Broader Implications of Labor Market Reforms in India: A General Equilibrium Perspective

This paper looks at the broader implications of labor market related reforms beyond the conventional partial equilibrium response, which typically deals with the employment effects in the formal sector. In recent times, this is an important issue for India where such reforms are being seriously contemplated. The issue is important in view of the fact that in the post independence India there has not been much movement of people from rural economic activities to the organized urban sector. It is also well known by now that the rural non-farm sector and unorganized manufacturing and services absorb most of our relatively unskilled workforce. Hence, the general equilibrium impact of the labor market reform can hardly be undermined. We analyze the impact of such policies on overall industrial and rural employment for an open economy with a large informal sector. We deploy a standard neo classical general equilibrium model to characterize the economy and argue that such reforms, in general, would increase employment in the formal sector and cut back the size of the urban informal sector, but at the cost of falling informal wage and an increase in the same for the rural informal sector. This will mean a decline in the average wage unless there is a substantial increase in the size of the urban organized sector. If not, this might cause reverse migration to a segment of the economy where per capita production is already very low. If eventually such reforms give rise to an incentive to accumulate capital, the prospect for higher income may continue to be bleak. Investment in education and skill formation is a possible way out.