Removing Small-Scale Reservations And Quality Upgradation: Evidence From India

Product quality is an important marker of economic growth and development. We study the impact of dismantling product reservation for small-scale industry production in India on product quality, shedding light on the relationship between firm size constraints, competition, and quality improvements. Exploiting the Indian government’s phased dereservation of previously reserved products between 2000 to 2007, we find that dereservation incentivized incumbent firms to produce better quality products. The effect is predominantly driven by large and productive firms. Firms constrained by the SSI policy (within the range of 5-10 million rupees investment in plant and machinery) also experienced an increase in quality, indicating a firm-size expansion effect. Large firms that improved the quality after dereservation also experienced an increase in capital intensity and skill intensity. We found that quality up-gradation also depends on the industry’s quality ladder (scope for product differentiation). Firms with a long industry quality ladder compete purely on quality catch-up, whereas firms operating in industries with a short quality ladder experience a decline in prices. We also observed the decline in quality-adjusted prices, indicating an improvement in consumer welfare. The quality results remain consistent across different variants of quality measures and alternate quality measure based on variable markups. To estimate heterogeneous treatment effects arising from the staggered treatment setup, we employ the De Chaisemartin and d’Haultfoeuille (2022) estimator. Our results are robust to a range of fixed effects and trends, including industry-year fixed effects, industry-time trends, state-year fixed effects, state-time trends, and product-specific time trends.