Two recent events offer a unique opportunity for economic and job growth in India. The first one that dominated the news cycle was the re-election of the incumbent government, which helped the goal of policy continuity towards transitioning India to a developed economy. The second piece of news justifiably did not gather similar interest but may play a more significant role in shaping India’s laws for the next five years. This is the expansion of the NITI Aayog’s mandate to two new areas of work: national security and legal proposals. From now on, proposals involving these two areas will be reviewed by the government’s premier think-tank. This positive development has the potential to align India’s laws with the country's goals. However, the approach that the Aayog is planning to take to evaluate legal proposals is probably 50 years outdated. For India to benefit from these developments, a new approach to the analysis of laws is required.
The review of proposed legal changes by the government’s premier think tank is a move in the right direction. However, the approach that NITI Aayog is planning to take may not yield the expected results. According to the news report about this development:
“the law vertical will undertake reviews of Cabinet notes and new law drafts for legal scrutiny and generating opinions from a law and justice perspective” (emphasis added).
This statement reflects the traditional approach to Indian lawmaking, where the questions about law are answered from within the field. In this approach, law is an insular and self-contained field that has the monopoly to answer both of the following questions:
What is the law?
What should the law be?
The first question may be within the domain of legal studies, but the second question has been outside the domain of law for quite some time. The gains from the expansion of NITI’s remit may not improve India’s lawmaking if the analysis of legal proposals and legislation is left to an insular system, which uses only legal theory to adjudge the quality of laws.
Using Economics for Law
Since the 1970s, laws have been increasingly analysed using economics. This approach started with Ronald Coase, the only faculty member of a law school to win the Nobel Prize in Economics. Economists have demonstrated the effects of legal systems with surprising levels of accuracy and, in some cases, even predict the outcomes of laws.
An example of this success was Coase’s prediction that auctioning the telecom spectrum would be an efficient method of allocation (Coase, 1959). Before Coase, the telecom spectrum was allocated through a complex administrative review process that involved the subjective judgement of bureaucrats. This was done to ensure reasonable telecom prices to consumers and expand service. According to Coase, auctioning the spectrum (as opposed to the administrative review process)to the highest bidder would be a better solution and would not harm consumers. Telecom experts roundly criticised Coase’s idea, but the U.S. government implemented it with the positive outcomes that Coase had predicted. After auctions, telecom penetration grew, and prices fell instead of rising (as predicted by experts). Shruti Rajagopalan has recorded how India leapfrogged into the wireless age within three decades using Coase’s idea of auctioning spectrum.
In spite of the success of the telecom industry, using economics in law is the exception rather than the rule in India. Four areas where the nation can benefit from adopting the law and economics approach are (i) Regulatory Impact Analysis (RIA), (ii) understanding strategic behaviour, (ii) facilitating competitive regulatory environments, and (iii) informed legal drafting.
Regulatory Impact Analysis
The Indian government has started taking the first steps to recognise that laws have economic consequences through an exercise to estimate the cost of regulations. This exercise has resulted in the first estimates of costs that businesses have to incur to comply with regulations as they stand. While this is a positive step, it misses the opportunity to examine the real unseen cost of regulations. Such an analysis, referred to as regulatory impact analysis, helps identify costs from the restrictions imposed by any law and then weigh them against the benefits that such restrictions are expected to bring about. It helps us answer the question of what the law ought to be.
An example from India’s construction laws highlights the difference between India’s current approach and the much deeper insight that may be available to lawmakers. Under the Ease of Doing Business Reforms, India improved its rank in dealing with construction permits from 182 in 2014 to 52 in 2019. However, these improvements only measure the time and steps taken to obtain construction permits. India still does not measure the loss of economic activity due to the restrictions placed on the buildings themselves. As an illustration, calculations show the restrictive nature of building regulations in Noida as opposed to Singapore. For a plot (5,000 sq metres), an office building in Singapore can employ 3,571 persons, but the same plot in Noida can employ 714 people. Such losses will not be offset by speeding up Noida’s construction permitting process. India needs to analyse its land use regulations using modern economic tools like regulatory impact analysis to fully understand the cost of regulatory choices (Anand et al., 2023).
Countries that have adopted these tools have usually created specialised independent bodies that have implemented economics in the field of regulation and laws. One example of such a body is the Productivity Commission of Australia, which advises the government on economic policy and is credited with improving Australia’s economic competitiveness through legal reforms. Similarly, the U.S. President is advised by the Office of Information and Regulatory Affairs that sets the standards for Regulatory Impact Analysis to be implemented by each U.S. government agency. The U.K. also has a similar body called the Better Regulation Delivery Office that evaluates the working of all regulatory agencies to improve rulemaking by such agencies. NITI Aayog can play a similar role by institutionalising regulatory impact analysis of legal proposals in India.
Understanding Strategic Behaviour
In the past, legal scholars believed that people would obey any law once made. If the Parliament commanded employers to increase wages to employees, employers would do so compliantly. Now, we know that the world is not simplistic, largely due to insights gleaned from law and economics. People do not blindly follow laws that are against their self-interest and engage in strategic behaviour. So, instead of increasing wages, employers would choose from a bouquet of strategies that traditional legal scholars were unable to predict. Employers may choose to reduce production, outsource production to unregulated firms, import from another country, or, at the extreme, stop carrying out the economic activity altogether. All these strategies end up harming the workers the original law intended to protect.
India’s labour laws may be examples of such strategic behaviour by employers. Many labour laws are designed to coerce employers into providing greater protection or wages to employees. There is some evidence that India’s labour laws may be harming workers more than benefiting them. Employers, faced with such regulations, engage in strategic behaviour that has the opposite effect than what the law intended. Two examples of laws with opposite outcomes are the (i) Industrial Disputes Act, 1947 (IDA) and (ii) Contract Labour (Regulation and Abolition) Act, 1970 (CLRA).
The first law, IDA, sets thresholds for restrictions on employers on retrenching workers and closing factories. However, only factories that employ more than the specified number of workers come under the ambit of the law and enjoy the law’s protections. This has led to employers choosing not to grow their factories in fear of the law. Instead, employers resorted to hiring workers through labour contractors and awarding only temporary jobs (as these did not trip the threshold conditions). The result of this legal system is a large number of temporary workers with no protection and very few factories of the size that employ workers covered by the Industrial Disputes Act. The debilitative effect of this law is well-recorded in the economics literature (Ahsan & Pagés, 2009; Besley & Burgess, 2004; Dougherty et al., 2014; Kapoor, 2015).
The second law, CLRA, saw the use of contract labour as an evil because such workers did not enjoy the benefits that the legally protected workers were expected to enjoy. However, the state did not carry out a cost-benefit analysis of the two types of employment from the perspective of the employer. This has resulted in a situation where the use of contractual labour is prevalent and still dominates industrial employment despite a law whose mandate was to abolish the system. Contractual workers outnumber protected workers in states like Telangana, Maharashtra, and Haryana. The ratio of contract workers to direct workers was 1.85, 1.11, and 1.07 in Telangana, Maharashtra, and Haryana, respectively, in 2021-22, according to the Annual Survey of Industry report.
The high number of contract workers does not include another concept provided by the economic analysis of laws– opportunity cost. This concept measures the forgone gains due to any legal principle. The contract workers at least have some jobs, unlike the number of workers who never get a job because the regulations dissuade firms from expanding. The traditional system of calculating the benefits of a regulation does not include this cost. Many laws would not have been adopted if a rigorous calculation of opportunity costs had been calculated before the laws were enacted.
A competitive regulatory environment
Federal countries like the U.S. have succeeded economically due to the variation of regulatory and legal approaches, according to a branch of literature in law and economics (Boyer, 1993; Knack & Keefer, 1995; North, 1994; Rodrik et al., 2004). This allows constituent states to experiment with different legal norms and carry out reforms on a smaller scale. Successful reforms can then be replicated by other jurisdictions within the country, while bad legal changes die due to natural selection.
The Indian experience has not been guided by this insight into the behaviour of governments provided by economic analysis. Instead, there has been a progressive centralisation of legislative functions by moving items from the jurisdiction of states to the concurrent jurisdiction of states and the Union. Though the list is called concurrent, the union legislature holds primacy over the subjects mentioned in this list. As a result, there is very little variation between states for subjects that have been brought to the concurrent list, leading to less policy experimentation and natural selection.
In addition to the lack of experimentation, centralisation makes legal reforms harder because it concentrates opposition to reforms and increases the downsides of incorrect reforms since the effects are felt nationwide. When subjects like agriculture are tabled for reform by the Union, the resistance to such reforms is concentrated. Instead, a slower but surer method of reform may be by encouraging reforms at the local level through decentralisation. Similarly, uniform labour laws across the country may be hampering competition between states to find the optimum labour laws that attract investment and workers. Reforms of these laws also face internal resistance due to the risks associated with changes at the national level, where the changes affect the entire country. The bureaucracy has to be extra-cautious when implementing such reforms. In contrast, local reforms have local downsides. The effects, including resistance against such reforms, may be contained within a smaller area and give future policymakers valuable information about what not to do.
Legal Drafting
Economics can not only inform policy but even guide the drafting of laws. Every law contains two components: the command and the consequence. The command component involves some actions that a person should refrain from doing (or must do), and the consequence component is the penalty for violating the command component. Both of these components of any legislation can be better formulated with economic insight.
For the command component, legislators can weigh the costs and benefits of placing a mandate. As economics has shown, people behave strategically to commands from the law. Economic theory predicts that humans are generally rational actors, and therefore, it is difficult to coerce people to take actions that are against their self-interest. Rational actors may even stop doing an economically beneficial activity (like growing their factories) if the command components (requirements of labour law) are too onerous.
Similar to the command component, the penalties imposed by law can also be informed by an understanding of economics. The breakthrough in this field happened with Gary Becker, who was the first to model crime and punishment in economic terms (Becker, 1968). Since then, the field has moved forward and expanded with the inclusion of complex analysis like Game Theory.
Many business laws in India carry such high criminal penalties that it may be rational for a business owner not to start a business in the first place. For example, a factory owner/manager was liable to be imprisoned for up to two years if they did not limewash the canteen walls every year or paint the canteen once every three years. The same penalty follows if the factory owner/manager fails to stock up adequate quantities of snake-bite lancets or install a spittoon in the factory premises.
The present government has made some important changes in the penalties (consequence component) of laws by decriminalising many laws, including the Companies Act, where many minor violations carried imprisonment terms. However, this does not address why the initial versions of Indian laws carry so many provisions with criminal consequences.
An economic understanding of laws allows legislators to model the consequences of the combination of commands of law and the consequences of breach. Indian legislators usually increase the penalty/punishment of a violation as a response to a sensational crime. However, according to law and economics, the deterrence effect of any punishment is the result of the penalty multiplied by the probability of the guilty being identified and prosecuted. Sadly, many Indian governments underinvest in the latter part (police, prosecutors, courts) to such an extent that the probability of the guilty being prosecuted tends to zero. In such a situation, increasing the punishment does not deter criminals because criminals are aware that the chances of getting caught are very low. This may explain why increasing punishments in India does not lead to a reduction in many crimes. NITI Aayog can contribute to legal proposals by evaluating the penalty component of any new laws. A scientific approach is needed to choose between many systems of imposing penalties, such as administrative law, criminal law, or civil adjudication. Similarly, law and economics can inform choices between imprisonment and fines.
The way forward
NITI Aayog’s expansion into analysis of laws is a welcome step, if the government’s premier think-tank brings to bear the tools of law and economics to the analysis of laws. However, the gains from the expansion of NITI’s remit may not improve India’s lawmaking, if the analysis of legal proposals and legislation is left to the insular system using legal theory to adjudge the quality of laws.
India has largely skipped the law and economics revolution that contributed to a surge in the wealth of the first world in the 1980s and '90s. NITI Aayog needs to bring this development in legal policy formulation to India to help the country achieve prosperity.
References
Ahsan, A., & Pagés, C. (2009). Are all labor regulations equal? Evidence from Indian manufacturing. Journal of Comparative Economics, 37(1), 62–75.
Anand, B., Kaur, S., & Roy, S. (2023). State of Regulation: Building standards reforms for jobs and growth. Prosperiti.
Becker, G. S. (1968). Crime and Punishment: An Economic Approach. Journal of Political Economy, 76(2), 169–217.
Besley, T., & Burgess, R. (2004). Can Labor Regulation Hinder Economic Performance? Evidence from India. The Quarterly Journal of Economics, 119(1), 91–134.
Boyer, R. (1993). Labour Institutions and Economic Growth: A Survey and a “Regulationist” Approach. LABOUR, 7(1), 25–72.
Coase, R. H. (1959). The Federal Communications Commission. The Journal of Law and Economics, 2, 1–40.
Dougherty, S., Frisancho, V., & Krishna, K. (2014). State-level Labor Reform and Firm-level Productivity in India.
Kapoor, R. (2015). Creating jobs in India’s organised manufacturing sector. The Indian Journal of Labour Economics, 58(3), 349–375.
Knack, S., & Keefer, P. (1995). Institutions and Economic Performance: Cross-Country Tests Using Alternative Institutional Measures. Economics & Politics, 7(3), 207–227.
North, D. C. (1994). Economic Performance Through Time. The American Economic Review, 84(3), 359–368.
Rodrik, D., Subramanian, A., & Trebbi, F. (2004). Institutions Rule: The Primacy of Institutions Over Geography and Integration in Economic Development. Journal of Economic Growth, 9(2), 131–165.
Bhuvana Anand and Shubho Roy are researchers at Prosperiti.