The reservation laws in India and the misallocation of production factors

The Small Scale Reservation Laws (SSRL) in India are a unique case of firm-level size restrictions. We quantify their aggregate productivity costs by use of a span-of-control model extended into a multisector setting. The reallocation of top managers away from the distorted sector partly offsets the effect of the distortions. We calibrate our model using plant level data from India. Lifting the SSRL increases output by 6.8% in manufacturing and 2% in the overall economy, and TFP by 2% and 0.75% respectively. While large, the costs of this size-dependent policy cannot account for the existing gap in manufacturing TFP between the US and India.