Deregulation, Misallocation, and Size: Evidence from India

Abstract

This paper examines the impact of the deregulation of compulsory industrial licensing in India on firm size dynamics and reallocation of resources within industries. Following deregulation, resource misallocation declines, and the left-hand tail of the firm size distribution thickens significantly, suggesting increased entry by small firms. However, the dominance and growth of large incumbents remains unchallenged. Quantile regressions reveal that the distributional effects of deregulation on firm size are significantly non-linear. The reallocation of market shares toward a small number of large firms and a large number of small firms is characterized as the "shrinking middle" in Indian manufacturing. Small- and medium-sized firms may continue to face constraints in their attempts to grow.