License Reform in India: Theory and Evidence

Abstract How do barriers to entry and expansion a¤ect productivity? I answer this question by examining the impact of India's industrial policy reforms during the 1980s. In 1985, the "License Raj", which controlled entry and capacity expansion in Indian manufacturing industries, was partially dismantled by removing a subset of industries from its jurisdiction. To assess the impact of this deregulation on TFP, I embed entry and expansion constraints in a heterogeneous …rm model of industry equilibrium. The model predicts that relaxing these constraints improves average industry productivity via changes in the composition of …rms in the industry. Moreover, the model yields structural equations that can be used to recover estimates of the TFP gains as well as estimates of the relative contributions of the changes in entry and expansion costs. Using establishment-level data, I …nd that over a ten year period the reform resulted in a relative TFP improvement of nearly 32% in the industries that were deregulated. The decomposition of these gains suggests that changes in entry and expansion costs contributed almost equally to the productivity improvement