India holds a 3 per cent share of global gross domestic product (GDP) and constitutes 17 per cent of the world’s population. But only 22 per cent of its 25–64-year-olds have attained upper secondary education levels or higher — and just 12 per cent have received a tertiary education.

Under labour statistics conventions, skill levels are narrowly construed as being synonymous with education, suggesting that India is abundant in low-skilled labour. As such, India’s inherent comparative advantage lies in low-skilled labour-intensive products. But surprisingly, its domestic manufacture of such products is threatened by import competition, as is clear from its recent hikes in import tariffs on many labour-intensive goods.

Modern production methods relying on production fragmentation and offshoring provide opportunities to export labour-intensive intermediate products, which can lead to further job creation. But India’s ratio of goods and services exports to GDP has stagnated at around 20 per cent over the last decade. While the ratio has increased to 22.4 per cent in 2023, it is still substantially lower than the 2013 figure of 25.4 per cent. India’s inability to expand exports acts as a constraint on the job creation needed for its rapidly growing young population.

While India has experienced growth levels of approximately 8 per cent or higher over 10 non-consecutive years between 2003 and 2022, its performance in the creation of jobs has been disappointing. Given the low average education levels, people can only be moved into better jobs by expanding the formal, labour-intensive manufacturing sector. Average education levels are too low for service-sector jobs, such as in information technology-enabled services and business services, to absorb the ‘demographic dividend’ — the change in the growth of India’s economy due to shifts in the age structure of its population.

Since average incomes in India’s agricultural and urban informal sectors are relatively low, they cannot provide the needed jobs. Based on data from NITI Aayog’s Three Year Action Agenda, the average agricultural income is 33–40 per cent of per capita income and the average urban informal wage is a sixth of the formal manufacturing wage. But the manufacturing sector’s share in employment has been stagnant at below 15 per cent.

A constraint on India’s manufacturing output, exports and employment is a strong belief in mercantilism — an interpretation of Indian Prime Minister Narendra Modi’s ‘Make in India’ motto. The mercantilist strategy to simultaneously pursue export promotion and import substitution is not feasible under the Lerner symmetry theorem, which states that a tax on exports can be equated to a tariff on imports.

Barriers to imports, by reducing the demand for foreign exchange, can lead to an overvalued domestic currency and make Indian exports more expensive abroad. Incentivising import substitution can also move resources away from exports and into the production of import-competing goods.

The push for import substitution has had damaging effects in many sectors. India’s rising import tariffs on electronic parts and components have hurt assembly and input processing, which was the engine of growth and employment generation in China. The 60–125 per cent tariffs on automobiles have made the industry inefficient and uncompetitive, leading to another missed opportunity in labour-intensive automobile assembly.

India’s labour laws also impose restrictions on the firing of workers by firms with more than 300 workers, the threshold having risen from the original 100 workers mainly over the last decade. The adverse effects of these laws have been shown to hold with even improved labour law indexes that take on criticisms of the Besley-Burgess index. This is especially reflected in the strong evidence on India’s use of relatively capital-intensive techniques of production. World Bank Surveys failing to find labour regulations as a top ‘business environment obstacle’ frame the question only in terms of managerial time lost due to these regulations.

There are also significant restrictions on land acquisition. The prevailing factor-market rigidities, generated by existing land and labour laws, prevent the structural change required for economic development and the creation of better jobs.

Geopolitics in the form of US–China tensions, including the trade war, along with China’s rising wages and long COVID-19 lockdowns, has presented India with an opportunity to jump onto global supply chains. Yet high input tariffs, leading to ‘tariff inversion’ — where input imports face higher tariffs than final good imports — have caused issues. But the slight reduction in tariff inversion in the last two budgets is an encouraging sign.

After its withdrawal from the Regional Comprehensive Economic Partnership, India has started signing new free trade agreements, including with Australia. The India–Australia Economic Cooperation and Trade Agreement will provide Indian manufacturers with cheaper inputs, such as raw cotton and aluminium, which are used in labour-intensive manufacturing. While it will provide a bigger market for many Indian manufacturers, they will have to compete with countries with more flexible labour markets, better infrastructure and higher education levels. This competition will create pressure on India to carry out comprehensive domestic reforms.

The recent set of labour reforms are also an encouraging development. Numerous labour regulations have been consolidated into four codes, eliminating contradictions among them. To prevent union proliferation, a union must now represent the majority of workers within a firm to be recognised. Shorter, fixed-term labour contracts and a new web portal for self-reporting of labour law compliance have also been introduced.

India’s recent labour reforms, along with the favourable geopolitical climate, suggest that it is taking steps in the right direction. Establishing Autonomous Economic Zones with more relaxed labour regulations, as proposed by Arvind Panagariya, could also be a further reform to promote employment.

Devashish Mitra is Professor of Economics and Gerald B. and Daphna Cramer Professor of Global Affairs at the Maxwell School, Syracuse University.