Fact of the Week: Reduced Tariffs Between 1989 and 2011 Induced Indian Firms to Increase Their Productivity

August 6, 2018

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Reduced tariffs between 1989 and 2011 induced Indian firms to increase their productivity by 39 percent.

Source: Joel Stiebale and Dev Vencappa, “Import Competition and Vertical Integration: Evidence from India”, DICE Discussion Paper 293, July 2018.

Commentary: Protectionists routinely attempt to justify tariffs on the notion that domestic firms need to become more efficient before facing competition from outside markets. But new research on Indian firms helps put the lie to this claim, finding that exposure to international competition actually causes firms to become more efficient and increase their investments in R&D, which implies that tariffs prevent firms from increasing their productivity.

A recent study found that for every 10 percentage points the Indian government reduced tariffs, thereby increasing competition, local firms responded by engaging in 7 percent more “backwards vertical integration”—expanding their businesses into the production of inputs necessary for their main products, thus cutting their costs to produce goods by reducing dependence on suppliers. This increased local companies’ total factor productivity by 39 percent between 1989 and 2011 and was associated with 58 percent more R&D spending among larger companies. Unsurprisingly, these effects were most prominent in Indian firms which primarily operated in domestic markets, as firms which rely heavily on exports already face increased competition in international markets.