Tariff liberalization and firm-level markups in Indian manufacturing

Abstract

Tariff liberalization has a significant bearing on firm performance. Existing theoretical studies predict that input tariff liberalization would raise firm-level markups while final goods tariff liberalization would lower markups. This paper examines whether this two-sided effect holds for Indian manufacturing firms and the role of size and classification. It employs fixed effects models and Heckman's two-step estimation procedure to estimate the impact of input and final goods tariff liberalization under India's Export-Import Policy of 1997–2003 and 2004-09 for large versus Micro, Small and Medium Enterprise (MSME) firms. It confirms the two-sided effect and finds that the input channel is stronger, with large rather than MSME firms experiencing higher markups following input tariff reduction. Further, using a semiparametric Difference-in-Difference model it finds that relaxed size limits in 2006 resulted in higher markups for importing MSMEs. This study highlights the importance of firm size, liberalization channel, and policy framework for firm-level markups.