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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.

Suggested Citation

  • Gupta, Abhay, 2009. "Pre-reform Conditions, Intermediate Inputs and Distortions: Solving the Indian Growth Puzzle," MPRA Paper 14481, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:14481
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    File URL: https://mpra.ub.uni-muenchen.de/14481/1/MPRA_paper_14481.pdf
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    References listed on IDEAS

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    3. Kochhar, Kalpana & Kumar, Utsav & Rajan, Raghuram & Subramanian, Arvind & Tokatlidis, Ioannis, 2006. "India's pattern of development: What happened, what follows?," Journal of Monetary Economics, Elsevier, vol. 53(5), pages 981-1019, July.
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    5. Chang-Tai Hsieh & Peter J. Klenow, 2009. "Misallocation and Manufacturing TFP in China and India," The Quarterly Journal of Economics, Oxford University Press, vol. 124(4), pages 1403-1448.
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    Cited by:

    1. Goel, Manisha & Restrepo-Echavarria, Paulina, 2015. "India’s Atypical Structural Transformation," Economic Synopses, Federal Reserve Bank of St. Louis, issue 23.

    More about this item

    Keywords

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

    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, Pricing, and Design - - - Rationing; Licensing
    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • O4 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity
    • B41 - Schools of Economic Thought and Methodology - - Economic Methodology - - - Economic Methodology

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