How Rising Heat Pushes Workers into Informality and Lowers Productivity in India

Rising heat in India pushes workers out of large, productive firms into smaller informal ones, worsening economic efficiency and cutting productivity in the short run. Over time, large firms adapt and reabsorb labor, but the long delay means climate change imposes significant transitional costs on the economy.

Researchers Jonah Rexer and Siddharth Sharma from the World Bank’s Office of the Chief Economist for South Asia study how rising temperatures affect businesses in India, going beyond the well-known impacts on agriculture. Their core argument is that heat not only reduces productivity inside firms, but it also changes where workers end up working. In an economy like India’s, where millions of tiny informal firms coexist with a small number of large, productive ones, these shifts in labor allocation can have major consequences for overall economic efficiency.

A unique dataset on firms and climate

The study uses data from India’s Economic Census, which covers nearly the entire universe of non-farm firms, about 42 million establishments, across four census years between 1990 and 2013. These firm records are matched with highly detailed village-level temperature data drawn from global climate reanalysis sources. This allows the authors to observe how unexpected heat shocks affect firms of different sizes across space and over time, rather than relying on small surveys or short time periods.

Heat hits large firms hardest in the short run

On average, a one-degree Celsius increase in temperature reduces firm employment by about 12 percent in the short run. But this average hides a striking pattern. Small firms, including informal microenterprises and self-employed workers, are barely affected and sometimes even grow. Large firms, by contrast, shed workers sharply. Firms at the upper end of the size distribution lose close to 20 percent of their workforce after a heat shock. This pattern holds even within the same industry, showing that it is not driven by shifts between sectors like manufacturing and services.

The authors explain this by pointing to adjustment costs. Large firms depend on coordinated work, machinery, and infrastructure that are sensitive to heat. Adapting, by installing cooling, changing production processes, or upgrading buildings, takes time and money. In the short run, cutting labor is often the fastest response.

Workers move into informality, lowering productivity

When large firms shed workers, those workers rarely move straight into other formal jobs. Instead, they are absorbed by the informal sector: self-employment and very small firms with fewer than eight workers. The data show that a one-degree temperature increase shifts about two percentage points of local employment away from large firms and into small informal ones.

This matters because informal firms are far less productive. Using additional survey data, the authors estimate that workers in informal firms produce only a fraction, often less than half, of what workers in formal firms produce. As a result, heat-driven labor reallocation reduces overall productivity even if total employment stays the same. The study estimates that this reallocation alone lowers aggregate labor productivity by between 1 and 4 percent for each degree of warming.

Adaptation works but it takes decades

The negative effects of heat are not permanent. Looking at longer time spans of 8 to 23 years, the authors find that the average impact of temperature on firm size becomes much smaller. This suggests that firms do adapt over time, offsetting roughly 60 percent of the initial shock. More importantly, the distributional pattern reverses. Large firms gradually recover and reabsorb workers, while the smallest firms begin to shrink.

This long-run reversal reflects the greater adaptive capacity of large firms, which eventually invest in cooling technologies, better buildings, and more resilient production systems. The informal sector’s expansion turns out to be temporary, acting as a safety net during periods of stress. However, the transition is costly. Because adaptation is slow, economies experience long periods in which labor is stuck in low-productivity activities. As climate change continues year after year, these adjustment costs are likely to accumulate rather than disappear.