Abstract
It is well established that misallocation of factor resources lowers productivity. In this paper, I use data from both formal and informal firms to study distortions in input and output markets as sources of misallocation in the Indian manufacturing sector. My work extends the seminal work of Hsieh and Klenow (2009). I consider output, capital, raw material, energy, and service sector distortions in a monopolistically competitive framework to measure the aggregate dispersion in total factor revenue productivity (TFPR). I also decompose the variance in TFPR and show that raw material and output distortions play a major role in defining aggregate misallocation.
Highlights
According to the World Bank, the per capita income of the United States (US) was 30 times that of India in 2017
I find output and raw material distortions are the primary sources of misallocation in the manufacturing sector
The equilibrium consists of the quantities of the consumption good and the intermediate raw materials produced at the level of the firm, industry, and aggregate economy
Summary
According to the World Bank, the per capita income of the United States (US) was 30 times that of India in 2017. The intuition behind this claim is as follows: if a firm has a high TFP, the marginal cost as well as the output price for that firm will be proportionally lower compared to a low-TFP firm in a particular industry, equalizing TFPR Based on this intuition from Restuccia and Rogerson (2008) and Hsieh and Klenow (2009), I build my empirical results by using data from both formal and informal manufacturing sector firms in India for the survey year 2005–2006. I find output and raw material distortions are the primary sources of misallocation in the manufacturing sector Another interesting result is that the distortions, when taken from several factor markets, together reduce the variation in TFPR.
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