How Well Do Businesses in India Comply with Regulatory Standards?

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World Bank research study shows substantial noncompliance with key labor law.

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Is there truth to the popular intuition that regulatory compliance is especially weak in the developing economies?  Two scholars recently sought to shed light on this empirical question using publicly available data from India’s manufacturing industry.

In a recent working paper released by the World Bank’s Poverty Reduction and Economic Management Uniteconomists Urmila Chatterjee and Ravi Kanbur report on research estimating compliance with India’s Factories Act, a law requiring manufacturers with 10 or more employees to register with the government and comply with various labor standards.

Although the Factories Act attempts to impose labor standards to protect workers, its employee threshold may create a potential escape valve for businesses.  Simply put, the law permits manufacturers to avoid obligations under the Act by employing nine or fewer employees.  If many businesses elect to go this route – keeping their workforce at nine employees rather than growing their operations – it could undermine the Act’s safety goals.  Perhaps worse still, companies could have ten or more employees but simply refuse to register, making it harder for the government to oversee their compliance with the Act’s labor standards.

How many businesses in India evade or simply refuse to comply with the Factories Act?  Measuring regulatory noncompliance presents obstacles.  As Chatterjee and Kanbur note, it is difficult to collect data on businesses’ avoidance or compliance with regulations because businesses are reluctant to volunteer that they are evading or breaking the law in a questionnaire.

However, every five years the National Sample Survey Office within India’s Ministry of Statistics and Programme Implementation conducts a comprehensive survey of businesses that are not registered under the Factories Act.  One of the questions in the survey asks about the number of employees.   Chatterjee and Kanbur were able to compare this information with data from the government’s annual survey of businesses registered under the Factories Act.

Undercutting concerns about regulatory evasion, Chatterjee and Kanbur find that less than one-half of one percent of businesses have exactly nine employees, an employment level that might be expected if companies were widely seeking to evade compliance.

However, Chatterjee and Kanbur found that evasion may be low because outright noncompliance with the law is much more widespread.  Almost two thirds of businesses with ten or more employees had not registered under the Act.

Chatterjee and Kanbur found that registered manufacturers are generally larger operations than unregistered ones, an average of about 80 employees in registered businesses compared with about 18 employees in noncompliant businesses.  As a result, they also found that almost three times as many employees work at properly registered businesses as noncompliant ones.

Nevertheless, about 97 percent of the manufacturers surveyed had fewer than ten employees, so they were not subject to the regulation.  About 64 percent of all workers in the surveyed firms worked at these smaller, unregulated yet compliant entities.

Chatterjee and Kanbur also discovered that enterprises in certain sectors were much more compliant with the Act than were businesses in other industries.  For example, while nearly every pharmaceutical company complied with the law, only around 20% of textile and apparel manufacturers registered when required.

Chatterjee and Kanbur’s paper shows that many small companies have opted to ignore the Factories Act, suggesting to its authors that where the penalties for noncompliance and the probability of enforcement are low enough, rational actors will choose the expected cost of noncompliance over the higher cost of compliance.

Chatterjee and Kanbur’s research should interest anyone concerned about economic development and worker safety in South Asia, particularly in light of recent tragedies in countries such as Bangladesh.   It also illustrates a broader point that can inform debate over regulation more broadly.  Too often, Chatterjee and Kanbur argue, regulation’s proponents and opponents assume full compliance.  Yet the real world effects of regulation – both in terms of benefits as well as costs – depending on how many businesses in fact comply with it.

“At the extreme,” they write, “if there is no enforcement and no compliance at all, then it is as though the regulation did not exist.”  In order to evaluate existing regulation or proposals for new regulation, policymakers should consider how many resources the government is willing to devote to enforcing regulation and what penalties will be in place for those that violate the law.