Analyzing the role of market share reallocation and average productivity improvements in aggregate productivity growth: Evidence from Indian manufacturing

• Published date: 01 May 2022
• Author: Ronny Thomas,Krishnan Narayanan
• Date: 01 May 2022
• DOI: http://doi.org/10.1002/pa.2457

ACADEMIC PAPER

Analyzing the role of market share reallocation and average

productivity improvements in aggregate productivity growth:

Evidence from Indian manufacturing

Ronny Thomas

1

| Krishnan Narayanan

2

1

Department of Finance & Economics, Rajagiri

Business School (RBS), Kakkanad, Kochi,

Kerala, India

2

Department of Humanities and Social

Sciences, Indian Institute of Technology

Bombay, Mumbai, India

Correspondence

Ronny Thomas, Department of Finance &

Economics, Rajagiri Business School (RBS),

Rajagiri Valley P.O., Kakkanad, Kochi, Kerala,

India-682039.

Email: ronny@rajagiri.edu

This study attempts to empirically examine the importance of market share

reallocation and average productivity improvements in driving aggregate productivity

growth. By using Olley and Pakes, Econometrica, 1996, 64(6), 1263–1297 decomposi-

tion method, we show that aggregate productivity growth has mainly been driven by

improvements in average productivity (with-in firm productivity improvement) and

not reallocation during the post liberalization phase (1999–2010) for the manufactur-

ing sector in India. We also show that for many industries (sub-sectors of

manufacturing) the reallocation effect is negative and was driving the aggregate pro-

ductivity down, compared to average productivity, which has driven the aggregate

productivity up. The findings from the study confirms the important role of with-in

firm productivity improvement in aggregate productivity growth. Hence, the study

emphasizes the need for positive policy interventions by the government that could

enhance with-in firm productivity growth through internal restructuring.

JEL CLASSIFICATION

D24; O47; O53

1|INTRODUCTION

Productivity growth has long been recognized by policy makers as a

major source of industrial progress and economic growth. Recent

years witnessed an increase in the literature examining aggregate pro-

ductivity growth at the industry level by looking at the evolution of

micro patterns of firm level productivity. Most of these studies follow

the early theoretical proposition that firms with-in the narrowly

defined industries are heterogeneous in terms of productivity and are

liable to respond to idiosyncratic shocks (Ericson & Pakes, 1995;

Hopenhayn, 1992; Jovanovic, 1982). According to these studies, pol-

icy changes or reforms would result in firm level productivity changes,

which in fact prompt the entry/exit of firms from the industry leading

to aggregate productivity gains (due to exit of least productive firms

and entry of more productive firms). Therefore, one channel of aggre-

gate productivity growth is the with-in firm productivity expansion

mostly achieved through internal restructuring (Bartelsman &

Doms, 2000; Foster, Haltiwanger, & Krizan, 2006; Harrison, Martin, &

Nataraj, 2013). Empirical studies in this area of research reports that

an increase in the average productivity of firms in the industry could

be taken as an indicator of the with-in firm productivity improvement

and hence could be used to study aggregate productivity gains (Foster

et al., 2006; Olley & Pakes, 1996). In comparison to the role of aver-

age productivity, studies also highlight that aggregate productivity

growth in a sector could be also due to the reallocation of market

share from less productive to more productive firms (Bollard,

Klenow, & Sharma, 2013; Foster, Haltiwanger, & Krizan, 2001; Harri-

son et al., 2013). This is based on the reasoning that, the selection of

firms into the market based on productivity leads to the reallocation

of outputs and inputs toward more productive firms and results in the

exit of the least productive firms (Melitz, 2003; Olley & Pakes, 1996).

This confirms the proposition that aggregate productivity growth is

not only achieved through internal restructuring alone but through

the process of reallocation across individual firms with-in the narrowly

defined industries (Baily, Hulten, & Campbell, 1992; Griliches &

Regev, 1995; Haltiwanger, 1997).

Empirical studies have been carried out in the context of

advanced countries to analyze the role of average productivity

Received: 7 May 2020 Revised: 15 July 2020 Accepted: 28 August 2020

DOI: 10.1002/pa.2457

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https://doi.org/10.1002/pa.2457