Import Competition, Formalization, and the Role of Contract Labor

The debate on the effects of import competition on sectoral composition of employment remains unsettled. Using the case of the Indian manufacturing sector and exploiting plausibly exogenous variation from Chinese imports, we provide the first causal evidence that higher import competition increases the share of the formal sector employment. We nd an increase in the level of formal sector employment, driven by firms in the top 50% of the productivity distribution, and in contrast, a fall in the informal sector employment. This labor reallocation from informal to formal enterprises is enabled by the usage of contract workers, who do not carry stringent ring costs and are usually not covered by trade unions. Our estimates imply that Chinese import competition led to an increase in the share of formal sector employment by 3.9 percentage points between 2000-2001 and 2005-2006, which suggests an increase in aggregate labor productivity by 3.28%. Our results are robust to an instrumental variables estimation, and controlling for a host of other potential trade channels and worker characteristics.