Misallocation and Network Externalities in Inefficient Economies

Governments, especially in low- and middle-income countries, frequently use industrial policy to preferentially subsidise or protect certain sectors at the cost of others. These policies can be directed at entire sectors or be targeted towards individual firms within a sector. In this context, there is the possibility of immense bureaucratic discretion and potentially large impacts on aggregate efficiency, particularly when the government has rights over the allocation of natural resources. The impact of these policies on wider output and welfare is difficult to estimate as the allocation of inputs to firms is rarely random and it is difficult to gather data to evaluate how these interventions spill over onto the rest of the production network through input-output linkages. In 2012, the Supreme Court of India cancelled the operation of 214 coal mines held by private firms after allegations that the initial allocations were corrupt and ordered that the mines be reallocated via a transparent auction. This project exploits this arguably exogenous shock to the allocation of an input and gathers new data to study the spillovers of misallocation in an upstream sector through the rest of the economy.

The project will first unlock a novel dataset containing granular firm-level information on output, prices, input use and trade flows for the three sectors affected by the coal block allocation: iron and steel producers, cement manufacturers, and captive power plants. With this dataset, difference-in-differences specifications will be used to estimate the impact of losing a mine and getting a mine allocated. For the impact of losing the license, the relevant control group will be all firms which were considered under the report that instigated the cancelled operation of the 214 mines but ended up retaining their licenses. For the impact of allocation, the relevant control group will be the firms next in line at the auction (for example, the firm with the second-highest bid for a mine).

This project has direct relevance to industrial policy in low- and middle-income countries. Understanding the extent of misallocation due to political favouritism in essential sectors, and how these distortions affect other sectors in the economy, is crucial to evaluating industrial policy so actively engaged in by such countries. Further, cronyism, lobbying, and ill-gotten gains by private companies are rampant in many of these countries and fundamentally a sign of weak institutions. The gains in efficiency from a strengthening of institutions (here, the allocation mechanism for coal mines) are insufficiently understood and are of first-order importance when studying industrial policy in this context. Lastly, understanding distortions in the allocation of resources with a carbon footprint as high as coal is crucial to address environmental concerns and will help initiatives targeted at moving towards cleaner energy. Even conditional on existing technologies, to the extent that cost efficiency is also correlated with energy efficiency, optimal allocation of coal may help reduce the overall carbon footprint.


Tishara Garg

Massachusetts Institute of Technology

Namrata Narain

Harvard University