Labour market rigidity and total factor productivity: a re-examination of the evidence from India

ABSTRACT The existing empirical studies concerning labour market rigidity associated with the labour laws in India suggest an adverse impact of rigidity on total factor productivity (TFP). In this paper, we improve upon both the measurement of spatiotemporal variation in labour market flexibility and plant-level TFP from production function estimates in the presence of institutional rigidity in labour inputs adjustment due to job security legislation based on the recent advancement in the literature. We use an unbalanced panel of manufacturing plants from the Annual Survey of Industries panel data from 1999–2000 to 2016–17 to analyse the relationship between labour market rigidity/flexibility and TFP. We find that establishments that fall under the purview of job security legislation have higher productivity than those outside the ambit of job security legislation. The results suggest that rigidity associated with job security provisions does not harm TFP, and higher flexibility is negatively associated with TFP. However, we find considerable heterogeneity in the flexibility–TFP relationship across various industry groups. The heterogeneity in the flexibility–TFP relationship suggests that flexibility-inducing labour policy may improve TFP in some industries and, at the same time, decrease it in others.