In this paper we quantify the effects of the Small Scale Reservation Laws in India on
the aggregate productivity, aggregate output and welfare of the Indian economy. To
this end, we extend the span-of-control model by Lucas (1978) into a multi-sector
setting and embed it into the neo-classical growth model. Our main theoretical
contribution is to model the occupational choice within this framework. We fully
calibrate our model to data from India for the early 2000’s. We find that lifting the Small
Scale Reservation Laws would increase output per worker by 3.2 percent, capital per
worker by 7.1 percent and aggregate TFP by 0.8 percent. Within manufacturing, output
per worker would increase by 9.8 percent, capital per worker by 12.5 percent and TFP
by 3.6 percent. Average firm size in manufacturing would raise from 19 to 69
employees. These are large numbers given that the size of the restricted sector is only
12 percent of manufacturing value added and 3 percent of total GDP. However, this
conspicuous type of size-dependent policy cannot account for the large gap in
manufacturing TFP existing between the US and India.