Designing resilient economic institutions
The tragic reverse migration, in the aftermath of the lockdown last year, is seen largely as a policy failure. The episode, however, also revealed deeper institutional weaknesses in the labour market. While working reasonably well during periods of normalcy, these weaknesses became our Achilles Heel in a crisis.
What are economic institutions and why do their weaknesses matter? Plainly put, economic institutions are the underlying structures — the nuts and bolts — that enable economic activities in general, and public policies in particular, to work properly. Some institutions work at macro- or economy-wide scale, such as the legal infrastructure, which ensures property rights or contractual obligations. Other institutions may be more specific, such as the Insolvency and Bankruptcy Code (IBC), which ensures smoother working of the financial system. The problem with institutional weaknesses is that they make it impossible for policies to achieve their desired targets. Even the best policies can fail if the underlying institutions do not support them.
What were the pre-existing labour market institutions that failed during the lockdown? Here, it is important to understand the difference between State and private institutions. Institutions of the State define the relationship between the government and private actors, for instance, individuals and firms. Private institutions, on the other hand, enable interactions within the private sector, say, between firms and individuals, or between two firms.
In India, reforms during the last three decades gave rise to two important labour market institutions — the first private, and the second, State. The first is third-party contracts, where the labour markets are run by private contractors. In this arrangement, firms rely on contractors to hire workers for them. These workers are not on company payrolls, but are paid by the contractor, who, in turn, is paid by the firm. This arrangement saves costs for firms, since contractual workers are not entitled to social security benefits and, generally, receive lower wages, relative to their colleagues in regular employment. It also enabled firms to enjoy much more flexibility. This transformed employment relationships in India and enabled a large number of new forms of employment.
The second institutional development happened due to the lack of significant manufacturing growth, which meant that employment did not keep up with labour force growth in the country. There was pressure on policymakers to develop social safety nets for those unable to get gainful employment. This resulted in an institution that came up specifically to address the problem of joblessness in a market economy. It took the form of a rural jobs guarantee programme, the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS).
The reverse migration was symptomatic of the failure of both these institutions in the face of the pandemic. Anecdotal evidence suggests that as soon as there was a lockdown, many of the labour contractors went missing. This meant that the labourers had no means through which they could retain their employment. On the other hand, firms that were willing to retain their workers during the lockdown could also not do so, since payments to contract workers go through the contractors that went missing. The main reason for this institutional crisis was that there was no incentive for these contractors and middlemen to continue their business in the midst of the uncertainty during the lockdown. Thus, the limitations of such an institutional arrangement became stark during the pandemic.
The problem was compounded by the fact that our social safety net programme, particularly MGNREGS, is not designed for an urban crisis. There was no mechanism through which income transfers could be made to those who lost jobs in the urban areas. It is hardly surprising then that millions risked their health and lives trying to return to their villages, rather than stay on in their urban dwellings.
What lessons can we take away from these experiences about future institutional design? The key learning here is that institutional capabilities that allow reasonable outcomes during normal circumstances may not do so during a crisis. Thus, the design of institutions has to keep in mind crisis scenarios and how to deliver during those conditions. In the labour market, for example, with the introduction of fixed-term contracts in the new industrial relations codes, firms have much more flexibility in labour markets, and so third-party contracts can be abolished altogether. The advantage of this is that in any future crisis, any form of income support to the labourers can be channeled directly through the firms.
As far as safety nets are concerned, we need to recognise that during a crisis, it is up to individuals and households to decide whether they want to stay on or migrate back home. However, providing them with support that can reach them wherever they are will definitely help to prevent a repeat of the massive migration-on-foot that we saw last year. The effort to universalise ration cards is a step in the right direction. However, the lockdown also showed that expenditures other than food can also become crippling and ultimately, only cash transfers can help solve some of these problems.
The bottom line is that we need to develop institutions that are not only efficient during normal circumstances but also resilient during a crisis.
Sabyasachi Kar is RBI chair professor, National Institute of Public Finance and Policy (NIPFP).
Mayank Jain is research Fellow at NIPFP
The views expressed are personal