Tariff Liberalisation, Labour Market Flexibility and Employment: Evidence from India

While it can be hypothesised that domestic labour market characteristics influence the impact of trade liberalisation, the evidence base in this context is thin. This paper examines the extent to which differences in regional labour market flexibility shaped the impact of tariff liberalisation on employment in both formal and informal manufacturing firms in India in the 1990s. Controlling for other reforms undertaken in the same period, and for a range of firm, industry and state characteristics, the analysis finds appreciable links between tariff liberalisation and firm level employment. Declines in downstream and input tariffs are found to be of particular significance relative to reductions in final goods tariffs. Ceteris paribus, following tariff liberalisation, employment in the average formal firm increased by 9 per cent in states with relatively flexible labour markets in the 1985-2004 period, but declined by up to 17 per cent in states with less flexible labour markets. In the same period, in association with the tariff declines, average informal firm level employment fell by close to 36 per cent in states with flexible labour markets, while no statistically significant corresponding change was registered in states with inflexible labour markets. The results suggest that a consideration of forward and backward linkages should be integral to any analysis of the firm level effects of trade reform.