# **Box 2: Reforms and Total Factor Productivity (TFP) during the 1990s**

Several studies have assessed the impact of the market opening after 1991 on TFP of firms as positive.<sup>a/</sup> In a study of 131,558 factories, based on the Annual Survey of Industries, Tata Services Limited (2003) finds that TFP growth increased from 0.68% per year during the pre-reform period (1981-82 to 1992-93) to 0.97% during the post-reform period (1993-94 to 2001-02). Similar findings were reported in Unel (2003). The contribution of TFP growth to real output growth has increased; as has labor productivity growth.

Pattnayak and Thangavelu (2003) find that reforms in India in the 1990s raised TFP in 10 out of 13 key industries, such as leather and leather products, chemical and chemical products, metal products and parts, machinery and equipment and electrical and related parts. In comparison, TFP growth in traditional industries such as food, beverage, basic metal and alloys, wool, silk and man-made fibres, textiles, and nonmetallic minerals has remained either constant or declined. Their comparison of technical change before and after the 1991 reforms suggests that the TFP trend in most of the sectors is significantly higher after the 1991 reforms.

There are also indications that productivity has increased most in those sectors that have opened up to the global markets. Topalova (2004a) and Goldar and Kumari (2003) find that reductions in trade protectionism lead to higher levels and growth of firm productivity. Interestingly, Topalova (2004a) shows that while this effect is robust and highly statistically significant for private companies, there is no evidence that trade liberalization leads to any productivity improvements for government-owned companies. This suggests that private companies are better able to take advantage of the new opportunities.

Further evidence of the links between productivity and reform has been provided in Dollar, Iarossi, and Mengistae (DIM, 2002) and in Veeramani and Goldar (2004) who analyze the influence of investment climate on TFP in Indian states. Based on a survey of over 1000 manufacturing establishments, and controlling for establishment size and industry, DIM (2002) find that value added per worker is about 45 percent lower in states that business managers consider to possess a relatively poor investment climate. Most of this gap is due to the lower TFP of firms in these states. The average rate of net fixed investment is less than 2 percent for firms from poor investment climate states against 8 percent in good investment climate states.

a/ Goldar (2004) and a number of other authors find that TFP growth in the 1990s decelerated. Goldar and Kumari (2003) suggest that gestation lags in investment projects and slower agricultural growth in the 1990s had an adverse effect on productivity growth. The analysis reveals that underutilization of industrial capacity was an important cause of the productivity slowdown. b/ DIM find that a quarter of the TFP gap can be traced to inferior power supply and poorer internet connectivity in poor investment climate states. About a tenth is due to a higher regulatory burden in the same states.

**_First stage_** Following the crisis in 1991, the initial post-crisis years witnessed a strong positive response from investment and growth. In the first half of the nineties, deregulation of industry and foreign trade, strong export performance and the overall reform momentum drove investment higher. The fixed investment surge was particularly strong in the manufacturing sector.  As shown in Figure 3 below, investment intentions filed in industry more than doubled from 3038 in 1991 to 6502 in 1995 and the proposed total investment also increased rapidly (from approximately Rs. 76310 crores in 1991 to Rs. 125509 crores in 1995).

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