# **5. Summary and conclusion**

Based on the analysis of data from the FACS survey of the World Bank and the Confederation of Indian Industry, this paper has offered a quantitative assessment of the effects of corruption, labor regulation, access to finance and the quality of power supply on investment decisions of manufacturing SMEs in India. All four factors are highly rated by business managers as obstacles to business operations and business growth almost in every state covered by the survey. The ratings are backed up by data on objective indicators of the incidence of corruption, the intrusiveness of labor regulation, the costliness of power shortages and the quality of access to formal external finance. India’s states vary enormously on all these indicators just as they do in per capita incomes and in terms of growth performance.

Businesses are most productive on average in what we have classified as high-income and high-growth states (or“quadrant-1 states”), but least productive in low-income lowgrowth states (“quadrant-3 states’). Businesses in low-income high-growth states (or ‘quadrant-2 states’) capture the middle ground in terms of productivity. Business growth rates are also much higher in high-growth states than in low-growth rates. This is because business investment rates and TFP growth rates are higher in high-growth rates. The paper has shown that, although these patterns in business performance rates do not map neatly into a pattern whereby the better performing states are also better in every important aspect of the institutional environment. It remains to be the case, though, that low-income low-growth states have the worst indicators of all four institutional variables except one, namely, labor regulation. Corruption appears to be most prevalent in those states while the cost of power outage and poorer access to finance are also highest for the same group of states.

In order to assess the role of the four institutional variables in the performance gaps between the four groups of states, we have estimated on the FACS survey sample a dynamic structural business investment equation for each group. Our estimates show that, over the full sample, excessive labor regulation and power shortages significantly reduce the average enterprise fixed investment rate. There is also evidence that fixed investment is constrained by access to finance in low-income but high-growth states. Although there are some nuances to it is also always the case that labor regulation, power shortages and access to finance influence the rate of fixed investment in ways that crucially depend on the incidence of corruption.

We interpret the result that excessive regulation, power shortages and problems of access to finance are significant influences on business investment rates as an instance of the importance of ‘contracting institutions’ in the current performance of India’s manufacturing industries. We have also argued that corruption is a good enough proxy for the quality of property rights institutions in general. Our result that those effects depend on the incidence of corruption would then be consistent with the AcemogluJohnson thesis of the primacy of property rights institutions over contracting institutions in investment outcomes.

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