Working Paper: NBER ID: w31233
Authors: Alessandra Peter; Cian Ruane
Abstract: We estimate long-run elasticities of substitution between intermediate inputs for Indian manufacturing plants. India's trade liberalization in the early 1990s provides an ideal natural policy experiment, with permanent and heterogeneous tariff reductions inducing changes in relative prices which we use for identification. We find a high degree of substitutability at the plant-level between 8 broad categories of material inputs, significantly above the Cobb-Douglas benchmark of 1. In contrast, we find elasticities less than 1 between energy, materials, and services as well as between value added and intermediates. We embed our elasticities in a general equilibrium model with a rich input-output structure to quantify their importance. Relative to a Cobb-Douglas benchmark, the aggregate gains from trade are 9% larger when intermediate inputs are substitutes, and come hand in hand with 40% more reallocation of labor across sectors. Furthermore, the aggregate gains from closing the India-U.S. TFP gap in any one sector are on average 29% larger with our estimated elasticities; losses from misallocation of intermediate inputs are more than 3 times larger.
Keywords: intermediate inputs; substitutability; trade liberalization; India; elasticities
JEL Codes: E23; O11; O47
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| India's trade liberalization (F14) | estimated long-run elasticities of substitution between intermediate inputs (C51) |
| India's trade liberalization (F14) | 9% increase in aggregate gains from trade (F19) |
| India's trade liberalization (F14) | 40% increase in labor reallocation across sectors (J29) |
| closing the India-US total factor productivity (TFP) gap (O49) | 29% larger gains with estimated elasticities compared to Cobb-Douglas framework (C51) |
| estimated long-run elasticities of substitution between intermediate inputs (C51) | manufacturing plants can substitute between these material inputs effectively (L69) |
| estimated elasticities (H30) | robustness to various checks including potential for unobserved quality changes in inputs (L15) |