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Productivity and Firm Size Distribution: Evidence from India's Organized and Unorganized Manufacturing Sectors

  • Author(s): Nataraj, Shanthi
  • Advisor(s): Harrison, Ann
  • et al.
Abstract

This dissertation examines the impacts of India's trade liberalization and a variety of other policies on productivity and employment among manufacturing firms. One main contribution of this work is that it considers not only large firms in India's organized (formal) manufacturing sector, but also small firms in the unorganized (informal) manufacturing sector. Informal firms are those that have fewer than 20 employees (10 employees if power is used), and are therefore not required to register with the government under India's Factories Act. Most of the literature on India's trade and other reforms has focused on formal firms, but the informal sector accounts for approximately 80% of manufacturing employment.

In the first chapter, I describe a unique dataset that I constructed by linking formal and informal firm-level surveys that were conducted by the Indian government. The resulting dataset provides three cross-sectional snapshots that are representative of the entire manufacturing industry during the course of the 1990's. This chapter discusses the industries in which formal and informal firms are found, examines various issues related to the size distribution of firms, and compares formal and informal firms with the same number of employees.

The second chapter examines the impact of India's trade liberalization on the productivity of manufacturing firms. Despite a large literature investigating the links between trade and productivity, there is almost no evidence on how small firms react to trade liberalization. In this chapter, I show that India's trade liberalization increased firm productivity in both the formal and informal sectors; however, the increases occurred through different channels in the two sectors. In the informal sector, I find that the liberalization of final goods tariffs increased productivity by approximately 15% during the course of the 1990's. In contrast, the increase in productivity among formal firms was driven by the liberalization of tariffs on intermediate inputs rather than final goods. Furthermore, I examine the effect of the trade liberalization on the productivity and output distributions, and I find evidence suggesting that at least part of the increase in productivity in the informal sector was driven by the exit of the smallest, least productive firms.

The third chapter investigates the phenomenon of the "missing middle" in Indian manufacturing - the fact that employment is concentrated in small and large firms, with relatively little employment in mid-sized firms (firms with 50-500 employees). A number of policies have been proposed as causes of the missing middle, but there is little quantitative evidence on how changes in these policies would affect the employment size distribution. I consider the impacts of five policies - credit availability for small firms, electricity surpluses, trade liberalization, industrial licensing, and foreign direct investment liberalization - on the employment size distribution. I find that improving India's poor electricity supplies would mitigate the missing middle by shifting the employment size distribution towards firms with 50-1,000 employees. India's liberalization measures of the 1990's had mixed effects on the missing middle: the liberalization of final goods tariffs exacerbated the missing middle, while the liberalization of intermediate input tariffs mitigated it. The foreign direct investment liberalization shifted the employment size distribution towards firms with 20-500 employees, while the industrial licensing reforms shifted the distribution towards firms with 10-60 employees, and away from firms with 60 or more employees. The results also indicate that India's labor regulations played a role in how many of these policies affected the missing middle.

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