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The Role of Input Capabilities in Shaping Multiproduct Firms: Evidence from Indian Manufacturing

How do firms decide which products to produce and in which industries to operate?

A new study by John Morrow and co-authors, published in the Journal of Political Economy (December 2022), explores the role of common input capabilities in determining the evolution of a firm's product space, focusing on Indian manufacturing data. This research brings to light the resource-based view of the firm and provides new insights into the factors driving product diversification.

The authors use the removal of size-based entry barriers in input markets as a natural experiment to establish a causal relationship between input capabilities and a firm's industry mix. They find that input capabilities define a firm's "core competencies" and are as important as time-invariant coproduction rates across industries.

The study reveals a key theoretical insight: economies of scope within multiproduct firms imply joint determination of production choices and input capabilities. This means that multiproduct firms do not behave like collections of single-product firms, and their production choices are interdependent on the relative demand and supply conditions they face.

These findings have significant implications for both firms and policymakers. Understanding the role of input capabilities in shaping production patterns can help firms make more informed decisions about product diversification and growth strategies. Policymakers should be aware that industries may respond to policy in ways that will not be captured by single-product firm models, highlighting the importance of studying input-output linkages both between firms and at the macroeconomic level.

Overall, the research emphasizes the significance of input-based comparative advantage in shaping the production patterns of multiproduct firms, providing valuable insights into the drivers of product diversification and firm growth.

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John  Morrow

John Morrow

Reader in Economics

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