Creative Destruction or Just Destruction? Effects of Floods on Manufacturing Establishments in India

Abstract

Climate change is projected to increase the frequency and severity of flooding. In this paper, I examine the direct consequences of floods on manufacturing establishments in India as well as indirect effects on the entire manufacturing sector through the sect-oral reallocation of labor. I construct a unique panel data set of flood inundations using high-precision satellite images, which I match with formal and informal sector establishment-level data. I show that floods cause a significant reduction in output, capital, and employment in formal establishments. I also document significant heterogeneity in vulnerability and resilience to floods within the formal manufacturing sector. The least-productive formal establishments are the most vulnerable to floods: a 10 percent increase in flood exposure leads to a 0.6 percentage point increased probability of exit among low-productivity firms. I do not observe any associated labor reallocation to more productive establishments, which could support the creative destruction hypothesis. Rather, I find suggestive evidence of labor reallocation to informal household-run micro-enterprises. As there is a large labor productivity gap across formal and informal sectors, I show that because of the disaster-induced labor reallocation, a 10 percent increase in the incidence of flooding causes a 17.3 percent reduction in aggregate productivity in the manufacturing sector.