The Rise and Fall of India's Relative Investment Price: A Tale of Policy Error and Reform

Abstract

India's relative price of investment rose 44% from 1981 to 1991 and fell 26% from 1991 to 2006. We build a simple DGE model calibrated to Indian data in order to explore the impact of capital import substitution policies and their reform post-1991, in accounting for this rise and fall. Our model delivers a 23% rise before reform and a 28% fall thereafter. GDP per worker was 2.9% lower in 1991 compared to 1981 due to import restrictions on capital goods. Their removal and a 64 percentage point reduction in tariff rates raised GDP per worker permanently by 17.8%.

Keywords: Relative price of investment, Policy reform in India

JEL Classification: O11, E17, E2