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Industrial Sickness in Indian Manufacturing

Doctoral Dissertation
Department of Economics
Ruprecht-Karls Universität

Rahel Falk
Vienna, August 17, 2005

– i –

Widmung und Danksagung

Diese Arbeit ist meinen Eltern gewidmet.
Meinem Vater, weil er sich seit dem ersten Schulzeugnis für meine akademischen
Leistungen interessiert und meiner Mutter, die diese zugunsten tausend wichtigerer
Dinge im Leben in aller Regel ignoriert. Aus dem einen kommt der Ansporn, aus den
anderen die Kraft.

Über die Autorin
Hausi Mams-Harel lebt in Wien in einer fast
echten Ritterburg und ist heute 2 Jahre
älter als die Schuhgröße ihrer Tochter
Noomi. Ihr Sohn Jossi begann sein Leben
auf ihrem Schoß liegend am Schreibtisch.
Wenn er mal groß ist, will er aber was
Richtiges werden: Panzer-Polizist. Ihr Mann
Martin ist gut aussehend, kann inzwischen
kochen und macht sie mit seiner leichten
Lebensart meistens sehr glücklich.
Euch Dreien gilt mein tiefster Dank.

– ii –


I would like to express my gratitude to the following people for their support and
assistance in writing this thesis:
To the staff and the students of the Indira Gandhi Insitute at Mumbai for providing
advice and hospitality when I came to compile my first data set; to Evelin Hust for
walking over to the CMIE’s headquarter in Delhi with enough cash in her purse to get
me an update of the data two years later; to my former colleagues at the South Asia
Institute in Heidelberg for making this place such a hospitable environment; to Ansgar
Wohlschlegel for lively discussions on the merits of lemma economics; to my current
colleagues at WIFO for valuable suggestions on how to deal with numerous problems in
empirical research; to Elisabeth Neppl-Oswald for providing diligent and efficient help
with the layout of around 70 tables.
I wish to thank Bertrand Koebel for joining the doctoral committee last-minute and Clive
Bell for not declining to supervise my thesis when I told him on the second day that my
research plans were different from the ones that he suggested. The disagreements
between applied microeconomic theory and applied micro-econometrics can be
deep and the disagreements between a distinguished scholar and an academic
entrant can be deep, too. In this context I thank Stefan Klonner and Ansgar for
occasional advice on how to deal with the boss. And I thank the boss for carefully
reading this study, including the footnotes, and for providing very instructive comments.
After I had thought them over, I was often amazed that you were right again.

– iii –

Industrial Sickness in Indian Manufacturing i
Acknowledgements ii
1 Introduction 1
1.1 Motivation 4
1.2 Previous Research 6
1.3 The Contribution of the Thesis 8
1.4 The Firm-Level Dataset 13
1.4.1 Sampling Design, Reliability and Content 13
1.4.2 Basic Features of the Sample 16
1.5 Appendix to chapter 1 25
2 The Policy Background 26
2.1 Industrial Licensing 26
2.2 Promotion of Priority Sectors: Small-Scale and Backward Industries 28
2.3 Foreign Trade and Foreign Collaboration 30
Evidence on the Effects of Trade Liberalization 33
2.3.1 FDI Provisions 34
2.4 Labor Market Rigidities 35
2.5 Development Finance Institutions 37
2.6 The Sick Industrial Companies (Special Provisions) Act, 1985 (SICA) 40
2.6.1 Timing and Sequencing under SICA 40
2.6.2 Provisions for Weak Companies 43
2.6.3 Malfeasance Provisions 43
2.7 Summary and Conclusion 44
2.8 Appendix to chapter 2 45
3 Concepts, Dimensions and Characteristics of Industrial Sickness 46
3.1 Alternative Concepts of Sickness and their Suitability for Applied Work 47
3.1.1 Problems with the SICA Definition 47
3.1.2 Alternative Definitions of Sickness 48
3.2 Dimension of Sickness 54
3.3 Characteristics of Distress 62
3.3.1 Profitability 63
3.3.2 Single Factor Productivity Measures 63
3.3.3 Measures of Financial Distress 65
3.4 Summary and Conclusion 67
3.5 Appendix to Chapter 3 68
– iv –
4 Manufacturing Productivity and Efficiency in the 1990s 79
4.1 Review of the Empirical Literature 80
4.2 The Growth Accounting Approach to Productivity Measurement 81
4.2.1 Growth Accounting: Results 84
4.2.2 Limitations of Growth Accounting 85
4.3 Econometric Approaches to Productivity and Productive Efficiency 86
4.3.1 Inference from the Error Component Model 87
4.3.2 Inference from the Covariance Model 89
4.3.3 Results 91
4.3.4 Has Firm Performance Become More Heterogenous within the
1990s? 94
4.4 Conclusion 97
4.5 Appendix to chapter 4 98
5 Impact of the New Economic Policy Reforms on Sickness 100
5.1 Pre-Reform Distress, Pre-Reform Relief and Past-Reform Health Status 101
5.1.1 Measures of Budget Softness at the Firm Level 102
5.1.2 Econometric Model and Issues 105 Marginal Effects of Continuous Covariates and their Standard
Errors 108 Marginal Effects of Discrete Covariates and their Standard Errors 109
5.1.3 Empirical Specification and Hypotheses 110
5.1.4 The Results 112
5.2 Links Between Market Structure, Efficiency and Re-Emerging Sickness 116
5.2.1 A Quick Inquiry into the Determinants of Efficiency 117
5.2.2 Why do at-Risk Firms Ultimately Fall Sick or Sick Ones Recover? 120 The Econometric Model 121 Estimation Results 124
5.3 Conclusions 126
5.4 Appendix to Chapter 5 128
6 Sickness as a Strategic Device 130
6.1 Execution of the Sickness Law 131
6.1.1 Performance of the BFIR 131
6.1.2 The Role of Employment, Unionization and Indebtedness: Sectoral
Evidence 133
6.2 A Micro-Theoretical Approach to the ‘Economics of Sickness’ 138
6.3 Econometric Approach 140
6.3.1 Empirical Specification 144
6.3.2 Discussion of the Results 146
6.4 Conclusion 154
6.5 Appendix to chapter 6 156
7 What Has Been Learned and what Directions Should Future Work
Take? 158
– v –
8 Appendix 161
A Concepts & Definitions 161
B Construction of variables from PROWESS database 168
B-1 Qualitative Variables 168
B.2 Quantitative Variables 172
B.2.1 Construction of the Output Measure 172
B.2.2 Construction of Labor Input 175
B.2.3 Construction of Firm-Specific Capital Stocks 176
B.2.3.1 Construction of the Revaluation Factors 180
B.2.3.2 Revaluation Factors by Form of Ownership and Capital
Component (1981-1998) 183
9 References 190

– vi –
List of Tables

Table 1-1: Industrial sickness in India: number of sick/weak units 4 2: Industrial sickness in India: outstanding bank credit locked up in sick/weak
units 5
Table1-3: Distribution of firms by industry (1988-1999) 17
Table 1-4: Distribution of firms by state and industry (on entering the sample) 18
Table 1-5: Industrywise distribution of firms by ownership form 22
Table 1-6: Distribution of firms by size class (1988 – 1999) 23
Table 1-7: Industrywise distribution of firms by size class (1988 – 1999) 25
Table 2-1: Indicators of trade barriers in Indian manufacturing 31
Table 2-2: Effects of foreign trade liberalization: Bivariate correlation coefficients 33
Table 2-3: List of industries reserved for the public sector 45 4: Listries in respect of which industrial licensing is compulsory 45
Table 3- 1: Evolution of profits and net worth for the sample firms that satisfy the SICA
definition 49
Table 3- 2: Share of sick firms: various definitions of sickness 53
Table 3- 3: Patterns of sickness (by firms that ever fell sick) 55
Table 3-4: Sample characteristics by health status 55
Table3-5: Gap-analysis for firms that ever fell sick 56
Table 3-6: Incidence of sickness by industry: 1988 – 1999 (number of firms) 57
Table 3-7: Incidence of sickness by state: 1988-1999 (number of firms) 58
Table 3-8: Hazard rates for sickness by age class 59
Table 3-9: Industrywise incidence of sickness by form of ownership 60
Table 3-10: Industrywise incidence of sickness by size class 61
Table 3-11: Incidence of sickness by size class: 1988 – 1999 (number of firms) 62
Table 3- 12: Characteristics of distress: profitability and single factor productivity
measures 64
Table 3- 13: Characteristics of distress: debt ratios 66
Table 3-14: Detailed pattern of sickness (by firm) 68
Table 3-15: Number of cases registered with the BFIR: by year and industry 78
– vii –
… continued

Table 4-1: Average annual sectoral TFP growth for selected subperiods 84
Table 4- 2: Productivity estimates for various subperiods 91
Table 4- 3: Productivity and annual rate of change in mean sec. efficiency ('89-'99) 93
Table 4-4: Incidence of sickness, mean technical efficiency and firm heterogeneity 95
Table 4-5: Production function estimates 98
Table 5-1: Hardening budgets: (combined) evidence from cash-flow and expenditure
statements 104
Table 5-2: Percentile distribution of “no. of prod. groups” and “no. of plants” 111
Table 5-3: Pre-reform firm characteristics and past-reform health status: Panel probit
estimates for the probability of sickness (1997-1999) 113
Table 5-4: Determinants of Firm Efficiency (1992-1999) 118 5: Re-emergence of industrial sickness: competitive pressure vs. budget
hardening (Panel logit estimates (1992-1999)) 124
Table 5-6: Pre-reform firm characteristics and past-reform health status: Pooled probit
estimates for the probability of sickness (1997-1999) 128
Table 5-7: Robustness Checks on the Determinants of Firm Efficiency – Level
Specification 129
Table 6-1: Status of companies registered with the BIFR 132
Table 6-2: Employment data for BIFR-registered firms: cumulative position in 2000 134
Table 6-3: 1993 employment data from the Annual Survey of Industries 135
Table 6-4: Sectoral union data 135
Table 6-5: Outstanding bank credit and net worth deficit 137
Table 6-6: Testing the basic model: soft loan determinants (panel estimates) 147
Table 6-7: Testing the basic model: the case of sickness (panel estimates) 149
Table 6-8: Model extension: soft loan determinants (1999 cross-section) 151
Table 6-9: Model extension: the case of sickness (1999 cross section) 153
Table 6-10: Testing the basic model: soft loan determinants (1999 cross-section) 156
Table 6-11: Testing the basic model: the case of sickness (1999 cross-section) 157
– viii –
… continued

Table A-1: Glossary (in alphabetical order) 161
Table A-2: List of abbreviations 163
Table A-3: Scheme of income-expenditure account of Indian manufacturing firms 164
Table A-4: Stylized scheme of balance account 165
Table A-5: Scheme of balance sheet of Indian manufacturing firms 166
Table A-6: Sources of funds - stylized scheme 167
Table A-7: Sources of funds - detailed scheme 167
Table B-1: Re-classification of industry affiliation at the 3-digit level and wholesale-price
deflators used 168
Table B-2: National industry classification at the 2-digit level (NIC-87 codes) 171
Table B-3: Ownership classification system 171
Table B-4: Output-deflators at the 3-digit level 172
Table B-5: Average annual payments per employee, by Industry (in Rs.) 176
Table B-6: Capital stock deflator-series by ownership form and type of asset 178
Table B-7: Gross fixed capital formation at constant 1988-89 prices (in Rs. crore) 181
Table B-8a: Revaluation factors for initial year capital stock (total economy) 183
Table B-8b: Revaluation factial year capital stock (pub. sec. undertakings) 184
Table B-8c: Revaluation factors for initial year capital stock (public sector undertakings -
construction) 185
Table B-8d: Revaluation factors for initial year capital stock (public sector undertakings –
machinery & equipment) 186
Table B-8e: Revaluation factors for initial year capital stock (priv. sec. undertakings) 187
Table B-8f: Revaluation factial year ca(private sector undertakings -
construction) 188
Table B-8g: Revaluation factors for initial year capital stock (privatakings
– machinery & equipment) 189

– ix –
List of Figures

Figure 1-1: Sectoral Value Added in India: 1960 – 2002 2
Figure 1-2: Annual Change of Gross Value Added – Manufacturing 3
Figure 1-3: State-wise share in aggregate industrial output (1997-1998) 19
Figure 1-4: Average ’real’ firm age by industry (1988-1999) 21
Figure 2-1: Correlation between (2-digit) sectoral value added growth and change in
(2-digit) import penetration rates 34
Figure 2-2: Foreign Direct Investment: total FDI vs. FIPB-approved FDI 35 3: Financial assistance disbursed by DFIs 39
Figure 2-4: Timing and sequencing under the sickness law 42
Figure 4-1a: Mean sectoral efficiency 1989-1999 (light industries) 93
Figure 4-1b: Mean sectoral efficiency 1989-1999 (heavy industries) 94
Figure 5-1: Fiscal benefits vs. tax burden (index numbers) 102 2: Long-term debt and soft loans (index numbers) 103
Figure 5-3: Effect of ownership type on predicted sickness probabilities 115
Figure 6-1: Unionization vs. sickness 136

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