Trade Liberalization and MSME Framework: Impact on Firm Productivity and Markups

Abstract

This paper examines the effects of tariff and non-tariff reductions on firm-level productivity and markups of large as well as Micro, Small and Medium Enterprises (MSMEs) in India’s manufacturing sector for the 1999-2009 period. We calculate input and final goods tariffs, effective rates of protection (ERP) and non-tariff barriers (NTBs) for broad product groups using information from India’s Exim Policy of 1997-2003 and 2004-09 to examine this impact. We use a balanced as well as unbalanced firm-level panel data set, while taking into account firm, industry, state and time-specific factors. By using fixed effect models and Heckman’s two-step estimation procedure, we find that trade liberalization is associated with improved firm-level productivity for large firms whereas this is not the case for MSMEs. We posit that this might be due to the relative disadvantages that Indian MSMEs face which prevent them from benefiting from trade liberalization. We also find that productivity gains arising from the sourcing of imported inputs have been greater than those arising from increased product competition and that NTB liberalization has had a greater impact compared to tariff liberalization on firm-level productivity. Markups are found to have declined due to increased final goods competition. Changes in MSME legislation and classification of firms are also found to have a bearing on firm performance.