(World Bank, 2006a). Also, thanks to rapid reforms of the stock market since the early 1990s, large firms have not had difficulty in raising external finance while reducing leverage. However, the report also notes that, bank lending to the private sector has hardly increased meanwhile. This has partly to do with India’s huge fiscal deficits. It is partly because the banking sector remains to be predominantly state-owned and heavily regulated. What this means is that small business access to finance may not have improved significantly over the years since, unlike large firms, SMEs in India are not yet attractive to equity markets or to FDI.

In this paper we analyze enterprise level data from the 2002 and 2005 waves of the Firm Analysis and Competitiveness Survey of India (FACS survey-henceforth) of the World Bank and the Confederation of Indian industry in order to help quantify the effect of all four factors, namely, labor regulation, power shortages, access to finance and corruption on manufacturing growth in India. As we have pointed out already, there is a degree of consensus, backed up by firm level and aggregate evidence, that labor regulation and power shortages are powerful influences on regional differences in industrial growth within India as well as on the growth of Indian industry relative to international benchmarks. However, we are not aware of similar investigations of the role of the other two factors. How important are corruption and access to finance as influences in manufacturing growth compared to labor regulation or power shortages? How much of the regional gap in industrial growth within India does each of the four factors account for? And how does each of the four factors influence the growth impact of the others?

We seek to address these questions by estimating a dynamic structural fixed business investment equation at the enterprise level on the FACS survey dataset for industrially advanced and lagging regions separately as well as on the all-India sample, with institutional variables among the right hand side variables. In a companion paper we relate the same set of variables to enterprise sales growth in order to address the same question (Honorati and Mengistae, 2007a). The value we expect to add here is to dig deeper into the same question by investigating how institutional variables impact on what we expect to be the more volatile of the two proximate determinants of output growth, namely investment in productive assets.<sup>1</sup> The specifications we estimate are influence by the hierarchy that Acemoglu and Johnson (2005) establish between what they call ‘property rights institutions’ and ‘contracting institutions’ as determinants of long-run economic growth. Property rights institutions provide private agents protection from predation by the state or powerful elites, while contacting institution regulate contracts between private parties. Acemoglu and Johnson argue and offer evidence that property rights institutions exert stronger influence on long-term economic outcomes than contracting institutions. The reason that they give for this is that private agents usually get around the problem of poor contracting institutions by developing informal substitutes for them albeit at a possible cost. On the other hand, there is little they could do to counter predatory exercise of political power and therefore withdraw entirely from

> 1 We investigate the role of institutional variables in the other co-determinant, namely, productivity growth in a separate paper.

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