What explains the high capital intensity of Indian manufacturing?

Abstract

Purpose – This study aims to focus on the role of labor regulation and credit market imperfections, in addition to that of factor endowments, in determining capital intensities in Indian manufacturing. Design/methodology/approach – The paper considers an alternative approach to identifying the effects of India ' s labor regulations on industrial performance. In particular, the paper uses a measure of the stringency of labor regulations across countries – one that is completely independent of the India-specific measures used by earlier studies – and examines its relationship with capital intensities across manufacturing industries. Additionally, since labor regulations are unlikely to be the only reason for imperfections in factor markets, the paper also examines whether and to what extent capital market imperfections affect capital intensities across manufacturing industries. The paper then presents a case study that seeks to ascertain whether actual capital intensities prevailing in Indian manufacturing in major industry groups from 1989 to 1996 were larger than predicted capital intensities for these industry groups based on relative factor demand functions estimated for the USA (a country with relatively less restrictive labor laws and a more developed financial system) evaluated at Indian wages. Finally, the paper uses a recently available dataset to compare capital intensities in Indian and Chinese manufacturing to investigate the behavior of these two emerging Asian economies since 1980, when they started out with relatively similar socio-economic conditions. Findings – The paper finds that India uses more capital-intensive techniques of production in manufacturing than countries at similar levels of development (and similar factor endowments), including China. For a majority of manufacturing industries, labor freedom and capital market development are, in addition to factor endowments, important determinants of capital intensity of production techniques used. Results reveal that, controlling for factor prices, India specializes in more capital-intensive varieties within broad industry groups relative to the USA, a more capital-abundant economy. Originality/value – To the best of the authors ' knowledge, such a study has not been done for any other country. The paper sheds light on the important issue regarding the use of capital-intensive techniques in manufacturing in India, which is a labor-abundant country. The role of labor regulation has been extensively debated and the paper also investigates its role along with the role played by credit market imperfections.

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