Abstract/Summary

In this paper, we examine the impact of macroeconomic conditions and firm characteristics on firm efficiency and output in the Indian manufacturing sector. We estimate stochastic frontier production functions for six different industries using level annual data for 1999–2007. Our results indicate that while frontier output showed an overall increase, efficiency levels remained largely stagnant during our study period. We find no positive impact of infrastructural improvements on firm efficiency. The results stay robust to using a synthetic index of macroeconomic variables. In almost all the cases, we find that infrastructural improvements in power generation capacity, electrification of railways, bank expansion or road construction are associated with a rise in frontier output (or production potential of firms) and a decline in firm efficiency (or the actual to potential output ratio). Our analysis suggests that the underlying reason for this puzzle might be a shifting out of production frontiers over time at a pace higher than the rate of increase in output, which is consistent with uneven utilisation of improvements in infrastructure amongst firms.