Labor protection laws and the drain on productivity: Evidence from India

Employment protection legislation (EPL) is designed to promote security for workers by placing restrictions on firing, but it generates unintended consequences. With India as a setting, I argue that EPL shifts jobs from younger to older workers in two ways: by discouraging the hiring of unproven young workers and by preventing the firing of low-productivity workers. The identification strategy is motivated by Rajan and Zingales (1998): I assume that EPL is more binding in those manufacturing sectors where the involuntary separation rate in other countries is high. The data show that older workers are more likely to have formal jobs, and the effect is strongest in high-firing sectors, which indicates EPL shifts jobs from young to old. Additionally, EPL reduces plant-level total productivity (TFP), and this effect is seen only in plants which are large enough to fall within the purview of EPL, which provides a useful placebo test.