Firing costs and flexibility: evidence from firms’ employment responses to shocks in India

A key prediction of dynamic labor demand models is that ?ring restrictions attenuate ?rms’ employment responses to economic ?uctuations. We provide the ?rst direct test of this prediction using data from India. We exploit the fact that rainfall ?uctuations, through their effects on agricultural productivity, generate variation in local demand within districts over time. Consistent with the theory, we ?nd that industrial employment is more sensitive to shocks where labor regulation is less restrictive. Our results are robust to controlling for endogenous ?rm placement and vary across factory size in a pattern consistent with institutional features of Indian labor law.