Productivity, investment slowdown, and misallocation: evidence from Indian manufacturing

Using rich firm-level data of around 12,000 firms over 2004–2016, this study attempts to identify the factors responsible for the slowdown in gross investment and productivity in Indian manufacturing post-Global Financial Crisis. Our analysis reveals that the decline in investment is more pronounced for firms with higher productivity. Furthermore, we find evidence indicating a slowdown in the flow of capital and labor from less productive to more productive firms post-Global Financial Crisis. This indicates that a part of the fall in investment can be attributed to a decline in allocative efficiency, which is likely to have an impact on both aggregate productivity and income. Moreover, we probe into the causes behind the slowdown in the relationship between firm productivity, investment, capital and labor growth. We find that credit misallocation, financial constraints, age, and firm size played key roles in the investment slowdown. Finally, we present a counterfactual scenario by analyzing the extent of extra output and aggregate productivity that could be generated in the absence of misallocation.