Product Market Liberalization and Productivity: Evidence from India∗

In this paper, we use a detailed plant-level dataset to study the effect of two reforms aimed at increasing product market competition in India – liberalization of foreign direct investment (FDI) and reduction in tariff rates. First, we examine the effect of the liberalization policies on mean plant-level productivity in the liberalized industries. We find a 23% increase in productivity level following the FDI liberalization and a 33% increase following tariff liberalization (comparing mean value added log productivity levels in 1994-95 to the pre-reform 1987-90 period). We check the robustness of these results to: (a) using alternative measures of productivity; (b) using alternative definitions of the liberalization variable; and (c) inclusion of controls to address bias from non-random selection of liberalized industries. The tariff liberalization effect is generally robust; the FDI liberalization effect is 14%-16% when controlling for non-random selection. Next, we examine aggregate productivity growth in liberalized industries; we find a 16% (15.6%) increase following FDI (tariff) liberalization. This increase appears to be driven largely by improvement in intra-plant productivity growth, with a small role for re-allocation. Finally, we examine who benefitted from the productivity gains; we find that the major beneficiaries were consumers (in the form of relatively lower wholesale output prices in the liberalized sectors).