Indian and Mexican factories aren't investing as much as their U.S. counterparts in process efficiency, quality, and in accessing foreign and domestic markets.
As U.S. manufacturing plants age, they become more productive and employ more workers. But in India, old plants show little improvement over new plants in terms of workers or productivity. Mexico does a little better: the average 40-year-old plant employs double the workers of a young plant, but that's nowhere near the American average of eight times as many workers at a 40-year-old plant compared with a plant that is five years old or less.
These patterns hold across many manufacturing sectors in the formal as well as the informal portions of the economy, according to Chang-Tai Hsieh and Pete Klenow. In The Life Cycle of Plants in India and Mexico (NBER Working Paper No. 18133), they conclude that this employment gap suggests that Indian and Mexican factories aren't investing as much as their U.S. counterparts in process efficiency, quality, and in accessing foreign and domestic markets. The result is a potential reduction of 25 percent or so in aggregate manufacturing productivity for these developing nations when compared with American productivity.
Why is average plant productivity lower in poor countries? The authors argue that "a certain type of misallocation - specifically misallocation that harms large establishments - can discourage investments that raise plant productivity and thus lower the productivity of the average plant in poor countries." One reason the authors chose Mexico and India for this study is because of their reliable manufacturing data, which allow the researchers to track the life cycle of plants in the informal as well as the formal parts of the economy. In Mexico, this data indicate that the plant's workforce doubles by the time the plant reaches age 25, which is similar to the U.S. experience. But after 25 years, plant growth stagnates, while in the United States it continues to swell. In India, plant employment hardly grows at all: 17 of 19 two-digit industries saw average employment grow of less than 20 percent for plants over 40 years old versus those less than five years old.
Why don't Indian and Mexican factory owners invest more in their plants? The authors point to several factors that discourage them from getting too big. India's labor regulations and taxes, for instance, apply to large firms but less so to smaller firms. Mexico enforces its payroll taxes on large plants more stringently than on small ones. Also, manufacturing plants are more likely to be family owned in India and Mexico and, thus, to rely on unpaid family workers (in 2005-6, such unpaid labor provided 62 percent of all India's employment; in 2008, nearly 30 percent of Mexico's employment). Moreover, the wage gap between large plants and small ones is double that in the United States, further discouraging plants from growing larger and taking on more expensive labor. The authors mention other potential factors: the need for bigger plants to supplement electric power from the grid with their own more expensive generators in India; and Mexican and Indian factories finding it difficult to buy more land, find skilled managers, and ship goods.
The result of these potential frictions to plant growth is that total factor productivity (TFP) suffers in older Mexican and Indian plants compared with their U.S. counterparts. "[L]ower life-cycle growth in Mexico and India can have important effects on aggregate TFP," the authors conclude. "Moving from the U.S. life cycle to the Indian or Mexican life cycle could plausibly produce a 25 percent drop in aggregate TFP."