Entry regulation, labor laws, and informality

This paper examines how industrial entry regulation and labor laws affect informality, using district-level panel data on informal manufacturing enterprises in India. A major policy reform in 1991 removed license controls on the setup and expansion of factories in several industries. Variation in the pre-reform size of deregulated industries across districts within states, and in labor laws across states allow for a differences in differences approach to measuring how the impact of this reform on informality depended on labor regulation. The paper finds that following this reform, the informal sector contracted to a greater extent in states with more flexible labor laws. The associated increase in value added per worker in manufacturing too was larger in these states. These findings suggest that entry deregulation can lead to productivity-enhancing labor reallocation from the informal to the formal sector, if labor laws are flexible. ∗I am grateful to Mark Rosenzweig, Rohini Pande, Christopher Udry, Simeon Djankov, David Kaplan,