This paper exploits the 1991 Indian liberalization to illustrate how such
a reform may have unequal effects on industries and regions within a single
country. We begin by developing a Schumpeterian growth model to analyze
the effects on growth and inequality of liberalization reforms aimed at increasing
entry. The main predictions of the model are: (i) liberalization fosters
innovation (technology adoption), profits and growth, in industries that are
initially close to the technological frontier, while it reduces innovation, profits
and growth in industries which are initially far below the frontier; (ii) proworker
labor regulations discourage innovation and growth in all industries
and this negative effect increases with liberalization. We test these predictions
in a 3-digit industry panel data set for the sixteen main states of India over the
period 1980-1997. The empirical results confirm the main predictions of the
model. We find that the 1991 liberalization in India had strong inequalizing
effects, by fostering productivity growth and profits in 3-digit industries that
were initially closer to the Indian productivity frontier and in states with more
flexible labor market institutions. These findings emphasize that the initial
level of technology and institutional context mattered for whether and to what
extent industries and states in India benefited from liberalization.