Estimation and decomposition of the Indian manufacturing sector's total factor productivity: a trade theory-based analysis

Abstract

Trade boosts productivity; hence, decomposing aggregate productivity based on major trade theories is essential to understanding the relative significance of each channel on productivity-led growth and its effects on living standards and real income of the nations. This paper uses the most recent control function estimation approaches to provide a more consistent and efficient estimate of the Indian manufacturing firms' Total Factor Productivity (TFP). Then, the article decomposes aggregate productivity loss of India's manufacturing due to the decline in trading activities into the inter-industry effect, the technology effect, the continuing-firm effect, and "the joint effects of entering and exiting firms". When India actively participates in trade, the primary drivers of increased aggregate productivity in the manufacturing sector are the technology and intra-industry effects, with the inter-industry effect contributing by around 24 percent. Declining trading activities caused productivity loss, primarily due to resource reallocation among continuing firms, followed by the technology effect, minor fluctuations in inter-industry, and the joint effects of entering and exiting firms. In light of these findings, the study recommends that trade policies prioritize boosting Indian manufacturing firms' trading activities to increase the sector's overall productivity.