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Misallocation and Capital Market Integration: Evidence from India

Author

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  • Natalie Bau

    (University of California at Los Angeles)

  • Adrien Matray

    (Princeton University)

Abstract

We show that foreign capital liberalization reduces capital misallocation and increases aggregate productivity in India. The staggered liberalization of access to foreign capital across disaggregated industries allows us to identify changes in firms' input wedges, overcoming major challenges in the measurement of the effects of changing misallocation. For domestic firms with initially high marginal revenue products of capital (MRPK), liberalization increases revenues by 25%, physical capital by 57%, wage bills by 27%, and reduces MRPK by 35% relative to low MRPK firms. There are no effects on low MRPK firms. The effects of liberalization are largest in areas with less developed local banking sectors, indicating that foreign capital partially substitutes for an efficient banking sector. Finally, we develop a novel method to use natural experiments to bound the effect of changes in misallocation on treated industries' aggregate productivity. Treated industries' Solow residual increases by 4-17%.

Suggested Citation

  • Natalie Bau & Adrien Matray, 2020. "Misallocation and Capital Market Integration: Evidence from India," Working Papers 2020-31, Princeton University. Economics Department..
    • Handle: RePEc:pri:econom:2020-31
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    More about this item

    Keywords

    India; aggregating reduced-form estimates; foreign capital liberalization;
    All these keywords.

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F38 - International Economics - - International Finance - - - International Financial Policy: Financial Transactions Tax; Capital Controls
    • F6 - International Economics - - Economic Impacts of Globalization
    • O1 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development
    • O11 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development
    • O12 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Microeconomic Analyses of Economic Development
    • O4 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity

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