Barriers to entry and productivity: Micro-evidence from Indian manufacturing sector reforms

The benefits and costs of policies (such as trade and investment liberalization) that reduce barriers to competition are the subject of a vibrant, ongoing debate. Structural reform measures introduced in India in 1991 provide excellent policy experiments to evaluate the benefits from such policies and address the debate on competition and productivity. We use a previously unexplored, comprehensive plant-level dataset for the period 1986--87 to 1994--95 to study the effect of removing licensing requirements, liberalizing foreign direct investment (FDI) and reducing tariff rates on plant-level and aggregate productivity. To address potential simultaneity bias while estimating the production function, we use a modified form of a recently proposed structural technique (Levinsohn and Petrin (2003a)).;We find evidence that de-licensing (and other macroeconomic reforms) had a significant positive impact on productivity. We find an 18 to 25% (30 to 35%) increase in mean intra-plant productivity level in the FDI (tariff) liberalized industries in the post reform period (1994--95) compared to the pre-reform (1987--90) period. There is also a 25% (25%) increase in aggregate output growth and a 15% (20%) increase in aggregate productivity growth following FDI (tariff) liberalization (in 1994--95 compared to 1987--90). Change in intra-plant productivity growth is the biggest component of changes in aggregate productivity and output growth. We find that the major beneficiaries from the post-liberalization productivity gains were consumers (in the form of relatively lower prices).