Using plant-level data from the Annual Survey of Industries (ASI) for the fiscal years from 1998-99 through
2007-08, this study provides plant-level cross-state/time-series evidence of the impact of employment protection
legislation (EPL) on total factor productivity (TFP) and labour productivity in India. Identification of the effect of
EPL follows from a difference-in-differences estimator inspired by Rajan and Zingales (1998) that takes advantage of
the state-level variation in labour regulation and heterogeneous industry characteristics. The fundamental
identification assumption is that EPL is more likely to restrict firms operating in industries with higher labour
intensity and/or higher sales volatility. Our results show that firms in labour intensive or more volatile industries
benefited the most from labour reforms in their states. Our point estimates indicate that, on average, firms in labour
intensive industries and in flexible labour markets have TFP residuals 14% higher than those registered for their
counterparts in states with more stringent labour laws. However, no important differences are identified among plants
in industries with low labour intensity when comparing states with high and low levels of EPL reform. Similarly, the
TFP of plants in volatile industries and in states that experienced more pro-employer reforms is 11% higher than that
of firms in volatile industries and in more restrictive states; however, the TFP residuals of plants in industries with
low labour intensity are 11% lower in high EPL reform states than in states with lower levels of EPL reform. In sum,
the evidence presented here suggests that the high labour costs and rigidities imposed through Indian federal labour
laws are lessened by labour market reforms at the state level.
