1

Trade liberalization and labor's slice of the pie: Evidence fromIndian rms
Reshad N. Ahsan
a,
, Devashish Mitra
b,c,d
a
Department of Economics, University of Melbourne, Level 3, FBE Building, 3010 Victoria, Australia
b
Department of Economics, The Maxwell School, Syracuse University, Eggers Hall, Syracuse, NY 13244, United States
c
IZA, Germany
d
CESifo, Germany
a b s t r a c t a r t i c l e i n f o
Article history:
Received 19 July 2012
Received in revised form 30 October 2013
Accepted 31 December 2013
Available online 14 January 2014
Keywords:
Trade reforms
Bargaining power of workers
Labor share
Markups
India
Firm-level data
We examine the impact of trade reforms initiated in 1991 on labor's share in revenue among a sample of Indian
rms. Theoretically, trade reforms will affect this share by reducing rm-level pricecost markups as well as the
bargaining power of workers. A simple model suggests that these changes can have ambiguous effects on rm-
level labor share and that the net effect of trade reforms will depend on the labor intensity of production. Using
rm-level data fromIndia, our empirical results suggest that trade liberalization led to anincrease inlabor's share
in revenue for small, labor-intensive rms but a reduction in this share in the case of larger, less labor-intensive
rms. These results are robust to controlling for alternative sources of heterogeneity and to the use of long-lagged
tariffs as instruments. We also nd that trade liberalization, onaverage, ledtoa decline inthe bargaining power of
workers.
2014 Elsevier B.V. All rights reserved.
1. Introduction
During the latter half of the 20th century, a stable labor share of na-
tional income was considered an empirical regularity. However, in re-
cent years this perceived stability has been challenged. For example,
ILO (2011) shows that, since the early 1990s, the labor share of national
income has declined in three-quarters of the 69 countries in their sam-
ple. This decline has been particularly pronounced in developing coun-
tries. Similarly, Karabarbounis and Neiman (2013) nd that the labor
share of corporate value added has declined for 38 out of the 56 coun-
tries in their sample. They nd that this decline is due mainly to
within-industry changes rather than between-industry changes in
labor share. These ndings raise the possibility that the declining labor
share of national income is an important cause of rising inequality in re-
cent years (Atkinson, 2009).
1
One of the perceived causes of this declining labor share is interna-
tional trade. As Rodrik (1997) has pointed out, international trade
makes domestic workers more substitutable and therefore lowers
their bargaining power. This is because trade allows rms to shift pro-
duction overseas and allows consumers to substitute away from
domestically-made products and towards imported ones. All else
equal, both of these factors will lower the bargaining power of workers
as well as their share of income relative to other factors of production.
2
However, the focus of the trade and inequality literature in recent years
has been on explaining the rising gap between skilled and unskilled
wages.
3
As a result, relatively little is known about how trade affects
labor's share of income. This is important because, to the extent that a
declining labor share is a key cause of rising inequality, studies that ex-
amine the effect of trade on the wage gap between skilled and unskilled
workers provide us with an incomplete picture of the relationship be-
tween trade and inequality.
In this paper, we add to the literature on trade and inequality by em-
pirically examining the impact of a major trade reform on labor's share
Journal of Development Economics 108 (2014) 116
We thank the editor, Nina Pavcnik, and two anonymous referees for their excellent
comments and suggestions on an earlier draft. We also thank seminar/conference partic-
ipants at Deakin University, Monash UniversityCauleld, Ryerson University, the
University of Adelaide, the University of Arkansas, the University of Melbourne, the
University of New South Wales, the University of Western Australia, the University of
Wollongong, York University, the Australasian Development Economics Workshop and
the UIBESyracuse Conference on Firm Responses to Trade Reforms held in Beijing for
useful comments, suggestions and discussions. The standard disclaimer applies.
Corresponding author.
E-mail addresses: rahsan@unimelb.edu.au (R.N. Ahsan), dmitra@maxwell.syr.edu
(D. Mitra).
1
Infact, Jacobsonand Occhino (2012) ndthat for every percentage point decline inthe
labor share in the U.S., the Gini index increases by up to 0.33 percentage points. This has
resulted in up to a 2.5 percentage point increase in the Gini coefcient attributable to
the labor share decline over the period 19802010, which is very close to the US
Congressional Budget Ofce's estimate of 2.3 percentage points for the period 19702007.
2
Given that the labor share has declined in both relatively labor-abundant as well as
relatively capital-abundant countries alike and the fact that this decline is driven mainly
by within-industry changes suggests that the StolperSamuelson channel has probably
not played a key role in this decline.
3
Kumar and Mishra (2008), using National Sample Survey labor force data, have shown
that trade reforms in India have led to a decline in wage inequality. On the other hand,
Feenstra and Hanson (1997a,b), using data for Mexico for the period 19751988, nd that
wage inequality has gone up as a result of trade. Similarly, Attanasio et al. (2003) nd a
small increase in wage inequality after the trade reforms in Colombia. Finally, Blom et al.
(2004) nd no signicant impact of trade liberalization on wage inequality in Brazil. See
Goldberg and Pavcnik (2007) for a very comprehensive and in-depth survey of the litera-
ture on the impact of trade on inequality.
0304-3878/$ see front matter 2014 Elsevier B.V. All rights reserved.
http://dx.doi.org/10.1016/j.jdeveco.2013.12.011
Contents lists available at ScienceDirect
Journal of Development Economics
j our nal homepage: www. el sevi er . com/ l ocat e/ devec
of rm revenue among a sample of Indian rms. Unlike the previous lit-
erature, our data allows us to identify the presence of signicant rm-
level heterogeneity. In particular, we nd that while labor's share of
rm revenue increased due to tariff cuts for labor-intensive rms, this
share declined due to tariff cuts for less labor-intensive rms. We consid-
er the identication of these robust, heterogeneous trends in labor share
in total revenue to be a key contribution of this paper. Asecond contribu-
tion of our paper is that we exploit an exogenous episode of trade liber-
alization. In particular, we exploit the fact that the Indian trade
liberalization of 1991 was enacted at the urging of the International
Monetary Fund(IMF) andcame as a surprise to many withinthe country.
This allows us to identify the causal effect of trade on labor share.
To explain the heterogeneous effect of trade liberalization on labor's
share of rm revenue, we develop a simple model where a rm and a
labor union negotiate over wages and employment. Our model is an ex-
tension of Brock and Dobbelaere (2006) and McDonald and Solow
(1981). In particular, we introduce imperfect competition in the product
market by assuming that rms have some monopoly power. We also as-
sume that the increased competition due to trade liberalization lowers a
rm's monopoly power, i.e. it lowers the pricecost markup charged by
rms. We show that this markup channel can have heterogeneous ef-
fects on labor's share in rm revenue.
4
This is because, in our model,
lower markups affect wages in two ways. First, the markup reduction
due to trade narrows the wedge between the marginal revenue product
(MRP) and the value of the marginal product (VMP). In other words, in-
creased competition due to trade lowers the wedge between labor pro-
ductivity and the wage received by workers. All else equal, this will
lead to an increase in labor's share of rm revenue. On the other hand,
lower markups due to trade also reduce the rents (as a share of rmrev-
enue) that are available for bargaining between the rm and the labor
union. All else equal, this will lower labor's share of rm revenue. Our
model suggests that the labor-share increasing effect of lower markups
is more likely for a labor-intensive rm. This is because, holding all else
equal, workers in a labor-intensive rm receive a higher fraction of
their wages through their MRP relative to their share in rms' rents. On
the other hand, for less labor-intensive rms, our model predicts that
trade liberalization will lower labor's share of total revenue.
To test these predictions, we use a panel dataset of publicly-traded
Indian rms that cover the period 19892004. Our empirical strategy
examines whether changes in industry-level tariffs due to India's exter-
nally imposed trade liberalization of 1991 has heterogeneous effects on
rms depending on their labor intensities. Our results suggest that trade
liberalization raises labor's share of rm revenue for labor-intensive
rms and lowers this share for less-labor intensive rms. Thus, an im-
portant implication of our results is that while it is informative to exam-
ine changes in aggregate labor share, such aggregate changes likely
mask a great deal of heterogeneity. Our results are robust to controlling
for alternative sources of heterogeneity (e.g. heterogeneous technolog-
ical upgrading); using alternate measures of labor share and trade pro-
tection; and to the use of long-lagged tariffs as instruments. Lastly, we
use our framework to examine the relationship between trade liberali-
zation and industry-level estimates of workers' bargaining power. Our
results indicate that, on average, industries that experienced greater de-
creases in output tariffs also experienced greater decreases in the
bargaining power of workers.
A key feature of our analysis is the focus on changes in labor shares
rather than changes in absolute real wages. This is important because
changes in labor shares are not necessarily equivalent to (or even posi-
tively correlated with) changes in absolute wages. For example,
Bentolila and Saint-Paul (2003) show that France experienced both
one of the sharpest declines in the labor share as well as a large increase
in the average real wage during the period 19701990. Thus, studying
the impact of trade on the absolute wages does not necessarily tell us
much about how the labor share will be impacted. Having said that, if
it is the case that trade raises both absolute wages and employment,
does it matter howit affects labor shares? As Atkinson(2009) has point-
ed out, a decline inthe labor share is associated with an increase inover-
all inequality. Further, he argues that the size of the labor share also
shows howrms are sharing their prots with workers and is therefore
associated with concerns about social justice and fairness. Thus, exam-
ining the relationship between trade and labor share provides insights
about inequality that cannot be obtained by just studying the impact
of trade on absolute wages and employment.
The results of this paper are related to a small cross-country litera-
ture examining the relationship between trade and labor share of na-
tional income. A key contribution to this literature is Harrison (2005)
who uses a panel of over a hundred countries for the period 1960
2000 to examine the impact of trade on labor share. She nds that anin-
crease in globalization, as reected in anincrease in the share of trade in
national income and a loosening of capital controls, is associated with a
decline in labor's share in national income. A similar conclusion has
been arrived at by Guscina (2006) whose study focuses on just OECD
countries over the same period 19602000.
The results of this paper are also related to the broader literature on
the impact of trade liberalization of the bargaining power of workers.
This literature can be classied into three broad categories. The rst cat-
egory includes studies that rely on an indirect approach that examines
the effect of trade on labor-demand elasticities, which is then used to
infer the effect of trade on bargaining power. The evidence here is some-
what inconclusive. For example, using four-digit industry-level data
from the US, Slaughter (2001) found very mixed evidence that trade in-
creases labor-demand elasticity. Using plant-level data from Turkey,
Krishna et al.'s (2001) ndings support this view. However, Hasan et al.
(2007), using two-digit industry-level data at the state level from India
found evidence to suggest that trade liberalization raises labor-demand
elasticities.
5,6
There are also more formal and direct tests of the effect
of trade on the bargaining power of workers. For example, Brock and
Dobbelaere (2006) use Belgian rm-level data to estimate an industry-
specic measure of bargaining. Their results do not indicate a signicant
negative relationship between trade and the bargaining power of
workers. Similarly, Arbache (2004) uses data fromBrazil during their pe-
riod of trade liberalization in the 1990s and nds that there is no signif-
icant effect of trade on bargaining power. On the other hand, Dumont
et al. (2006) use data fromve EU countries and conclude that trade lib-
eralization does lead to a decline in the bargaining power of workers.
Lastly, our paper is related to a literature that empirically examines
the relationship between trade liberalization and unionization and
union wages. For example, Gaston and Treer (1995) use U.S. data to
examine the relationship between trade and union wages. They nd
that lower tariffs are associated with higher union wages. However,
this result does not holdwhenthey use other measures of trade (e.g. im-
port and export volume). Similarly, Bastos et al. (2010) examine the im-
pact of product market competition on union wages in the U.K. They
4
Our model also allows trade liberalization to affect labor's share in rm revenue by
lowering the bargaining power of workers. However, this effect is homogenous across
rms and therefore does not explainthe heterogeneity we observe inthe data. We discuss
this bargaining power channel in greater detail in Section 2.2.
5
Hasan et al. (2007) also carry out a rough test of the relationship between trade liber-
alization and labor's share of revenue. Using industry-level data from India, they nd that
the wage bill as a share of output was 21% lower inthe period post reform, while the wage
bill as a share of value added was 19% lower in the period after 1991. Since their work was
based on industry-level data, it is difcult to use their results to disentangle rm-level re-
actions to trade reformfromcompositional effects based on changes in the distribution of
rms. In addition, their paper could not look specically at bargaining power effects and
also did not look at the effect of trade policy on wage share after controlling for year xed
effects. The investigation on labor demand elasticities in that paper, however, had time
controls.
6
See also Senses (2010) who shows, using US plant-level data, that offshoring in-
creased the conditional demand elasticity of production workers. In addition, Sly and
Soderbery (2012) showboth theoretically and empirically that multinational rms strate-
gically source production abroadinthe case of high-markupproducts to increase labor de-
mand elasticities, thereby reducing negotiated wages.
2 R.N. Ahsan, D. Mitra / Journal of Development Economics 108 (2014) 116
nd that, for lowlevels of unionization, greater product market compe-
tition raises union wages. This result does not hold for unionization
levels above a certain threshold. Lastly, using South African data,
Shendy (2010) nds that trade liberalization lowered wages in indus-
tries with high levels of unionization.
The literature discussed above examines various mechanisms
through which trade liberalization affects workers' bargaining power.
However, as we show in this paper, changes in labor share capture
much more than just changes in bargaining power. As a result, the pre-
vious literature provides indirect insight, at best, as to the true nature of
the relationship between trade and labor share. To get a better sense of
this relationship, our paper incorporates a richer interaction between
imperfect competition in the goods market and labor-rm bargaining.
As a result, unlike the previous literature, our paper provides an expla-
nation for the heterogeneous relationship between trade liberalization
and labor's share of rm revenue that we observe in the data.
The remainder of the paper is structured as follows. Section 2 takes a
preliminary look at the data and provides a theoretical model that high-
lights howthe factor intensity of a rmcan lead to heterogeneous effects
of trade liberalization on labor's share of rmrevenue. Section 3 describes
the data while Section 4 discusses the empirical strategy used to test the
predictions of the model. It also describes a procedure that uses the model
introduced in Section 2 to back out estimates for bargaining power at the
industry level. Section5 presents the results while Section6conducts sev-
eral robustness checks. Section 7 examines the impact of trade liberaliza-
tion on bargaining power using the industry-level bargaining power
estimates. Finally, Section 8 provides a conclusion.
2. Background and motivating theory
2.1. A preliminary look at the data
Faced with an acute scal crisis in 1991, the newly elected govern-
ment inIndia approached the International Monetary Fund(IMF) for as-
sistance. The IMF agreed to provide loans under the condition that
major economic reforms be undertaken. While these reforms were
very broad, one key component was a reduction of tariff levels and
their dispersion. Fig. A1 in the web appendix illustrates the dramatic na-
ture of the tariff reduction around 1991.
7
The average tariffs fell from
152.1% in 1990 to 44.1% in 1996 and eventually to 23.2% in 2003. In ad-
dition, the standard deviation of tariffs fell from 33.2 percentage points
in 1990 to 12.9 in 2003.
How have workers in India fared during this period of trade liberal-
ization? To answer this question we use Indian rm-level data fromthe
Prowess database. As we describe in greater detail in Section 3.1, this
dataset provides information on a panel of publicly-traded rms that
represent 6070% of output in the organized industrial sector
(Goldberg et al., 2010). Fig. 1 graphs the changes in the share of wages
in total revenue during the period 19882004. These shares are annual
averages of the rm-level data and are described in greater detail in
Section 4.1. The middle line in Fig. 1 represents the average change in
the wage share over this period. As the graph demonstrates, the average
share of wages in total revenue declined during the rst phase of trade
liberalization (until the mid 1990s), but increased during the remaining
portion of our sample period.
Next, we examine the heterogeneity in the data by examining the
trends in the share of wages in rm revenue for large and small rms.
We classify a rm as large if its sales in any given year are above the
67th percentile of the sample's sales distribution. Similarly, we classify
a rmas small if its sales in any given year are belowthe 33rd percentile
of the sample's sales distribution. As Fig. 1 illustrates, the trendinthe av-
erage share of wages in total revenue masks a great deal of heterogene-
ity in the data. For example, the top line in the graph suggests that the
share of wages in total revenue increased rapidly among smaller rms
in the sample. Similarly, the bottom line in Fig. 1 indicates that the
share of wages in total revenue declined among the larger rms in the
sample. Thus, the behavior of smaller, more labor-intensive rms ap-
pears to be drastically different than that of larger, less labor-intensive
rms.
8
This nding also holds when we examine changes in the share
of wages in value added (Fig. 2). The goal of this paper is to explore
this heterogeneity and examine whether the impact of trade liberaliza-
tion varies depending on the labor intensity and the size of the rm. The
next section describes a simple model that provides an explanation for
this heterogeneity within a simple bargaining framework.
2.2. Theory
The model in this section is an extension of Brock and Dobbelaere
(2006) and McDonald and Solow (1981). We build on their framework
by allowing all inputs of production to be variable. In addition, we intro-
duce imperfect competition in the product market by assuming that
rms have some monopoly power. These changes allow us to highlight
the important role that rm characteristics, such as size and market
power play in determining the impact of trade liberalization on the
share of wages in total revenue.
We consider a setup in which a rm and a workers' union bargain
over both wages w and employment N. We allow trade liberalization
to affect this bargaining process in two ways. First, trade liberalization
lowers the bargaining power of workers. This reects the fact that
trade makes it easier for rms and consumers to substitute the services
of domestic workers with those of foreign workers (Dumont et al.,
2006; Rodrik, 1997).
9
Second, trade liberalization reduces the supernor-
mal prots (as a share of output or sales) enjoyed by domestic rms and
the pricecost markup (Harrison, 1994; Krishna and Mitra, 1998;
Levinsohn, 1993).
10
While this reduces the rents (relative to sales)
7
The web appendix is available at the following website: https://sites.google.com/site/
reshadahsan/research.
8
Our assumption that smaller rms are, on average, more labor intensive is supported
by the correlation between rm size and our estimate of the elasticity of output with re-
spect to labor and the summary statistics in Table 1.
9
InSection3.2 we explainhowour framework canbe used to backout bargaining pow-
er estimates at the industry level. We use these estimates to examine the relationship be-
tween trade liberalization and bargaining power. The results, which support our
assumption that trade liberalization lowers bargaining power, are reported in Section 7.
Note that we do not model in this paper exactly how tariff changes affect workers'
bargaining power. We accept Rodrik's narrative on this and assume in our theory that
bargaining power depends on the level of protection. The contribution of the paper is,
therefore, mainly empirical.
10
See also the recent work on the impact of trade liberalization on markups in India by
De Loecker et al. (2012) where they also nd that the liberalization of output tariffs leads
to a reduction in price-marginal cost markups.
6
8
1
0
1
2
1
4
1990 1995 2000 2005
Year
W
a
g
e

B
i
l
l

/

S
a
l
e
s
All Firms Large Firms
Small Firms
Fig. 1. Changes in the share of wages in total revenue in India over the period 19882003.
Large rms are rms with sales above the 67th percentile of the sample sales distribution.
Small rms are rms below the 33rd percentile of the sample sales distribution.
over which bargaining will occur between the rm and workers, the
added competition, by reducing the markup, shrinks the wedge be-
tween the value of the marginal product (VMP) and the marginal reve-
nue product (MRP). All else equal, the reduction in the VMPMRP
wedge increases the wage bill net of shared rents (as a proportion of
output). Thus trade liberalization unleashes different forces, going in
different directions, on the share of wages in total revenue. Our model
helps us explore the impact of these different forces, unleashed by
trade liberalization, on the share of the wages in total revenue both the-
oretically and empirically.
Consider a rm with the following production function:
Q F N; v 1
where Nis rm's employment of labor and v is the rowvector of all other
factor inputs. This production function is assumed to be constant returns
to scale and thus it exhibits diminishing marginal product of labor. The
rm's utility function (commonly known as the prot function) is:
w; N; v P Q; QwNvp
v
2
where wis the wage paid by the rm, p
v
is the column vector of prices of
other factor inputs and P is the output price, which depends on quantity,
Q, and the import tariff, , as the rm is assumed to have market power
and that power depends on how protected its market is. In other
words, P(Q;) is the inverse demand function.
There is also a risk-neutral labor union with the following utility
function:
U Nw NN
_ _
w
a
3
where N is union membership and w
a
is alternative or outside wage.
The Nash bargaining problem is represented by the following maxi-
mization problem
11
:
Max
w;N;v
Nw NN
_ _
w
a
Nw
a
_ _

P Q; QwNvp
v

1
where () is the bargaining power of workers and is a function of the
output tariff, , with () N 0. As mentioned above, P(Q;) is the in-
verse demand function with the price being a function of output and
the tariff.
12
We assume that the markets for all other factors are perfect-
ly competitive (the rmis a price taker in those markets) and that both
the rmand the union also take the alternative wage, w
a
, as given. After
a fewmanipulations, the rst-order conditionof the rmwithrespect to
w can be written as:
w w
a

1
P Q; QwNvp
v
N
_ _
: 4
The rst-order condition with respect to N, with Eq. (4) substituted
into it gives us:
w
a
MR F
N
5
where MR is marginal revenue and F
N
is the marginal product of labor.
From Eqs. (4) and (5) above, in combination with the rst order condi-
tions with respect to the other inputs (equating each input price to mar-
ginal revenue times the input's marginal product), we can arrive at the
following expression for the share of wages in total revenue:
S
N

Q;N

1
1

_ _
6
where
Q,N
is the elasticity of output with respect to employment and
() is the price-marginal cost (or the price-marginal revenue) ratio,
with the latter being a function of the tariff.
13
This is due to the inverse
demand function also being a function of the tariff. As long as the do-
mestic price P(Q(); ) increases with the output tariff for given market
factor prices (in the case of labor, it would be given w
a
), we will have
() N 0.
14
Note that we are not treating
Q,N
as a function of . This assumption
is consistent with, for instance, a CobbDouglas production function,
while with some other production functions
Q,N
could be an increas-
ing, decreasing, or even a nonmonotonic function of . The nature of
this relationship depends on how the elasticity responds to changes in
inputs, with the inputs responding to tariffs. Thus the
Q,N
being invari-
ant to tariffs is a neutral assumptionthat we are comfortable making, es-
pecially given the absence of a systematic relationship between the two
variables. In such a case, even if w
a
and other factor prices respond to
tariffs, the wage share will depend on the tariff only through its impact
onthe markupand the bargaining power of workers, i.e., Eq. (6) will still
hold.
In Eq. (6),
Q;N

is the non-unionized wage share for workers. Union-
ization leads to anadditional share for workers, whichis given by
1
1

_ _
. This is again a fraction () of the share of output that is not
covered by the non-unionized wage share and the share of other factors
of production. Note that the non-unionized wage share plus the share of
all other factors of production equals
1

.
11
While the rmand the union normally would negotiate on wages and employment of
labor, one would not necessarily expect them to bargain over the employment of other
factor inputs. However, the bargaining problem with all variable inputs, as it is written
here, is equivalent to the case where one department of the rmnegotiates with the union
on wages and employment of labor and another department simultaneously makes deci-
sion on the quantities of other inputs to be employed to maximize prots. If bargaining
with the union breaks down, then the rmdoes not place its order for other inputs (or al-
ternatively, if the order is placed, we assume that it can be canceled). If bargaining is suc-
cessful, the order is placed (or not canceled if placed). The other justication for this
approach is that it is not uncommon for unions to participate in regular production deci-
sions of rms.
12
The associated demand function here is Q = Q(P;) where
Q
P
b0 and
Q
N0.
13
Note that the measure of marginal cost usedinthe determination of the markupis ap-
propriately the one that is evaluated at the alternative wage (and the market prices of the
other inputs/factors) and not at the actual wage paid, as any excess of the actual over the
alternative wage paid to workers comes fromrent sharing and does not affect the employ-
ment decision (see Eqs. (4) and (5)). From the rst order conditions, this is the version of
the marginal cost that gets equatedto marginal revenue. Thus the denitionof the markup
we are using is standard in that it also equals the ratio of price to marginal revenue.
14
Asufcient conditionfor a positive signof the derivative of the markupwithrespect to
the tariff is that the absolute value of the output demand elasticity is decreasing in the tar-
iff. This is logical as output tariff liberalization gives domestic consumers greater access to
imported substitutes, which should make the demand for domestic products more elastic.
Also, as mentioned above there is a fair amount of empirical evidence on markups being
positively related to output tariffs.
1
0
1
5
2
0
2
5
1990 1995 2000 2005
Year
W
a
g
e

B
i
l
l

/

V
a
l
u
e

A
d
d
e
d
All Firms Large Firms
Small Firms
Fig. 2. Changes in the share of wages in value added in India over the period 19882003.
See the caption for Fig. 1 for the denition of large and small rms.
Eq. (6) yields the following derivative with respect to :
dS
N
d
1
1

_ _

Q;N

_ _

2

: 7
The rst term on the right-hand-side, 1
1

_ _
, represents the
effect of the tariff on the labor share through its impact on the
bargaining power. We will refer to this as the bargaining power channel.
Notice that, given () N 0, the bargaining power channel predicts
that trade liberalization will lower the share of wages in total revenue.
This effect is independent of the relative sizes of
Q,N
and (). The sec-
ond term on the right-hand-side,

Q;N

2

, represents the ef-

fect of the tariff through its impact on the markup. We will refer to
this as the markup channel. The sign on this effect is ambiguous as it de-
pends on whether
Q,N
b or N (). For rms that are sufciently labor
intensive (i.e. have
Q,N
N ), this effect is negative, which means that
trade liberalization will, through lower markups, lead to a higher
share of wages in total revenue.
15
Alternatively, for rms with suf-
ciently low labor intensity (i.e. have
Q,N
b ), this effect is positive,
which means trade liberalization will, through lower markups, lead to
a lower share of wages in total revenue.
The intuition for this can be better understood by examining Eq. (6)
more carefully. The non-unionized share,
Q;N

, increases with a reduction
in markup as the workers are paid closer to the value of their marginal
product. On the other hand, all other factors or inputs also get paid clos-
er to their marginal products. As a result, the sumof the non-unionized
wage share and the share of all other factors of production, whichis rep-
resented by
1

, increases. Alternatively, the share of output available for
bargaining between the rm and the union, 1
1

_ _
, declines when
the markup goes down. When the elasticity of output with respect to
labor is relatively small, the effect of markup on the non-unionized
share is relatively small and is dominated by the effect of the markup
on rent sharing. In this case, with trade liberalization the markup chan-
nel will lead to a decrease in the share of wages in total revenue. On the
other hand, with high elasticity of output with respect to labor, the ef-
fect of markup on the non-unionized share is the dominant effect. In
this case, withtrade liberalizationthe markupchannel will leadto anin-
crease in the share of wages in total revenue.
Thus, trade liberalization will have ambiguous effects on the share of
wages in total revenue for labor-intensive rms (which are expected
and seen in our data to be the relatively small rms). For such rms,
trade liberalization, through the bargaining power channel, will lower
the share of wages in total revenue, while, through the markup channel,
it will raise this share. Inthe case of less-labor intensive rms (whichare
expected to be large rms), both the bargaining power channel and the
markup channel predict that trade liberalization will lower the share of
wages in revenue.
We can use the above results to state the following hypotheses:
Hypothesis 1. Trade liberalization leads to a decline in the share of
wages in total revenue for rms with sufciently low labor intensity.
Hypothesis 2. Trade liberalization has anambiguous effect onthe share
of wages in total revenue for rms that are labor-intensive.
Lastly, fromEq. (7), notice that the overall effect of tariffs on the share
of wages in total revenue depends also on the size of the markup, ().
This raises the question of whether heterogeneity of markups alters the
two hypotheses above. To make this more concrete, suppose that
markups are lower for smaller rms than for relatively larger rms. In
this case, the weight given to () in Eq. (7) will be lower relative to
the weight givento () for the smaller rms. This is because the weights
on the two components are 1
1

_ _
and
Q;N

2
_ _
, respectively,
whose magnitudes are increasing and decreasing withrespect to (), re-
spectively. The fact that, with heterogeneous markups, smaller rms will
have a higher weight placed on the markup channel strengthens our re-
sults further about the impact of trade liberalization on wage shares
based on rm size. For larger rms, both the bargaining power and the
markup channels predict that trade liberalization will lower the share
of wages intotal revenue andthus, the relative weights onthese channels
do not affect the qualitative prediction for such rms.
16
3. Data
3.1. Firm-level data
The rm-level data used in the paper are fromthe Prowess database.
This includes all publicly traded rms in India and is collected by the
Center for Monitoring the Indian Economy (CMIE). These data have
been used previously by Goldberg et al. (2010) and Topalova and
Khandelwal (2011). Together the rms in the sample represent 60 to
70% of output in the organized industrial sector and 75% of all corporate
taxes paid in India (Goldberg et al., 2010). The key advantage of this
dataset is that it provides information on a panel of rms from1988 on-
wards. This allows us to examine behavioral changes due to the trade
reforminitiated in 1991. However, since the database consists of public-
ly traded rms, the data are not representative of small and informal
Indian rms. Appendix A provides details on the construction of our
working sample.
The compensation data included in the Prowess database consists of
salaries and wages as well as other compensation such as bonuses and
contribution to pension funds. To calculate the share of wages in total
revenue, we divide the total compensation to employees by the sales re-
ported for each rm. As the summary statistics in Table 1 demonstrate,
the average rm pays 8.9% of its total revenue as compensation to
workers. For large rms this number is 7.7% while for small rms the
share of wages in total revenue is 11.3%. This difference between the
two types of rms is robust to alternate denitions of wage share. For ex-
ample, smaller rms have a 6.2 percentage point higher share of wages in
value added and a 2.6 percentage point higher share of wages in total
cost. Total cost is estimated by subtracting reported prots from sales.
3.2. Tariff data
The data on output tariffs, covering the period 19882003 are from
the Asian Development Bank (ADB) and are an extension of the data se-
ries used in Hasan et al. (2007).
17
The original data are reported at the
sector/commodity level and were converted to three-digit 1998 Nation-
al Industrial Classication(NIC) industries. As Fig. 1 inthe web appendix
demonstrates, the average tariff level in India declined dramatically
15
The best way to see why
Q,N
is an indicator of labor intensity is with the help of a
constant-returns-to-scale CobbDouglas production function. For a given wagerental ra-
tio, the labor intensity in production is increasing in the exponent of labor in the produc-
tion function. This exponent is nothing but the elasticity of output with respect to labor.
16
Heterogeneity in bargaining power (where bargaining power is inversely related to
rmsize) can weaken or overturn our theoretical results by weakening the markup chan-
nel (relative to the bargaining power channel) for small rms and strengthening it for
large rms, as it makes rent sharing relatively more important for the former and less im-
portant for the latter. While we do not model this aspect, in our empirical work we allow
for the heterogeneity in by controlling for rm size. In addition, we divide our sample
based on an industry's labor intensity and unionization rate. In all such cases our results
conformto the predictions of our model. Thus, even if the heterogeneity of is important,
a straightforward implication of our empirical work is that the dominant form of hetero-
geneity that shows up in the trade and wage share relationship is the variation of labor in-
tensity across rm size (supported by the positive relationship between markups and
size). Lastly, heterogeneous responses of bargaining power to tariffs could also affect our
results. We examine this issue empirically and nd that trade liberalization lowers
bargaining power for all rm size categories.
17
We thank Rana Hasan at the ADB for providing us the protection data.
after the trade reformwas initiatedin1991. Inaddition, there is signicant
cross-industry variation in tariffs over our sample period. For example,
Table A1 inthe web appendix lists the tenmost andtenleast protectedin-
dustries in the sample. This classication was made based on the average
tariffs for each industry over the period 19882003. As the table shows,
the difference in tariffs between the most protected industry (Manufac-
ture of beverages) and the least protected industry (Manufacture of
railway and tramway locomotives) is 64.7 percentage points.
To test the robustness of our results we use several alternative mea-
sures of protection. In particular, we replace three-digit output tariffs
with a three-digit measure of non-tariff barriers. Second, we also use
three-digit input tariffs in place of output tariffs. These input tariffs are
constructed using the 19931994 Indian inputoutput table.
18
Lastly,
we also replace output tariffs with the effective rate of protection
(ERP), calculated at the three-digit industry level. This was done using
the following formula:
ERP
jt

Tarif f
jt
jt
Input Tarif f
jt
1
jt
_ _
where Tariff
jt
is the output tariff for three-digit industry j at year t,
jt
= Cost of materials/Sales is calculated using industry-level data
and InputTariff
jt
is the input tariff for industry j at year t.
Due to the use of lagged tariffs in the estimation equations, our nal
sample covers the period 19892004. This sample includes an unbal-
anced panel of 5519 rms with a total of 40,165 observations. Complete
summary statistics are provided in Table 1. All monetary values have
been deated by a three-digit industry level wholesale price index and
are in constant 1993 Rupees.
4. Estimation strategy
Our model predicts that trade liberalization will have ambiguous ef-
fects onthe share of wages intotal revenue for labor-intensive rms and
will lower the share of wages in total revenue for less labor-intensive
rms. To test these predictions, we need to rst calculate a rm-level
measure of labor intensity. Our decision to allow rms within the same
industry to have different labor intensities is mainly driven by the hetero-
geneity we observe in the data. In particular, our estimates of rm-level
labor intensity, as measured by the elasticity of output with respect to
labor, clearly suggest that there is tremendous cross-rm heterogeneity
in labor intensity among the rms in our sample. Such variation in factor
intensities across rms is also found in Chilean data (Harrigan and Reshef,
2011) as well as Sub-Saharan African data (Van Biesebroeck, 2005).
Why would rms in the same industry have different labor intensi-
ties? Stoyanov (2013) offers two explanations for this. First, rms with-
in an industry may face a menu of technologies with different labor
intensities that can be used to produce a product. Given heterogeneity
in rm productivity and with technology adoption costs being increas-
ing in capital intensity, each rm will choose a different technology. In
particular, more productive rms will choose more capital-intensive
technologies. This will yield within-industry variation in labor intensity.
Arelated argument is that production technologies may be product spe-
cic. Alternatively, production technologies could be specic to a partic-
ular set of products. In either case, to the extent that there are a variety
of products (or product sets) within an industry, there will be heteroge-
neity in production technology and, therefore, in labor intensity within
any given industry. A third source of heterogeneity in labor intensity is
variation in capital costs. For example, in Stoyanov's model, larger and
more productive rms pay lower interest rates on loans compared to
small rms. This is because, due to their higher productivity, larger
rms are better able to repay loans. This will lead to rm-specic capital
costs, which in turn will imply rm-specic labor intensities.
To estimate rm-specic labor intensities, we use two approaches.
In the rst approach, we directly estimate the elasticity of output with
respect to labor for each rm in our sample. We do this by assuming
that the production function in Eq. (1) is trans-log in labor, materials,
and capital. We then estimate the parameters of this trans-log produc-
tion function using the Ackerberg et al. (2006) approach. They provide
a method that can be used to consistently estimate production function
parameters in the presence of unobserved, rm-level productivity. See
Appendix B for further details on this method. This approach yields a
time-varying, rm-level elasticity of output with respect to labor. We
average this elasticity over the entire sample period for each rmto ob-
tain a time-invariant elasticity measure at the rm-level. The idea here
is that each rmis endowed with a rm-specic production technology
that provides it with a rm-specic labor intensity. Our estimate of the
elasticity of output with respect to labor, averaged over the entire sam-
ple period, is a reasonable proxy for this rm-specic labor intensity.
Table A2 in the web appendix reports these estimates. While the labor
intensity measure is calculated at the rmlevel, we report two-digit in-
dustry averages in Table A2 for ease of presentation.
With our estimate of rm-level labor intensity in hand, we test our
model's predictions using the following specication:
S
N
ijt

1
Tarif f
jt1

2
Tarif f
jt1
Epsilon
ij

3
ln R&D
ijt
_ _
4
X
ijt

i

t
u
ijt
8
where i indexes rms, j indexes industries, t indexes years and S
N
is
the share of wages in total revenue. In alternate specications, the
latter is replaced by the share of wages in value added and the
share of wages in total costs.
19
Tariff
jt 1
captures the level of pro-
tection placed on the nal good in a three-digit industry and is
18
See Ahsan (2013) for further details on the construction of the input tariffs.
19
We believe that the share of wages in total revenue is the best dependent variable to
use in our case as we are trying to capture the effects that work through the substitutabil-
ity between domestic labor and intermediate inputs (both imported and domestic) and
those that work through markups. The drawback of using value added is that it nets out
intermediate inputs while total costs do not capture markups.
Table 1
Summary statistics.
All rms Large rms Small rms
Wage bill/sales 8.94 7.73 11.25
[9.28] [6.78] [12.29]
Wage bill/value added 17.71 15.29 21.47
[14.84] [12.26] [17.77]
Wage bill/total costs 8.78 7.88 10.54
[8.97] [6.69] [11.73]
Epsilon 0.42 0.31 0.59
[.24] [0.17] [0.26]
ln(R&D expenditure) 0.10 0.24 0.01
[.38] [0.58] [0.08]
Large 0.36
[.48]
Small 0.30
[.46]
Output tariffs 0.65 0.71 0.56
[.48] [0.53] [0.39]
Input tariffs 0.62 0.68 0.55
[.42] [0.46] [0.35]
Effective rate of protection
industry (ERP Industry)
0.68 0.75 0.58
[.58] [0.65] [0.47]
Number of rms 5519 1436 2140
Notes: The numbers in brackets are standard deviations. Epsilon is the elasticity of output
with respect to labor, which is estimatedusing the Ackerberg et al. (2006) approach. Large
rms are dened as rms whose average sales over the entire sample period are above the
67th percentile of its industry's sales distribution over this period. Small rms are ones
whose average sales over the entire sample period are below the 33rd percentile of its
industry's sales distribution over this period. Both of these measures are time invariant.
ERP-Industry is calculated using three-digit industry-level data. All monetary values are
in crores of 1993 Rupees where 1 crore equals 10 million. The exchange rate in 1993
was approximately US $1 = 31 Rupees.
lagged by one year.
20
Epsilon
ij
is our rm-specic estimate of the
elasticity of output with respect to labor. As this variable is averaged
over the entire sample period for each rm, its level effect is cap-
tured by the rm xed effects.
The remaining variables in Eq. (8) control for other factors that are
potentially correlated with the bargaining power of workers. These fac-
tors include the level of technology used by a rm. All else equal, we ex-
pect workers in rms that more technology intensive to have a weaker
bargaining position. This should result in a lower share of wages in total
revenue for these rms. We proxy technological intensity using the nat-
ural logarithm of R&D expenditure by a given rm. More precisely, we
use ln(1 + R&Dexpenditure) to account for the fact that a large fraction
of rms report zero R&D expenditure in any given year. In addition, we
alsoinclude a vector of rm-specic control variables, X
ijt
. This vector in-
cludes rm age in natural logarithm as well as indicators for exporting
rms and importing rms respectively. We also include rm xed ef-
fects,
i
, which control for time-invariant rm characteristics as well as
year xed effects,
t
, which capture the effect of macroeconomic vari-
ables.
21
Finally, u
ijt
is a classical error term. Our model predicts that
less labor-intensive rms will see a relatively larger decrease in wage
shares after trade liberalization. As a result, we expect
2
to be negative.
In addition, we expect
1
+
2
to be negative for sufciently labor in-
tensive rms, i.e. rms with a sufciently high value of Epsilon
ij
.
Next, we also test the predictions of our model using rmsize indica-
tors as a proxy for labor intensity. This relies on the assumption that rm
size is negatively correlated with labor intensity with large rms being
relatively less labor intensive than small rms. We test this assumption
by comparing our rm-specic estimate of the elasticity of output with
respect to labor to a continuous measure of rm size in Fig. 3. The latter
is simply each rm's average real sales over the entire sample period in
natural logarithm. As Fig. 3demonstrates, these two measures are indeed
negatively correlated with a correlation coefcient of 0.60. The advan-
tage of using rmsize is that it is a more exible proxy for labor intensity.
In particular, while the estimated elasticity of output with respect to
labor captures labor intensity differences due to differences in produc-
tion technology, rm size will also capture other determinants of labor
intensity differences. These determinants include differences in capital
costs arising from differences in the degree to which credit constraints
(or credit market imperfections) bind. Thus, we believe that these two
measures of labor intensity are complements rather than substitutes.
To create these rm size indicators we rst calculate the 33rd and
67th percentiles of each industry's sales distribution over the entire
sample period. This is done using the distribution of real rm sales,
whichis constructed by deating sales withanindustry-level wholesale
price index. We then classify a rm as being Large if its average sales
over the entire sample period are above the 67th percentile of its
industry's sales distribution as constructed above. Similarly, we classify
a rm as being Small if its average sales over the entire sample period
are below the 33rd percentile of its industry's sales distribution as con-
structed above. The variables Large and Small constructed in this man-
ner are time invariant and are our default size measures.
We then use these rm size indicators to estimate the following
econometric specication:
S
N
ijt

1
Tarif f
jt1

2
Tarif f
jt1
Large
ij

3
Tarif f
jt1
Small
ij
4
ln R&D
ijt
_ _
5
X
ijt

i

t

ijt
9
where Large
ij
and Small
ij
are the time-invariant rm-size indicators de-
scribed above and all other variables are as dened below Eq. (8). We
expect
1
+
2
to be positive, which would imply a decline in the
share of wages in total revenue after trade reform for large, less labor-
intensive rms. On the other hand, based on Hypothesis 2, the sign of
1
+
3
is ambiguous. It will be positive if, in the case of small rms,
the effect of tariff on wage share through its effect on bargaining
power dominates and negative if its effect through its overall impact
on the markup dominates.
4.1. Econometric issues
One of the concerns with the specications used in this paper is
the potential endogeneity of tariffs. For example, if tariffs are used to
protect labor-intensive industries, then the estimated coefcient of
tariffs will be biased. There are two main reasons why we do not ex-
pect the endogeneity of tariffs to be a primary concern in this paper.
First, as explained in greater detail in Hasan et al. (2007) and
Krishna and Mitra (1998), the trade reform in 1991 was conducted
under pressure from the International Monetary Fund (IMF) and
was quite unexpected. Thus, this reform can be considered exogenous
to the rms in our sample. Second, as Figs. A2 and A3 in the web ap-
pendix demonstrate, the decline in tariffs during the sample period
was very similar across both the most protected and least protected
industries.
However, Topalova and Khandelwal (2011) argue that while the im-
mediate changes in tariffs after the 1991 reformis exogenous, the same
cannot be said of tariffs after 1997. This is because the government of
India announced a new exportimport policy in the Ninth Plan (1997
2002) during that year. They argue that the external pressure applied
by the IMF in 1991 had abated by this time, and that the issue of poten-
tial endogeneity of tariffs became more pronounced. Note that this does
not necessarily imply that tariffs are endogenous to the share of wages
in total revenue. Nonetheless, we address this concern in several
ways. First, we examine whether past wage shares in total revenue pre-
dict current tariffs. To do so, we calculate a weighted average industry-
level wage share in total revenue, where the weights are each rm's
sales as a share of its industry's total sales. We then regressed our mea-
sure of tariffs on the one-year lagged industry-level wage share as well
as industry and year effects. The results do not support the notion that
tariffs are driven by the share of wages in total revenue. Second, we fol-
low Topalova and Khandelwal (2011) and re-estimate our main results
after restricting the sample to 19891997. This approach has the advan-
tage of minimizing endogeneity concerns related to tariffs. However, as
20
The use of one-year lagged tariffs is reasonable given that the impact of changes in
trade policy on rm decision-making is unlikely to be instantaneous. The primary results
in the paper are robust to the use of contemporaneous tariffs.
21
Note that industry and state xed effects are time-invariant and are captured by the
rmxed effects.
-
1
0
1
2
-5 0 5 10
Ln(Average Sales)
E
p
s
i
l
o
n

(
A
C
F
)
Fig. 3. Correlation between the rm-level elasticity of output with respect to labor (Epsi-
lon) and the average sales of a rmover the period 19892004. The elasticity is calculated
using the Ackerberg et al. (2006) approach. The correlation coefcient between these two
variables is 0.60.
is evident from Figs. 1 and 2, restricting the sample to this period also
truncates variation in wage shares.
Third, we address further concerns about the endogeneity of tariffs
by adopting a variant of the instrumental variable (IV) strategy used
by Goldberg and Pavcnik (2005). Inparticular, we rst convert our base-
line specications to rst differences. This removes any time-invariant
characteristic that is correlated with both the share of wages in revenue
and output tariffs. We then instrument the differenced tariff term using
5-year lagged output tariffs. For the differenced interaction between out-
put tariffs and Epsilon, we use as an instrument the interaction between
5-year lagged tariffs and Epsilon. Similarly, for the differenced interaction
between output tariffs and the rm size indicators, we use as instru-
ments the interaction between 5-year lagged tariffs and the rmsize in-
dicators. For this IV strategy to be valid we need two assumptions to
hold. First, we need current differenced output tariffs to be reasonably
correlated with 5-year lagged output tariffs. This is ensured by the fact
that one of the goals of the trade reform conducted in 1991 was to har-
monize tariffs across industries in India. As a result, tariffs in an industry
at any given point in time will be highly correlated with future changes
in this industry's tariffs. Second, we need the current differences in the
error term to be uncorrelated with 5-year lagged output tariffs. Given
the time difference between the differenced error term and the instru-
ment, we believe that the two are sufciently far removed from each
other and are therefore unlikely to be correlated.
4.2. The bargaining power of workers
As described in detail in Section 2.2, our explanation for the hetero-
geneous impact of trade liberalization on the share of wages in revenue
relies on two key channels: (a) that output tariff liberalization lowers
the bargaining power of workers, and(b) that output tariff liberalization
lowers the markup charged by rms. While we believe that the latter re-
lationship is widely and unambiguously supported in the empirical lit-
erature (e.g. see empirical studies by De Loecker et al., 2012; Harrison,
1994; Krishna and Mitra, 1998; Levinsohn, 1993 on Turkey, Cote
d'Ivoire, India and also India respectively), there could be some doubt
about the validity of the former. In this section we adapt the framework
introduced in Section 2.2 to examine the impact of trade liberalization
on the bargaining power of workers using a two-stage process.
22
4.2.1. Markup estimation
To examine the relationship between output tariff liberalization and
bargaining power we rst need to estimate markups at the rm level.
We do this by modifying the approach used by De Loecker et al.
(2012). We begin by altering the presentation of the production func-
tion in (1) as follows:
Q
ijt
exp a
ijt
_ _
H X
ijt
_ _
1a
where Q
ijt
is the output for rm i in industry j at year t, a
ijt
is rm-level
productivity that is observed by the rm but is unobservable to the
econometrician, and X
ijt
is a vector of inputs. As De Loecker et al.
(2012) show, the rst-order-condition of the associated cost minimiza-
tion problem with respect to a freely adjustable input, m, yields the
following:
ijt

m
ijt
S
ijt
m
_ _
1
where
ijt
is the markup dened as before,
ijt
m
is the elasticity of output
with respect to variable input m, and S
ijt
m
is the expenditure on m
divided by total revenue. In our empirical implementation, m is repre-
sented by material costs. Thus, to estimate rm-level markups we can
simply combineS
ijt
m
, whichis available in the data, with our existing es-
timates of
ijt
m
. Recall that these rm-level elasticity estimates are obtain-
ed by estimating a trans-log production function using the Ackerberg
et al. (2006) approach. These estimates are summarized in Table A2 of
the web appendix. Dividing these time-varying, rm-level estimates of
ijt
m
by S
ijt
m
yields a rm-level measure of markup,
ijt
, for each rm i in
industry j at year t.
23
Lastly, following De Loecker et al. (2012), we
trim the markup estimates at the 3rd and 97th percentiles to remove
outliers.
4.2.2. Stage one
With our measure of rm-level markups in hand, we estimate the
bargaining power of workers as follows. Note that from Eq. (6), we
can express the share of wages in revenue for rm i as follows:
S
N

1
_ _
10
where =
Q,N
. The corresponding estimating equation is:
S
N
ihkt

hkt

hkt
1
ihkt
_ _
ihkt
10a
where h indexes two-digit industries,
24
k indexes size categories where
the size categories are Small, Medium, Large, and All, and t indexes years.
25
S
ihkt
N
is the ratio of wage bill to sales,
ihkt
is the markup estimated
above and
ihkt
is a classical error term. We use our rm-level data to es-
timate Eq. (10a) separately for each rm-size category, industry and
year combination in our sample. The coefcient of the constant in the
above regression gives us the bargaining power of workers for rms in
a given size category, industry and year.
26
4.2.3. Stage two
In the second stage, we estimate the following equation for each size
category separately:
hkt

k
ht1

X
ht1

r

hkt
11
where
hkt
is the bargaining power of workers in industry h, size catego-
ry k, and year t as estimated in the rst stage.
ht 1
is one-year lagged
output tariff at the 2-digit level and

X
ht1
is a vector of one-year lagged
industry controls that include the natural logarithmof output per plant
(degree of concentration), a categorical variable that categorizes indus-
tries as having either high, medium, or low labor intensity, the fraction
of exporters, the fraction of importers, the natural logarithmof total in-
dustry R&Dexpenditure, andthe natural logarithmof total industry out-
put. Lastly,
r
are one-digit industry xed effects while
hkt
is a classical
22
To test whether the effect of tariffs on markups depends on the size of a rm, we es-
timated a version of Eq. (9) with the log of rm-level markup as the dependent variable.
The coefcients of the interaction between tariffs and both the large and small size indica-
tors were insignicant. This indicates that the effect of trade liberalization on markups
does not depend on rm size.
23
Note that our focus in this paper is on labor share and bargaining power. The markups
are an input into computing the latter and their estimation is not the main focus of the pa-
per. Thus to remain within the scope of our paper, we use a slightly simplied procedure
(relative to the De Loecker et al. approach) and abstract from the product scope of the
rms inour sample. Inour view, full justice to the innovative approach used by De Loecker
et al. (2012) can only be done in a paper dedicated to the estimation of markups.
24
As we state below, Eq. (10a) is estimated by size category, industry, and year. After
restricting the data in this manner we are left with size category, industry and year com-
binations with very small sample sizes. Thus, to minimize noise in our bargaining power
estimates, we rst collapse our industries to the two-digit level. We then identify two-
digit industries with fewer than 500 observations over the entire sample period. We com-
bine these small industries with their closest neighbor. This leaves us with 14 two-digit
industries, which are listed in Table 8.
25
Mediumrms are rms inthe middle thirdof the size distribution while the other size
categories are as dened before.
26
Note that for our bargaining power estimation, we are effectively restricting the
bargaining power parameter and the elasticity of output with respect to labor to be com-
mon to all rms of a particular size category within an industry. This is a simplifying as-
sumption that makes the problem of estimating bargaining power tractable.
error term.
k
thus represents the impact of trade liberalization on the
bargaining power of workers belonging to rms in size category k.
5. Results
5.1. Basic results
In Table 2 we report the results from estimating Eq. (8). From the
analysis in Section 2.2 we knowthat the relationship between trade lib-
eralizationand the share of wages intotal revenue is ambiguous and de-
pends on the labor intensity of a particular rm. The regressions
reported in Table 2 use our time-invariant estimates of rm-level elas-
ticity of output with respect to labor, Epsilon
ij
, to capture the labor inten-
sity of each rm. We begin in column (1) by examining the average
effect of trade liberalization on the share of wages in rm revenue.
The point estimate suggests that a decline in tariff leads to a decrease
in the share of wages in total revenue, although the result is statistically
insignicant. Next, the coefcient of the natural logarithm of R&D in
column (1) suggests that rms that are more technologically advanced
pay a smaller share of its sales as wages.
27
This makes sense given that
these rms are likely to be the least labor intensive. In column (2) we
add an interaction between output tariffs and Epsilon
ij
. The coefcient
of the interaction term is negative and signicant, which indicates that
trade liberalization raises the share of revenue for rms that are suf-
ciently labor intensive, i.e. rms that have a sufciently high value
of Epsilon
ij
.
28
In fact, the cutoff value for Epsilon
ij
in column (2) is 0.48.
Of the 5519 rms in the sample, 1931 rms (or 34.6% of rms) have
an estimated Epsilon
ij
that is above this cutoff value.
If we extend our theoretical predictions further, we should observe
that in industries with sufciently high labor intensity relative to
union bargaining power (i.e. industries where it is more likely to be
the case that
Q,N
N ), the overall wage share increasing effect of
trade liberalization for labor intensive rms should be stronger.
29
We
test these predictions in columns (3)(6) of Table 2. We determine
the labor intensity of an industry using pre-1991 industry-level data
from the Annual Survey of Industries (ASI). In particular, we use these
data to calculate the share of wages in output at the three-digit National
Industrial Classication (NIC) level.
30
Industries that had a share of
wages in output above the sample median were classied as high
labor intensity industries, while the remaining industries were classi-
ed as low labor intensity industries. Similarly, we determine the
unionization rate of an industry using household-level data from the
50th Round of the National Sample Surveys (19931994). These
household-level surveys asked currently employed individuals whether
they belonged to a union. We used these data to calculate the fraction of
employed individuals in each industry that belonged to a union (union-
ization rate). We then classied industries that had a unionization rate
above the sample median as high unionization industries while the re-
maining industries were classied as low unionization industries.
31
In column (3) of Table 2, we restrict the sample to rms in the 31 in-
dustries that have above medianpre-reformlabor intensity. Similarly, in
column (4) we restrict the sample to rms inthe 25 industries with pre-
reform labor intensity that is at or below the median. For a given value
of Epsilon
ij
, the overall effect of trade liberalization is more likely to be
wage share increasing in column (3) than column (4).
32
This is exactly
what we should expect given our discussion above. Next, in column
(5) we restrict the sample to rms in the 17 industries that have
above median pre-reform labor intensity and a unionization rate that
is at or below the median. In column (6) we restrict the sample to
rms in the 13 industries that have pre-reform labor intensity at or
belowthe medianand a unionization rate above the median. The results
suggest that, for a given value of Epsilon
ij
, the overall effect of trade lib-
eralization is more likely to be wage share increasing in column (5) than
column (6). Lastly, we divide our wage share variable into its compo-
nents and use them as dependent variables in columns (7) and (8). In
particular, the dependent variable in column (7) is the natural
Table 2
Trade liberalization, labor intensity, and labor's share of revenue.
(1) (2) (3) (4) (5) (6) (7) (8)
Sample All High labor intensity
industries
Low labor intensity
industries
High labor intensity
& low union.
Low labor intensity
& high union.
All
Dependent variable Wage bill/sales ln(Wage bill) ln(Sales)
Output tariffs 0.66 2.42 1.58 2.81 0.18 1.03 0.18 0.30
(0.716) (0.865) (0.470) (0.324) (0.631) (0.347) (0.053) (0.066)
Output tariffs
Epsilon
5.07 5.46 4.77 3.76 4.21 0.44 0.71
(0.889) (0.509) (0.716) (0.584) (0.787) (0.075) (0.107)
Log of R&D
expenditure
0.55 0.45 0.37 0.50 0.16 0.56 0.22 0.24
(0.145) (0.112) (0.143) (0.076) (0.206) (0.106) (0.027) (0.027)
Observations 40,165 40,165 16,149 24,016 9982 12,430 40,165 40,165
R-squared 0.075 0.083 0.093 0.080 0.081 0.093 0.435 0.236
Notes: Epsilonis the elasticity of output withrespect tolabor and is estimatedusing the Ackerberg et al. (2006) approach. Output tariffs are lagged by one period. Industries are classiedas
high or low labor intensive based on industry-level data from the Annual Survey of Industries. The industry-level unionization measure is calculated using household-level data from the
19931994 Round of the National Sample Surveys. All regressions include the log of rmage, indicators for export and import status, and a constant. All regressions also include rmand
year xed effects. The standard errors in column (1) are robust and clustered at the three-digit industry level. The standard errors in columns (2), (7), and (8) are cluster bootstrapped at
the 3-digit industry level with 100 repetitions. In columns (3)(6), the number of clusters decline appreciably. As a result, the standard errors reported in these columns are bootstrapped
with 100 repetitions.
p b 0.01.
p b 0.05.
27
To account for rms that report zero annual R&Dwe add 1 rupee to each rm's report-
ed R&D expenditure before taking logs.
28
As Epsilon
ij
is a generated regressor, the standard errors in column (2) are cluster
bootstrapped at the three-digit industry level.
29
These predictions make sense if we believe that our estimates of rm-level labor in-
tensities as measured by rm-level elasticities of output with respect to labor (or as cap-
tured by rm size) can capture the variation in labor intensities within an industry but
cannot fully capture the variation across industries.
30
The results are essentially identical when we use the share of wages in total costs in-
stead. Total costs are calculated by subtracting prots from sales.
31
We also used pre-reformindustry-level variation in labor intensity and industry-level
variation in union membership to identify the effects of trade liberalization on wage
shares. That is, we compared the effects of trade on wage shares in industries where it is
more likely to be the case that
Q,N
N with industries where it is not. The results from
implementing this empirical strategy are reported in Table A3 in the web appendix. In
the end, we choose not to feature these results because, even within these sets of indus-
tries, we observe tremendous heterogeneity in wage share trends across rms in different
size categories. Thus, we believe that an empirical strategy that relies only on cross-
industry variation in labor intensity and unionization will completely miss this
heterogeneity.
32
For example, consider a rmwith Epsilon
ij
= 0.5. In this case, the overall effect of tar-
iffs for this rm in column (3) is 1.15 (1.58 + (0.5 5.46)). On the other hand, the
overall effect of tariffs for this rm in column (4) is 0.425 (2.81 + (0.5 4.77).
logarithm of each rm's wage bill while in column (8) the dependent
variable is the natural logarithm of each rm's sales. In both columns,
the interaction term is positive and signicant with the magnitude
being slightly larger in column (8).
In Table 3 we report the results from estimating Eq. (9). The regres-
sions reported in Table 3 use the time-invariant rm-size indicators to
proxy the labor intensity of each rm. That is, to capture the heteroge-
neous effect of trade liberalization, we now interact output tariffs with
a large rm indicator and a small rm indicator, respectively. The con-
struction of these time-invariant indicators is described in detail in
Section 4. Recall that an advantage of using rm-size indicators is that
it is a more exible proxy of rm-level labor intensity. In particular,
while the estimated elasticity of output with respect to labor captures
labor intensity differences due to differences in production technology,
rm size will also capture other determinants of labor intensity such as
differences in capital costs.
In column (1) we report the results from estimating Eq. (9) on the
full sample of industries. The coefcients suggest that trade liberaliza-
tion leads to an increase in the share of wages in total revenue for
small rms. For such rms, the elasticity of wage share with respect to
tariff, evaluated at the mean, is 0.05. The results also suggest that
trade liberalization leads to a decrease in the share of wages for large
rms. In this case, the elasticity, evaluated at the mean, is 0.09. In
other words, the wage-share increasing effect of lower markups domi-
nates for small rms while the combined impact through the bargaining
power and the markup channels leads to a decline in the share of wages
in total revenue for large rms.
33
In column (3) we again restrict the
sample to industries that have above medianpre-reformlabor intensity.
Similarly, in column (4) we restrict the sample to rms in industries
withpre-reformlabor intensity that is at or belowthe median. The over-
all effect of output tariffs is more strongly wage share increasing for
small rms in high labor intensity industries (column (3)) compared
to small rms inlowlabor intensity industries (column(4)). In addition,
the wage share reducing effect of trade liberalization is smaller for large
rms in high labor intensity industries (column (3)) relative to large
rms in low labor intensity industries (column (4)).
Next, in column (5) we once again restrict the sample to rms in in-
dustries that have above median pre-reform labor intensity and a
unionization rate that is at or below the median. In column (6) we re-
strict the sample to rms in industries that have pre-reform labor
intensity at or belowthe median and a unionization rate above the me-
dian. The relative difference between trade liberalization impacts for
large and small rms is consistent with both our earlier discussion and
with what we nd in columns (3) and (4).
34
Lastly, in column (6) we
address the question of how small a rm has to be to see an increase
in the share of wages in revenue after trade liberalization by replacing
our size indicators with a percentile rank of average sales for every
rm. In other words, we rst calculate each rm's average sales over
the entire sample period and then assign each rm a rank that species
its position inthe distribution of average sales within the sample. As this
percentile rank is based on a rm's average sales over the entire sample
period, it is a time-invariant measure. The results suggest that rms that
are below(above) the 41st percentile will see an increase (decrease) in
their share of wages in total revenue after trade liberalization. This cut-
off corresponds to an approximate average sales value of Rs. 19.6 crores
(USD 6.32 million). These monetary values are in 1993 Rs. (USD).
35
5.2. Alternate sources of heterogeneity
Apart from differences in labor intensity, rms in the sample differ
along several other dimensions. Thus, the differential effect of trade lib-
eralization on the share of wages in revenue that we've observed so far
could be operating through any of these other channels. For example,
the differential effect of trade on wage shares could be due to heteroge-
neous technology upgrading. Alternatively, the differential effect of
trade on wage shares could be due to the heterogeneous productivity
levels of these rms. To account for this, we add proxies for these alter-
nate rm characteristics along with their interaction with output tariffs
sequentially and then simultaneously to our baseline specications. The
results including these alternative sources of heterogeneity as controls
are listed in Table 4. In Panel A the baseline specication is Eq. (8)
while in Panel B the baseline specication is Eq. (9). In column (1) we
allow trade to have heterogeneous effects on wage shares through
Table 3
Trade liberalization, rm size, and labor's share of revenue.
(1) (2) (3) (4) (5) (6)
industries
Low labor intensity
industries
High labor intensity & low
union.
Low labor intensity & high
union.
All
Output tariffs 0.36 1.07 0.81 1.72 0.78 1.13
(0.732) (0.690) (1.031) (1.121) (0.412) (0.752)
Output tariffs Large 0.82 0.82 0.85 0.70 0.94
(0.137) (0.319) (0.147) (0.337) (0.219)
Output tariffs Small 1.02 1.99 0.55 1.69 0.54
(0.293) (0.425) (0.281) (0.524) (0.446)
Log of R&D expenditure 0.36 0.35 0.35 0.02 0.38 0.25
(0.145) (0.208) (0.174) (0.252) (0.181) (0.139)
Output tariffs Percentile rank 2.74
(0.383)
Observations 40,165 16,149 24,016 9982 12,430 40,165
R-squared 0.079 0.089 0.076 0.082 0.090 0.079
Notes: The dependent variable is wage bill/sales inall regressions. See notes for Table 1 for details on the construction of the large and small rmindicators. Output tariffs are laggedby one
period. Industries are classied as high or low labor intensive based on industry-level data from the Annual Survey of Industries. The industry-level unionization measure is calculated
using household-level data fromthe 19931994 Round of the National Sample Surveys. All regressions include the log of rmage, indicators for export and import status, and a constant.
All regressions also include rm and year xed effects. Robust standard errors in parentheses are clustered at the three-digit industry level.
p b 0.01.
p b 0.05.
p b 0.1.
33
In Table A4 in the web appendix we showthat these results are robust to using differ-
ent percentile cutoffs to construct our large and small rm size indicators.
34
In results not reported here, we experimented with a specication in which we
interacted tariffs with a measure of the labor market exibility in each state. The labor
market exibility measure is from Hasan et al. (2007). The negative coefcient on the in-
teraction term, while imprecisely estimated, suggests that the reduction in the share of
wages in total revenue after trade liberalization is smaller in states with more pro-
worker labor market regulations.
35
With a more representative sample of rms the cutoff rmwill have a smaller amount
of average sales. Therefore, such a rmshould have a negative relationship between tariff
and the share with the effect likely being larger in magnitude than what we nd with our
CMIE rm-level data.
technology upgrading by adding aninteractionbetweenthe natural log-
arithm of R&D expenditure and output tariffs to our baseline specica-
tions. Note that these specications already include the natural
logarithm of R&D expenditure in levels. Our key results in both panels
are strongly robust to the inclusion of this added interaction term. Inad-
dition, we also nd that the interaction between the natural logarithm
of R&D expenditure and output tariffs is positive and signicant,
which suggests that the wage share reducing effect of trade liberaliza-
tion is stronger for rms with higher R&D expenditure.
Next, in columns (2) and (3) we allow trade to have heterogeneous
effects on wage shares through rm productivity, where the latter is
proxied by indicators of export and import status. In particular, we
add interactions between each rm's export and import status and out-
put tariffs to columns (2) and (3) respectively. The baseline specica-
tions already include the level effects of export and import status. In
both cases our main results remain robust. Finally, in column (4) we
add all three interaction terms simultaneously to our baseline specica-
tions. The coefcients of the interaction terms of interest in both panels
maintain the correct sign and remain statistically signicant. Finally, in
column (5) we add the natural logarithm of rm-level markups that
we estimated using the method described in Section 4.2 to our baseline
specications. In addition, we also include the interaction between
markups and output tariffs. The aim here is to control for the heteroge-
neity in markups. Our key results in both panels once again remain
robust.
The results thus far highlight a robust, heterogeneous relationship
between trade liberalization and the share of wages in revenue. While
we believe that the channels identied in our model in Section 2 are
strongly supported by our empirical analysis, alternative explanations
are possible. We account for some of these alternate explanations in
Table 4 where we have allowed output tariffs to have differential effects
on the share of wages in revenue through channels other than labor in-
tensity. Even after doing so, we have found that our earlier results re-
main robust. Thus, while these other channels may be important
sources of heterogeneity, they do not diminish the role played by differ-
ences in labor intensity. In addition, in Tables 2 and 3, we tested our
model further by splitting the sample by industry labor intensity and
the extent of unionization. We demonstrated that the results in the var-
ious subsamples conform to our model's predictions. Thus, we have
empirically investigated all other explanations that we could think of
for the wage share heterogeneity we observe in the data. Irrespective
of this, we want to emphasize that we view the unearthing of this het-
erogeneity itself as one of the main contributions of the paper. In addi-
tion, towards the end of the paper we investigate the link between
bargaining power and tariffs, where the bargaining power is economet-
rically estimated using an equation derived from our theory. As will be
seen, these bargaining power results further strengthen our belief in
the channels we presented at the outset.
6. Robustness checks
6.1. Endogeneity of tariffs and alternate specications
Up to this point we have assumed that the output tariffs included in
our regressions are exogenous. This assumption is supported by the fact
that the Indian trade reform of 1991 was conducted under pressure
fromthe International Monetary Fund (IMF) and was quite unexpected.
Thus, this reform can be considered exogenous to the rms in our sam-
ple. While this assumptionis reasonable during the initial years after the
trade reformof 1991, it is potentially problematic during the latter years
of the sample when the external pressure imposed by the IMF had abat-
ed (Topalova and Khandelwal, 2011).
36
We account for endogeneity concerns in two ways. First, we restrict
our sample to the period 19891997 and re-estimate our key results.
The advantage of this is that it restricts the sample to a period in
which tariffs are less likely to be a function of political economy factors.
However, the disadvantage of this is that, according to Figs. 1 and 2, we
are also eliminating important post-1997 variation in wage shares. We
report these results in columns (1)(3) of Table 5. In Panel A, we re-
estimate columns (2) and (5)(6) from Table 2 using the truncated
sample. Our two key results from these earlier columns remain robust.
In other words, we still nd that trade liberalization raises the share of
wages in revenue for rms that are sufciently labor intensive and
that this effect is stronger in industries that have above median pre-
reform labor intensity and a unionization rate that is at or below the
36
Note that while output tariffs may be driven by political economy concerns in the lat-
ter periods of the sample, it still need not be a function of the share of wages in revenue.
Table 4
Alternate sources of heterogeneity.
(1) (2) (3) (4) (5)
Additional interactions included R&D Export Import All Markup
Panel A: Epsilon interactions
Output tariffs 2.38 2.19 2.06 1.96 2.43
(0.859) (0.914) (0.792) (0.827) (0.770)
Output tariffs Epsilon 5.04 4.99 4.93 4.89 4.91
(0.891) (0.900) (0.884) (0.892) (0.767)
Observations 40,165 40,165 40,165 40,165 37,734
Panel B: Firm size interactions
Output tariffs 0.35 0.30 0.22 0.20 0.58
(0.729) (0.783) (0.625) (0.670) (0.724)
Output tariffs Large 0.80 0.80 0.79 0.76 0.71
(0.136) (0.134) (0.141) (0.133) (0.143)
Output tariffs Small 1.01 0.99 0.95 0.94 0.89
(0.293) (0.298) (0.300) (0.300) (0.323)
Observations 40,165 40,165 40,165 40,165 37,734
Notes: The dependent variable is wage bill/sales in all regressions. In column (1) of both panels we add an interaction between the log of R&D expenses and output tariffs to our baseline
specication, which already includes the log of R&D expenses in levels. In columns (2) and (3) we repeat this process using the interaction between output tariffs and export and import
status respectively. In column (4) we add the interaction between output tariffs and R&D, export and import status simultaneously. Finally, in column (5) we add the interaction between
the log of markup and output tariffs along with the log of markup itself to our baseline specication. The sample size is smaller in column (5) because we trimobservations with markups
that are above and belowthe 97th and 3rd percentiles, respectively. Output tariffs are lagged by one period. See notes for Table 1 for details on the construction of the large and small rm
indicators. All regressions include the log of rm age and a constant. All regressions also include rm and year xed effects. The standard errors in parenthesis in Panel A are cluster
bootstrapped at the 3-digit industry level with 100 repetitions. Robust standard errors in parentheses are clustered at the three-digit industry level in Panel B.
p b 0.01.
p b 0.05.
median. In Panel B, we re-estimate columns (1) and (4)(5) from
Table 3 using the truncated sample. In column (1) we continue to nd
that trade liberalization lowered the share of wages in revenue for
large rms. In addition, the interaction of tariffs with the small rm in-
dicator is negative but no longer statistically signicant. This is not en-
tirely surprising given the variation in wage shares that we observe
for small rms after 1997 in Figs. 1 and 2. In columns (2) and (3) we
still nd that the overall effect of output tariffs is more strongly wage
share increasing for small rms in high labor intensity and low unioni-
zation industries (column (2)) compared to small rms in lowlabor in-
tensity and high unionization industries (column (3)). Similarly, we still
nd that the wage share reducing effect of trade liberalization is smaller
for large rms in high labor intensity and low unionization industries
(column (2)) relative to large rms in low labor intensity and high
unionization industries (column (3)). However, compared to Table 3,
some of the Panel B results in columns (1)(3) of Table 5 are more im-
precisely estimated.
We also address concerns about the endogeneity of output tariffs
using a second method. This method adopts a variant of the instrumen-
tal variable (IV) strategy used by Goldberg and Pavcnik (2005). In par-
ticular, we rst convert our baseline specication to rst differences.
This removes any time-invariant characteristic that is correlated with
both the share of wages in revenue and output tariffs. We then instru-
ment the differenced tariff term using 5-year lagged output tariffs. For
the differenced interaction between output tariffs and Epsilon, we use
as an instrument the interaction between 5-year lagged tariffs and
Epsilon. Similarly, for the differenced interaction between output tariffs
and the rm size indicators, we use as instruments the interaction be-
tween 5-year lagged tariffs and the rm size indicators. Section 4.1 dis-
cusses the assumptions that need to hold in order for this IV strategy to
be valid. The results of the IV regressions are reported in columns
(4)(6) of Table 5. In column (4) of Panel A, the interaction between
output tariffs and Epsilon remains negative and signicant. The rst-
stage Shea's partial R
2
for the differenced tariff termand the differenced
interaction term is 0.08 and 0.47, respectively. Next, in column (4) of
Panel B, the interactions between output tariffs and both rm size indi-
cators have the correct sign and are statistically signicant. In this case,
the rst-stage Shea's partial R
2
ranges from 0.06 to 0.46.
A criticism of this IV strategy is that it does not control for the fact
that rms may face differential time trends that are potentially correlat-
ed with the instrument. To address this we followPark et al. (2010) and
add time trends interacted with initial rm characteristics. These char-
acteristics include the natural logarithmof R&Dexpenditure, export sta-
tus, import status, and the age of the rm during its initial year in the
sample. The results with the differential time trends included, as report-
ed in column (5) of both panels, are very similar to the baseline IV re-
sults in column (4). Finally, we further test the robustness of the IV
results by simultaneously including differenced interactions between
output tariffs and the natural logarithmof R&Dexpenditure, export sta-
tus, and import status respectively. In other words, we are allowing out-
put tariffs to have differential effects on wage shares through these
three additional channels. Each of these additional variables is instru-
mented by the interaction between 5-year lagged tariffs and the
differenced variable itself. The results, as reported in column (6) of
both panels, are once again consistent with the baseline IV results.
Finally, in Table 6 we experiment with alternate specications by
using three, ve, and seven-year differences. By taking differences over
a relatively long period, we allowrms to have considerable time to ad-
just their labor employment decisions. In addition, long-difference esti-
mators tend to be less sensitive to measurement error (Griliches and
Hausman, 1986). The results inall three columns conrmthat the impact
of trade liberalization on the share of wages in total revenue depends on
the labor intensity of a rm. This is true in both panels where we mea-
sure labor intensity using the elasticity of output with respect to labor
and the rm size indicators respectively. In addition, in Panel B we ob-
serve that the longer the time horizon considered, the larger are the
Table 5
Endogeneity of tariffs.
(1) (2) (3) (4) (5) (6)
Sample period 19891997 19892004
& low union.
Low labor intensity
& high union.
All
Estimation method OLS-FE One-year difference (IV)
Output tariffs 1.00 0.33 0.12 2.36 2.60 2.02
(0.427) (0.490) (0.369) (2.066) (1.908) (2.091)
Output tariffs Epsilon 2.72 2.65 0.57 6.51 6.36 6.31
(0.918) (0.639) (0.822) (1.514) (1.436) (1.511)
Observations 19,366 4886 6100 29,160 29,160 29,160
Output tariffs 0.06 1.03 0.40 0.03 0.17 0.18
(0.330) (0.992) (0.378) (1.201) (1.219) (1.280)
Output tariffs Large 0.36 0.47 0.60 0.65 0.70 0.53
(0.130) (0.394) (0.131) (0.187) (0.191) (0.228)
Output tariffs Small 0.40 0.74 0.28 1.51 1.53 1.37
(0.295) (0.392) (0.389) (0.475) (0.441) (0.438)
Observations 19,366 4886 6100 29,160 29,160 29,160
Initial rm controls Time effects No Yes No
Other rm controls Output tariffs No No Yes
Notes: The dependent variable is wage bill/sales incolumns (1)(3) and the wage bill/sales inrst differences incolumns (4)(6). All right-hand-side variables incolumns (4)(6) are also
inrst differences. Incolumns (4)(6) the differenced tariff termis instrumented using ve-year laggedoutput tariffs. The rst-differenced interactions betweentariffs and epsilonand the
rmsize indicators are instrumented using the interactions between ve-year lagged tariffs and the differenced epsilon and rmsize indicators respectively. Initial rmcontrols include
each rm's log of R&Dexpenses, export status, import status, and the log of age in their rst year in the sample. Other rmcontrols include log of contemporaneous R&Dexpenses, export
status, and import status. Output tariffs are laggedby one period. See notes for Table 1 for details on the construction of the large and small rmindicators. All regressions include the log of
rm age and a constant. All regressions also include year xed effects. The standard errors in parenthesis in columns (1) and (4)(6) of Panel A are cluster bootstrapped at the 3-digit
industry level with 100 repetitions. Due to the small number of clusters, the standard errors in columns (2)(3) of Panel A are bootstrapped with 100 repetitions. Robust standard errors
in parentheses are clustered at the three-digit industry level in Panel B.
p b 0.01.
p b 0.05.
p b 0.1.
magnitudes of the effects of trade liberalization on the share of the wage
in total revenue. Thus, the central nding in this paper is robust to the
use of these alternate specications.
6.2. Alternate measures of wage share & protection
In columns (1) and (2) of Table 7 we examine the robustness of our
previous ndings by using alternate measures of wage share as the de-
pendent variable. In column (1) we divide the wage bill by value added
instead of sales. The results in this column are consistent with previous
ndings. Similarly, in column (2) we divide the wage bill by total cost.
The latter is calculated by subtracting reported prots from sales. Once
again the results are consistent with our earlier ndings. Next, in
columns (3)(6) of Table 7 we experiment with alternate measures of
protection. In particular, in column (3) we replace output tariffs with
three-digit industry-level output non-tariff barriers (NTB). The point es-
timates in both panels suggest that lower NTBs raise the share of wages
in total revenue for labor intensive rms and decrease this share for less
labor intensive rms. In column (4) we replace output tariffs with
three-digit industry-level input tariffs. The coefcients of the interaction
terms are similar to our earlier ndings. Because of the strong correla-
tion between output and input tariffs, we are unable to include both
of them together in the right-hand side of a regression. Instead, to ad-
dress the issue that output and input tariffs might be affecting the
wage share differently, we measure protection using the effective rate
of protection (ERP) calculated at the industry level in column (6). The
exact procedure used to calculate this is outlined in Section 3.2. The co-
efcients of the interaction terms in both panels conrm that trade lib-
eralization leads to an increase in the share of wages in total revenue for
small, labor-intensive rms and to a decrease in the share of wages for
large rms.
7. Trade liberalization and the bargaining power of workers
We begin this section by examining our estimates of the industry-
level bargaining power of workers. We obtain these values by estimat-
ing Eq. (10a) on a sample that includes all rms in our sample. Further,
we estimate Eq. (10a) separately for eachindustryyear pair in our data.
The resulting industry-level bargaining power values are averaged over
the entire sample period and are listed in Table 8. Note that all of the es-
timates are positive and range from 0.04 to 0.30. The estimates in
Table 8 give us a sense of the bargaining power of workers in the aver-
age rm in each industry. However, they do not provide any insight on
how bargaining power has evolved over time. We address this issue in
Table 9 where we present the results from estimating Eq. (11). Recall
that the dependent variables in Table 9 are obtained by estimating
Eq. (10a) separately for each rm-size category, industry and year com-
bination in our sample.
In column (1) the dependent variable is the bargaining power of
workers for all rms in a given two-digit industry and year. The coef-
cient of output tariffs suggest that worker bargaining power decreased
more in industries that experienced larger decreases in tariffs. In column
(2) we use the bargaining power of workers inlarge rms ina giventwo-
Table 6
Alternate specications.
(1) (2) (3)
Estimation method 3 year difference 5 year difference 7 year difference
(0.542) (0.880) (0.653)
Output tariffs Epsilon 3.31 3.24 3.82
(0.755) (0.795) (0.993)
Observations 21,621 14,326 9236
(0.463) (0.716) (0.607)
Output tariffs Large 0.39 0.56 0.92
(0.095) (0.130) (0.175)
Output tariffs Small 0.65 0.96 1.37
(0.233) (0.315) (0.338)
Observations 21,621 14,326 9236
Notes: The dependent variable is wage bill/sales in three, ve, and seven year differences
respectively in columns (1)(3). Output tariffs are lagged by one period. See notes for
Table 1 for details on the construction of the large and small rm indicators. All
regressions include the log of R&D expenses, the log of rm age, indicators for export
and import statuses in differenced form. All regressions also include year xed effects.
The standard errors inparenthesis inPanel A are cluster bootstrappedat the 3-digit indus-
try level with 100 repetitions. Robust standard errors in parentheses are clustered at the
three-digit industry level in Panel B.
p b 0.01.
p b 0.05.
p b 0.1.
Table 7
Alternate measures of wage share and trade protection.
(1) (2) (3) (4) (5)
Trade protection measure used Output tariffs Output NTB Input tariffs ERP Industry
Dependent variable Wage bill/value added Wage bill/total costs Wage bill/sales
Trade protection 2.88 1.46 3.84 4.38 1.76
(0.910) (0.575) (0.966) (2.253) (0.566)
Trade protection Epsilon 5.62 3.73 10.67 6.05 4.22
(1.287) (0.885) (2.706) (1.117) (0.844)
Observations 40,165 40,147 40,165 39,909 39,909
Trade protection 0.62 0.08 0.64 2.24 0.09
(0.794) (0.478) (0.485) (2.003) (0.329)
Trade protection Large 1.05 0.65 1.69 1.04 0.58
(0.295) (0.127) (0.294) (0.148) (0.141)
Trade protection Small 1.75 0.72 2.60 1.23 0.69
(0.499) (0.303) (0.793) (0.328) (0.254)
Observations 40,165 40,147 40,165 39,909 39,909
Notes: All trade protection measures are laggedby one period. See notes for Table 1 for details onthe construction of the large and small rmindicators. NTBrepresents Non-Tariff Barriers.
ERP-Industry is calculated using industry-level data. All regressions include the log of R&Dexpenses, the log of rmage, indicators for export and import status, and a constant. All regres-
sions also include rmand year xed effects. The standarderrors inparenthesis inPanel Aare cluster bootstrappedat the 3-digit industry level with100 repetitions. Robust standarderrors
in parentheses are clustered at the three-digit industry level in Panel B.
p b 0.01.
p b 0.05.
p b 0.1.
digit industry and year as the dependent variable. The coefcient of out-
put tariffs is similar to that found in column (1) and suggests that worker
bargaining power in large rms decreased more in industries that expe-
rienced larger decreases in tariffs. In column (3) we use the bargaining
power of workers in medium-sized rms in a given two-digit industry
and year as the dependent variable. The coefcient of output tariffs is
positive but not statistically signicant. Finally, in column (4) we use
the bargaining power of workers in small rms in a given two-digit in-
dustry and year as the dependent variable. The results are statistically
signicant and once again suggest that worker bargaining power in
small rms decreased more in industries that experienced larger de-
creases in tariffs.
To further examine whether the impact of trade liberalization on
bargaining power depends on the size category of rms, we next
stack our bargaining power estimates. In other words, for each indus-
tryyear pair, we create three observations: (a) a bargaining power es-
timate for large rms, (b) a bargaining power estimate for medium
rms, and (c) a bargaining power estimate for small rms. We then re-
gress these bargaining power estimates on output tariffs, size indicators,
the one-year lagged industry controls listed below Eq. (11), and one-
digit industry and year xed effects. The results in column (5) conrm
the earlier nding that worker bargaining power decreased more in in-
dustries that experienced larger decreases in tariffs. In column (6) we
interact output tariffs with all three rm size indicators (i.e. excluding
the tariff term by itself) to examine whether the effect of trade liberali-
zationonbargaining power depends onthe size category of rms. For all
three size categories, the interaction term is positive. Furthermore, the
differences in the size of the coefcients are not statistically signicant.
This suggests that trade liberalization lowered the bargaining power of
workers in rms across all size categories.
Overall, the results in Table 9 suggest that trade liberalizationis asso-
ciated with a decline in bargaining power for rms in all size categories.
It also demonstrates that the relationship between trade liberalization
and bargaining power does not vary by size category. Thus, these results
strongly support our assumption regarding the relationship between
trade liberalization and bargaining power in Section 2.2.
8. Conclusion
In this paper, we add to the literature on trade and inequality by ex-
amining the impact of a major trade reform initiated in 1991 on the
share of wages in rmrevenue in India. As Atkinson (2009) has pointed
out, a decline in the labor share is associated with an increase in overall
inequality andraises concerns about social justice andfairness. Thus, ex-
amining the relationship between trade and labor share provides in-
sights that cannot be obtained by just studying the impact of trade on
absolute wages and employment or by studying the impact of trade
on the skilledunskilled wage gap.
A key contribution of this paper is the identication of signicant
rm-level heterogeneity in the evolution of wage shares during our
sample period. In particular, we nd that while labor's share of rmrev-
enue increased during our sample period for relatively labor-intensive
rms, this share declined for less labor-intensive rms. To explain this
Table 8
Bargaining power estimates by industry.
Industry code Industry name Bargaining power
15 Food and beverage, tobacco 0.301
[0.067]
17 Textiles 0.087
[0.045]
18 Wearing apparel, leather 0.071
[0.031]
21 Paper, printing and publishing 0.105
[0.016]
24 Rened petroleum, chemicals 0.082
[0.014]
25 Rubber 0.079
[0.022]
26 Non-metallic minerals 0.075
[0.014]
27 Basic metals 0.04
[0.018]
28 Fabricated metals 0.119
[0.035]
29 Machinery & equipment,
ofce machinery
0.069
[0.031]
31 Electrical machinery, precision
instruments
0.061
[0.029]
32 Communications equipment 0.068
[0.038]
34 Motor vehicles, other transport 0.119
[0.028]
36 Furniture and manufacturing not
elsewhere classied
0.133
[0.03]
Mean 0.101
Standard deviation 0.069
Notes: Bargaining power is the coefcient of the constant termina rm-level regressionof
the share of wages in total revenue on the inverse of markup. These regressions were run
separately for each industryyear pair in the sample. The numbers reported above are av-
eraged over the period 19902004. The numbers in brackets are standard deviations.
Table 9
The impact of trade liberalization on bargaining power.
(1) (2) (3) (4) (5) (6)
All Large Medium Small Stacked sample
Output tariffs 0.09 0.07 0.07 0.20 0.117
(0.028) (0.019) (0.045) (0.074) (0.035)
Output tariffs Large rm sample 0.116
(0.033)
Output tariffs Medium rm sample 0.108
(0.027)
Output tariffs Small rm sample 0.114
(0.029)
Constant 0.41 0.09 0.26 0.28 0.268 0.272
(0.080) (0.076) (0.297) (0.428) (0.184) (0.180)
Observations 210 210 210 210 630 630
R-squared 0.615 0.471 0.357 0.313 0.315 0.315
Notes: Dependent variable is the industry-level bargaining power of workers. Output tariffs are lagged by one year. In columns (5)(6) each industry has three observations per year: one
for all large rms in the industry, one for all medium rms, and one for all small rms. These regressions also include rm size category effects. All regressions include one-year lagged
industry controls. These industry controls consist of the natural logarithmof output per plant (degree of concentration), a categorical variable that categorizes industries as having either
high, medium, or lowlabor intensity, the fractionof exporters, the fractionof importers, the natural logarithmof total industry R&Dexpenditure, andthe natural logarithmof total industry
output. All regressions also include year xed effects and one-digit industry xed effects. Robust standard errors in parentheses.
p b 0.01.
heterogeneity we develop a simple model where a rm and a labor
union negotiate over wages and employment. This model extends the
framework of Brock and Dobbelaere (2006) and McDonald and Solow
(1981) by allowing rms to have market power. We show that trade,
by lowering the markup charged by rms, can have heterogeneous ef-
fects on the share of wages in revenue.
We test this prediction using rm-level panel data from India. Our
data cover the period 19892004 and allow us to exploit the IMF-
imposed trade liberalization in India in 1991. Our results suggest that
trade liberalization raises labor's share of rm revenue for labor-
intensive rms and lower this share for less-labor intensive rms.
These results are robust to controlling for alternative sources of hetero-
geneity (e.g. heterogeneous technological upgrading); using alternate
measures of labor share and trade protection; and to the use of long-
lagged tariffs as instruments. Lastly, we use our framework to examine
the relationship between trade liberalization and industry-level esti-
mates of workers' bargaining power. Our results indicate that, on aver-
age, industries that experienced greater decreases in output tariffs also
experienced greater decreases in the bargaining power of workers.
While our empirical results underscore the need for social protec-
tion, the negative impact of trade on bargaining power need not be
harmful for workers. In fact, this could be one of the channels through
which trade might reduce unemployment. In addition, given the low
levels of labor productivity in India, a decline in the bargaining power
of labor might realign incentives in a way in which greater effort is
rewarded. This can be productivity enhancing and can ultimately lead
to an increase in wages. Besides, in the context of India's rapid growth
in this current phase of liberalized trade, a declining share of an
expanding pie might still mean a growth in the absolute size of the
slice going to workers.
Appendix A. Construction of working sample
To construct our working sample, we begin by omitting erroneous
data from the Prowess database. In particular, we omit observations
with missing industry data. We also omit observations that report miss-
ing sales data or those that report either zero sales, material costs, em-
ployee compensation and xed assets. We also omit observations
where either the materials costs, employee compensation, capital
stock, R&D expenses or rm age are reported as negative. Next, we
omit observations where the total compensation to workers exceeds a
rm's value added and observations for which estimated total costs
(sales prot) are negative. In addition, because our estimation of
the production function requires lagged values, we omit any rm that
appears only once in our sample period. Lastly, we restrict our working
sample to the 15 major states in India as well as the 56 three digit
manufacturing industries available in the data.
37,38
Appendix B. Production function estimation
Suppose that the production function in Eq. (1) is trans-log in labor,
materials, and capital as follows:
q
ijt

0

l
l
ijt

ll
l
2
ijt

m
m
ijt

mm
m
2
ijt

k
k
ijt

kk
k
2
ijt
lm
l
ijt
m
ijt

lk
l
ijt
k
ijt

mk
m
ijt
k
ijt

ijt

ijt
1a
where i, j, and t indexes rms, industries and year respectively. Output
(q
ijt
), labor (l
ijt
), material costs (m
ijt
), and capital (k
ijt
) are all in natural
logarithm.
ijt
is a classical error termand is assumed to be uncorrelated
with the input choices. Onthe other hand,
ijt
is each rm's productivity
and is correlated with its input choices. This productivity is observed by
the rm but is not observed by the econometrician.
To control for unobserved productivity, we use the Ackerberg et al.
(2006) proxy approach. In particular, we assume that
t
is a function
of capital and materials. As a result, the production function in
Eq. (1a) becomes (with the i and j subscripts removed to avoid clutter):
q
t

t
k
t
; m
t
; l
t

t
A1
where
t
k
t
; m
t
; l
t

0

l
l
t

ll
l
2
t

m
m
t

mm
m
2
t

lm
l
t
m
t

k
k
t

kk
k
2
t
lk
l
t
k
t

mk
m
t
k
t

t
k
t
; m
t
: A2
Following Ackerberg et al. (2006), we estimate the production func-
tion above in two stages. In the rst stage, we estimate Eq. (A1) by ap-
proximating
t
(k
t
,m
t
,l
t
) using a third-order polynomial series in k
t
, m
t
,
and l
t
along with its interactions. This allows us to obtain an estimate
for the expected output

t
.
In the second stage, we obtain estimates of the production function
coefcients by relying on the assumption that productivity follows a
rst-order Markov process. That is,
t
g
t

t1

t
A3
where
t
is the innovation component of
t
and will be used to gener-
ate moment conditions to estimate the production function parameters.
Tocompute
t
, we use our estimate of

t
above along withany candidate
values of the 's to calculate productivity as follows:
^
t

^
l
l
t
ll
l
2
t

m
m
t
mm
m
2
t

lm
l
t
m
t
k
k
t
kk
k
2
t
lk
l
t
k
t
mk
m
t
k
t
:
A4
We then estimate Eq. (A3) by regressing
t
on a third-order polyno-
mial of its lagged term
t1
as well as a constant. The residual fromthis
regression provides us with an estimate of the innovation term
t
. In the
nal step, we estimate the production function coefcients by
exploiting the following moment conditions:
E
t
Z 0 A5
where Z = (l
t 1
, l
t 1
2
, m
t 1
, m
t 1
2
, k
t
, k
t
2
, l
t 1
m
t 1
, l
t 1
k
t
,
m
t 1
k
t
). These moment conditions rely on the following assumptions.
First, capital stock inany period(k
t
) is determined by the capital stock in
the previous period along with investment in the previous period. This
implies that k
t
will be uncorrelated with
t
. On the other hand, both l
t
and m
t
are expected to be correlated with current shocks to productiv-
ity. As a result, to estimate the labor and material coefcients, we use
their one-year lags. We estimate Eq. (A5) using standard GMM tech-
niques to obtain our nine production function coefcients.
With our production function estimates in hand, we calculate the
rm-specic elasticity of output with respect to labor as follows:

Q;N

l
2
ll
l
t

lm
m
t

lk
k
t
:
Similarly, we also calculate the rm-specic elasticity of output with
respect to materials as follows:

Q;M

m
2
mm
m
t

lm
l
t

mk
k
t
:
Bothof these variables vary by rmandyear. Table A2inthe web ap-
pendix reports these estimates. While the elasticities are calculated at
the rm level, we report two-digit industry averages in Table A2 for
ease of presentation.
37
These states are: Andhra Pradesh, Assam, Bihar, Gujarat, Haryana, Karnataka, Kerala,
Madhya Pradesh, Maharashtra, Orissa, Punjab, Rajasthan, Tamil Nadu, Uttar Pradesh, and
West Bengal. Firms in the remaining states represent 1.1% of the sample.
38
During our sample period three of these fteen states were subdivided to form new
states. These new states are: Chattisgarh, formerly part of Madhya Pradesh; Jharkhand,
formerly part of Bihar; and Uttaranchal, formerly part of Uttar Pradesh. In order to main-
tainconsistency across rounds, we donot consider these newstates separately and instead
consider the earlier state boundaries.
Appendix C. Supplementary data
Supplementary data to this article can be found online at http://dx.
doi.org/10.1016/j.jdeveco.2013.12.011.
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