Improving firm productivity: Policy and business factors

Improving firm productivity: Policy and business factors

Jagadeesh SivadasanUniversity of Michigan

BRAC-IGC-IIG Conference on Entrepreneurship and

Development: Policies, Practices and

ExperienceMarch 27-28, Dhaka

BRIC-IGC-IIG,March 27-28/11

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)

2


Outline of Presentation

1. My paper on 1991 Indian policy reforms and plant productivity– Background on reforms– Theoretical framework– Data– Empirical results

2. Summary of recent related work on economic policies/trade liberalization and productivity

3. Summary of recent work on business practices and productivity

3


Indian reforms and productivity

Management practices and productivity

Other recent work on policy reforms

Background on 1991 reforms

Liberalization in 1991 on all three policy fronts1. Industrial policy

• License requirements almost completely abolished

2. Foreign investment (FDI) regulations• FDI upto 51% allowed in a number of targeted sectors

3. 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

4




Other recent work on policy reforms 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




Other recent work on policy reforms 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





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

7





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

8





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

9





Summary graph: large relative improvements of productivity in

reformed sectors

10





Effects of FDI and Tariff Reform on TFP

(1) (2) (3) (4)LP_TFP LP_TFP LP_TFP LP_TFP

FDI_LIB * I_(91-93) 0.087 -0.011 0.085[0.093] [0.085] [0.093]

FDI_LIB * I_(94-95) 0.376*** 0.186* 0.375***[0.095] [0.097] [0.095]

TAR_LIB * I_(91-93) 0.247** 0.163 0.247**[0.120] [0.101] [0.120]

TAR_LIB * I_(94-95) 0.577*** 0.419*** 0.578***[0.157] [0.132] [0.157]

FDI_LIB * TAR_LIB*I_(91-93) -0.334*[0.195]

FDI_LIB * TAR_LIB* I_(94-95) -0.626***[0.221]

Observations 225,662 240,275 337,104 337,104 Adj R-sq 0.443 0.448 0.412 0.414

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Robustness checks

Robust to using seven other productivity measuresRobust 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

12





Aggregate output growth decomposition (1) (2) (3) (4) (5) (6)

Output growth

(2)+(3)+(4)

Input growth

Inter-industry

reallocation

Aggregate productivity

growth (5)+(6)

Intra-plant productivity growth

Intra-industry

reallocation

FDI_LIB 0.325* 0.111 0.010 0.222** 0.252*** -0.029[0.191] [0.0794] [0.0649] [0.111] [0.0929] [0.0652]

TAR_LIB 1.613*** 0.520*** 0.547** 0.587*** 0.549*** 0.038[0.542] [0.127] [0.271] [0.194] [0.141] [0.137]

FDI_LIB * TAR_LIB -1.597** -0.470*** -0.406 -0.741*** -0.719*** -0.022

[0.636] [0.168] [0.299] [0.270] [0.198] [0.159]

Constant 0.366*** 0.0618 0.101*** 0.193*** 0.0601 0.133**[0.104] [0.0562] [0.0319] [0.0649] [0.0530] [0.0543]

Observations 464 464 464 464 464 464R-squared 0.14 0.15 0.05 0.04 0.04 0.00

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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





TFP growth across the distribution

(1) (2) (3) (4) (5) (6) (7) (8)Dependent variable Mean P5 P10 P25 P50 P75 P90 P95

FDI_LIB * I_(91-93) 0.0852 0.134 0.0927 0.0691 0.0757 0.0871 0.109 0.122[0.0994

] [0.163] [0.140] [0.108][0.0915

][0.0856

][0.0820

][0.0783

]FDI_LIB * I_(94-95) 0.377*

**0.550*

**0.460*

**0.368*

**0.338*

**0.347*

**0.370*

**0.375*

**[0.102

][0.148

][0.135

][0.109

][0.102

][0.093

7][0.092

1][0.090

3]TAR_LIB * I_(91-93)

0.248* 0.282 0.256 0.235 0.235* 0.252**0.283**

*0.254**

*

[0.129] [0.218] [0.186] [0.152] [0.123] [0.108][0.0964

][0.0870

]TAR_LIB * I_(94-95) 0.579*

**0.708*

**0.667*

**0.597*

**0.568*

**0.551*

**0.532*

**0.479*

**[0.168

][0.245

][0.219

][0.184

][0.170

][0.156

][0.127

][0.112

]FDI_LIB * TAR_LIB*I_(91-93) -0.334 -0.527 -0.439 -0.327 -0.299 -0.293

-0.339**

-0.333**

[0.209] [0.336] [0.296] [0.229] [0.196] [0.180] [0.160] [0.145]FDI_LIB * TAR_LIB* I_(94-95)

-0.626**

*

-0.912**

*-

0.784**-

0.617**-

0.571**

-0.566**

*

-0.564**

*

-0.525**

*[0.237] [0.336] [0.306] [0.257] [0.237] [0.218] [0.187] [0.168]

Observations 3701 3701 3701 3701 3701 3701 3701 3701Adj R-sq 0.83 0.656 0.719 0.791 0.835 0.86 0.87 0.859

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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





Role of competition (1) (2) (3) (4) (5) (6) (7) (8)

Dependent variable Output price index

Input price index

Blue-collar wage index

White-collar wage index

Mean gross

margin

Mean net

profit margin

Herfindahl index

C10 ratio

FDI_LIB * I_(91-93)

-1.791 2.166*** 2.242 3.501

-0.0260**

* -0.006 -0.002 -0.026[3.870] [0.578] [2.227] [4.320] [0.0068] [0.0036] [0.0055] [0.0186]

FDI_LIB * I_(94-95) -18.06**

* -0.874 -4.758 -10.15 -0.024** -0.004

-0.0195*

*-

0.088***

[5.823] [0.984] [4.567] [10.18][0.0104][0.0043

][0.0085][0.0196]TAR_LIB * I_(91-93) -9.836** -2.079** -0.920 7.245 -0.015 -0.001 -0.002 -0.024

[4.620] [0.814] [2.434] [5.007] [0.0099] [0.0049][0.00425

] [0.0214]TAR_LIB * I_(94-95) -

26.96*** -3.726** -7.356 9.276 -0.013 -0.002-0.0165*

-0.0716*

**[8.28

6] [1.553] [4.712] [13.92][0.0129][0.0049

][0.0085][0.0201]FDI_LIB * TAR_LIB*I_(91-93) 12.10* -1.719 -1.324 -10.120 0.041*** 0.011 -0.014 0.034

[7.306] [1.284] [4.907] [8.441] [0.0141] [0.0069] [0.0165] [0.0388]FDI_LIB * TAR_LIB* I_(94-95)

28.70*** -0.446 3.886 -23.270 0.0326** 0.007 0.0242* 0.0869**

[10.79] [2.177] [8.665] [19.00] [0.0145] [0.0063] [0.0144] [0.0403]Observations 3,701 3,701 3,701 3,697 3,701 3,701 3,701 3,701 Adj R-sq 0.855 0.993 0.923 0.852 0.877 0.675 0.648 0.859

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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





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

16





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

– Shanthi Nataraj (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)

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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

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Indian reforms and productivity Management practices and productivityOther recent work on policy reforms

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

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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)

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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)

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Managerial practices and productivity

Bloom, Eifert Mahajan, 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:1. Factory operations: Tracking machines, breakdowns and

keeping factory floor tidy2. Quality control: Recording and formalizing ways to address

quality defects3. Inventory: Monitoring and tracking inventory4. Human resources management: Performance driven

incentives/defined job descriptions5. 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

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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

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Improving firm productivity: Policy and business factors

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