The Unequal Effects of Liberalization: Evidence from Dismantling the License Raj in India

GAICIL Insights

One national reform, opposite regional fates.¹ The Unequal Effects of Liberalization: Evidence from Dismantling the License Raj in India, by Philippe Aghion, Robin Burgess, Stephen J. Redding and Fabrizio Zilibotti, studies the progressive elimination of the License Raj, a system of central controls regulating entry and production in registered manufacturing, and asks whether its effects varied across Indian states with different labor market regulations.

India is an emblematic case. It began post-independence life as the poster child for planned industrialization and shifted more recently to a market-oriented strategy. Intellectual fashions about encouraging industrial development have changed radically over the last fifty years, and the question remains one of development work's holy grails.

The findings are striking. Registered manufacturing fell in some states and rose in others in response to the same delicensing reform, depending on labor institutions. After delicensing, industries in states with labor market institutions more favorable to employers grew more quickly than those in states whose institutions favored workers. As predicted, delicensing reallocated industrial production across states according to their labor institutions. The reform opened the door; local rules decided who walked through it.

The lesson is clear. Local institutions and policies matter for whether a region benefits from or is harmed by nationwide liberalization. This fits a growing literature on heterogeneous effects of trade liberalization depending on local institutions. The focus should be squarely on the local policy and institutional environment when thinking about encouraging growth in particular regions during reform. National averages hide regional destinies.

AI is a national, indeed global, shock whose effects will vary across regions with local institutions. Regions with flexible labor markets, supportive regulations and complementary institutions may benefit more from AI, while others may lag. National AI strategies should attend to the local institutional environment. The AI map of any large country may soon look like India's post-reform manufacturing map.

Reallocation is the mechanism to watch. Liberalization shifted industrial production toward states whose institutions let firms adjust. AI may likewise shift activity toward regions where firms can adapt workforces and operations. Understanding these dynamics helps policymakers anticipate regional winners and losers and design support for lagging regions. A technology that is the same everywhere can produce very different places.

Local policy is also an opportunity. Regional governments can shape institutional environments to attract AI-driven activity and help firms adapt. Local policies on labor regulation, skills, infrastructure and business climate influence how much a region gains from technological change. In the AI era, a state legislature may matter as much as a national ministry.

Labor regulation's interaction with reform deserves care. Rules intended to protect workers may, in some circumstances, limit firms' ability to expand after liberalization, reducing regional growth and employment. Designing labor institutions that protect workers while letting firms adapt is a central challenge, especially as AI changes the nature of work. Protection that freezes firms can end up shrinking the jobs it was meant to protect.

The identification is credible. Comparing the same national reform's effects across states with different institutions isolates the role of local institutions, valuable evidence for policy design in large, diverse economies.

National reforms need attention to local conditions. The benefits of liberalization, and of new technologies like AI, are not automatically shared across regions. Complementary local reforms can help more regions benefit.

Distilled to one claim: liberalization's effects depend on local institutions. Dismantling the License Raj boosted manufacturing in states whose labor institutions let firms adjust and reduced it in others. As AI transforms economies, local institutional environments will again shape which regions thrive, making local policy a key lever for inclusive growth.

National AI strategies in large federations might start here: draft the regional annex before the national plan. If local institutions decide who benefits, a strategy that ignores them is predicting the average of a distribution that nobody lives in.