WPS4233

# **INDIAN MANUFACTURING:**

# **A SLOW SECTOR IN A RAPIDLY GROWING ECONOMY**<sup>*****</sup>

## **Devashish Mitra**<sup>**†**</sup>

Syracuse University, NBER and IZA

**Beyza P. Ural**<sup>∗</sup> Syracuse University

**Abstract:** In this paper, we investigate the determinants of productivity in Indian manufacturing industries during the period 1988-2000.  Using two-digit industry level data for the Indian states, we find evidence of imperfect interindustry and interstate labor mobility as well as misallocation of resources across industries and states. Trade liberalization increases productivity in all industries across all states, and productivity is higher in the less protected industries. These effects of protection and trade liberalization are more pronounced in states that have relatively more flexible labor markets. Similar effects are also found in the case of employment, capital stock and investment. Furthermore, labor market flexibility, independent of other policies, has a positive effect on productivity. Importantly, per capita state development expenditure seems to be the strongest and the most robust predictor of productivity, employment, capital stock and investment. Industrial delicensing increases both labor productivity and employment but only in the states with flexible labor market institutions. Even after controlling for delicensing, the analysis shows that trade liberalization has a productivity-enhancing effect. Finally, trade liberalization benefits most the export-oriented industries located in states with flexible labormarket institutions.

## _JEL Codes:_ F14, L60, O53 _Keywords:_ productivity, manufacturing sector, India

World Bank Policy Research Working Paper 4233, May 2007 _The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent. Policy Research Working Papers are available online at http://econ.worldbank.org._

* This paper is part of a research project on the “Rise of India and China” undertaken jointly by the World Bank and the Institute of Policy Studies (IPS), Singapore. We thank IPS for financial support and Will Martin of the World Bank for very useful discussions and valuable suggestions, as well as for detailed comments on an earlier version. We would also like to thank Carmen Pages and Rana Hasan for advice and for sharing their data with us. The standard disclaimer applies. This paper represents the views of the authors and does not necessarily represent those of the World Bank or the IPS or the institutions to which they belong.

† Department of Economics, the Maxwell School of Citizenship and Public Affairs, Syracuse University, Eggers Hall, Syracuse NY 13244, Email <u>dmitra@maxwell.syr.edu, Phone (315) 443-6143, Fax (315) 443-</u> 3717.

> ∗ Department of Economics, Syracuse University, 124 Eggers Hall, Syracuse, NY 13244-1020. Email: <u>bpural@maxwell.syr.edu.</u>