Does a declining unemployment rate suggest economic recovery? Look closer

According to the annual Periodic Labour Force Survey (PLFS) report for 2020-21 (year-ending June 2021), India’s unemployment rate (for 15-59 years age group, defined as the number of unemployed persons over labour force) declined to 4.6 percent — the lowest in the past four years since the annual PLFS began.

Further, the labour force participation ratio (LFPR, defined as the sum of employed and unemployed persons to total population) increased to 58.4 percent in 2020-21 from 53 percent in 2017-18, same as in 2011-12. More people looking for work (i.e. entering the labour force) and falling unemployment rate signify healthy labour demand.

In any developed/advanced economy, this combination of higher LFPR and lower unemployment rate is a sign of tightening labour market, generally associated with strong economic recovery. For a low per capita income economy such as India, however, the unemployment rate does not hold too much significance, and rising LFPR may ironically indicate weak labour market.

Sir William Arthur Lewis introduced the dual sector model, or the Lewis Model, in his influential article titled ‘Economic development with unlimited supplies of labour’ in 1954. He discussed the co-existence of ‘capitalist’ (or organised) and ‘subsistence’ (or unorganised) sectors in under-developed economies. The existence of a relatively large unorganised sector provides an opportunity for almost anyone to be ‘employed’.

However, the related under-employment (or disguised) means that not only is the output growth negligible with such labour use, but the wage growth is also limited. For sure, though, it helps achieve the dual objective of a rise in LFPR (led by an expansion in unorganised workforce), and a fall in the unemployment rate (as the rise in labour force does not lead to higher unemployment).

In simple words, a low income economy with a large working-age population, and a substantial unorganised sector can witness a combination of higher LFPR and lower unemployment rate because people enter the labour force as employed. Since the unorganised sector has almost unlimited appetite to absorb excess labour without any output or wage gains, such factors are at play primarily during the slowdowns.

Notwithstanding the worst post-Independence contraction of 6.6 percent in real GDP in FY21, the rise in LFPR and worker-population ratio (WPR for 15 years+ population) to 52.6 percent in 2020-21 is definitely surprising. However, the details confirm the existence of the ‘Lewis Model’ characteristics in India. There are four key facts to be noted:

• Although the WPR increased in 2020-21, the maximum rise was among the illiterate population, and there was a decline or stagnancy in the most-educated group (post-graduate and above). The WPR among the illiterate group increased to 53.6 percent (from 45.2 percent in 2018-19), while it was stable at 59.5 percent among the highest-education population.
• More than 80 percent of the rise in employment was led by agricultural workers in 2020-21. The share of agriculture, which is already massively over-employed, increased to 46.4 percent in total employment in 2020-21, from 42.5 percent in 2018-19. The share of the manufacturing and services sectors declined.
• The number of workers engaged in the informal sector in non-agricultural activities increased further to 71.4 percent in 2020-21, from 69.5 percent in the previous year.
• Like in 2019-20, the share of self-employed workers increased, while the share of regular wage/salaried workers declined in 2020-21. Self-employed workers (also termed as the vulnerable employment) accounted for 55.6 percent of total employment in 2020-21, up from 52.1 percent in 2018-19 — the highest in more than a decade.

Agriculture and construction, thus, play the role of ‘subsistence’ sectors in India. With a real GDP growth of just 3.7 percent in FY20, and a contraction of 6.6 percent in FY21, India’s total employment grew 8 percent and 4.4 percent, respectively, during the two years, much higher than up to 3 percent annual growth during the past four decades. However, employment in the subsistence sectors increased disproportionately — up 13.9 percent in 2019-20 and 7.4 percent in 2020-21, compared with a range of -1.7 percent to +2.3 percent YoY during the previous four decades. The employment in the non-agricultural non-construction sectors, on the other hand, grew 1.8 percent in 2020-21, slower than 3.1 percent in 2019-20, and compared to the range of 0.8 percent to 5.8 percent in the past four decades.

This is not the first time it has happened. The same combination of higher LFPR and falling unemployment rate was witnessed during the turn of the 21st century. Between 1999-00 and 2004-05, India’s LFPR (for 15-59 years group) increased to 66.6 percent from 64.6 percent, though the unemployment rate was unchanged at 2.4 percent. The share of self-employed workers increased, while the share of organised sector (based on the number of workers employed by a firm) declined during the period. This was in stark contrast to the trends noticed in the prior (1993-94 and 1999-00), and the latter (2004-05 to 2009-10) periods.

Overall, with weakening growth, disguised employment tends to rise in a low-income country such as India, pushing the LFPR higher and unemployment rate lower. It is, therefore, wise to make conclusions based on the internals of the labour market, rather than the headline data. Besides, the details suggest that the economic recovery remains weak in India.

Views are personal and do not represent the stand of this publication.