Conflict Management and Economic Growth

Such inflexible arrangements are not without cost. In a downturn, too many firms will fail, because they cannot shed labor. Alternatively, knowing that they cannot fire permanent workers, firms may remain tiny in order to remain below the authorities’ radar. Or they may hire informal workers who have no rights, or pay inspectors to look the other way (a related point could be made about workplace safety in Bangladesh’s garment factories).

Thus, the attempt to protect workers with rigid labor laws may have the unintended consequence of generating too few protected jobs. This may be the situation in India, where most workers have few rights, and the few large firms that are established in the formal sector tend to use a lot of labor-saving capital in order to avoid hiring protected workers.

Change is not easy. Protected workers have no reason to give up their benefits. Moreover, removing rigid protections without offering alternative, contingent safety nets and judicial redress is a recipe for conflict. At the same time, some protection is better than none, and if most workers are unprotected, change becomes necessary to avoid even worse conflict.

Sustainable change in developing countries requires reforming not only specific arrangements, such as rigid labor laws, but also more basic institutions, such as the legislature and the judiciary, to make them more responsive to people’s needs. If developed countries’ citizens want to feel slightly better about their economies’ slow growth and high unemployment, they should contemplate how much worse matters could be without the institutions that they have.

The view expressed here are the author’s own.

Raghuram Rajan, Professor of Finance at the University of Chicago Booth School of Business and the chief economic adviser in India’s finance ministry, is the author of Fault Lines: How Hidden Fractures Still Threaten the World Economy.

Copyright: Project Syndicate, 2013.

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