The impact of policy reform on pro-poor growth lies in the relative expansion of the formal and informal sectors in a developing country such as India. The relative expansion of the informal sector is influenced not only by the form of
industrial and labour regulation of the sub-national state but also by their functioning, which is influenced by cultural, social and political institutional environments operating at the level of the state and how these institutions cope
with policy shocks originating at the national level. We find that the lock-out to strike ratio, enforcement of contract labour laws along with political stagnation in a more competitive environment in the state impede the growth of the formal sector and lead to a shift of economic activity to the informal sector, thus constraining the overall economic growth of the state in question. However, we find that these same factors have a direct and stronger effect on poverty
reduction by encouraging the growth of the informal sector. Therefore, the labour and industrial laws and the degree to which they are enforced could be treated as a set of strategic choices that affect the trade-off between growth and poverty reduction in the Indian context.