ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Market Reforms and Industrial Productivity

This paper brings out the factors that determine micro level firm level productivity in the context of a developing economy that had undertaken policy reforms towards a freer market. It econometrically tests a few hypotheses on the basis of firm level panel data for a set of Indian industries. One of the strong results of the paper is that firm level outward orientation of exports and imports contributes significantly and positively to firm level productivity. This finding supports one of the propositions of the new growth theory that developing economies benefit significantly from free trade with developed economies through free flow of new ideas and technologies and externalities.

The 1980s and 1990s have seen several developing economies make a radical shift towards a market economy after years of pursuing import substituting policy regimes. Several of them have experienced higher economic growth after implementing the market reforms. In the case of India, the reforms on the internal front were initiated in the mid-1980s and larger-scale reforms on the internal and external fronts were initiated in the early-1990s [The Economist, 2001]. India’s annual average growth of GDP was at 6.2 per cent and GDP per capita at 4.4 per cent for the decade of 1990-2000 and at 5.9 per cent and 3.8 per cent for the decade of 1980-1990 and 3.7 per cent and 1.5 per cent for the period of 1950 to 1980 respectively (IMF). The neo-classical growth theory postulates that GDP grows as a consequence of capital accumulation, population growth and technological change. The growth rate in GDP per capita can be attributed to higher growth in capital accumulation and technological progress than population growth. Capital accumulation and technological progress make workers more productive which leads to increase in marginal productivity of labour and wage rate and a decline in product prices and consequent increase in real incomes. This implies that in the 1990s there was higher level of capital accumulation and technological progress than the previous four decades in the Indian economy. To recapitulate, India’s policy reforms towards freer markets were initiated in the mid-1980s and the early-1990s [Ahluwalia 1999]. At a qualitative level, one could put together the policy reforms and higher growth of GDP per capita, and attribute the higher growth rates to the market reforms.

The key issue concerns why a free market mechanism should contribute to capital accumulation and technological progress at a higher degree than under state interventionist policy regime. The neo-classical growth theory of Solow (1956) does not make a theoretical link between economic growth and market mechanism. In a production function framework, output is a function of capital and labour and any residual in the output, that is not explained by the inputs, is attributed to technological change. Technological change is assumed to be exogenous. There is no theoretical basis to explain why capital accumulation should be higher in a free market than in a socialist economy unless one shows that there are higher incentives for saving and its mobilisation in a free market than in a socialist economy. The recent theoretical developments in the new (endogenous) growth theory shed light on the link between economic growth and market mechanism [Romer 1986; Luca, 1988]. The link can be seen in terms of incentives to private agents for investing in research and development and human capital accumulation in a free market mechanism in which technological change is not purely a public good. Partial excludability of technological innovations gives them private good properties. At the same time, technological change is partially a public good causing spillover effects, which increase aggregate and cumulative stock of knowledge. The non-rivalrious nature (use of a blueprint of a technology or new idea by one agent does not preclude use by other agents) of technological change is a source of increasing returns to scale and sustained long-run growth [Romer 1990].

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