Informality in the Formal Sector Evidence from India s manufacturing sector. Radhicka Kapoor and P.P. Krishnapriya May 11, 2018

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1 Informality in the Formal Sector Evidence from India s manufacturing sector Radhicka Kapoor and P.P. Krishnapriya May 11, 2018

2 Dualism India s manufacturing sector is characterized by its dualistic structure i.e., the prevalence of an organised sector which coexists with a large unorganised sector.

3 Changing Structure of Employment in Organised Manufacturing

4 What induces entrepreneurs to hire contract workers? Usual suspect Rigid labour regulations Other factors Increasing import penetration leads to substitution of regular workers by contract workers due to lower wages of the latter ( Sen et al., 2014) Effect of staffing companies (Betrand et al., 2015)

5 Data Annual Survey of Industries database covers firms that are registered under the Factories Act (firms employing 10 or more workers using power, or 20 or more workers without using power). Time period: to Build panel of firm data on value added, capital, age, employment (contract and directly employed workers), age, profits and wage bill. Unit of analysis: Establishment

Stylized fact#1: All states witnessed an increase in use of contract workers Share of contract workers in total workers by state (%) States 2000-01 2013-14 Himachal Pradesh 16.09 22.03 Punjab 17.

6 Stylized fact#1: All states witnessed an increase in use of contract workers Share of contract workers in total workers by state (%) States Himachal Pradesh Punjab Uttaranchal Haryana Rajasthan Uttar Pradesh Bihar Assam West Bengal Jharkhand Orissa Chattisgarh Madhya Pradesh Gujarat Maharashtra Andhra Pradesh Karnataka Kerala Tamil Nadu Source: ASI unit data to

Stylized fact#2: Capital intensive industries have seen a larger increase in contract worker usage Share (%) of contract workers in total workers by industry NIC codes 2000-01 2013-14 Manufacture of

7 Stylized fact#2: Capital intensive industries have seen a larger increase in contract worker usage Share (%) of contract workers in total workers by industry NIC codes Manufacture of food and beverages Manufacture of tobbaco products Manufacture of textiles Manufacture of wearing apparel ; dressing and dyeing of fur Tanning and dressing of leather, manufacture of luggage, handbags, saddlery, harness and footwear Manufacture of wood and of products of wood and cork, except furniture;manufacture of articles of straw and plaiting materials Manufacture of paper and paper products Publishing, printing and reproduction of recorded media Manufacture of coke, refined petroleum products and nuclear fuel Manufacture of chemicals and chemical products Manufacture of rubber and plastics products Manufacture of other non-metallic mineral products Manufacture of basic metals Manufacture of fabricated metal products, except machinery and equipment Manufacture of machinery and equipment n.e.c Manufacture of office, accounting and computing machinery Manufacture of electrical machinery and apparatus n.e.c Manufacture of radio, television and communication equipment and apparatus Manufacture of medical, precision and optical instruments, watches and clocks Manufacture of motor vehicles, trailers and semi-trailers Manufacture of other transport equipment Manufacture of furniture; manufacturing n.e.c

8 Stylized fact #3: The use of contract labour has spread, especially across large firms

9 Stylized fact #4: Large capital intensive firms expanded via contract workers in flex and inflex states, while large labour intensive firms have done so more in inflex states

10 Stylized fact #5: Wages of contract workers are significantly lower than those of regular workers But, the wage differential seems to be narrowing

11 Stylized fact #6 : Wage differential has narrowed in both labour and capital intensive industries, and in large firms

12 Why are firms hiring more contract workers even though they are becoming relatively more expensive? Possible Explanation: To curb the bargaining power of regular workers keeping their wage demand in check. To use them as an alternative workforce to their strategic advantage against unionised regular workers.

13 Empirical specification: fist: firm f belongs to industry i in state s at time t Instrumental variable approach: Instruments used for W c /W d are minimum wages and absenteeism rates of directly employed workers

14 Results Category All (1) K- intensive (2) L- intensive (3) Small (4) Medium (5) ln(cw/tw) Large (6) Large K- Large L- Low CW (9) intensive intensive (7) (8) High CW (10) ln(w C /W D ) ** * *** ** *** (0.162) (0.243) (0.621) (5.209) (0.307) (0.227) (0.287) (0.566) (0.208) (0.036) Time *** *** *** *** *** *** *** *** *** (0.001) (0.002) (0.003) (0.034) (0.002) (0.003) (0.004) (0.004) (0.003) (0.001) LMR-GHK *** *** ** *** *** ** *** (0.011) (0.016) (0.044) (0.179) (0.013) (0.016) (0.022) (0.051) (0.015) (0.002) ln(age of firm in *** ** *** *** ** ** years) (0.014) (0.022) (0.037) (0.048) (0.006) (0.024) (0.032) (0.046) (0.022) (0.002) N Industry fixed Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes effects RMSE Source: ASI unit-level panel data to ; Note: Standard errors clustered at plant level are given in parentheses; (* p<0.01; ** p <0.05; *** p<0.10).

15 Do contract workers have an adverse effect on firm productivity? Ln(OUTPUT) (t) Pooled OLS (1) Fixed effect OLS (2) SYS1-GMM (3) SYS2-GMM (4) DIFF1-GMM (5) DIFF2-GMM (6) ln(output) (t-1) 0.743*** 0.246*** 0.091*** 0.135*** 0.290*** 0.280*** (0.01) (0.11) (0.01) (0.01) (0.02) (0.02) ln(cw) 0.088*** 136*** 0.135*** 0.103*** 0.107*** 0.108*** (0.00) (0.01) (0.01) (0.01) (0.01) (0.01) ln(dw) 0.059*** 177*** 0.168*** 0.140*** 0.150*** 0.156*** (0.00) (0.01) (0.01) (0.01) (0.01) (0.01) ln(plant and machinery) 0.105** 0.105** 0.146*** 0.145*** 0.066*** 0.064*** (0.00) (0.01) (0.01) (0.01) (0.01) (0.01) Time effect Yes Yes Yes yes yes Yes AR(1) AR(2) Obs Source: ASI unit-level panel data to ; (* p<0.01; ** p <0.05; *** p<0.10).

16 Summing up Labour regulations: Much ado about something? Do regular workers experience increasingly vulnerable terms of employment as contract worker pool expands? Question mark on the sustainability of employment growth driven by growth of contract workers. Supply side factors: Do workers prefer to be hired as contract workers in the organised sector over working in the unorganised sector? Does contractualisation disincentivise workers from investing in skills, as returns on their investment may not translate into higher wages and job stability?

17 Theoretical Framework Cobb Douglas Production Function Firm s Short Run Profit Function Labour Union s Objective Function The Bargaining Problem

18 On differentiation, we get the following first order condition: The sufficient condition for to be inversely related to their wage ratio is that the productivity of contract workers is below a certain threshold,

41.8 hours per week, respectively. Workers in the. clothing and chemicals and chemical products industries on average worked less than other

41.8 hours per week, respectively. Workers in the. clothing and chemicals and chemical products industries on average worked less than other CZECH REPUBLIC 3,500,000 3,000,000 2,500,000 2,000,000 1,500,000 1,000,000 500,000 5000 4000 3000 2000 1000 0 Fig. 1: Employment by Major Economic Activity ('000s), 2000-2008 2000 2002 2004 2006 2008 Source: