Addressing impediments to domestic and foreign competition in retail, transport, professional and other services should be a top priority for the Indian government. That is the central conclusion of research by Jens Arnold, Beata Javorcik, Molly Lipscomb and Aaditya Mattoo, published in the February 2016 issue of the Economic Journal.
Their analysis of over 4,000 manufacturing firms reveals that a major reason for the recent success of industry in India has been improved access to services as a result of policy reforms in those sectors.
So while the new government''s ''Make in India'' programme seeks to transform the country into a manufacturing hub, the new study suggests that a key factor in its future success lies outside manufacturing – in the service sector, where reforms remain incomplete.
The authors note that India''s rapid economic growth since the early 1990s has been driven in large part by the impressive performance of its manufacturing industries. In seeking to explain this growth, economists have typically focused on tariff liberalisation, the dismantling of the ''license raj'' (Aghion et al, 2005, 2008) and the limited labour market reforms (Besley and Burgess, 2004).
An alternative explanation, which is explored and tested in the new research, suggests that service sector reforms have been a key contributor to productivity growth in the manufacturing sector.
Service inputs – particularly finance, transport and telecommunications – are key determinants of manufacturing performance. Reforms in the 1990s in India visibly transformed these sectors. Allowing greater foreign and domestic entry with greatly improved regulation led to a dramatic growth in domestic and foreign investment in service sectors. Indian manufacturing firms were no longer at the mercy of inefficient public monopolies, but could now source services from a wide range of domestic and foreign providers operating in an increasingly competitive environment.
The reforms produced striking improvements in the performance of service providers. For example, the average turn-around time for containers went from eight days to three and a half days between 1990 and 2005; and waiting lists for telephone services had virtually disappeared by 2005.
These improvements enhanced firms'' ability to invest in new business opportunities and better production technologies, to exploit economies of scale by concentrating production in fewer locations, to manage inventories more efficiently and to make coordinated decisions with their suppliers and consumers.
The research team documents the competition-enhancing policy changes affecting India''s service sectors, and they provide empirical evidence for the importance of these reforms for the productivity of downstream manufacturing firms.
The results are based on panel data for about 4,000 Indian firms for the period from 1993 to 2005. The authors collect detailed information on the pace of reform across Indian service sectors, with a particular focus on entry and conduct restrictions. In a second step, they relate the state of liberalisation in service sectors to the total factor productivity of manufacturing firms, weighted by their use of services.
The results suggest that pro-competitive reforms in banking, telecommunications, insurance and transport boosted the productivity of manufacturing firms. The reforms benefited both foreign and locally owned manufacturing firms, but the effects on foreign firms tended to be even stronger. A one standard deviation increase in the aggregate index of liberalisation in the service sectors resulted in a productivity increase of 11.7% for domestic firms and 13.2% for foreign enterprises.
Today, most of the policy barriers to competition – and to foreign direct investment – are not in goods but in services (Borchert et al, 2014). This is not only true for India but also for countries in South East Asia, such as Malaysia and Thailand, which have reaped huge benefits from the liberalisation of trade and investment in goods, yet maintain restrictions on foreign presence in services.
The new evidence suggests that such restrictions in service sectors may deprive manufacturing industries of substantial productivity gains.
''Services Reform and Manufacturing Performance: Evidence from India'' by Jens Matthias Arnold, Beata Javorcik, Molly Lipscomb and Aaditya Mattoo is published in the February 2016 issue of the Economic Journal. Jens Matthias Arnold is at the OECD. Beata Javorcik is at the University of Oxford. Molly Lipscomb is at the University of Notre Dame. Aaditya Mattoo is at the World Bank.
References
Aghion, Philippe, Robin Burgess, Stephen Redding and Fabrizio Zilibotti (2005) ''Entry Liberalization and Inequality in Industrial Performance'', Journal of the European Economic Association 3(2-3).
Aghion, Philippe, Robin Burgess, Stephen Redding and Fabrizio Zilibotti (2008) ''The Unequal Effects of Liberalization: Evidence from Dismantling the License Raj in India'', American Economic Review 98(4).
Besley, Timothy and Robin Burgess (2004) ''Can Labor Regulations Hinder Economic Performance? Evidence from India'', Quarterly Journal of Economics 119(1).
Borchert, Ingo, Batshur Gootiiz and Aaditya Mattoo (2014) ''Policy Barriers to International Trade in Services: Evidence from a New Database'', World Bank Economic Review 28(1).
