Endogenous Employment Protection and Total Factor Productivity: Plant‐Level Evidence From India

This study examines the impact of court‐enforced employment protection (EP) on total factor productivity (TFP) in India's formal manufacturing sector. Using high‐court judgments on labour disputes citing Chapters 5A and 5B of the Industrial Disputes Act, 1947, the study quantifies the extent of judicial enforcement of employment protection legislations (EPL) across states. Employing plant‐level unbalanced panel data (1999–2018) and addressing endogeneity through instrumental variable (IV) estimation using lawyer density, I find that EP negatively affects TFP, particularly in medium or large enterprises. However, my threshold regression analysis reveals that this negative effect emerges only when the de‐facto EP exceeds a certain level; below this threshold, it is positively correlated with TFP. These findings are further reinforced by the results of a quadratic regression model, which reveals an inverted U‐shaped relationship between EP and TFP. The results of the study remain robust across alternative model specifications and the inclusion of control variables, underscoring the need for a balanced approach to labour flexibility and job security.