We have four new labour codes but also need the safety net of job-loss insurance

But for the Codes to deliver on that promise, they should be accompanied by a reform that has been conspicuously absent from the conversation: a properly designed, state-sponsored unemployment insurance system. Without it, the Codes will continue to impose costs on the wrong parties, distort company behaviour and leave workers exposed to financial precarity in every business-cycle downturn.

Most developed market economies have long understood this. Insurance cover for joblessness is seen as a standard feature of the labour market—not as charity, but as a mechanism for helping workers weather temporary job losses. The logic is economic.

When workers lose jobs for no fault of their own—say, because of a recession, a sectoral contraction or a firm-level restructuring— the ability to maintain consumption while searching for a new role keeps skills from atrophying and prevents people from being pushed into the first available job rather than the best-matched one.

Why must the state provide this rather than private insurers? The answer lies in two problems of information asymmetry. First, adverse selection: workers most likely to face unemployment are those most eager to buy coverage, making private insurance financially unviable. Second, moral hazard: such coverage may reduce the urgency with which the laid off seek re-employment.

Together, these are market failures. The state, which can mandate participation and spread risk across the entire workforce, is the only institution structurally capable of insuring workers efficiently.

India’s Employee State Insurance (ESI) scheme is ineffective. Applicable to firms with ten or more workers, it mandates contributions from both employers and employees.

The intention is reasonable, but the design is not. By tying the cost of social protection directly to a firm’s hiring decision, the ESI creates a powerful disincentive for growth.

Firms nearing the ESI threshold have an incentive to stay below it, restructure contracts or to rely on informal hires designed to avoid this liability. The result is a system that has failed to provide adequate coverage while making formal labour more expensive to hire. The new Labour Codes were an opportunity to break this pattern, but it was largely left untaken.

A better model exists— in two distinct forms—in developed economies. Unemployment insurance in the US emerged as a federal-state response to the mass layoffs of the Great Depression. The system that evolved is marked by modest replacement rates and benefits that fade away fairly quickly, preserving incentives for beneficiaries to find jobs.

In contrast, West European economies have generous replacement rates, sometimes exceeding 60% or 70% of previous earnings, sustained over considerably longer periods.

There are lessons in the outcomes of these contrasting designs. European unemployment insurance, while far more protective of worker consumption, has historically been associated with higher unemployment rates and longer durations of joblessness. Given a big cushion, the urgency of accepting a new job diminishes.

American-style insurance, leaner and shorter, produces more dynamic labour markets with faster transitions back to employment, though it offers workers less of a buffer. The big lesson is not that one system is superior, but that the trade-off between generosity and labour market dynamism can be calibrated through careful design.

For India, with its vast informal sector and fast formalizing workforce, the right balance is a time-bound, contributory scheme that prevents distress without blunting the incentive to find work.

To design such a scheme well, however, we must confront an uncomfortable truth about Indian federalism. Unemployment insurance must be a joint responsibility of the Centre and states, and the Centre cannot be permitted to offload its obligations as it has done before.

The redesign of MNREGA offers a cautionary tale; its fiscal and administrative burdens were progressively shifted onto states ill-equipped to bear them. This must not happen to job-loss insurance.

With rival political coalitions often in charge at the state and central levels, the temptation to delay transfers, underfund schemes or use fiscal levers against opposition-ruled states is well-documented. Insurance coverage fragmented along these fault lines would be uneven in coverage and unreliable in delivery.

Getting the institutional architecture right—clear fiscal commitments, ring-fenced funding and arm’s-length administration—could make all the difference.

Economic theory is unambiguous. Unemployment insurance coverage is the responsibility of the state, not of individual firms. The moment we tie social protection to an job contract, we create distortions that undermine the very labour market flexibility the new Codes are meant to produce.

India’s four Labour Codes offer a legislative framework with high potential. But the sooner we add a well-designed unemployment insurance system to that framework— one informed by economic logic, international evidence and a clear grasp of Indian federal realities—the more likely it would deliver a dynamic, inclusive and better rewarding labour market.

The author is professor of economics at SRM University.