Competition, Financial Constraints and Misallocation: Plant-Level Evidence from Indian Manufacturing

Tuesday, 29 November, 2016
This working paper by Galle (2018) demonstrates a dual impact of increased competition on misallocation in a setting with both oligopolistic competition and financial constraints. Without financial constraints, more competition unambiguously increases aggregate output by reducing mark-up levels and mark-up dispersion. However, with financial constraints, increased competition reduces the profitability of constrained firms, and thereby slows down their rate of self-financed investment and convergence to their optimal capital levels. I test these theoretical predictions by leveraging the pro-competitive impact of India's 1997 dereservation reform. As predicted, this reform leads to reduced mark-up levels and mark-up dispersion, and to slower capital convergence.