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The Unequal Effects of Trade Liberalization: Theory and Evidence from India

Author

Listed:
  • F. Zilibotti
  • P. Aghion
  • R. Burgess
Abstract
This paper focuses on the effects of a recent episode of trade liberalization in India. India underwent a massive reform in 1991 which involved slashing tariffs and opening up different industrial sectors to foreign direct investment. This episode, which is described in detail in a section of the paper, represents, for its size and impact, an attractive experiment to assess the validity of the theory. More precisely, we construct a three-dimensional panel for the period 1970 to 1996 using "Annual Survey of Industries" (ASI) data with variations over 3-digit industry, state and time. The available data include value added, capital, labor and profits for each industry-state-time observation. We use a measure of output per worker in the period just before liberalization (relative to the most productive state-industry observation in the same year) as a proxy of the distance to frontier for a particular 3-digit industry. We interact this variable with a reform measure which is zero before 1991 and takes on a value of one thereafter to test whether the distance to frontier prior to reform influences the post-reform performance. We first document the effects of the reform on labor productivity, and then consider separately the effects on total factor productivity, profitability employment and investments. This provides a test of the first prediction of the theory, i.e., that firms closer to the frontier respond more to the threat of entry introduced by liberalization. Second, we consider state-specific labor market regulations. To this aim, we use a measure of the direction of labor regulation constructed by Besley and Burgess (2002), which coded state amendments to the Industrial Dispute Act as pro-labor, neutral or pro-capital. The level of this variable in 1991, which captures the relative bargaining powers of workers and employers at the moment of the reform, is then interacted with the dummy for the reform and used as an explanatory variable for separate regressions for labor productivity, TFP etc.. The estimated coefficient on this interaction term provides an inference on whether labor regulations mattered in determining the effect of the reform on state industrial performances. Finally, we consider the three way interaction between distance to frontier, labor regulation and reform to examine whether the impact of regulation on industrial performance is larger for industries that are closer to the world frontier. The regression analysis show that (i) state-industries that are closer to the technological frontier experienced larger increases in real manufacturing output, labor productivity, TFP and rents (profits) in the post-reform period. (ii) pro-worker labor regulations have a negative effect on the growth of the same variables, and this effect is strengthened by liberalization. Both results hold true after controlling for state, industry and state-industry fixed effects plus time dummies. Robustness checks include adding controls for state dummies interacted with the dummy for reform to show that the results are due, as the theory suggests, to variations within industries. Also, adding industry-specific time trends to account for different convergence patterns across industries does not change the results.

Suggested Citation

  • F. Zilibotti & P. Aghion & R. Burgess, 2004. "The Unequal Effects of Trade Liberalization: Theory and Evidence from India," 2004 Meeting Papers 40, Society for Economic Dynamics.
    • Handle: RePEc:red:sed004:40
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    Citations

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    Cited by:

    1. Sudip Ranjan Basu, 2009. "Comparing China and India: Is the dividend of economic reforms polarized?," European Journal of Comparative Economics, Cattaneo University (LIUC), vol. 6(1), pages 57-99, June.
    2. Sivadasan, Jagadeesh & Slemrod, Joel, 2008. "Tax law changes, income-shifting and measured wage inequality: Evidence from India," Journal of Public Economics, Elsevier, vol. 92(10-11), pages 2199-2224, October.
    3. Pinelopi K. Goldberg & Nina Pavcnik, 2004. "Trade, Inequality, and Poverty: What Do We Know? Evidence from Recent Trade Liberalization Episodes in Developing Countries," NBER Working Papers 10593, National Bureau of Economic Research, Inc.
    4. Klara Sabirianova Peter & Jan Svejnar & Katherine Terrell, 2012. "Foreign Investment, Corporate Ownership, and Development: Are Firms in Emerging Markets Catching Up to the World Standard?," The Review of Economics and Statistics, MIT Press, vol. 94(4), pages 981-999, November.
    5. Petia Topalova & Amit Khandelwal, 2011. "Trade Liberalization and Firm Productivity: The Case of India," The Review of Economics and Statistics, MIT Press, vol. 93(3), pages 995-1009, August.
    6. Mr. Tushar Poddar, 2004. "Domestic Competition Spurs Exports: The Indian Example," IMF Working Papers 2004/173, International Monetary Fund.
    7. Ms. Prachi Mishra & Mr. Utsav Kumar, 2005. "Trade Liberalization and Wage Inequality: Evidence From India," IMF Working Papers 2005/020, International Monetary Fund.
    8. Philippe Aghion & Evguenia Bessonova, 2006. "On Entry and Growth: Theory and Evidence," Revue de l'OFCE, Presses de Sciences-Po, vol. 97(5), pages 259-278.
    9. Rodrik, Dani, 2005. "Growth Strategies," Handbook of Economic Growth, in: Philippe Aghion & Steven Durlauf (ed.), Handbook of Economic Growth, edition 1, volume 1, chapter 14, pages 967-1014, Elsevier.
    10. Burgess, Robin & Venables, Anthony J., 2004. "Toward a microeconomics of growth," Policy Research Working Paper Series 3257, The World Bank.
    11. Philippe Aghion & Richard Blundell & Rachel Griffith & Peter Howitt & Susanne Prantl, 2009. "The Effects of Entry on Incumbent Innovation and Productivity," The Review of Economics and Statistics, MIT Press, vol. 91(1), pages 20-32, February.
    12. Lall, Somik V. & Mengistae, Taye, 2005. "The impact of business environment and economic geography on plant-level productivity : an analysis of Indian industry," Policy Research Working Paper Series 3664, The World Bank.
    13. Eli Berman & Rohini Somanathan & Hong W. Tan, 2010. "Is Skill-Biased Technological Change Here Yet? Evidence from Indian Manufacturing in the 1990s," NBER Chapters, in: Contributions in Memory of Zvi Griliches, pages 299-321, National Bureau of Economic Research, Inc.
    14. Fabio Schiantarelli, 2005. "Product Market Regulation and Macroeconomic Performance: A Review of Cross Country Evidence," Boston College Working Papers in Economics 623, Boston College Department of Economics, revised 04 Aug 2008.
    15. repec:pru:wpaper:27 is not listed on IDEAS
    16. Jérôme Vandenbussche & Philippe Aghion & Costas Meghir, 2006. "Growth, distance to frontier and composition of human capital," Journal of Economic Growth, Springer, vol. 11(2), pages 97-127, June.
    17. Roberto Álvarez & Ricardo A. López, 2008. "Trade Liberalization and Industry Dynamics: A Difference in Difference Approach," Working Papers Central Bank of Chile 470, Central Bank of Chile.
    18. Erkan Erdem & James Tybout, 2003. "Trade Policy and Industrial Sector Responses: Using Evolutionary Models to Interpret the Evidence," NBER Working Papers 9947, National Bureau of Economic Research, Inc.
    19. Marie Daumal, 2013. "The Impact of Trade Openness on Regional Inequality: The Cases of India and Brazil," The International Trade Journal, Taylor & Francis Journals, vol. 27(3), pages 243-280, August.
    20. Rajesh Natarajan & Malathy Duraisamy, 2008. "Efficiency and productivity in the Indian unorganized manufacturing sector: did reforms matter?," International Review of Economics, Springer;Happiness Economics and Interpersonal Relations (HEIRS), vol. 55(4), pages 373-399, December.
    21. Sumon Kumar Bhaumik & Shubhashis Gangopadhyay & Shagun Krishnan, 2006. "Reforms, Entry and Productivity: Some Evidence from the Indian Manufacturing Sector," William Davidson Institute Working Papers Series 822, William Davidson Institute at the University of Michigan.
    22. Moreno-Monroy, Ana Isabel & Pieters, Janneke & Erumban, Abdul Azeez, 2012. "Subcontracting and the Size and Composition of the Informal Sector: Evidence from Indian Manufacturing," IZA Discussion Papers 6785, Institute of Labor Economics (IZA).

    More about this item

    Keywords

    reform; distance to frontier;

    JEL classification:

    • O53 - Economic Development, Innovation, Technological Change, and Growth - - Economywide Country Studies - - - Asia including Middle East

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