In the third part of our series on India’s new labour reforms, Afridi and Smruti focus on the Industrial Relations Code, 2020 – in terms of its rationale, the key legislative changes that it entails, state-level implementation, and what the existing theoretical and empirical literature says about potential impacts. They contend that the Code may improve allocative efficiency by easing constraints where regulatory thresholds are binding and economies of scale matter.

India’s manufacturing sector has long been characterised by the “missing middle” problem – a dominance of small firms alongside a relative absence of mid-sized enterprises. Data from the 2023-24 Annual Survey of Industries (ASI) show that about 65% of factories have fewer than 50 employees, while only a small fraction scale beyond 100 workers (Figure 1). This skewed firm-size distribution has important implications for productivity, employment quality, and structural transformation. In most industrialised economies, firms grow through intermediate size categories, gradually benefiting from economies of scale, improved access to finance, and greater technology adoption. In contrast, firms in India remain concentrated at the lower end of the size distribution, with limited transition into medium-sized firms that can realise these gains.

One commonly cited explanation for this pattern lies in regulatory thresholds embedded in labour laws. Historically, firms employing 100 or more workers faced stricter requirements related to retrenchment and layoffs, including prior government approval. As a result, firms had strong incentives to remain just below these thresholds, even when business conditions would otherwise justify expansion. This phenomenon, often described as “bunching”, reflects strategic firm behaviour in response to regulatory discontinuities.

Figure 1. The “missing middle” in Indian manufacturing

Source: Authors’ compilation based on ASI 2023-24 Summary Statistics. 

Note: The raw data were available for the employment size 200-499 category, which has been bifurcated assuming a uniform distribution within the bin.

The Indian labour market, therefore, sits at the intersection of two competing priorities: enabling firms to grow and adapt in a rapidly changing economic environment, while ensuring adequate security and protection for workers. With the introduction of the Industrial Relations (IR) Code, 2020, policymakers have attempted to recalibrate this balance. 

Key legislative changes under the Industrial Relations Code

The IR Code, 2020 seeks to address these concerns by rationalising and consolidating existing provisions into a more unified framework, while also introducing several substantive policy changes. A key reform is the expansion of thresholds for prior government approval for layoffs, retrenchment, and closure, which has been raised from 100 to 300 workers. This change is intended to provide firms with greater operational flexibility and reduce regulatory frictions associated with scaling up employment.

The Code also introduces Fixed-Term Employment (FTE) as a formal category of hiring. Under this provision, firms can employ workers for specified durations while ensuring parity in wages and statutory benefits – including social security and pro rata gratuity – with those of permanent employees. This is designed to increase hiring flexibility while maintaining a baseline level of worker protection.

From an ease-of-doing-business perspective, the Code significantly simplifies compliance requirements. The number of rules has been reduced from 105 to 51, and the number of prescribed forms from 37 to 18. In addition, firms employing fewer than 300 workers are exempted from the requirement of certifying employment conditions through standing orders, thereby reducing procedural obligations for a large segment of enterprises.

On the industrial relations front, the Code introduces the concept of a “Negotiating Union” or “Negotiating Council” as a single bargaining agent, intending to reduce inter-union rivalry and lower transaction costs in collective bargaining. In the area of dispute resolution, it establishes a unified Industrial Tribunal, replacing multiple adjudicating bodies and allowing workers to approach the Tribunal directly after the failure of conciliation proceedings.

Finally, the reforms incorporate transitional safeguards through the creation of a Worker Re-skilling Fund, under which employers are required to contribute an amount equivalent to 15 days’ wages of retrenched workers. This provision is intended to support retraining and facilitate smoother labour market adjustment in the event of job losses.

State-level implementation

However, the effectiveness of such reforms depends not only on legislative change but also on how firms and states respond in practice. Labour regulation in India is deeply heterogeneous, with significant variation in enforcement capacity and administrative interpretation across states. As a result, the impact of the reforms is likely to be uneven, both across regions and across sectors.

This variation is already evident in the pace of implementation of the IR Code across states (Figure 2). States can be broadly categorised based on their progress in notifying rules under the Code. Early adopters – such as Bihar, Gujarat, and Karnataka – had notified the rules by 2021. A second group of states, including Tamil Nadu and Delhi, followed later, with notifications issued between 2022 and 2025. In contrast, West Bengal, has yet to notify the rules, reflecting continued divergence in the operationalisation of the reform framework.

Figure 2. State-wise adoption of rules under the IR Code

Source: Authors’ compilation based on state government gazette notifications issued by state labour departments.

Notes: Where both draft and final rules were notified, the year of the first notification is reported. As of April 2026, final rules have been notified by Arunachal Pradesh and Gujarat.

‍Literature review

The industrial relations code is expected to increase employment and productivity at the intensive margin by reducing compliance costs, enabling faster dispute resolution, strengthening collective bargaining mechanisms, and improving allocation efficiency. However, gains at the extensive margin remain uncertain and depend critically on how binding the expanded regulatory thresholds are, the intensity of implementation, and prevailing market conditions. Hence, the overall magnitude of impact may be constrained without complementary policies that enable smaller firms, especially those below the 100-worker level, to expand.  

Potential impact on employment 

Theoretically, the impact of the IR Code on employment varies depending on firm behaviour and the structural characteristics of the labour market

Table 1. Theoretical impact of the IR Code on employment

‍Source: Authors’ compilation.

Empirically, the impact in India is likely to be positive with downside risks. The 1982 tightening of firing restrictions reduced manufacturing employment by 27% (Kotia et al. 2025), suggesting that easing such constraints under the new Code may support employment gains by lowering barriers to expansion. At the same time, more recent evaluations of the 2014 Rajasthan deregulation, where the threshold for retrenchment was expanded, found that firms utilised increased flexibility primarily to shed surplus labour, resulting in a 3% decline in total employment within existing plants (Goswami and Paul 2021), reflecting transitional reallocation as firms adjusted to greater flexibility.

Beyond market structure, the employment impact of the IR Code in India depends on several key factors:

Binding of thresholds: The reform’s immediate benefits may be concentrated in states with high shares of mid-sized firms; for instance, Bihar and Tripura have 20-24% of firms in the 50-99 worker band, while Andhra Pradesh has only 4-6%. (Figure 3)

Figure 3. Factories in operation with 50 to 99 workers for each state/UT

Source: ASI 2023-24, Summary Statistics; Authors’ compilation.

Judicial mediation: The impact of labour laws depends heavily on enforcement and interpretation; research suggests firms in states with pro-worker judicial regimes employ roughly 9% fewer workers than those in pro-employer states (Sofi et al. 2022).

Complementary reforms: Gains are more likely when labour reforms are synchronised with broader market-friendly measures, such as industrial delicensing, which creates the growth opportunities necessary for firm expansion (Aghion et al. 2008).

Potential impact on productivity

The impact of the IR Code on productivity is primarily mediated through changes in allocative efficiency and incentives for human capital investment

Table 2. Theoretical impact of the IR Code on productivity

Source: Authors’ compilation. 

Empirically, the IR code may have a positive impact on productivity. Greater flexibility improves firm selection and allocative efficiency. More recent evidence points in the same direction. Evaluations of Rajasthan’s 2014 deregulatory reforms – closely aligned with the logic of the new Code – find an increase of about 3% in both total factor productivity (TFP) and value added among affected plants (Goswami and Paul 2021). 

Beyond allocative efficiencies and skill formation, the productivity impact of the IR Code in India depends heavily on the composition of the workforce and ultimately worker effort:

The introduction of FTE under the IR Code represents a strategic attempt to create a hybrid employment category that balances firm flexibility with worker protection (Table 3).

Table 3. Comparison of employment contracts under the IR Code, 2020

‍Source: Authors’ compilation.

While permanent employment continues to build essential institutional knowledge and skills, its high separation costs have historically created rigidities that misallocate labour. Conversely, contract labour maximises flexibility but often constrains productivity because workers hired through intermediaries typically receive minimal training and show lower task efficiency. FTE addresses these gaps by ensuring parity in wages and benefits with permanent employees. There can be a possible increase in productivity through improved worker effort and better matching of labour to specific firm needs.

Ultimately, the net impact on productivity will depend on labour composition adjustments. If firms shift from informal contract labour to formal FTE, productivity is likely to rise. However, if FTE primarily replaces permanent roles, long-term productivity may be hampered by weaker incentives for broader skill development.

Summary of potential impact

The Industrial Relations Code, 2020 is a structural reform aimed at simplifying India’s fragmented industrial relations framework to support firm growth while maintaining worker protections. Based on theory and evidence, it may improve allocative efficiency by easing constraints where regulatory thresholds are binding and economies of scale matter. Regulatory uncertainty is also expected to decline with the consolidation of multiple statutes into a unified framework.

The impact on employment may be positive, with dampening associated with adjustment effects. Raising the retrenchment threshold from 100 to 300 workers may reduce incentives for firms to “bunch” below regulatory cut-offs. However, constraints from the existing firm-size distribution mean that stronger gains may require complementary reforms to fully unlock scaling effects.

Labour productivity is expected to improve through greater flexibility and the introduction of FTE, which may strengthen effort incentives and improve worker–firm matching, though outcomes depend on how employment structures adjust in practice.

Overall, the impact will depend on implementation and complementary reforms, which will determine whether India can move beyond the “missing middle” constraint and support sustained firm scaling.

The views expressed in this post are solely those of the author and do not necessarily reflect those of the I4I Editorial Board.