Labour Laws and Informalisation of Employment: Panel Evidences from Indian Formal Manufacturing Sector

Labour law is widely being cited as one of the principal factors creating rigidities in industrial business and, thereby, holding back productivity growth and employment generation. However, a substantial chunk of literature disputes the “rigidity argument” on the ground that there has been a sharp growth in informal employment, which is often considered as flexible labor input as it does not fall under the purview of what is believed to be directly related with rigidity – employment protection legislation (EPL). However, given empirical evidence showing that informal worker is less productive as compared to its formal (regular) counterpart, the question arises: what motivates the employer to employ less productive worker? Using three-dimensional panel data on 28 industrial sectors between 1999–2000 and 2007–2008 across 13 states of India, our results show that the incidence of informal employment is directly linked with EPL, volatility, and labor bargaining power. We utilize instrumental variable two stage least square (IV 2SLS) to overcome the endogeneity issues. The results are robust.