How Rising Heat Pushes Workers into Informality and Reshapes Firm Productivity in India

Rising heat in India initially forces large, productive firms to shed workers, pushing labor into small informal enterprises and causing significant short-run productivity losses. Over time, larger firms adapt to higher temperatures and reabsorb labor, partially reversing misallocation but only after long and costly adjustment periods.

A study, conducted by researchers at the World Bank’s Office of the Chief Economist for the South Asia Region, explores how rising temperatures reshape firms, jobs, and productivity in India. Using detailed evidence from the World Bank’s Policy Research Working Paper series, the paper goes beyond asking whether heat hurts productivity and instead examines how climate shocks change where workers are employed. India offers a critical case: it faces intense and growing heat stress, while its economy is dominated by millions of tiny informal firms alongside a small number of large, highly productive formal ones. This structure makes the country especially vulnerable to climate-driven misallocation, where workers move away from productive firms into less productive activities.

A Unique Dataset Linking Firms and Weather

The analysis is based on India’s Economic Census, which covers about 42 million non-farm establishments across four census rounds between 1990 and 2013. Unlike most firm surveys, the census captures both formal firms and informal microenterprises, including self-employed workers. The researchers link this firm data to high-resolution village-level temperature records derived from global climate reanalysis data. By focusing on temperature anomalies, unexpected deviations from long-run local averages, the study isolates the impact of heat shocks while holding constant long-term geographic differences. This approach allows the authors to observe how firms respond to heat in the short run, when adaptation is limited, and in the long run, when firms have time to adjust.

Short-Run Heat Shocks Hit Big Firms Hardest

In the short run, rising temperatures clearly reduce firm size. A one-degree Celsius increase in annual maximum temperature lowers average firm employment by about 12 percent. However, this average hides stark differences across firms. Small and micro firms generally do not shrink when temperatures rise, and some even grow slightly. Large firms, by contrast, suffer heavy losses, with employment at the top of the firm size distribution falling by nearly 20 percent after a one-degree heat shock. These effects occur even within narrowly defined sectors, showing that the damage is not simply due to workers moving between industries.

Informality as a Buffer, but at a Cost

The evidence suggests that workers released by large, formal firms do not disappear from the labor market. Instead, they move into self-employment or small informal firms. At the level of local labor markets, a one-degree increase in temperature shifts about two percentage points of employment away from larger firms toward informal activities. This means the informal sector acts as a safety net, absorbing workers when formal firms cut back. But this adjustment comes at a price. Informal firms are far less productive than formal ones, so this reallocation lowers overall economic efficiency. Using independent data on value added per worker, the study estimates that heat-driven labor reallocation reduces aggregate labor productivity by roughly 1 to 4 percent for each degree Celsius of warming, even before accounting for future climate change.

Adaptation and Reversal in the Long Run

The long-run story is more hopeful. When the researchers examine changes over 8, 15, and 23 years, they find that the negative effects of heat on firm size become much smaller. Over time, large firms adapt by investing in cooling, infrastructure, and new ways of organizing production. As a result, they gradually reabsorb labor. After two decades, the pattern seen in the short run largely reverses: the smallest firms become the most vulnerable to higher temperatures, while the largest firms are barely affected. This suggests that adaptation offsets nearly 60 percent of the initial labor demand shock from heat. However, the transition is slow, implying long periods during which workers remain stuck in low-productivity informal jobs.

Why This Matters for Policy

The study shows that climate change affects economies not only through direct productivity losses but also through prolonged periods of inefficient adjustment. In the short run, heat worsens misallocation by pushing workers out of productive firms and into informal survival activities. In the long run, larger firms adapt, and efficiency improves, but only after years or even decades. Policies that help productive firms adapt faster, by easing access to finance, electricity, and regulatory approvals, could reduce these transitional losses. At the same time, improving the resilience of small informal firms is essential, as they remain highly exposed to rising temperatures. Understanding these dynamics is crucial as India and other developing economies face a hotter future.