three and five year periods for 1989-1995 period. Goldberg et al. (2010a) present the same table for 1989-2003 period. The results presented in Table 2 are quite similar to those presented in their study. Firms do not change their product mix too often annually. This is not surprising because it requires relatively high investment (the R&D cost) to introduce a new product to the market. Percentage of firms that change their product mix increases over longer time periods. Over five year around 40% of firms add or drop a product. Adding new products is much more common among Indian firms than dropping existing products and it is more common among multi-product firms than single-product firms. This evidence is in accordance with the model. Firms with multiple products have higher knowledge capital which makes them more likely to add new products (recall that innovation function is given as _I_   _n_ ).

# **Economic Reforms in India**

I complement the data from Prowess with several other data sources to investigate whether the economic reforms that took place in India affected innovation. Starting from 1980s, India liberalized its economy by dismantling government controls over industries and opened up to trade. One of these reforms is on product market regulations. Up until 1985, Industries Act of 1951 brought all key industries in the registered manufacturing sector under central government control through industrial licensing. Under this act firms were required to get a license to establish a new factory, significantly expand capacity, start a new product line, or change location. The granting of the licenses was subject to heavy bureaucracy. Moreover firms were discouraged to pursue investment projects because each project would require multiple licenses. In 1985 after Rajiv Gandhi’s rise to the power, a group of the industries were delicensed. Later in 1991 India went through a balance of payment crisis which resulted in a Stand-By arrangement with IMF in August 1991. In this period IMF requested macroeconomic stabilization policies and structural reforms. As a part of the structural reforms licenses were removed for another group of industries. A number of industries were retained from the licensing reform due to security and strategic concerns, social reasons, hazardous nature of the products, and to elitist consumption.<sup>6</sup> Aghion et al. (2008) and Chari (2009) provide a detailed discussion of this reform and list the industries that were delicensed and when they were delicensed. Delicensing reforms were mostly unanticipated.<sup>7</sup> I use the data on licensing reform compiled by Aghion et al. (2008). They use various issues of Handbook of Industrial Policy and Statistics, press notes, and notifications issued by the federal government to code when different industries were exempted from industrial licensing. In Table 3, I present the percentage of firms that belong to a 4-digit NIC industry that has been delicensed. In 1989 around 40% of the firms belonged to an industry that was delicensed on or before 1988. In 1992, the share of delicensed firms more than doubles.

India had several other major market reforms. One of these reforms was on international trade. Average tariff rates and non-tariff barriers were among the most restrictive in Asia towards the end of 1980s. Topalova and Khandelwal (2011) show that there has been radical changes in economic policies during 1990s and this has led to a continuous decline in average tariff rates from 97% in 1989 to 46% in

> 6 There were also some industries that were delicensed in different years than 1985 and 1991 such as manufacture of domestic appliances, n.e.c which was delicensed in 1993.

> 7 Aghion et al. (2008) provide a discussion of this conclusion.

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