You Get What You Pay For: Electricity Quality and Firm Dynamics

Electricity sectors in many developing countries are stuck in a vicious cycle of low prices, financial insolvency, and unreliable service. India’s state-owned utilities are emblematic of this problem, costing the government billions in bailouts while delivering poor electricity reliability. This paper leverages a large-scale reform in India’s power sector to show that raising electricity prices—while seemingly counterintuitive—can help propel the sector out of this cycle. Using state-level variation in the implementation of the reforms, I find that manufacturing firms in states where electricity reliability improved increased their consumption of grid electricity by 19%, despite a 3% rise in average prices. Firms also increased worker hours and output, highlighting that previously, unreliable electricity was a binding constraint on production. These results suggest that raising prices, when coupled with improved service quality, is a viable strategy for breaking the cycle of low investment and poor utility performance in the developing world.