“ Measuring the Effects of Trade reforms on Informality : Evidence from India”

Abstract : This paper estimates the effects of trade liberalization on informality in India. We use representative survey data on formal firms, informal firms, and workers over the period 1990-2010. We adopt a difference-in-differences methodology and exploit exogenous import and input tariff variation. We first aggregate the firm-level data at the industry-state level and show that trade reallocates employment between formal and informal sectors through changes in firms’ labor demand. We then use detailed worker-level data to validate our results, using a within-industry analysis and a local labor markets approach. For both firms and workers, our results show the ambiguous effect of trade liberalization on informality status : import tariff reductions are associated to greater informality levels because of increased import competition, but input-trade liberalization formalizes the economy through access to better foreign inputs. In our baseline specification for workers, using a reduction in tariffs of 20pp over the period 1999-2010, import tariff cuts increase the probability of being informal by 3.1%, but input tariff reductions decrease it by 7.3%. Our results are robust to alternative definitions of informality, and we also investigate the heterogeneous effects of trade policy (by location and labor market regulations regime).