to argument, I decided to tell them a story.
I reminded them of the fable of King Shibi whose compassion was tested by Indra and Agni. When Shibi tried to save the dove (into which Agni had turned himself) from Indra (who had taken the form of a hawk), the latter asked the king not to deprive a raptor of its rightful prey. Shibi offered an equal weight of his own flesh as a substitute but when the dove was put in a weighing scale it turned out (leaving out gory details of sliced body parts) that nothing short of all of the King’s body could balance the scale. At this stage, the deities revealed themselves, restored the king’s physical self and praised him fulsomely. I pointed out that, as much as I had searched, I had been unable to find a different ending to the story with Shibi advising the dove that if only he had exerted himself to retrain (perhaps in self-defense or faster flying) he could have been saved – and then complacently leaving the dove to become hawk’s d'oeuvre.
Apart from corporate skeptics, the tale of Shibi’s compassion driving him to make a major sacrifice has a message for another group. If India’s economic ministries are serious about generating employment, rather than jobless GDP growth, they will have to demonstrate some of Shibi’s spirit and put their fiscal muscles where only their vocal muscles have been so far.