Big Reforms but Small Payoffs: Explaining the Weak Record of

Growth in Indian Manufacturing

 Poonam Gupta, Rana Hasan and Utsav Kumar

India Policy Forum 2008Brookings and NCAER

Issue

• India undertook major reforms starting mid to late 1980s

• Reforms mostly focused on the manufacturing sector

• Yet growth and hence employment generation in manufacturing did not accelerate.

• On the contrary services sector has picked up impressively.

What could be the potential factors?• Several eminent observers have pointed out the

importance of the following constraints.

• Labor laws: Krueger 2007; Panagariya 2006; Panagariya 2008

• Financing Constraints: Banerjee and Duflo 2004; Nagaraj 2005

• Infrastructural deficiencies: Krueger 2007, Kumar and Sen Gupta 2007

• Implementation lags at the state level

Empirical literature and existing evidence

• Papers have looked at the impact of labor laws but not other constraints: Besley and Burgess; Aghion, Burgess, Redding, and Zilibotti (BB, ABRZ)

• BB and ABRZ use ASI data till 1998; find that the labor regulations affect industrial performance, determine gains from reforms (delicensing)

• Their labor regulation variable has been criticized (Bhattacharjea).

What do we do?1. Exploit variation at state level to see whether

differences in LMR, PMR, Infrastructure and financial sector are associated with differential performance of the industrial sector post delicensing.

2. Look at the performance across industries: does poor performance of certain industries imply anything about the lack of a particular input?

3. Finally address the labor market issue by considering an alternative coding of LMR across states and by looking at the interaction of LMR and labor intensive industries

Methodology

yist = αis dis + βst dst+ θi trendi

+ γ (delicensingit )

+ δ (industry characteristici * delicensingit) + π (state characteristics * delicensingit)

+ τ (state characteristics * industry characteristic i * delicensingit)

+ μ other controls + εist

Key data series

• Three digit ASI data from 1980-2004 at state level

• Industry level: Labor Intensity, Infrastructure Dependence of Industries

• Used different data sources; data for an earlier period; as indices and as dummies- results are robust

Key data series contd.

State Level

Labor Market Regulation

Product Market Regulation

Infrastructure

Financial sector

Key data series concluded

Labor market regulation:

1. Take various measures: BB, Ahsan and Pages, OECD, Bhattacharjea (2008)

2. Since many different measures, look for common trends across studies—where conflict we use what the majority of the papers say

Table 1: Did Labor Intensive Industries Benefit less from Delicensing?

I II III IV Dependent Variable: Log Real Value Added Delicense -0.001 0.07 0.17** 0.26 [0.02] [1.27] [1.97] [0.59] Share of industry i in VA in 1980*Delicense 0.003 0 0.002 0.001 [0.47] [0.08] [0.31] [0.13] Size (log of fixed capital)*Delicense -0.018 [0.43] Labor Intensive Industry*Delicense -0.15** -0.13** -0.18** [2.24] [1.98] [1.97] Low Skill Labor Intensive* Delicense -0.69 [1.58] State-Ind FE Yes Yes Yes Yes State-Year FE Yes Yes Yes Yes Ind-Trends Yes Yes Yes Yes Observations 13257 13257 13257 13257 Number of state-industry 579 579 579 579 R-squared 0.87 0.87 0.87 0.87

Table 2: Did Delicensing have a Uniform Effect on Industries?

I II III IV

Dependent Variable: Log Real Value Added

Delicense 0.09* 0.17** 0.06 0.22**

[1.68] [2.52] [0.94] [2.51]

Share of industry i in VA in 1980*Delicense 0.006 0.003 0.007 0.007

[1.06] [0.50] [1.22] [1.14]

Infrastructure Intensive Industry*Delicense -0.32*** -0.33*** -0.31*** -0.28**

[2.70] [2.76] [2.59] [2.33]

Labor intensive Industry*Delicense -0.16** -0.13*

[2.32] [1.93]

Exporting Industries*Delicense 0.06 0.09

[1.11] [1.59]

Low Skill Labor Intensive* Delicense -0.83*

[1.78]

R-squared 0.87 0.87 0.87 0.87

Table 4: Infrastructure and Payoffs from Delicensing

I II III

Delicense -0.01 -0.01 -0.01

[0.13] [0.13] [0.14]

Share S,I in 1980*Delicense -0.02*** -0.02*** -0.02***

[3.50] [3.66] [3.55]

Initial PCY in state s*Delicense 0.013* -0.18** -0.02

[1.95] [2.00] [1.10]

Physical infrastructure*Delicense 0.12**

[2.25]

Credit by Scheduled Banks*Delicense 0.25**

[2.19]

Branches*Delicense 0.008**

[2.03]

R-squared 0.87 0.87 0.87

Table 5: Does the Regulatory Framework Across States Matter for Growth?

I II III IV V

Delicense -0.01 -0.01 -0.01 -0.01 -0.01

[0.23] [0.16] [0.15] [0.14] [0.13]

Share S,I in 1980* -0.02*** -0.02*** -0.02*** -0.02*** -0.02***

Delicense [3.38] [3.56] [3.55] [3.65] [3.48]

Initial PCY, State s* 0.02** 0.02** 0.02** -0.11** 0.01*

Delicense [2.23] [2.38] [2.35] [2.06] [1.88]

LMR*Delicense 0.01 -0.03 0.02 -0.01

[0.09] [0.33] [0.26] [0.10]

PMR*Delicense 0.11* 0.12*

[1.69] [1.85]

Bank Credit * 0.25**

Delicense [2.39]

Infrastructure* 0.12**

Delicense [2.30]

R-squared 0.87 0.87 0.87 0.87 0.87

Table 6: Labor Market Regulations and Labor Intensive Industries

I II III IV Delicense -0.01 0.00 0.00 0.00 [0.11] [0.04] [0.02] [0.03] Share S,I in 1980*Delicense -0.02*** -0.02*** -0.02*** -0.02*** [3.30] [3.46] [3.40] [3.57] Initial PCY in state s*Delicense 0.02*** 0.02*** 0.02*** -0.10* [2.97] [3.07] [2.64] [1.88] Labor intensive Industry *Delicense -0.18** -0.18** -0.18** -0.18** [2.57] [2.54] [2.54] [2.55] LMR*Delicense -0.07 -0.10 -0.08 -0.05 [0.74] [1.13] [0.93] [0.57] LMR*Labor Intensive*Delicense 0.16* 0.15* 0.16* 0.15* [1.77] [1.75] [1.77] [1.75] PMR*Delicense 0.12* [1.81] Infrastructure*Delicense 0.12** [2.28] Bank credit *Delicense 0.25** [2.38] R-squared 0.87 0.87 0.87 0.87

Table 7: Labor Market Regulations and Labor Intensive Industries, Robustness

I II III Delicense -0.01 0.00 0.00 [0.11] [0.08] [0.02] Share S,I in 1980*Delicense -0.015*** -0.015*** -0.016*** [3.30] [3.26] [3.49] Initial PCY in state s*Delicense 0.024*** 0.03*** 0.02*** [2.97] [3.40] [2.98] Labor intensive Industry*Delicense -0.18** -0.19*** -5.9*** [2.57] [2.73] [2.85] LMR*Delicense -0.07 0.07 -0.07 [0.74] [0.74] [0.77] LMR*Labor Intensive*Delicense 0.16* 0.15* 0.22** [1.77] [1.71] [2.34] Infrastructure Industry*Delicense -0.12* [1.71] LMR* Infrastructure Industry*Delicense -0.22*** [2.82] PCY*Labor Intensity*Delicense 0.67*** [2.77] R-squared 0.87 0.87 0.87

Table 8: Labor Market regulations and Employment I II III IV V Dependent Variable: Log Real Value Added Delicense -0.03 -0.03 -0.03 -0.03 -0.03 [1.30] [1.26] [1.25] [1.27] [1.25] Share state in industry i in 1980*Delicense 0.00 0.00 0.00 0.00 0.00 [0.19] [0.33] [0.24] [0.31] [0.18] Initial PCY in state s*delicense 0.00 0.00 0.00 -0.01 0.01 [1.16] [1.20] [1.01] [0.62] [1.54] Gross Value Added (log) 0.45*** 0.45*** 0.45*** 0.45*** 0.45*** [29.9] [29.9] [29.9] [29.9] [29.8] LMR*delicense 0.09** 0.08** 0.08** 0.09** 0.08** [2.45] [2.26] [2.34] [2.50] [2.26] PMR*delicense 0.03 [1.02] Physical infrastructure*delicense 0.02 [1.22] Bank Credit *delicense 0.03 [0.78] Labor intensive Industry *delicense -0.04 [1.18] LMR*Labor Intensive*delicense 0.01 [0.22] R-squared 0.92 0.92 0.92 0.92 0.92

Looking at these patterns through charts

20.

52

12

1.5

22

22.

5L

og o

f Re

al G

ross

Val

ue A

dde

d

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004Year

GVA in Flexible Labor MarketsGVA in Inflexible Labor Markets

Industrial output across industries2

02

0.5

21

21.

52

2L

og o

f Re

al G

ross

Val

ue A

dde

d

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004Year

GVA in Below Median Labor Intensive Industries in Flexible Labor MarketsGVA in Below Median Labor Intensive Industries in Inflexible Labor Markets

Labor intensive industries across states1

9.5

20

20.

52

12

1.5

Log

of R

eal

Gro

ss V

alue

Ad

ded

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004Year

GVA in Labor Intensive Industries in Flexible Labor MarketsGVA in Labor Intensive Industries in Inflexible Labor Markets

Robustness tests

• Potential Outliers: tobacco, petroleum

• Alternative LMR indices

• Alternative series for industry characteristics

• Omitted variables

• Limiting the data to 1998 (when the sampling frame used in ASI changed)

Summary of results….

• Post-delicensing:industries dependent on infrastructure, dependent on the financial sector and the labor intensive industries have grown less--infrastructure, financial sector imperfections, labor regulations are emerging as bottlenecks on growth?

• Post-delicensing: states with more developed infrastructure, and financial sector have grown faster.

• States with business friendly regulatory environment have grown faster.

Summary of results….

• Labor Intensive Industries have grown slowly, particularly in states with pro labor regulations.

• Employment generation has been slower in states with pro labor regulations

Going back to the title of the paperwhat explains the weak record of growth and

employment in Indian manufacturing?

• Labor Laws, Product market regulations, Infrastructural deficiencies, Financial sector weaknesses

• It seems that everything matters! Does it dilute the message?

• Unfortunately we cannot prioritize or compare quantitatively the effect of each of these factors

Caveats and Limitations

• We only look at registered manufacturing (formal sector) in the paper

• We do not consider the dismantling of the policy of reserving particular industries for production by the small-scale sector

• regulations can affect firms and industries in many different ways: operate in the informal sector, size, or adopt particular types of techniques

Thank You!

State Labor Market Regulation

Product Market Regulations

Andhra Pradesh Flexible Neutral

Assam Neutral Restrictive

Bihar Neutral Restrictive

Gujarat Neutral Neutral

Haryana Neutral Pro-competition

Karnataka Flexible Pro-competition

Kerala Neutral Neutral

Madhya Pradesh Neutral Restrictive

Maharashtra Inflexible Pro-competition

Orissa Inflexible Restrictive

Punjab Neutral Pro-competition

Rajasthan Flexible Restrictive

Tamil Nadu Flexible Pro-competition

Uttar Pradesh Flexible Neutral

West Bengal Inflexible Restrictive

Summarizing the results that we could not include in the paper

• Size of the Indian Firms is smaller as compared to China

• Labor intensity of Indian industries is less than that of Chinese Industries and the gap is increasing overtime—

The size of Indian firms as Compared to China

Labor Intensity of Indian Firms as Compared to China

0

50

100

150

1980 1985 1990 1995 2000 2005year

India PRC

Source: Wu, Lee, Rao 2007

Capital-labor ratio, 1980-2004

0.0

5.1

.15

Labo

r/C

apita

l in

Indi

a

0 .1 .2 .3Labor/capital in China

L_K 19801990 2000

Table : Comparing the labor Intensities of Indian and Chinese Industries

I II III Dependent variable L/K L/K L/K in India Dummy for India -0.011* -0.011*** [1.87] [2.94] Dummy for 1990 -0.032*** [6.73] Dummy for 2000 -0.053*** [10.10] L/K in China in 1980 0.78*** [9.13] L/K in China in 1990 0.67*** [6.42] L/K in China in 2000 0.55*** [8.69] Industry FE Yes Yes yes Observations 106 106 53 R-squared 0.44 0.78 0.89