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Pre-reform Conditions, Intermediate Inputs and Distortions: Solving the Indian Growth Puzzle

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Gupta, Abhay

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Abstract

This paper answers the puzzling questions that why under the similar set of economic conditions service sector in India grew while manufacturing could not and how economic reforms in 1990s accelerated the productivity growth. The paper provides a very innovative and convincing explanation. Two subtle but important distortion-inefficiency mechanisms, which work through distorting the intermediate input allocation, are identified in the paper. Interaction of policies of quantitative restrictions and inflexible labor laws resulted in lower than optimal materials per worker usage.Combination of high inflation and unavailability of credit exacerbated this factor distortion and lowered the productivity growth further. Using panel data on Indian industries, I find underutilization of materials compared to labor until recently. This sub-optimal materials per worker usage lowers productivity growth. Productivity estimates are negatively related to labor growth and positively related to materials growth. Real wages and labor productivity are negatively related to materials inflation and this relationship breaks down after the capital market reforms in 1990s. Since these mechanisms work through intermediate inputs, service sector productivity is not affected as adversely. Estimates show that after 1990s firms have started oversubstituting materials and capital relative to labor, which can explain the jobless growth in Indian manufacturing.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 14481.

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Date of creation: Apr 2009
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Handle: RePEc:pra:mprapa:14481

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Related research
Keywords: License Quota. Labor Laws. Price Change and Factor Substitution. Credit Constraints. Intermediate Inputs. Distortions and Productivity Growth.;

Find related papers by JEL classification:
J08 - Labor and Demographic Economics - - General - - - Labor Economics Policies
C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation
L6 - Industrial Organization - - Industry Studies: Manufacturing
D45 - Microeconomics - - Market Structure and Pricing - - - Rationing; Licensing
D24 - Microeconomics - - Production and Organizations - - - Production; Capital and Total Factor Productivity; Capacity
O4 - Economic Development, Technological Change, and Growth - - Economic Growth and Aggregate Productivity
B41 - Schools of Economic Thought and Methodology - - Economic Methodology - - - Economic Methodology

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  1. Anne O. Krueger, 1997. "Trade Policy and Economic Development: How We Learn," NBER Working Papers 5896, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Barry Bosworth & Susan M. Collins, 2008. "Accounting for Growth: Comparing China and India," Journal of Economic Perspectives, American Economic Association, vol. 22(1), pages 45-66, Winter.
  3. Deb Kusum Das, 2003. "Quantifing trade barriers: Has protection declined substantially in Indian manufacturing?," Indian Council for Research on International Economic Relations, New Delhi Working Papers 105, Indian Council for Research on International Economic Relations, New Delhi, India. [Downloadable!]
  4. Ana M. Fernandes & Ariel Pakes, 2008. "Factor Utilization in Indian Manufacturing: A Look at the World Bank Investment Climate Surveys Data," NBER Working Papers 14178, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. Mohammad, Sharif & Whalley, John, 1984. "Rent Seeking in India: Its Costs and Policy Significance," Kyklos, Blackwell Publishing, vol. 37(3), pages 387-413.
  6. Krueger, Anne O, 1997. "Trade Policy and Economic Development: How We Learn," American Economic Review, American Economic Association, vol. 87(1), pages 1-22, March. [Downloadable!] (restricted)
  7. Chang-Tai Hsieh & Peter J. Klenow, 2007. "Misallocation and Manufacturing TFP in China and India," NBER Working Papers 13290, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Badri Narayan Rath & S.Madheswaran, 2004. "Productivity Growth of Indian Manufacturing Sector: Panel Estimation of Stochastic Production Frontier and Technical Inefficiency," Econometric Society 2004 Far Eastern Meetings 527, Econometric Society.
  9. King, Robert G & Levine, Ross, 1993. "Finance and Growth: Schumpeter Might Be Right," The Quarterly Journal of Economics, MIT Press, vol. 108(3), pages 717-37, August. [Downloadable!] (restricted)
    Other versions:
  10. Bhalotra, Sonia R, 1998. "The Puzzle of Jobless Growth in Indian Manufacturing," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 60(1), pages 5-32, February.
  11. Badri Narayan Rath & S.Madheswaran, 2004. "Productivity Growth of Indian Manufacturing Sector: Panel Estimation of Stochastic Production Frontier and Technical Inefficiency," Econometric Society 2004 Far Eastern Meetings 528, Econometric Society.
  12. Satish Chand & Kunal Sen, 1996. "Trade Liberalization and Productivity Growth: Evidence from Indian Manufacturing," Departmental Working Papers 1996-11, Australian National University, Economics RSPAS. [Downloadable!]
    Other versions:
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