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.