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Market imperfections, trade reform and total factor productivity growth: theory and practices from India


The study investigates how market imperfections distort the impact of trade reform on productivity growth. As the trade expands it influences both product and factor prices and if the distortions arise due to these market imperfections are not eliminated, the usual estimate of total factor productivity growth, using the growth accounting method, would be misleading. Theoretically, it shows that the usual estimate tends to be overestimated in the export competing sector and underestimated in the import competing sector. A modified approach of Olley–Pakes and Levinsohn–Petrin methods involving three-digits industries over the fifteen major Indian states during the period 1998–2005 has been used to deal with the simultaneity issue of factor choice and market distortions for the better estimate. A positive and significant impact of openness on the productivity growth has been observed only when the market imperfections are eliminated. Moreover, the modified productivity growth, after controlling market imperfections, has turned out to be lower than that of the usual estimate in India.

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  1. It essentially means the residual growth that is not explained by the growth of inputs used in production, and the growth depends on the level of technological improvement, efficient and intense use of resource in the economic activities.

  2. For example, Young (1992) found a low level of TFPG in Singapore, using a growth accounting exercise, when the per capita income of the economy rose from third world levels to those of industrialized levels during 1970s and 1980s.

  3. The domestic firms in some sectors receive favorable treatment from other non-tariff barriers (like Anti-Dumping initiatives) in India (Maiti 2012). As a result, the domestic price is perhaps not reduced significantly with the rise of import competition. .


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I sincerely acknowledge the research grant (ref.: RP02/001/2008/RP) sponsored by the Indian Council of Social Science Research that helped in preparing this paper. I am grateful to Biswanath Goldar and D N Bhattacharyya for insightful suggestions in the previous version of the paper and also thankful to Poulomi Dasgupta for research assistance in this work. My sincere thanks also go to the editor and the anonymous referees of this journal for giving me some insightful comments in the earlier draft. Usual disclaimers apply.

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Correspondence to Dibyendu Maiti.



Let us consider the Cobb-Douglas production function where value added Q of a firm using labor L and capital K:

$$ Q = AF(L,K) $$

The production function is homogeneous of degree 1 + λ for all input factors. By taking a total differentiation of (22) and logarithmic values we get:

$$ (q - k) - \varepsilon_{L} (l - k) = \lambda k + a $$

Under perfection competition, the wage is paid according to the value of marginal product, i.e., \( w = PMP_{L} \). Re-arranging the terms, we get that \( \varepsilon_{L} = \frac{\Updelta \ln Q}{\Updelta \ln L} = \frac{wL}{PQ} = s_{L} \). Then, we get:

$$ (q - k) - s_{L} (l - k) = \lambda k + a $$

Now, (q − k) − s L (l − k) is defined as SR.

Under imperfections in product market, the wage is paid according to their marginal revenue product, i.e., \( w = MR.MPP_{L} \). If \( \mu = P/MC \), then \( \varepsilon_{L} = \mu s_{L} \). Assuming \( \varepsilon_{L} + \varepsilon_{K} = 1 + \lambda \) and substituting then in (24), we can easily rearrange as follows:

$$ (q - k) - s_{L} (l - k) = \left( {1 - \frac{1}{\mu }} \right)(q - k) + \lambda k + (1 - \beta )a $$

Under imperfections both in the product and labor markets, the labor union is assumed to have a bargaining power θ. \( \bar{L} \) is the total workers and w 0 is the alternative wage for workers outside the firm. Nash bargaining equation is as follows:

$$ \max_{w,L} \Upomega = (Lw + (\bar{L} - L)w_{a} - \bar{L}w_{a} )^{\theta } (PQ - wL)^{1 - \theta } $$

Differentiating with respect to wage and employment and then rearranging the terms, we get:

$$ w = (1 - \theta )w_{a} + \theta \frac{PQ}{L} $$
$$ w = \frac{\theta }{1 - \theta }\left( {\frac{PQ - wL}{L}} \right) + \frac{\partial (PQ)}{\partial L} $$

Now, we get \( \frac{\partial (PQ)}{\partial L} = \frac{\partial (PQ)}{\partial Q}\frac{\partial Q}{\partial L} = \frac{P}{\mu }\frac{\partial Q}{\partial L} \) where \( \mu = \frac{{e_{p} }}{{e_{p} - 1}} \) and \( e_{p} = \frac{P}{Q}\frac{\partial Q}{\partial P} \).

Then, we find that

$$ \varepsilon_{L} = \mu s_{L} + \mu (s_{L} - 1)\theta /(1 - \theta ) $$

Combining (25) and (29), we find that

$$ (q - k) - s_{L} (l - k) = \left( {1 - \frac{1}{\mu }} \right)(q - k) + \frac{\lambda }{\mu }k + \frac{\theta }{1 - \theta }(s - 1)(l - k) + (1 - \beta )a $$

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Maiti, D. Market imperfections, trade reform and total factor productivity growth: theory and practices from India. J Prod Anal 40, 207–218 (2013).

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  • Trade reform
  • Solow residual
  • TFPG
  • Union bargaining
  • Mark-up

JEL Classification

  • D24
  • F16
  • L11