28-09-2012, 10:59 AM
TRADE LIBERALISATION, MARKET POWER AND SCALE EFFICIENCY IN
INDIAN INDUSTRY
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ABSTRACT
Using information on listed firms in each of the industry groups at
the two-digit level within Manufacturing this study investigates whether
the radical shift in trade policy in India in 1991 resulted in a reduction
in market power and/or an improvement in scale efficiency. We estimate
a group-wise production function allowing for firm-specific effects. A
plausible estimate of market power is obtained and the assumption of
constant returns to scale is mostly rejected. As regards the effects of the
trade-policy shock of 1991, evidence of a move to a more competitive
market structure or of an improvement in scale efficiency is not
widespread across Indian manufacturing.
Introduction
The introduction of imperfect competition into the analysis
generates gains from trade inconceivable under the standard assumption
of perfect competition1 . Now, trade holds out the distinct possibility of
influencing market power, defined as an excess of price over marginal
cost. This occurs as the domestic price, presumably higher than the
international one due to protection, is driven downward as imports
become an option either due to the removal of quantitative controls or
the lowering of tariffs, the central features of trade liberalisation. In this
scenario, costs - determined by production relations in domestic industry
- are taken to remain unchanged, contributing to a compression of the
price-marginal-cost ratio. An altogether independent story of the
consequences of trade for market performance can be told in terms of the
Lerner index of the degree of monopoly, also known alternatively as the
mark-up or the gross margin. Recall that the mark-up is inversely related2
to the elasticity of demand and/or the number of firms in the market.
Import liberalisation may be seen as introducing greater rivalry into the
market and thus raising the industry-wide elasticity of demand. Now the
mark-up may be expected to decline, even as the number of domestic
firms remains constant.
Trade-policy Reform in India:
By any reckoning India’s foreign trade regime was severely
restrictive over the period 1947-91. Its several instruments may be
gathered under the categories ‘quantitative restrictions’ (QRs) or ‘tariffs’.
QRs ranged from an outright ban on specific imports – for instance,
consumer goods – to the ‘canalization’ of certain others – ranging from
crude and edible oils to foodgrains, mostly necessitated by the need to
maintain administered prices of these commodities within the economy.
QRs extended with near symmetry also to exports, notably foodgrains.
Further, a complex system of export promotion also existed, ranging
from Special Import Licenses for large exporters and a duty-exemption
scheme dispensing advance licenses for the import of materials and
components. When it comes to considering trade reform, as opposed to
changes in a regime of QRs, the lowering of a tariff barrier is more easy
to comprehend, which does not of course imply its being any less
restrictive due to its simplicity. In 1990-91, the unweighted average
nominal tariff was 125 percent, with a peak rate of 355 percent.
The Data Base
The data for the present exercise is drawn from the database
PROWESS of the Centre for Monitoring Indian Economy (CMIE). CMIE
provide annual data on 7000 firms registered with the Bombay Stock
Exchange, limiting itself to public limited companies. Public limited
companies in India account for almost 50% of the labor force and 80%
of the fixed capital of the private sector factories, contributing to around
60% of the output and 70% of the value added. Information regarding
all the firms in all the industrial groups was collected.
No effort was made to balance the panel. Only firms for which
unacceptable values for certain variables were encountered were
excluded. The final data set as thus compiled included 3596 firms for
the ten-year period 1988-89 to 1997-98. Firms in the industry groups
chosen for the study account for nearly 73 percent of the value of output
of the manufacturing sector and approximately 70 percent of value
added in the year 1997-98, the final year for which data is available in
our sample. The distribution of firms across industry groups as arranged
for the present study along with the number of observations
corresponding to each industry group is provided in Table A1 of the
Appendix. On an average, these firms account for more than 60 percent
of the output of the corresponding industrial group reported in the
Annual Survey of Industries (ASI). It may legitimately be asked why we
may not have worked with data from the ASI. In the present context, we
emphasise that we are also interested in estimating the returns to scale.
Since ASI data for the nineteen eighties is at the industry level, it is not
ideally suited for the purpose.
Conclusion
The consequences of trade reform for Indian industry may be
considered to be a matter of some interest for reasons that we have
already discussed at the beginning of this paper. Indeed it should prove
of interest to both international-trade theorists and to those economists
exclusively interested in the outcome of trade liberalisation as a policy
adopted internationally since the late seventies. We have found a less
than widespread and non-uniform impact on industry of trade reforms in
India. While evidence of an improvement in scale efficiency is likely to
attract little extra attention, for a priori it may be viewed as an entirely
empirical issue, the finding of an increase in market power may evoke
some surprise if one is to go entirely by the prediction of mainstream
economic theory. However, we are able to offer two explanations of the
finding of an increase in the price-marginal cost ratio since trade reforms
in India. First, we may visualise a decrease in the number of domestic
firms consequent upon what has been referred to as the ‘rationalisation
of industry structure’, originally seen as the route to an improvement in
scale efficiency and actually signalled by our results to have taken
place in Indian industry since 1991.