Competition and Productivity – Evidence from Indian Manufacturing Sector Reforms

The extensive reform measures introduced in the early 90s in India provide a unique opportunity to study policy experiments aimed at reducing barriers to entry and increasing product market competition. We use a rich, comprehensive, plant-level dataset for the period 1986-87 to 1994-95 to identify the effects of de-licensing, liberalization of foreign direct investment (FDI) and the reduction of tariff barriers on productivity in the Indian manufacturing sector. The two main goals of this paper are to test whether intra-firm productivity levels went up following the reforms and to assess the roles of intra-firm productivity growth and the reallocation of inputs in aggregate output growth. We find a 10% increase in mean intra-firm productivity level following the reforms in investment friendly states. We estimate an increase in mean intra-firm productivity level in the reformed industries by 17% following liberalization of FDI and by 24% (weakly significant) following tariff liberalization. We analyze a novel decomposition of industry level output growth and find an increase in output growth, by 15.6% following FDI liberalization and by 18.9% following tariff liberalization, in the reformed industries. Our analysis suggests that about 75% of the increase in output growth arises from increase in intra-firm productivity growth, which is the only component of output growth that shows a statistically significant increase following reforms. The contribution of intra-industry and inter-industry reallocation of inputs to aggregate output growth is relatively minor. I have benefitted from enormously from discussions with Sam Peltzman and Marianne Bertrand and Amil Petrin. I thank James Levinsohn for his thoughts and inputs. I also thank participants at the micro lunch at the University of Chicago for their comments. All remaining errors are my own. Address: Office of Doctoral Studies, Graduate School of Business, University of Chicago, 1101 E 58th Street, Chicago, IL 60637. email: [email protected]