The Impact of Lifting Firing Restrictions on Firms : Evidence from a State-Level LaborLaw Amendment

Stringent employment protection laws are argued to be a cause of reduced employment flexibility,slower growth and increased reliance on temporary employment contracts in many countries, including India. In 2014, theIndian state of Rajasthan amended labor laws to increase employment flexibility in firms. The most discussed of theamendments lifted the requirement for government approval for retrenching regular workers in medium-size factories.This paper first conducts a synthetic control analysis of the policy change using state-level panel data from 1980 to2018, finding no evidence of an impact on aggregate manufacturing employment and output. The paper then usesfirm-level panel data to conduct a difference-in-differences analysis of the main amendment, exploiting itssize-dependent feature for identification. This analysis finds that the amendment reduced the implicit regulatorycost of labor in firms, but there is no discernible impact on their total employment and output. The amendment also ledto firms substituting temporary (“contract”) workers for permanent workers. This collateral impact is contrary to theexpectation that easing the flexibility of permanent employment arrangements would make them more attractive to firms.