Working Paper: CEPR ID: DP14282
Authors: Natalie Bau; Adrien Matray
Abstract: We show that foreign capital liberalization reduces capital misallocation and increases aggregate productivity for affected industries in India. The staggered liberalization of access to foreign capital across disaggregated industries allows us to identify changes in firms' input wedges, overcoming major challenges in the measurement of the effects of changing misallocation. Liberalization increases capital overall. For domestic firms with initially high marginal revenue products of capital (MRPK), liberalization increases revenues by 23%, physical capital by 53%, wage bills by 28%, and reduces MRPK by 33% relative to low MRPK firms. The effects of liberalization are largest in areas with less developed local banking sectors, indicating that inefficiencies in that sector may cause misallocation. Finally, we propose an assumption under which a novel method exploiting natural experiments can be used to bound the effect of changes in misallocation on treated industries' aggregate productivity. These industries' Solow residual increases by 3--16%.
Keywords: foreign capital liberalization; misallocation; India; aggregating reduced-form estimates
JEL Codes: O11; O12; O16; O47
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| foreign capital liberalization (F21) | capital misallocation (E22) |
| foreign capital liberalization (F21) | capital allocated to high MRPk firms (G31) |
| capital allocated to high MRPk firms (G31) | revenues (H27) |
| capital allocated to high MRPk firms (G31) | wage bills (J31) |
| capital allocated to high MRPk firms (G31) | MRPk (C59) |
| foreign capital liberalization (F21) | aggregate productivity (E23) |
| foreign capital liberalization (F21) | capital misallocation in less developed banking sectors (O16) |