Improving firm productivity: Policy and business factors

1. Improving firm productivity: Policy and business factors Jagadeesh Sivadasan University of Michigan BRAC-IGC-IIG Conference on Entrepreneurship and Development: Policies, Practices and ExperienceMarch 27-28, Dhaka

2. Productivity and GDP • Early work by Solow (1957) and Denison (1962, 1967) found that per capita capital accumulation accounted for less than 25% of per capita GDP growth; productivity (TFP) growth accounted for more than 50% • Young (1995) argued that factor accumulation (capital + education) key to East Asian growth miracle; later work by Klenow and Rodriguez-Clare (1997) suggests a very strong role for TFP in most of these countries as well • Easterly and Levine (2001) review concluded that TFP plays a prominent role in explaining growth across the world • Understanding micro-economic underpinnings of country-level TFP important then for promoting growth • At the micro-level, incredible variation in TFP across firms • In the US 90th percentile plant produces 2 times as much output as the 10th percentile plant (for same level of inputs) (Syverson 2004) • In China and India, this ratio is 5:1 (Hseih and Klenow, 2009)

3. Outline of Presentation • My paper on 1991 Indian policy reforms and plant productivity • Background on reforms • Theoretical framework • Data • Empirical results • Summary of recent related work on economic policies/trade liberalization and productivity • Summary of recent work on business practices and productivity

4. Background on 1991 reforms • Liberalization in 1991 on all three policy fronts • Industrial policy • License requirements almost completely abolished • Foreign investment (FDI) regulations • FDI upto 51% allowed in a number of targeted sectors • Trade policy (tariff/non-tariff barriers) • Tariff rates reduced, with larger cuts for some sectors\ • All of these essentially reduced barriers to competition • My empirical paper focuses on 2 and 3 • Because these were differentially targeted at certain industries, easier to assess effects

5. Competition & Productivity – Reasons for productivity improvements • More competitive markets leads to higher productivity: • More innovation [Arrow 1962 etc] • Less slack [Hicks 1935 etc] • Encouraging adoption of technology [Rodrik 1992 etc] • Less resources wasted on rent-seeking [Posner 1975 etc] • Barriers to entry also barriers to adoption of new methods/technology -- allows insiders/incumbents to (e.g. Parente and Prescott 2002) • Reallocation to more productive firms [Hopenhayn 1992, Melitz 2003 etc] • Trade specifically • Learning from foreign investors/competitors • Technology embodied in inputs

6. Arguments for protection • Protection was motivated by following arguments: • Better incentives for innovation [Schumpeter 1942, etc] • Encouraging adoption of technology [Aghion & Howitt 1992, etc] • Less slack [Horn, Lang, and Lundgren 1994, etc] • External scale economies at national level [Helpman & Krugman, 1985] • High learning rates and spillover [Grossman & Helpman 1991, etc

7. Motivation for reforms • Reforms triggered by BOP crisis, in turn caused by • Collapse of Soviet Union (India’s key trade partner) • First Gulf war (which impacted inward remittances) • But also motivated by realization by mid-80s that new policies required: • Export-focused countries had grown faster: e.g. Korea, Taiwan • Failure of Soviet model • Indian industry clearly uncompetitive: e.g. Indian cars still mostly 1950s models

8. Description of data • Dataset based on annual survey of plants – similar to the LRD in the US • Repeated cross-section of about 40,000 plants (see table 1), 1986-87 to 1994-95, covers entire manufacturing sector • A census sector of about 22,000 larger plants surveyed every year, all other firms randomly sampled at approximately 1/3rd every year • Some data issues (mitigated by diff-in-diff approach): • Possible under-reporting of value added (for tax purposes) and workers (for labor law reasons) • Large informal sector not covered by the surveys

9. Methodology • In first step estimate TFP • adopt a method that addressing some endogeneity concerns typical in TFP measurement • check robustness to using a range of measures • Next, we regress estimated TFP on dummies for reforms • Because reforms introduced in 1991 targeting specific industries • use time and industry fixed effects, to estimate Difference-in-differences effects on plant-level TFP • this controls for contemporaneous macro-shocks • We also do some further explorations of the results, looking at: • contributions of plant and reallocation terms to aggregate productivity change • whether TFP changes linked to changes in measures of competition • check for heterogeneous effects across industries/regions

10. Summary graph: large relative improvements of productivity in reformed sectors

11. Effects of FDI and Tariff Reform on TFP

12. Robustness checks • Robust to using seven other productivity measures • Robust to using alternative measures of Tariff liberalization (including continuous measure of tariff changes) • Robust to including a number of period-specific industry controls • Pre-91 productivity growth • Export intensity • Capital intensity • Distance to frontier • Robust to excluding new entrants – so improvements are to older/existing plants • Robust to controlling for de-licensing of some sectors

13. Aggregate output growth decomposition • FDI reformed industries: most output growth from intra-plant TFP growth • Tariff reformed industries: equal share of input growth, inter-industry reallocation and intra-plant TFP growth • Not much role for intra-industry reallocation

14. TFP growth across the distribution • Consistent with prominent role for within-plant changes, we find shift in productivity across the full distribution • Improvement at top quartiles suggest there was slack/inefficiency even at productive firms, not just at the bottom of the distribution

15. Role of competition • The pattern here is consistent with competition leading to TFP growth • output price declined, consistent with higher competitive intensity • the output price declines NOT from pass-through of input price declines • TFP growth offsets the competitive pressure, so no net margin declines • consistent with increased competition, herfindahl index and concentration ratios fell

16. Which regions/industries show greater improvements • Some evidence that employer friendly states (per Besley and Burgess 2002) saw greater improvements • No/ weak effect for financial development/coastal status • Some weak evidence that industries closer to the frontier fared better • Some evidence that privately-owned plants fared better than government owned • No/weak effect for export orientation/capital intensity

17. Other recent work on trade/industrial policy • Industrial policy • Aghion, Burgess, Redding and Zilibotti (2008) examined effect of de-licensing • Find much stronger firm growth in employer-friendly states • Trade liberalization • ShanthiNataraj (2009) looked at effect of tariff reductions on a larger sample that includes informal firms; confirms strong improvements in productivity even among small informal firms • Amiti and Konings (2007) find strong TFP improvements after trade liberalization in Indonesia • They find a stronger role for input tariff reductions; we (and Nataraj) find stronger role for output tariff reductions • De Loecker (2009) finds increases in productivity for Belgian textile firms following lifting of quotas (trade liberalization) • Ruiz and Utar (2009) find Mexican firms that compete closely with Chinese firms improved productivity following China’s entry into WTO • A recent literature review is in Holmes and Schmitz (2010, FRB-Minneapolis)

18. Role of reallocation • Foster, Haltiwanger and Krizan (2001) for US (and studies for other developed countries) show reallocation of resources to productive firms/industries play an important role in aggregate productivity growth • Hseih and Klenow (2009) (consistent with earlier work by Duflo and Banerjee (2005)) find that reallocating to US efficiency levels could increase India’ manufacturing productivity by 40-60% (30-50% for China) • policies “constrain the most efficient producers and coddle the least efficient” • the most productive companies much larger in US • need to be cautious about studies of GDP share of “SMEs”; does a larger share suggest “good SME development” or “misallocation”? • E.g. Retail sector in India productivity was just 6% of US (McKinsey report, 1997). Among other important factors, two key policy factors : • restrictions on FDI (still not fully opened delaying Walmart retail entry) • restrictions on big stores due to tax and labor laws (smaller stores avoid both) • Caselli (2005) – holding productivity fixed, redistributing from agriculture to other sectors would reduce income inequality by 2/3

19. Other drivers of productivity • Syverson (2010) surveys literature on productivity determinants • In addition to competition (induced by industrial policy/trade reforms) and access to inputs (trade reforms), other key sources include • Worker human capital -- but maybe small role per Fox and Smeets (2009) • Incentive pay for workers and human resource practices • Managerial talent and practices

20. Human Resource Practices • Piece rates or output linked incentives could lead to large productivity improvements (and increased firm profits) (Lazear 2000) • Linking managerial pay to productivity of workers improves overall productivity (Bandiera et al 2007) • Where production happens in teams, • Group incentives and problem solving teams help increase productivity (Hamilton et al 2003, Boning et al 2007) • relative ability of peers and also social connections with peers affect productivity (Mas and Moretti, 2010, Bandiera et al 2010)

21. Managerial practices and productivity • Economists have considered managerial talent/practices as a potential driver of productivity for long (Walker 1887) • Bloom and Van Reenen (2007) • Surveyed 734 US and European firms on about 18 management practices in 4 areas (operations, monitoring, targets and incentives) • found measures of “good management practices” strongly correlated with high productivity • Again more competition associated with better management • Family firms with CEO chosen as eldest son very badly managed • Bloom and Van Reenen (2010) and Bloom at al (2010) extended study to 17 countries • Key finding is that for less developed countries, low scores are because a large number of smaller firms are poorly managed (whereas for US relatively few are badly managed)

22. Managerial practices and productivity • Bloom, EifertMahajan, McKenzie and Roberts (2010) conducted a randomized experiment • Random subset of textile firms provide management consulting advice • Find productivity gains for firms that received advice • Management practices encouraged were: • Factory operations: Tracking machines, breakdowns and keeping factory floor tidy • Quality control: Recording and formalizing ways to address quality defects • Inventory: Monitoring and tracking inventory • Human resources management: Performance driven incentives/defined job descriptions • Sales/order management: Tracking production per order (to improve pricing) • Study suggests lack of knowledge about management practices – firms unaware of good practices and underestimate how impactful they can be

23. Conclusions • Industrial and trade policy • A large number of studies suggest increased competition from industrial and trade liberalization spurs productivity growth • Aggregate growth gains from reallocation to more productive firms after liberalization • Business practices play an important part in productivity • academic work has tested and found strong positive effects for a number of incentive pay, human resources and management practices • while results are intuitive, surprisingly these practices are not widespread , particularly among smaller firms in developing countries! • Competition could play a role in promoting adoption of these practices