Are We Undercounting Reallocation's Contribution to Growth?

Abstract

There has been a strong surge in aggregate productivity growth in India since 1990, following significant economic reforms. Three recent studies have used two distinct methodologies to decompose the sources of growth, and all conclude that it has been driven by within-plant increases in technical eciency and not between-plant reallocation of inputs. Given the nature of the reforms, where many barriers to input reallocation were removed, this finding has surprised researchers and been dubbed “India’s Mysterious Manufacturing Miracle.” In this paper, we show that the methodologies used may artificially understate the extent of reallocation. One approach, using growth in value added, counts all reallocation growth arising from the movement of intermediate inputs as technical eciency growth. The second approach, using the OlleyPakes decomposition, uses estimates of plant-level total factor productivity (TFP) as a proxy for the marginal product of inputs. However, in equilibrium, TFP and the marginal product of inputs are unrelated. Using microdata on manufacturing from five countries ‐ India, the U.S., Chile, Colombia, and Slovenia ‐ we show that both approaches significantly understate the true role of reallocation in economic growth. In particular, reallocation of materials is responsible for over half of aggregate Indian manufacturing productivity growth since 2000, substantially larger than either the contribution of primary inputs or the change in the covariance of productivity and size. Some of the research in this paper was conducted while the second and fourth authors were Special Sworn Status researchers of the U.S. Census Bureau at the Minnesota Census Research Data Center and the Triangle Census Research Data Center, respectively, and some of the research was conducted while the fourth author was an employee of Census Bureau. The third author thanks the National Science Foundation for a generous graduate research fellowship. Any opinions and conclusions expressed herein are those of the authors and do not necessarily represent the views of the U.S. Census Bureau. All results have been reviewed to ensure that no confidential information is disclosed.