Bottlenecks Versus Ripple Effects: The Role Of Linkages In India’S Product Market Liberalization
Speaker(s) Vybhavi Balasundharam, University of Michigan Publication CAFRAL Conference room on Mezzanine Floor, Main Building. Reserve Bank of India, Fort, Mumbai 400 001

I investigate the impact of input-output linkages on aggregate productivity gains from reducing distortions in a market. Removing distortionary policies that implicitly tax larger and more productive firms within a market propagates to upstream suppliers as a demand shock and to downstream customers as an input cost shock. I analyze the heterogeneous response of firms in these linked markets, leveraging the elimination of firm-size restrictions for a set of product markets in India during the 2000s combined with rich firm-level data. Upon reform, I find an increase in aggregate productivity from both the directly exposed and linked markets. These gains are primarily driven by reallocation of inputs to larger and more productive firms. However, productivity gains are attenuated when linked markets are highly concentrated. More productive firms in concentrated linked markets raise their markups in response to the demand or supply shock, thereby increasing misallocation. The adjustment of markups is consistent with models where demand elasticity decreases with firm productivity and underlines the substantial bias from ignoring market structure in linked markets when assessing the impact of piecemeal reforms. Conditional on the supply-chain being sufficiently competitive, linkages can amplify the overall gains from reforms that reduce distortions in a market. 

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