To investigate the determinants of productivity in the Indian manufacturing industries during the period 1988-2000.

A set of rules, compliance procedures and moral and ethical

behavioral norms designed to constrain the behavior of individuals in the interest of maximizing wealth or utility of principals (Douglas North) These non-market institutions need to exist to support the full and proper functioning of the market mechanism Usually taken for granted but absent in poor countries e.g labor market institutions Affect the process of capital accumulation as well as converting this capital into output, both of which are really key to economic growth and poverty reduction. Meta-institution of democracy and participatory politics to establish the appropriate economic institutions for local conditions India Despite strong meta-institutions for growth, manufacturing sector has been lagging.

It refers to various strategies and measures the government adopts to achieve its goals and objectives within the countrys institutional framework. Degree of openness in trade (protection) Market size effect - negative impact on productivity Pro-Competitive effect positive impact on productivity Dominating effect ?? Development expenditure- Productivity depends on quality of skilled labors and human capital which clearly depends on quality of education, health and social services. Delicensed Industries Rules restricting entry and exit of firms Limit competition faced by existing firms, hence lower firm efficiency Prevent inefficient firms from exiting the market. Productivity as whole is adversely affected.

A.

Trade Reforms in India(1991) Prior to 1991, India had probably the worlds most complex and restrictive trade regime. Till 1991, Indias external payments problem had assumed crisis like proportions. Loans granted by IMF with the condition of implementing deep and major economic reforms in the country. Major trade reform objectives were: Removal of licensing and NTB from imported capital & intermediate goods Removal of export restrictions Elimination of public sector monopoly Tariff reduction Full convertibility of Indian Rupee for foreign exchange transactions. Mean tariff reduced from 128% (1991) to roughly 35% by 1997-98

B. Labor Markets: Regulations and Rigidity

Legislative authority over labor issues lies with both the Central and the State Govts. Thus, interstate variation in labor laws and their enforcement. Indias labor laws pose a serious hindrance in the hiring and firing of workers Industrial Disputes Act(IDA) : Firms with 100 or more workers need permission of State Govt. to retrench/layoff workers. Industrial Employment(Standing Orders) Act : Employers with 100(50 in some states) or more workers need to specify the terms and conditions of their employment. Modification of job description or transplant of workers not possible without worker consent. Trade Union Act(TUA) : Makes it difficult to obtain worker consent Impact of these laws: Restrict the size of firms below their minimum efficient scale, hurting their competitiveness in the export market Hiring workers is a costly activity especially when the number runs into thousands. These laws prevent entry and reduce competition.

State Andrha Pradesh Assam Bihar Gujarat Haryana Karnataka Kerala Madhya Pradesh Maharashtra Orissa Punjab Rajasthan Tamil Nadu Uttar Pradesh West Bengal * Source: Hasan, Mitra and Ramaswamy (2006)

Composite Measure * Flexible Inflexible Inflexible Flexible Inflexible Flexible Inflexible Flexible Inflexible Flexible Flexible Inflexible Inflexible Flexible Flexible

Basic measure of productivity is the labor productivity = Real net value added/ No. of workers General Cobb-Douglas type production function approach: Y = AK L , Y = Real net value added/ total output A = Productivity Level K = Amt. of real capital L = Labor Input

ln Yist = lnAist + lnKist + lnList , i= 1...I ; s= 1...S ; t= 1T

(contd.) Productivity Aist depends on policy variables : ln Aist = 0 + 1FLEXs + 2NRPit + 3(FLEXs*NRPit) +
4DEVst + 5(NRPit*DEVst) + 7GSDPst + uist

where, uist = i + t + ist (unobservable characteristics), i= industries s= state t= time FLEX = 1 (for flexible labor market states) & 0 (for inflexible labor market states) NRP = Industry and time varying tariff rates term DEV = per capital development expenditure term GSDP= real Gross State Domestic Product term

Value added in services as a proportion of GDP has been rising gradually for the period 1980-2004 from 37% to 51% The proportion of manufacturing has remained in the narrow range of 15-18%. Hence the growth is service driven and manufacturing has not taken off in a big way. Output share of delicenced industries rose from 0 to roughly 92% in 2000 There was 50% increase in average per capita state expenditure in the period 1981-91. This may have been driven by the economic growth in the 80s but it is also plausible that the economic growth was partly driven by per capita state expenditure growth. FLEX remains unchanged as it varies across states and not over time.

Inequality in per worker output and value added has an upward trend, showing labor productivity is becoming more and more unequally distributed across the states over time This shows there are barriers to movement of resources across states and industries Productivity is becoming more and more heterogeneous across states and industries. However , total income is becoming more and more equal across states. Thus, employment is rising faster in less productive states.
It is clear from above that there is serious interindustry and interstate labor immobility that leads to substantial misallocation of resources.

 Policy and institutional variables involved

NRP, FLEX ,real per capita development expenditure, delicensed

Delicensed : Share of manufacturing output accounted by

delicensed industries.
Regression run on 3-dimensional panel with data from 2

digit industries across 15 Indian states. Magnitude and signs of the variables determine its effect on the dependent variable.

Real net value added is higher in less protected industries. Tariff liberalization leads to an increase in productivity and the effect is more pronounced in the flexible states.

Labor market flexibility leads to higher productivity A flexible labor market has about 11% higher productivity than a rigid labor market with all other variables fixed. The interaction between NRP and DEV is small in magnitude, economically insignificant.

The positive effects of trade liberalization are more stronger in states with flexible labor market institutions.

FLEX in itself is not quite significant.

DEV has positive effect on TFP.

 Trade liberalization can improve employment, especially in

states with more flexible labor markets(mixed evidence). The positive effect of per capita development expenditure on employment is very robust , irrespective of GDP.
Similar effect on capital stock. Negative effect of NRP and NTB on investment

Positive effects of both FLEX and DEV on investment are

robust irrespective of the GDP.

New independent variable delicensed Throw in delicensed and delicensed*FLEX into the regression Delicensed variable has a negative and significant coefficient which becomes positive and even more significant upon interaction with FLEX. Thus, delicensing has a positive impact on labor productivity in states with flexible labor markets only.

Export dummy = 1(for export-oriented industries) else 0

The triple interaction terms Export dummy*NRP*FLEX and Export dummy*NTB*FLEX are negative and significant. Hence, trade liberalization has a greater positive impact on productivity in export oriented industries located in states having flexible labor markets.

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Imperfect interindustry and interstate labor mobility as well as misallocation of resources across industries and states. Trade liberalization increases productivity in all industries across all states and productivity is higher in the lesser protected industries. The beneficial effects of trade reforms on productivity are stronger in states with more flexible labor market institutions and the productivity varies with the protection received. Labor market flexibility, independent of other policies, has a positive effect on productivity. Per capita development expenditure by itself seems to be the strongest predictor of productivity. Industrial delicensing increases labor productivity but only in the states with flexible labor market institutions. The productivity-enhancing effect of trade liberalization is greater in export-oriented industries located in states with flexible labor-market institutions.

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Although India is not a major global contributor in manufacturing sector, it has gained from globalization. The pro-competitive effect clearly dominated the marketsize effect. Policies are complementary to each other lowering protection, promoting exports and reducing rigid labor laws. Various types of economic reforms should go hand in hand to generate maximum benefit. State development spending has been the most important determinant of productivity and thus the Govt. and the Public Sector has a vital role. We should seek policy reforms in order to clean the system from corruption in order to achieve more efficient govt. spending.