Tuesday, January 24, 2012

Services reform and manufacturing performance: evidence from India

The growth of India's manufacturing sector since 1991 has been attributed mostly to trade liberalization and more permissive industrial licensing. This paper demonstrates the significant impact of a neglected factor: India's policy reforms in services. The authors examine the link between those reforms and the productivity of manufacturing firms using panel data for about 4,000 Indian firms from1993 to 2005. They find that banking, telecommunications, insurance and transport reforms all had significant, positive effects on the productivity of manufacturing firms. Services reforms benefited both foreign and locally-owned manufacturing firms, but the effects on foreign firms tended to be stronger. A one-standard-deviation increase in the aggregate index of services liberalization resulted in a productivity increase of 11.7 percent for domestic firms and 13.2 percent for foreign enterprises.

A vital element of India‟s rapid economic growth since the early 1990s has been the improved performance of its manufacturing sector. Output in manufacturing grew by 5.7 percent per year in the period 1993-2005 (Reserve Bank of India, 2008). Previous explanations for the revival of manufacturing emphasize trade liberalization, more permissive industrial licensing policies, and the limited labor market reforms undertaken since 1991 (see review below). In focusing primarily on proximate policies, however, previous analyses have ignored what we demonstrate is a critical factor, policy reforms in services sectors.

The neglect of services is surprising, first of all, because service inputs, notably finance, transport and telecommunications, are an important component of inputs to manufacturing, so the potential for downstream effects is large.1 Moreover, reforms in the 1990s, allowing greater foreign and domestic competition with greatly improved regulation, have visibly transformed these services sectors.2 Indian firms are no longer at the mercy of inefficient public monopolies, but can now source from a wide range of domestic and foreign private sector providers operating in an increasingly competitive environment. Available evidence suggests that firms today have access to better, newer and more diverse business services.

In this paper, we address three questions: Has services reform led to an increase in manufacturing productivity? Have reforms in some services had a bigger impact than in others? Have some manufacturers (e.g. foreign firms based in India) benefitted more than others? These questions matter profoundly for policy; not only is services reform in India incomplete, but across the world some of themost intransigent policy restrictions today are in services.3 Convincing evidence that these restrictions penalize the politically cherished manufacturing sector could provide an impetus to reform.

Exploring whether there is a systematic link between liberalization in services sectors and the performance of firms in downstream manufacturing industries requires three types of information: a measure of policy reform in services, a performance measure for manufacturing firms and information on the linkages between different sectors of the economy.

WB.Author:Arnold, Jens Matthias ; Javorcik, Beata; Lipscomb, Molly; Mattoo,Aaditya.Document Date: 2012/01/01. Document Type: Policy Research Working Paper.Report Number: WPS5948. Services reform and manufacturing performance : evidence from India

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