Job Market Paper: PRIMARY

This paper answers the puzzling questions that why under the sim-ilar set of economic conditions service sector in India grew while manu-facturing could not and how economic reforms in 1990s accelerated the productivity growth. The paper provides a very innovative and con-vincing explanation. Two subtle but important distortion-inefficiency mechanisms, which work through distorting the intermediate input allocation, are identified in the paper. Interaction of policies of quan-titative restrictions and inflexible labor laws resulted in lower than optimal materials per worker usage.Combination of high inflation and unavailability of credit exacerbated this factor distortion and lowered the productivity growth further. Using panel data on Indian industries, I find underutilization of materials compared to labor until recently. This sub-optimal mate-rials per worker usage lowers productivity growth. Productivity esti-mates are negatively related to labor growth and positively related to materials growth. Real wages and labor productivity are negatively related to materials inflation and this relationship breaks down af-ter the capital market reforms in 1990s. Since these mechanisms work through intermediate inputs, service sector productivity is not affected as adversely. Estimates show that after 1990s firms have started over-substituting materials and capital relative to labor, which can explain the jobless growth in Indian manufacturing. Keywords