1995. They also show that there were significant decreases in the share of products that are subject to quantitative restrictions which went down from 87% in 1987 to 45% in 1994. Goldberg et al. (2010b) explain that the tariff liberalization up until 1997 was unanticipated, not targeted toward specific industries, and they were free of political economy pressures. I obtain the data on tariff rates at four digit industry level from Topalova and Khandelwal (2011). They construct a database of annual tariff rates at 6-digit level according to Indian Trade Classification Harmonized System Code based on various publications of the Ministry of Finance. Then they match the products at 6-digit with 4-digit NIC codes using the concordance by Debroy and Santhanam (1993) to calculate average industry level tariffs. These industry-level output tariffs are combined with input-output transaction table from 1993-1994 to calculate the input tariffs. Controlling for input tariff rates is particularly important because Goldberg et al. (2010b) find that reduction of input tariff rates significantly increased innovation capacities of firms. Hence, the relationship between licensing reform and innovation can be biased if the effect of tariff reform is not controlled for.

Indian government also reduced the barriers to foreign direct investment in a group of industries after the balance of payments crisis in 1991. The reform allowed majority ownership rights to foreign firms. As a result of this reform, total foreign direct investment in India increased from around 250 million dollars in 1989 to around 2200 million dollars according to the numbers in UNCTAD’s FDI database. I use the data compiled by Topalova and Khandelwal (2011) which is a 4-digit industry level, time varying measure of openness to foreign direct investment. They obtain the data from the publications of Handbook of Industrial Statistics. The FDI measure takes a value of zero before 1991 in all industries when FDI was strictly controlled. After that year it shows the percentage of the industry that is opened to FDI. Foreign held companies are usually better at technology adoption and they are more innovative than domestic firms. They can get easier access to technology, capital resources, and R&D facilities of the parent company which facilitate innovation and growth. Seker (2011), Criscuolo et al. (2010), and Almeida and Fernandes (2008) provide empirical evidence on the relationship between FDI and innovation. There are also studies like Haddad and Harrison (1993) and Sinha (1993) that find a positive impact of foreign ownership on firms’ productivity levels.

India is a federal democracy and industrial relations fall under the joint jurisdiction of central and state governments in the constitution. Labor regulations are affected by both jurisdictions. Key central legislation is the Industrial Disputes Act of 1947 which sets out the conciliation, arbitration, and adjudication procedures to be followed in the case of an industrial dispute. Although all states have the same starting labor regulations, they have diverged from one another over time. Besley and Burgess (2004) divide states into three groups: pro-worker, pro-employer, and neutral. A state has a pro-worker labor regulation if the legislations benefitted workers compared to employers. They show that states which had pro-worker labor regulations experienced lower output, employment, investment, and productivity in registered or formal manufacturing sector. In the Prowess database some firms provided information on the geographic location of their headquarters. Following Besley and Burgess (2004) I set a dummy equal to one if the firm is located in a state that has pro-worker labor regulations. I analyze whether the relationship between licensing reform and innovation varied with the labor regulations in the states.

The trade liberalization, FDI reform, and variation in labor regulations across states can affect innovation performances of firms. In the empirical analysis I test whether the licensing reform increased 8