Market Reallocation Barriers and Bad Management Persistence
RCTClinical Trial
Product market competition fails to drive unproductive, badly managed firms out of the market when capital, trade, and managerial span-of-control constraints prevent well-managed firms from expanding their market share.
Picture this
Think of a town where one bakery makes delicious bread and another makes stale bread. Normally, the delicious bakery would expand and drive the stale bakery out of business. But if the delicious bakery is legally forbidden from opening new stores or hiring new managers, townsfolk are forced to keep buying stale bread from the inefficient bakery.
What the evidence says
Indian textile firms faced a 35% import tariff on cotton fabric, strict credit access limits, and severe managerial span-of-control constraints where firm size was driven by the supply of adult male family members (R-squared impact of 10.1%). These distortions allowed poorly managed firms (baseline management score mean of 2.60 out of 5) to survive over 20 years without exiting.
- Who was studied
- 113 textile firms surveyed around Mumbai, India (including 17 project firms and 96 nonproject firms), representing large manufacturing plants averaging 270 employees.
- How
- Observational industry survey and structural trade/growth framework (Lucas span-of-control combined with Melitz selection model) using firm size, tariff rates (35%), and family ownership dynamics.
What to do
1. Eliminate regulatory plant-size thresholds and import tariffs to allow competitive market selection to reallocate output toward high-productivity plants.
From the source
"Because spans of control are constrained, productive firms are limited from expanding, so reallocation does not drive out badly run firms."
541 Management in India QJE.pdf