Yesterday, I had linked to a paper by Bloom et al, and said that it would be a good place to start reading about productivity, particularly from an Indian point of view. Here are my notes from the paper:
As per Hsieh and Klenow the ratio of TFP in Indian and Chinese firms is 5(!) between the 90th and the 10th percentile
The quality of management, and therefore management practices, is one explanatory factor
Economists tend to not buy into this because they assume that profit maximization implies cost minimization
So in other words, if firms are not minimizing costs by adopting good management practices, it is because “wages are so low that repairing defects is cheap. Hence, their management practices are not bad, but the optimal response to low wages.”
In this paper, large multiplant textile firms were split into treatment and control groups. The treatment groups were given management consulting from a top consulting group, the control groups weren’t.
The result: “We estimate that within the first year productivity increased by 17%; based on these changes we impute that annual profitability increased by over $300,000. These better-managed firms also appeared to grow faster, with suggestive evidence that better management allowed them to delegate more and open more production plants in the three years following the start of the experiment. These firms also spread these management improvements from their treatment plants to other plants they owned, providing revealed preference evidence on their beneficial impact.”
So why wasn’t this being done already?
No need, because benchmarking was with local competition, who weren’t doing it anyway
Simple lack of awareness
A naïve belief that nothing would change by adopting these practices
But even within local competition, why did firms not exit?
Competitive pressures were heavily restricted
High import tariffs
No entry of firms by lack of external finance
Number of male family members
Lack of trust of professional managers (family owned businesses)
TFP in India is about 40% that of the USA, as per Caselli 2011
“Indian firms tend not to collect and analyze data systematically in their factories, they tend not to set and monitor clear targets for performance, and they do not explicitly link pay or promotion with performance. The scores for Brazil and China in the third panel, with an average of 2.67, are similar, suggesting that the management of Indian firms is broadly representative of large firms in emerging economies.”
The interventions comprised of improvements in:
Human Resource Management
Sales and order management
This was done by implementing the following steps:
A diagnostic phase
An implementation phase (this was for only the treatment group, obviously)
A measurement phase
The authors carefully consider whether the Hawthorne effect was at play, and reject the possibility.
” In every firm in our sample, before the treatment, only members of the owning family had positions with any real decision-making power over finance, purchasing, operations, or employment. Non-family members were given only lower-level managerial positions with authority only over basic day-to-day activities. The principal reason seems to be that family members did not trust non-family members. For example, they were concerned if they let their plant managers procure yarn they may do so at inflated rates from friends and receive kickbacks.”
“A key reason for this inability to decentralize appears to be the weak rule of law in India. Even if directors found managers stealing, their ability to successfully prosecute them and recover the assets is likely minimal because of the inefficiency of Indian courts”
“Hence, the equilibrium appears to be that with Indian wage rates being extremely low, firms can survive with poor management practices. Because spans of control are constrained, productive firms are limited from expanding, so reallocation does not drive out badly run firms. Because entry is limited, new firms do not enter rapidly. The situation approximates a Melitz (2003)–style model with firms experiencing high decreasing returns to scale due to Lucas (1978) span of control constraints, high entry costs, and low initial productivity draws (because good management practices are not widespread).”
There are three reasons for inefficiency:
I need to read Lucas (1978) and Melitz (2003) next!