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THE EFFECTS OF ECONOMIC REFORMS ON MANUFACTURING DUALISM: EVIDENCE FROM INDIA Vinish Kathuria IIT Bombay (Rajesh Raj S N CMDR Dharwad Kunal Sen University.

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Presentation on theme: "THE EFFECTS OF ECONOMIC REFORMS ON MANUFACTURING DUALISM: EVIDENCE FROM INDIA Vinish Kathuria IIT Bombay (Rajesh Raj S N CMDR Dharwad Kunal Sen University."— Presentation transcript:

1 THE EFFECTS OF ECONOMIC REFORMS ON MANUFACTURING DUALISM: EVIDENCE FROM INDIA Vinish Kathuria IIT Bombay (Rajesh Raj S N CMDR Dharwad Kunal Sen University of Manchester) PROJECT FUNDED by Economic and Social Research Council, UK ESDS Conference Nov 28 2011

2 4/16/2014 Economic reforms and manufacturing dualism 2 1.Introduction Dualism in the organization of production activities is a permanent feature of developing countries, where a large informal sector coexists with a relatively small formal sector. Despite strong economic growth, the persistence in the size of informal sector along with large differences in productivity between the formal and informal sectors has remained a matter of concern

3 4/16/2014 Economic reforms and manufacturing dualism 3 This paper examines the effects of economic reforms on manufacturing dualism Dualism: differences in efficiency levels between informal and formal manufacturing firms Considered absolute (AE) and relative technical efficiency (RE) AE - extent to which firms in the manufacturing sector are producing the maximum possible output, for a given bundle of inputs, in a given industry (improvement in level) RE - extent to which other firms are close to the most efficient firm in a given industry (improvement in equity) Objective……

4 4/16/2014 Economic reforms and manufacturing dualism 4 Our objective is to investigate whether economic reforms have led to an increase in absolute technical efficiency and a decrease in RTE of informal firms relative to formal firms Reforms would have reduced manufacturing dualism if absolute TE of informal firms have improved relative to formal firms while RTE has fallen This implies that reforms would have had a positive effect on both the level and distribution of efficiency in the informal sector as compared to the formal sector, and therefore, would have strong pro-poor growth effects If dualism has reduced……….

5 4/16/2014 Economic reforms and manufacturing dualism 5 Present study……… focuses on Indian manufacturing sector where about 80 per cent of manufacturing employment and 17 per cent of manufacturing output is in the informal sector we have large cross-sections of firm-level data-set for both the informal and formal manufacturing sectors for four years, beginning in 1989-90 and ending in 2005-06

6 4/16/2014 Economic reforms and manufacturing dualism 6 We employ a method developed by Greene (2010) that corrects for self-selection bias to obtain firm level measure of absolute and relative technical efficiency Theoretical models predict that firms choose whether to be in the informal or formal sector depending on factors which are mostly available to the formal sector (Dessy and Pallage 2003, Straub 2005, Ulyssea 2010) Efficiency comparison needs to address the endogeneity of firm location Else bias upwards the efficiency levels of formal firms if these levels depended on the firm being located in the formal sector. 2. Methodology – Sample Selection Framework

7 4/16/2014 Economic reforms and manufacturing dualism 7 First stage analysis Firms choose between formal or informal sector subject to a set of variables that capture the benefits and costs of formalization We estimate probit models of the following type: F = αZi + wi Where F is a dummy variable that takes the value 1 for formal sector firms and 0 for informal sector firms, Z is a vector of variables explaining the decision to formalize, α is a vector of parameters, and w i is the white noise error term 3. Empirical Specification

8 4/16/2014 Economic reforms and manufacturing dualism8 Drawing from the recent theoretical literature, we considered: labour laws, priority sector lending, price of power supply and firm size as the variables that determine the benefits and costs of formalization in Indian manufacturing Choice of these variables also exploit the fact that there are important differences in institutions relating to labour regulation, access to credit and the provision of infrastructure across Indian states and over time 3. Empirical Specification

9 4/16/2014 Economic reforms and manufacturing dualism9 Second stage analysis We modelled the production behaviour of formal and informal sector firms using a simple Cobb-Douglas function as follows: ln(Q iT ) = 0 + 1 ln(K iT ) + 2 ln(L iT ) + (v iT - u iT ) Where T=1989-90, 1994-95, 2000-01 & 2005-06 and i is the firm. Q is output, K is capital, L is labour, and s are parameters to be estimated v iT captures the random shocks that are beyond the control of firms u iT represents technical inefficiency which is the combined outcome of non-price and organizational factors that constrains a firm from achieving their maximum possible output 3. Empirical Specification

10 4/16/2014 Economic reforms and manufacturing dualism10 3. Testing for Impact of Reforms on Duality Effect of reforms on duality an interaction term for our reform variable with that of the formal firms is introduced TE ijt = α + β1*FORMAL ijt + β2*REFORMS jt + β3*FORMALxREFORMS ijt + δj +γt + ε ijt If δTE/δFORMAL = β1 + β3*REFORMS < 0 reforms have reduced duality We used estimates of absolute and relative technical efficiency alternately as our dependent variable

11 4/16/2014 Economic reforms and manufacturing dualism11 4. Data and Variables ASI data for the formal sector and NSSO data - surveys on the unorganized manufacturing sector for the informal sector Unit level data for four years, 1989-90, 1994-95, 2000-01 and 2005-06; repeated cross-sections, and not in panel form Confined the analysis to those informal firms that employ at least one hired worker (i) serious limitations of the data on output and capital stock for firms that employ only family labour (ii) interest is in firms that are likely to modify their behaviour in response to policy changes as family firms in informal sector are often in business to bring in additional income with little additional effort and are unlikely to expand or invest in their businesses

12 4/16/2014 Economic reforms and manufacturing dualism 12 4. Data and Variables –Reform Variables Tariff: trade and industrial output data of the World Bank Trade Data-base (World Bank 2006) Delicensing : Data on number of industries delicensed is obtained from Aghion et al (2006) and different notifications of GoI. constructed as the total number of four-digit industries delicensed in a year to that of total number of four-digit industries in the sector Dereservation: list of number of products dereserved is obtained from different notifications of the GoI constructed as the cumulative number of products dereserved in respective two-digit industries to that of total reserved products

13 4/16/2014 Economic reforms and manufacturing dualism13 4. Trend of Reform Variables (a)most of the delicensing reforms were over by 1995 (b)dereservation reforms started after 1995 (c)by 2005-06, only 4% of industries required delicensing, nearly one- third products needed to be dereserved and average tariff was 29% (ranging between 24% to 37%), much below 100% tariff around 1991

14 4/16/2014 Economic reforms and manufacturing dualism 14 5. Impact of Reforms on Duality VARIABLESAbsolute Technical EfficiencyRelative Technical Efficiency (1)(2)(3) (4) (5)(6)(7) (8) Formal -0.223* (0.004) -0.220* (0.00469) -0.00277 (0.00199) 0.205* (0.00455) 17.977* (0.310) 39.41* (0.297) 3.972* (0.111) -2.318* (0.285) REFORMS 0.009* (0.000) -0.166* (0.007) Formal*REFORMS 0.005* (0.000) -0.240* (0.006) Delicense 0.00415* (4.84e-05) -0.0724* (0.00247) Formal*delicense 0.00317* (5.37e-05) -0.409* (0.00328) Dereserv 0.00208* (9.49e-05) -0.102* (0.00618) Formal*dereserv 0.00205* (6.73e-05) 0.109* (0.00439) Tariff 0.000885* (0.000110) -0.105* (0.00683) Formal*tariff -0.00338* (8.64e-05) 0.158* (0.00569) Constant 0.247* (0.004) 0.269* (0.00362) 0.357* (0.00304) 0.333* (0.00901) 36.937* (0.240) 29.55* (0.194) 40.18* (0.194) 43.79* (0.620) Ind. dmy YYYYYYYY Yr dmy YYYYYYYY N173108 R-squared0.190.1790.1390.1190.230.3140.215 Impact of reforms on duality of Indian manufacturing industry

15 4/16/2014 Economic reforms and manufacturing dualism15 5. Results For the average values of REFORM variable, the efficiency difference between formal and informal firms is 0.04 for absolute efficiency and 5.35 for RTE. At the mean value of absolute technical efficiency (0.44), this suggests that reforms have increased the efficiency of formal firms by 9 per cent vis-à-vis informal firms. Similarly, relative to a mean RTE of 24.5%, the efficiency gap between the representative formal firm and the MEF in a particular industry has increased by 21.9% as compared to the efficiency gap between the representative informal firm and the MEF in the same industry.

16 4/16/2014 Economic reforms and manufacturing dualism 16 5. Results – TE vs. Reforms REFORM vs efficiency relationship - stronger in the formal sector as compared to the informal sector

17 4/16/2014 Economic reforms and manufacturing dualism 17 5. Results – RTE vs. Reforms REFORM vs efficiency relationship - stronger in the formal sector as compared to the informal sector

18 4/16/2014 Economic reforms and manufacturing dualism18 6. Conclusions Do economic reforms reduce or exacerbate manufacturing dualism? Our regression results suggest that these reforms have had an unambiguous positive effect on the absolute efficiency levels of formal firms relative to informal firms, and a negative effect on the relative efficiency levels

19 4/16/2014 Economic reforms and manufacturing dualism19 Economic reforms (as measured by individual reform variable or composite index) had an unequalising effect on the manufacturing sector, as it exacerbated the productivity differentials between average firm in the informal & formal sectors, and at the same time, it reduced the gap in efficiency levels between formal firms as compared to informal firms Dualism has increased in Indian mfrg. after the reforms, both between formal and informal firms and within the informal sector 6. Conclusions


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