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

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  • Gupta, Abhay

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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Bibliographic Info

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

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  1. 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.
  2. Chang, Tai Hsieh & Peter, J- Klenow, 2007. "Misallocation and manufacturing TFP in China and India," MPRA Paper 35084, University Library of Munich, Germany, revised 15 Jun 2007.
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  13. 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.
  14. 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.
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  16. Gupta, Abhay, 2009. "Looking beyond the methods: Productivity Estimates and Growth Trends in Indian Manufacturing," MPRA Paper 14482, University Library of Munich, Germany.
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