How Does Energy-Efficiency Pass-Through to Product Markets? Evidence from Indian Manufacturing Firms

Nick Ryan

There appears to be a vast number of unproductive and poorly managed firms in developing countries that somehow manage to survive. One explanation for this phenomenon may be that firms are insulated by product differentiation, which, combined with unobserved product market frictions (e.g. high transport or information costs), might make productive firms unable to lower prices and increase their market share. The researcher aims to investigate how product-market differentiation affects cost pass-through, using new data on India’s two largest manufacturing sectors.

This study will extend a large-scale randomized trial of energy-efficiency investments in the Indian textile and chemical manufacturing sectors, of which preliminary results suggest that treatment plants have indeed become more energy-efficient. The researcher plans to test, by hiring actual traders to make output bids to treatment and control firms, whether newly more efficient firms respond by reducing output prices. A key focus of the analysis will be whether the amount that firms pass-through efficient improvements in lower prices varies with product-differentiation and energy-intensity: plants in less differentiated and more energy-intensive sectors might be expected to pass-through cost reductions more completely.

The project’s innovative data collection strategy of involving actual traders relies on the structure of the wholesale markets for textiles and chemicals. Plants in this sample do not sell their end product to retailers. Rather, wholesale traders intermediate with retailers or exporters. The traders provide raw inputs (such as cloth) and agree on a price before work begins for processing those inputs. As a typical plant deals with many traders, the traders hired by the researcher will be able to make credible bids to plants and solicit actual product-level prices. Indeed, the price data from traders’ simulated bids will be much more reliable and detailed than plant-level surveys allow, as plants are usually reluctant to share data on their finances or competitiveness.

The study findings will be relevant for industrial and climate policy. Input subsidies, for services like energy audits or for efficient capital, are common instruments for climate policy in both developing and developed countries. The full effect of these subsidies can only be known by tracing their impact through product markets in general equilibrium: if a policy induces more efficient firms to expand production, the extent to which energy consumption and carbon production falls will depend on how much they displace less-efficient competitors. The data and estimates from this study could be used to simulate effects of various energy policies on consumption and carbon emissions for an important part of the Indian manufacturing sector.