Earlier this year, India officially became the most populous country in the world, with 1.4 billion inhabitants. Long considered a poor country, its economy has now overtaken that of its former colonial ruler, the United Kingdom, and ranks fifth in the world, while its growth rate is one of the world’s highest.

These indicators may divert attention from the structural weaknesses of the Indian economy, chief amongst which are the employment situation and poverty. Forty-five per cent of the population lives on less than US$3.65 a day, and the country onlyranks 127th in the world in terms of GDP per capita.

The spectacular rates of economic growth seen in India over the last 20 years have brought only modest improvements in living conditions for the vast majority of Indians. Employment is the main channel through which economic growth improves living conditions but, in this instance, it has become a source of major concern.

Economic expansion that fails to create jobs cannot foster human development. And in India, the employment elasticity of growth, that is, the percentage change in the number of jobs for 1 per cent of growth, has been falling steadily since the 1970s. It was 0.44 in the early 2000s, which amounts to less than half a job created for every point of growth, and it has been falling ever since, reaching negative figures in 2014, when growth was destroying jobs. Growth at the time was described as “jobless growth”. Since then, it has settled at around 0.01. This means that a growth rate of 7.2 per cent (the rate recorded for the 2022-2023 fiscal year) would give rise to six million jobs, while the working population is growing by 10 million a year, and only four out of ten Indians of working age are in employment or seeking employment.

This end of demographic transition and the associated increase in the active population underline the seriousness of the employment issue.

Employment primarily dependent on manufacturing

Growth’s limited ability to create jobs in India is partly owed to the restricted development of the manufacturing industry and partly to the precocious growth of the services sector.

During the 1970s, the combined introduction of two pieces of legislation hampered the growth of production units and their ability to benefit from economies of scale. Firstly, the amendments to the Industrial Disputes Act in 1976 and 1984 introduced constraints on the labour market, encouraging companies to resort to informal work arrangements, which are also less costly. As the average cost of labour fell, industries preferred to use this factor at the expense of capital. The sector’s capital intensity was therefore relatively low, as was labour productivity.

In addition, regulations were introduced in the 1970s and 1980s to restrict the production of certain goods to small units, hampering the growth in the size of production units.

The combination of these two phenomena – low wages and the protection of small production units – discouraged recourse to capital and limited the ability of these industries to benefit from economies of scale. Employment in the manufacturing sector was relatively high at the time but labour productivity was low.

When, in the 1990s and early 2000s, India embarked, partly under the aegis of the International Monetary Fund, on opening up and liberalising its economy, the protective measures for these small industries were withdrawn, leaving them not only faced with internal competition but also with competition from imports.

They sought to increase their size, prioritising recourse to capital over labour. The growth in the manufacturing sector that followed was based on higher labour productivity, while its employment content was low. Between 2011 and 2018, the manufacturing sector grew at an average rate of 5.8 per cent but eliminated three million jobs.

Too slow a transfer of labour across sectors

Employment growth in the manufacturing sector, through the transfer of labour between sectors, is essential to improving living standards for a large share of the Indian population. Given that 44 per cent of the active population is employed in the primary sector – which, only contributes to 17 per cent of GDP – the productivity and therefore the remuneration of agricultural labour is low.

This overabundance of labour may in part be attributable to the ‘insurance’ provided by the agricultural sector in India: with two-thirds of employment being informal, workers have no other safety net than work on the land.

Despite a downward trend in the proportion of the workforce employed in agriculture over the last 30 years, this figure rose again from 2020 onwards, following the lockdown measures introduced in response to the Covid-19 epidemic. Deprived of their livelihoods, many Indians returned to their villages to work the land. A transfer of labour from agriculture to industry would increase productivity and, in turn, incomes from agriculture, while wages in industry are, on average, higher.

Also, in view of the average level of qualification of the Indian workforce, with a third of the working population not having received an elementary education, employment in manufacturing seems best placed to absorb these workers. Improving the living standards of almost one Indian in two depends on this transfer of labour, and therefore on job creation in industry, which has been very weak in recent years.

The service sector’s limited contribution

The services sector could also have generated more jobs, if its growth since the 1980s had not been based on highly productive niche sectors requiring a high level of qualifications, such as financial, communication or business services. In 1983, this sub-sector accounted for 9 per cent of value added and 5 per cent of employment in services. In 2012, it accounted for 30 per cent of value added in services but employed just 10 per cent of the sector’s workforce.

The sector’s expansion has not led to massive job creation. In many comparable countries, the service sector’s share of total GDP and employment are equivalent. In India, the services sector now contributes 48 per cent of value added, but employs only 31 per cent of the workforce. Not only is the source of growth in services not enabling massive job creation, but these jobs also require a high level of qualification, which few Indian workers have. As we said, 78 per cent of the working population has not gone beyond secondary school.

Job creation in manufacturing is a key challenge for the Indian economy, if it is to absorb the large number of new entrants to the labour market, enable the transfer of labour from agriculture to other sectors, and so improve living conditions, while making growth sustainable by encouraging domestic demand, given that the Indian economy is not, for now, very export-oriented.

The government has recognised the importance of developing manufacturing, introducing plans to stimulate the sector such as ‘Make in India’ and the industrial component of the ‘Atmanirbhar Bharat Abhiyaan’ or Autonomous India programme, as well as relaxing its labour laws.

Between 2020 and 2022, the manufacturing sector once again created eight million new jobs. Whilst encouraging, these figures are not yet commensurate with the challenge ahead, given the massive influx of new entrants to the labour market. Employment is central to India’s economic expansion and political stability.