Infrastructure regulation and reallocations within industry: Theory and evidence from Indian firms

Many firms in developing countries adopt captive power generators to deal with expensive and unreliable supply of electricity. I present a model that combines upstream regulation with downstream heterogeneous firms in a monopolistic competition framework, where firms can pay a fixed cost to adopt this marginal cost-reducing device. The presence of captive power affects the market equilibrium by increasing the level of idiosyncratic productivity a firm needs to survive in the market and by re-allocating sales and profits towards the more productive, adopting firms. Additionally, the rate of adoption is shown to increase with the price of electricity, industries' electricity–intensity and with higher barriers to firm entry. The mechanisms I propose are present for a cross-section of Indian firms.