Firing Costs and Flexibility: Evidence from Firms' Employment Responses to Shocks in India

43 Pages Posted: 3 Jan 2012

See all articles by Achyuta R. Adhvaryu

Achyuta R. Adhvaryu

University of Michigan, Stephen M. Ross School of Business; Yale University Department of Economics

A.V. Chari

University of Sussex - School of Business, Management and Economics

Siddharth Sharma

The World Bank

Date Written: August 3, 2011

Abstract

A key prediction of models of dynamic labor demand is that restrictions on firing attenuate firms’ employment responses to economic fluctuations. The authors provide the first direct empirical test of this prediction using data on industrial firms in India. They exploit the fact that fluctuation in rainfall within districts, through its effects on agricultural productivity, generates variation in local demand and local labor supply. Using a measure of labor regulation strictness, they compare factories’ input and output responses to these shocks in pro-worker and pro-employer districts. Their results confirm the theory’s predictions: industrial employment is more sensitive to shocks in areas where labor regulations are less restrictive. They verify that their results are robust to controlling for endogenous firm placement and vary across factory size in the pattern predicted by the institutional features of labor laws in India. However, their results also indicate that the inability to adjust employment does not significantly appear to affect firm profits, suggesting that firms may be adjusting along other (unobservable) margins.

Suggested Citation

Adhvaryu, Achyuta R. and Chari, Amalavoyal and Sharma, Siddharth, Firing Costs and Flexibility: Evidence from Firms' Employment Responses to Shocks in India (August 3, 2011). RAND Working Paper Series No. WR-901, Available at SSRN: https://ssrn.com/abstract=1978961 or http://dx.doi.org/10.2139/ssrn.1978961

Achyuta R. Adhvaryu (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

Yale University Department of Economics ( email )

28 Hillhouse Ave
New Haven, CT 06520-8269
United States

HOME PAGE: http://pantheon.yale.edu/~ara29

Amalavoyal Chari

University of Sussex - School of Business, Management and Economics ( email )

Falmer, Brighton BN1 9SL
United Kingdom

Siddharth Sharma

The World Bank ( email )

2121 Pennsylvania Avenue, NW
Washington, DC 20433
United States

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