Jobless and Desperate: India’s Labor Slowdown

While India’s unemployment challenge has taken on worrying proportions and is now seen as the most significant headwind for the prospect of a post-pandemic economic recovery, it has taken a long time to build up.

The triumvirate of structural, cyclical and policy implementation challenges all have a role to play in this undesirable outcome, especially for a populous country as young as India.

The problem began to manifest itself in 2006, when the agricultural sector had reached its peak level of employment. Interest in agriculture has declined as climate change has made farm incomes vulnerable, suggesting the structural challenge plaguing the economy.

At that time, India’s employment elasticity (the percentage change in employment associated with a 1% increase in GDP), which had peaked at 0.31 in 2002, had already begun to decline. It touched its lowest point of -0.04 in 2014 before recovering, albeit modestly. In fact, the average elasticity between 2006 and 2018 was only 0.01. Predictably, as the agricultural sector began to release workers in large numbers, the absorptive capacity of other sectors was tested.

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Generally, the construction sector, which is India’s second largest employer after agriculture, acts as a shock absorber for the economy as it can employ many unskilled and low-skilled workers leaving agriculture. As long as the construction sector was doing well, total employment in the economy grew, albeit at a slower rate. While non-labour-intensive services have become the fastest growing sector of the economy, the elasticity of employment has continued to decline.

After 2013, the construction sector went into a tailspin as the bubble burst once the Reserve Bank of India announced strict Non-Performing Asset (NPA) recognition measures. The RBI announcement led to the bankruptcy of a large number of real estate companies as banks had to turn off the liquidity tap which until now had allowed many non-viable companies to continue to be recognized as successful , even if they were, for all intents and purposes, NPA. The ensuing cyclical downturn in this sector further undermined the economy’s ability to create jobs.

The biggest obstacle

However, India’s job creation capacity has met its greatest obstacle in the form of the political push towards economic formalization. Not that economic formalization is undesirable – any economy that aims to grow and develop goes through this process. However, a country of India’s stature faces a unique challenge of a large number of unskilled workers.

A push towards economic formalization requires enabling factors that allow the labor force to move up the skills continuum to take advantage of the potentially higher-skilled jobs that would likely be available in large numbers. Unfortunately, the rapid pace of formalization has resulted in immense pressure on the informal sector which provides employment to a large majority of India’s workforce.

Demonetization has proven to be the biggest challenge for India’s informal workers as many businesses, unable to adapt to the rapidly changing business environment, have had to close, leaving large numbers of workers unemployed.

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Even such a desirable policy as the GST put many of these businesses out of business since the large businesses to which these entities provided ancillary support ceased doing business with them, as this directly impacted their ability to obtain credit for input tax (ITC).

Then came the pandemic. Micro, small and medium-sized enterprises (MSMEs), many of which operate in the informal sector, have faced their greatest existential crisis.

In fact, the pandemic has been a disaster even for MSMEs operating in the formal sector. An analysis of RBI data on the performance of non-financial corporations (NFCs) listed on Indian stock markets shows that the expected ‘K’-shaped recovery in the immediate post-lockdown period continues unabated – largest companies continue to gain market share at the expense of MSMEs.

In the first quarter of 2022, their share of total sales fell below 4% for the very first time, and it fell further in the second quarter of 2022, even two years after the lockdown. This has obvious implications for job creation. As employment data from the Indian Economy Monitoring Center suggests, India has now apparently entered a period of job loss growth after an earlier period of jobless growth, as total employment currently remains below pre-pandemic levels.

Outside the labor force

A concomitant problem with this prolonged period of little or no job creation is that India currently has virtually the highest proportion of discouraged workers in the world. As unskilled or relatively unskilled workers do not find employment for a prolonged period, they become discouraged and eventually drop out of the labor force.

For the uninitiated, those who are in the labor force age bracket (15-64) and actively seeking employment are considered part of the labor force. The proportion of this population (of the total working-age population) is the labor force participation rate (LFPR). Those who are not actively seeking employment are considered discouraged workers and are therefore not part of the labor force.

There can be several reasons for a worker to fall into this category – wanting to study further, falling ill, or societal mores (for example, the stigmatization of working women). However, not finding a job is also an important reason for discouragement.

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The current LFPR, around 42%, indicates that nearly 60% of the population able to participate in active life remains outside it.

The continued inability to secure livelihoods therefore remains an important factor explaining the low LFPR. And a high unemployment rate despite a low LFPR has a worrying omen. We fear this will have serious implications for India’s ability to reap the demographic dividend that its people have to offer.

The most relevant reason that can be attributed to the average skills of the Indian workforce being skewed towards the lower end of the skills continuum is that government spending on health and education remains quite low. This limits India’s ability to move its workers up the continuum even as the economy formalizes faster.

Policy measures

The immediate policy measure would be to increase these two expenditures by an additional 1% of GDP in the 2023 budget by reallocating spending away from populist spending plans. While the benefits of such spending only materialize in the long term, there are a few other measures that help create more jobs in the short to medium term.

The emphasis on infrastructure remains at the heart of these policies, given the high elasticity of employment in this sector. Fortunately, the government, through targeted public spending on infrastructure and the establishment of several project pipelines, is moving the needle somewhat. That said, a more practical solution would be to ensure that the stress on MSMEs is reduced enough to prevent more of them from throwing in the towel.

An important step in this direction would be to significantly increase the exemption threshold for MSMEs in GST compliance to encourage larger companies to do business with them, without having to worry about not getting the ITC.

Although this may lead to some erosion of tax revenue, such measures may not only help prevent further job losses, but may even contribute to job creation by encouraging MSMEs to set up businesses. This can trigger a virtuous cycle of reducing discouraged workers, increasing the level of employment and improving consumer confidence.

With such measures, the benefits of improved consumption and robust economic activity through higher tax revenues would eventually outweigh the loss of revenue.

(Kunal Kumar Kundu is Indian Economist, Societe Generale Corporate & Investment Bank)

Michael A. Bynum