This paper presents causal evidence of the effect of local courts on the formal–informal labor divide in India’s manufacturing sector. Employing a dataset of 80 million district court trials and microdata on manufacturing establishments for the years 2010–2018, we construct a novel empirical setting. We analyze how judicial efficiency influences establishments decisions to hire formal labor. Our findings indicate that higher judicial efficiency reduces formal labor employment, particularly in larger establishments that are subject to labor laws. Further, we find that in states with worker-friendly regulations, the impact of higher judicial efficiency is more pronounced, leading to a relative decrease in marginal permanent workers hired when compared to states with employer-friendly regulations. This study contributes to understanding the interaction between legal institutions and labor laws in employment dynamics in India. While judicial efficiency is crucial, it may not alone promote labor formalization under strict job security regulations.

This paper presents causal evidence of the disruption in economic activity among manufacturing firms in India due to the 2016 Indian Demonetization—a unique monetary shock that caused a severe cash shortage nationwide. Exploiting industry variation in reliance on informal labor, we find that the smallest firms predominantly employing cash-paid temporary workers (the terms “informal workers,” “temporary workers,” “contract workers,” and “casual workers” are used interchangeably throughout this thesis. Similarly, the terms “formal workers,” “permanent workers,” and “directly hired workers” are used interchangeably throughout this thesis) experienced substantial decreases in temporary labor, wage bills, and output following demonetization. Further analysis indicates that the smallest firms in industries with higher cash reserves experienced significant adverse effects. Taken together, the findings highlight the importance of paper currency and the informal sector, particularly for small firms, demonstrating how sudden cash unavailability can disrupt the entire economy. Policies incentivizing cashless transactions could enhance economic resilience, particularly for small businesses, which are a significant part of the Indian economy.

This paper re-examines the extent of resource misallocation in developing countries by relaxing the standard assumption of unitary elasticity of substitution (\(\sigma\)) between labor and capital. We investigate the premise that developing countries typically have a \(\sigma\) lower than one, indicating a complementary rather than substitutable relationship between production inputs such as capital and labor. This complementary relationship hinders firms' ability to switch to more efficient production factors. Using the Constant Elasticity of Substitution (CES) production function, we analyze firm-level data from developing regions in Latin America, Africa, and Southeast Asia. Our findings reveal that when the elasticity of substitution (\(\sigma\)) falls below 1, there is a substantial increase in capital misallocation. Conversely, as the \(\sigma\) value increases, the extent of capital misallocation decreases, becoming less pronounced with higher values of \(\sigma\). This occurs because a low \(\sigma\) increases the dispersion of capital-labor ratios, amplifying misallocation as the marginal product of capital declines rapidly with an increasing capital-labor ratio. Moreover, since developing countries are likely to have an input substitution elasticity below one, the extent of resource misallocation may be greater than previously estimated.