Misallocation and Capital Market Integration: Evidence from India

72 Pages Posted: 14 Jan 2020 Last revised: 2 Nov 2020

See all articles by Natalie Bau

Natalie Bau

University of California, Los Angeles (UCLA)

Adrien Matray

Princeton University

Multiple version iconThere are 2 versions of this paper

Date Written: January 2020


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%.

Keywords: aggregating reduced-form estimates, foreign capital liberalization, India, Misallocation

JEL Classification: O11, O12, O16, O47

Suggested Citation

Bau, Natalie and Matray, Adrien, Misallocation and Capital Market Integration: Evidence from India (January 2020). CEPR Discussion Paper No. DP14282, Available at SSRN: https://ssrn.com/abstract=3518623

Natalie Bau (Contact Author)

University of California, Los Angeles (UCLA) ( email )

405 Hilgard Avenue
Box 951361
Los Angeles, CA 90095
United States

Adrien Matray

Princeton University ( email )

22 Chambers Street
Princeton, NJ 08544-0708
United States

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