Judicial efficiency and the comparative disadvantage of Indian manufacturing

• Published date: 01 February 2022
• Author: Santosh Adhikari,Michael Alexeev
• Date: 01 February 2022
• DOI: http://doi.org/10.1111/rode.12828

Rev Dev Econ. 2022;26:375–404. wileyonlinelibrary.com/journal/rode

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© 2021 John Wiley & Sons Ltd.

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INTRODUCTION

The process of economic development is accompanied by structural transformation in employment

and production. Initially labor moves out of the traditional agricultural sector into manufacturing and

Received: 23 September 2019

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Revised: 14 August 2021

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Accepted: 19 August 2021

DOI: 10.1111/rode.12828

REGULAR ARTICLE

Judicial efficiency and the comparative

disadvantage of Indian manufacturing

SantoshAdhikari1

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MichaelAlexeev2,3

1Kathmandu University, Lalitpur, Nepal

2Department of Economics, Indiana

University, Bloomington, Indiana, USA

3The Russian Academy of National

Economy and Public Administration,

Moscow, Russia

Correspondence

Michael Alexeev, Department of

Economics, Indiana University,

Bloomington, IN, 47408, USA.

Email: malexeev@indiana.edu

Abstract

We examine whether poor efficiency of the judicial system

can explain the sluggish growth of contract- intensive manu-

facturing in India. We use a large set of fixed effects to ad-

dress the potential endogeneity problem. More important,

we contribute to the literature by exploiting the time dimen-

sion of the data, including the use of a conventional “within”

estimator, and by employing three different measures of ju-

dicial efficiency. Our results, confirm the hypothesis that

a more efficient judicial system facilitates development of

industries with a higher degree of “relationship specific-

ity.” This finding, combined with the lack of significant

improvement in institutional quality in the country since

the early 1990s, provides one explanation for comparative

disadvantage of India’s contract- intensive manufacturing

sectors which also tend to be sectors producing complex

manufacturing goods.

KEYWORDS

allocation of industry, Indian economy, judicial efficiency,

relationship specificity

JEL CLASSIFICATION

D02; O14; O53

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ADHIKARI AnD ALEXEEV

then into services. The share of agriculture in gross domestic product (GDP) falls while the share

of manufacturing initially rises and then falls forming a hump- like shape, and the share of services

goes up monotonically. Also, within manufacturing, the development usually proceeds from produc-

ing relatively simple standardized goods to progressively more complex output. This has been the

typical development trajectory for most world economies, including the advanced OECD countries

that achieved substantial growth after the industrial revolution and the East Asian tigers that took off

during the 1960s and 1970s. More recently, the dramatic growth of the Chinese economy has followed

a similar path. In contrast, the Indian economy, the growth of which accelerated in the early 1980s has

developed differently.1 The outflow of workers from traditional agriculture in India has been slow, the

manufacturing sector has largely stagnated and continued to focus mostly on relatively simple goods,

while the services sector has seen a rapid rise in the 2000s, reaching more than half of GDP in 2013.

The main goal of our paper is to exploit the state- level variation in the efficiency of the judicial

system in India to show that the poor quality of that system provides at least a partial explanation for

the slow growth of output and complexity of the country's manufacturing sector in absolute terms

and relative to the service sector.2 Of course, in India as in many other developing countries, formal

contract enforcement does not play the same role as in developed economies. Instead, agreements are

often enforced via informal mechanisms and relational contracting (see, for example, McMillan &

Woodruff,1999a, 1999b). Nevertheless, even in developing countries formal contract enforcement

does take place and informal enforcement may operate “in the shadow of the law,” that is, using for-

mal enforcement as a threat point. For example, in a survey conducted by a civil society organization

Daksh, about 70% of respondents who had a dispute wanted to go to court to resolve it, with only 30%

preferring non- cour t methods.3

For more than three decades after independence, India's economic growth was sluggish, but the

situation improved after the government undertook a series of import liberalization reforms in the

1980s and further liberalizing reforms after the 1991 fiscal crisis. This has resulted in rapid economic

growth in recent decades. However, unlike many other countries at a comparable stage of develop-

ment, this growth has been driven mostly by the expansion of services while manufacturing has stag-

nated. Moreover, India's revealed comparative advantage in manufacturing in general and in complex

contract intensive products in particular has not shown much improvement since the mid- 1990s.4

Using UNCTAD data, Balasubramanyam and Wei (2015) calculate that India's revealed comparative

advantage in manufacturing goods increased from 0.80 in 1995 to just 0.81 in 2013.5 The respective

change for electronics was from 0.10 to 0.08. Even in those contract- intensive sectors where Indian

manufacturing made substantial progress, such as machinery and transport equipment, the improve-

ment significantly lagged that of the corresponding Chinese sectors both in relative and in absolute

terms.

We conjecture that this has happened because, despite a series of reforms, India has not achieved

much improvement in terms of the quality of its economic institutions, and the rule of law and judicial

system in particular, since the early 1990s. According to the World Governance Indicators, the rule of

law measure for India, on a scale of (approximately) −2.5 to 2.5, fell from about 0.31 in 1996 to −0.05

in 2015 (the end of our data), placing India around the 56th percentile in the world. India's judicial

system also deteriorated between 2000 and 2015 according to our measures of judicial efficiency.

For example, the average expected time to have a case processed went from 11.3years in 2001 to

12.3years in 2015.

Although India as a whole has not seen an improvement in the rule of law, there is substantial

variation in this respect at the state level. For our purposes, the most important aspect of the rule of

law is contract enforcement, which to a large extent depends on the efficiency of the judicial system

that reflects the speed of processing claims submitted to it. This point is emphasized in the related