Resistance to free exits continues to hobble India’s economy

Free exit occurs when a firm can exit the market without limit when incurring economic losses.

Companies, both domestic and foreign, as well as workers will connect to this. Take the case of automaker General Motors, which is battling its workers’ union on a voluntary separation. A court in Pune last week ordered the company and the union to mediate after differences emerged over a severance package. Meanwhile, a leading edtech company that sacked several staffers at one of its offices in Kerala a few months ago had to backpedal after facing resistance from staffers and politicians.

Indian industry and many economists have traced the origins of such resistance to the country’s restrictive industrial policies in the early decades of the republic. Such fetters have hobbled the growth of firms, discouraged large, labour-intensive manufacturing, increased transaction costs and reduced competitiveness, they’ve argued.

Indian policymakers have long recognised this and sought to address the issue of free entry and exit for firms in the first flush of economic liberalisation in 1991.

While that government and subsequent ones did progressively ease restrictions on domestic and foreign companies, success on a free exit policy has been elusive.

The central government may have changed labour laws with the introduction of four labour codes, but labour is on the concurrent list. And not all states may want to play ball. Indeed, Rajasthan and Madhya Pradesh have moved on this front, but the majority of investment still flows to states with superior infrastructure and an industrial base.

It isn’t as if the government hasn’t tried. The Insolvency and Bankruptcy Code (IBC) introduced during the first term of the Modi-led government was aimed at easing the pain of closing a firm, stemming erosion of the value of assets of a company, and helping lenders realise better value.

But the early success and euphoria that was generated after the quick resolution of some firms’ bankruptcies has since dissipated, with the average time lines for resolution now more than twice the mandated period of 270 days.

Building an exit policy that will meet the competing demands of business and labour is a difficult challenge for any government. Over 30 years ago, the Narasimha Rao government approved the formation of a National Renewal Fund (NRF) to provide a safety net for workers. The idea was to fund the severance costs of employees hit by the closure of both state-owned units and private companies, and to help them to adapt to a new world of technology.

That initiative was perceived as a nudge by the World Bank, which had approved a loan that did not materialise thanks to political and economic constraints. Similarly, promises of using the proceeds from the sale of state-run companies to protect workers haven’t been delivered either.

The failure to build consensus on a suitable exit policy has been costly for the economy as it incentivises firms to remain small and limit their ambitions.

Overcoming this will require a social safety net to which workers contribute, more skill training, generous severance packages, and insurance tools. That won’t be easy for a country with limited fiscal resources. The Chakravyuha challenge still looms large.