Production bottleneck effects and role of market power: Evidence from India's dereservation reform

In this paper, I investigate how aggregate gains from reducing distortions within a market depend on the extent of market power in the production network. Improving a production bottleneck 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 vertically linked markets using the elimination of firm–size restrictions products in India during the 2000s combined with a rich firm–level data set. On impact of the reform, I find an increase in productivity, primarily driven by reallocation of inputs to larger and more productive firms that were previously constrained by the size restrictions. Similarly, more productive upstream and downstream firms expand output despite evidence of increasing markups. These results are consistent with models where demand elasticity decreases with firm performance, and highlight the importance of accounting for markup variation when studying misallocation. Finally, I find allocative efficiency gains within vertically linked markets that are attenuated in more concentrated markets, where larger firms increase markups more than quantity. These results underline the moderating effects of imperfect competition within vertical linkages when correcting for distortions in one sector.

Vybhavi Balasundharam is a Ph.D. candidate in Economics at the University of Michigan with research interests in Development Economics and International Economics.  She is interested in policy – oriented research. Prior to joining the Department of Economics, she received her BA in Economics from The University of Western Ontario. 

• India
• EDS
• Vybhavi Balasundharam
• production bottleneck