The Long-run Effects of Distortions on the Geography of Production: Evidence from Indian Freight Equalization

India’s Freight Equalization Scheme (FES) aimed to promote even industrial development by subsidizing long-distance transport of key inputs such as iron and steel. Many observers speculate that FES actually exacerbated inequality by allowing rich manufacturing centers on the coast to cheaply source raw materials from poor eastern regions. We exploit state-by-industry variation in the effects of FES on input costs, in order to show how it affected the geography of production. We find, first, that over the long-run FES contributed to the decline of industry in eastern India, pushing iron and steel using industries toward more prosperous states. This effect sinks in gradually, however, with the time needed to construct new plants serving as a friction to industry relocation. Finally, we test for the stickiness of these effects, by studying the repeal of FES. Contrary to popular opinions of the policy and to agglomeration-based reasons for hypothesizing stickiness, we find that the effects of repealing FES are equal and opposite to those of its implementation. Still, due to changing locations of the processing of basic iron and steel materials, the resource-rich states suffering under FES never fully recover.

Zoom link:
18 January 2022, 15:10-15:55 (Tuesday)

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