Empirical studies on total factor productivity growth (TFPG) in developing countries highlight trade openness, research and development and market structure as being the most important determinants of TFPG. The role of institutions remains overlooked in the literature on the determinants of TFPG. In this article, we look into the role of institutional quality as captured by effective state–business relationships (SBRs) in influencing TFPG, using Indian manufacturing as a case study. By SBRs we mean a set of highly institutionalized, responsive and public interactions between the state and the business sector. To compute TFPG, we use firm level data for both the formal and informal manufacturing sectors. We correct for the simultaneity bias associated with the production function approach for TFPG estimation by employing a method developed by Levinsohn and Petrin. We propose measures of effective SBRs for 15 Indian states over the period 1994–2005, and then use them in TFPG equations to estimate the effect of SBR on TFPG. The results indicate that SBR has positively affected the TFPG of Indian industry. The effect, however, is primarily for the formal sector.
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