Economic Reforms, Labour Markets and Formal Sector Employment: Evidence from India

Nihar Shembavnekar

doi:10.3390/economies7020031

Abstract

Development economists generally concur that the implications of economic reform for employment are influenced by an economy’s institutional framework. This paper examines the extent to which differences in regional labour market flexibility shaped the impact of unanticipated economic reforms on employment in formal manufacturing firms in India in the 1990s, using pooled cross-sectional firm survey data. It employs a difference-in-differences strategy for this analysis and finds that, on average and ceteris paribus in the 1990–1997 period, declines in input tariffs were associated with increased employment in formal firms across all Indian states, while FDI reform was associated with increased (reduced) formal firm employment in states with flexible (inflexible) labour markets. Supporting analysis indicates that these results were underpinned, at least in part, by product market competition within the formal sector. As policy makers in developing economies increasingly emphasise increases in formal employment as a key policy objective, these findings are of general interest. They underline the relevance of market structure and geographical variation in institutional characteristics to a study of the effects of economic reform. Furthermore, this paper highlights the continuing relevance of formal sector analysis, notwithstanding the persistent primacy of informal enterprises in developing economies.

Highlights

In the latter half of the twentieth century, a number of developing economies initiated comprehensive economic reform policies
While I am unable to study firm entry and exit owing to the lack of firm level panel data, I explore the potential for extensive margin shifts by constructing industry level data on firm numbers and employment, using the survey weights provided in the firm level data for aggregation
Input tariff declines and foreign direct investment (FDI) reform, as well as final goods tariff reductions, are not associated with significant changes in industry level employment or firm numbers across all states. This suggests that the effects associated with the former two reforms in Section 5.1 may be restricted to subsets of formal firms, or to firms operating in specific industries

Summary

Introduction

In the latter half of the twentieth century, a number of developing economies initiated comprehensive economic reform policies. A number of studies, Nunn and Trefler (2014) and Ahsan (2013) being among the more recent, have documented that this impact is likely to be influenced by domestic institutions This view has received scant attention in the Indian context, in particular at a ‘micro’ or firm level. A reduction in final goods tariffs might be expected to result in a more competitive domestic product market landscape, on account of an increase in imports. This could induce domestic manufacturers to shed surplus labour in a bid to cut costs and remain competitive. In sectors where product quality is more variable, domestic manufacturers might seek to employ more labour, skilled labour, following a final goods tariff cut

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