Why are Manufacturing Plants Smaller in Developing Countries? Theory and Evidence from India

Poorer countries (and poorer states within India) have a larger share of manufacturing employment in small plants. This paper presents empirical evidence and a theoretical model to show that this relationship is driven by greater demand for lower quality goods in poorer regions, which can be produced efficiently in small plants. First, using data for India, we show that richer households buy higher price goods and larger plants produce higher price products. Second, we develop a model that matches these facts. Finally, we find that our model explains about forty percent of the cross-state variation in the size distribution of manufacturing plants in India.