DP8242 Small Scale Reservation Laws and the Misallocation of Talent

Author(s): Manuel García-Santana, Josep Pijoan-Mas
Publication Date: February 2011
Keyword(s): Firm size, Multisector growth models, Occupational choice, TFP differences
JEL(s): E23, J24, L11, L26, O41, O47
Programme Areas: International Macroeconomics, Development Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8242

In this paper we quantify the effects of the Small Scale Reservation Laws in India on the aggregate productivity, aggregate output and welfare of the Indian economy. To this end, we extend the span-of-control model by Lucas (1978) into a multi-sector setting and embed it into the neo-classical growth model. Our main theoretical contribution is to model the occupational choice within this framework. We fully calibrate our model to data from India for the early 2000's. We find that lifting the Small Scale Reservation Laws would increase output per worker by 3.2 percent, capital per worker by 7.1 percent and aggregate TFP by 0.8 percent. Within manufacturing, output per worker would increase by 9.8 percent, capital per worker by 12.5 percent and TFP by 3.6 percent. Average firm size in manufacturing would raise from 19 to 69 employees. These are large numbers given that the size of the restricted sector is only 12 percent of manufacturing value added and 3 percent of total GDP. However, this conspicuous type of size-dependent policy cannot account for the large gap in manufacturing TFP existing between the US and India.