Frictional Market Survival of Inefficient Firms
High import tariffs, financial entry barriers, and managerial span-of-control limits insulate poorly managed firms from market competition, preventing efficient enterprises from driving out unproductive competitors.
Picture this
Imagine a town where a high wall stops cheap outside bread from entering, banks refuse to loan money to new bakers, and efficient bakeries cannot open more than two shops because the owner has only one adult son to manage a cash register. Even if a bakery burns half its flour every morning, it stays open and makes a profit because no competitor can expand to take its customers.
What the evidence says
Indian woven cotton fabric imports faced a 35% tariff insulating domestic producers, while firm expansion was capped by male family member availability, maintaining low average firm size and wide TFP dispersion (90th-to-10th percentile ratio of 5.0).
- Who
- 113 large Indian textile manufacturing firms (17 experimental firms and 96 nonproject firms) in Tarapur and Umbergaon near Mumbai, India.
- How
- Cross-sectional survey and structural framework combining industrial trade protection data, firm size distributions, and TFP dispersion metrics.
What to do
Policy makers should reduce trade protection tariffs and remove credit market barriers to strengthen market competition against inefficient incumbent producers.
From the source
"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."
541 Management in India QJE.pdf
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