Misallocation and Capital Market Integration: Evidence From India

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%.

Micro Propagation and Macro Aggregation

“…In an open economy setting, Edmond et al (2015) show how trade liberalization affects welfare and productivity, over time, by changing markups. Bau & Matray (2020) combine Proposition 4 with a quasi-experimental research design to quantify how the liberalization of foreign direct investment raised industry-level Solow residuals in Indian manufacturing. Gopinath et al (2017) study misallocation in capital markets and follow a similar logic to Equation 19 to document an inefficient allocation of the capital inflow in Southern Europe during the Euro convergence period.…”

Regional integration policy, industrial chain and corporate total factor productivity: An econometric empirical analysis from China

“…Therefore, logically, RIP may have a positive impact on corporate TFP. Many scholars have carried out theoretical and empirical analyses and provided empirical supporting evidence (Jensen & Miller, 2018;Bau and Matray, 2020;Blankespoor et al, 2022). For example, Li et al (2022) apply the PSM-DID method to examine the impact of RIP on firm productivity and its heterogeneity based on the city data of the Yangtze River Economic Belt.…”

Dividend Taxes, Firm Growth, and the Allocation of Capital

“…The large 5. See Bau and Matray (2020) for a detailed description of the methodology and complete set of references to the literature on capital misallocation.…”

“…Finally, because we study how tax-induced increase in available liquidity affect the misallocation of capital, we relate to the literature studying the effect of financial constraints on various types of misallocation (all the references are detailed in Bau and Matray, 2020): misallocation of firms across sectors (e.g., Buera, Kaboski, and Shin, 2011;Midrigan and Xu, 2014), of labor (e.g., Hombert and Matray, 2016;Hombert and Matray, 2019;Hsieh, Hurst, Jones, and Klenow, 2019;Fonseca and Doornik, 2021) of capital within sectors across firms (e.g., Hsieh and Klenow, 2009;Sraer and Thesmar, 2020;Bau and Matray, 2020), of capital within multi-plants firms (Kehrig and Vincent, 2019), of capital over the business cycle (Kehrig, 2015), of bank lending (e.g., Delatte, Matray, and Pinardon Touati, 2020) or of international trade (Xu, 2022).…”