08.15.2013 - Robert Jensen

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Market Size and the Growth of Firms: Evidence from a Natural Experiment in India

Market Size and the Growth of Firms: Evidence from a Natural Experiment in India

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  • 1. Market Size and the Growth of Firms: Evidence from a Natural Experiment in India Robert Jensen Wharton School University of Pennsylvania Nolan Miller University of Illinois at Urbana-Champaign NBER
  • 2. Firms in Developing Countries 1. On average very small (Tybout 1998, Hsieh-Klenow 2012)  e.g., Hsieh and Klenow (2012) Avg. manufacturing firm in U.S.: 42 employees Avg. manufacturing firm in India: 2.6 employees 2. Often do not grow as they age  Compared to firm < 5 years old, avg. 40 year old firm has: U.S.: 8X employees Mexico: 2X employees India: < 1X employees 3. Much less productive than in rich countries (Tybout 1998, Bloom et. al 2010). 4. Productivity varies widely across firms (a puzzle, as in rich countries)  Firm size & growth important for economic growth & development  Returns to scale, productivity, competitiveness, etc.
  • 3. Many Possible Explanations for Small Firm Size  Limited access to credit  Regulations, taxes, permits/licensing may apply if grow more  Institutions (legal, etc.)  Labor markets (esp. as try to expand beyond family labor)  Infrastructure (power, water, transportation, communication)  Organizational factors/management
  • 4. In this paper...  Test whether limited demand/market size for any given firm’s output, arising from information problems, limits growth (and productivity). (highly localized demand)  Take advantage of a natural experiment created by spread of mobile phones in Kerala, India  Related to previous work, Jensen 2007  Focus on boat manufacturing, using 6 yrs of firm-level census data
  • 5. Setting: Mobile Phones & Arbitrage  In previous work (Jensen 2007), show that fishermen use mobiles to check price in different markets. Welfare-improving arbitrage.  Similar results in Aker 2010 and others.
  • 6. Figure 1. Region of Study Source: Reproduced from SIFFS (1999).
  • 7. Table 1. Prices and Excess Supply and Demand in 15 Beach Sardine Markets Tuesday, January 14, 1997 Tuesday, January 21, 1997 Price Excess Buyers Excess Sellers Price Excess Buyers Excess Sellers Kasaragod District Hosabethe 6.2 0 0 4.3 0 0 Aarikkadi 4.0 0 0 5.9 0 0 Kasaba 0.0 0 4 5.9 0 0 Kanhangad 9.9 15 0 0.0 0 9 Thaikadappuram 0.0 0 11 6.1 0 0 Kannur District Puthiangadi 9.8 12 0 5.0 0 0 Neerkadavu 6.9 0 0 7.7 0 0 Ayikkara 8.4 1 0 0.0 0 13 Thalassery 4.3 0 0 5.7 0 0 New Mahe 6.2 0 0 0.0 0 5 Kozhikode District Chombala 8.7 2 0 1.9 0 0 Badagara 9.7 11 0 5.2 0 0 Quilandi 7.2 0 0 0.0 0 8 Puthyiyangadi 0.0 0 5 6.2 0 0 Chaliyam 6.4 0 0 9.7 8 0
  • 8. Large Changes in Fish Marketing 20011997
  • 9. Large Changes in Fish Marketing
  • 10. Phones, Effective Market Size and Firm Growth  Now, fishermen visiting different markets learn about different boat builders and their prices and quality  Experience good, quality difficult to observe. Particularly, life expectancy.  Reputation, develop ties to others, trust.  Phones may also reduce transactions costs (updates on schedule, payments, modifications/adjustments to costs or design, etc.)  We argue that mobile phones increased the effective market size or demand for any given builder:  Prior to phones, builders sold almost all of their boats locally. Firm demand limited by local market. more learning leads to shifts in demand towards better builders.
  • 11. Phones, Effective Market Size and Firm Growth  Provided there are no barriers to trade or bigger limitations on firm growth/output, we expect increased competition, D demand  Increased market share for more productive, highest quality manufacturers.  Growth & increased output of high quality manufacturers.  Possibly exit of least productive or lowest quality manufacturers
  • 12. Theoretical Motivation—Basic Setup  Producers differ in their location and in the cost of producing a boat (-year).  There is also some fixed cost of production.  Low-cost producers are higher quality (i.e., their boats last longer), Qf. Life years of the boat.  Consumers can perfectly assess the price and quality of their local producer. u = v QA – pA – x ; u = v QB – pB – (1 – x)  Before cell phones, consumers have no information on non-local producers. Experience good. No direct opportunities for learning.
  • 13. Theoretical Motivation--outcomes  In this environment, all producers charge monopoly prices for their boats.  Low-cost producers charge lower prices (per boat-year) than high-cost producers (with same local demand curve).  Due to lack of demand, high-quality producers remain small.  Due to lack of competition, low-quality producers can survive.  Quality/productivity/cost dispersion can persist in equilibrium.
  • 14. Theoretical Motivation—Introduce search/learning  Now introduce cell phones—suppose makes it possible for consumers to learn prices (per boat-year) or quality of other nearby producers.  Thinking of it here more as phonesarbitrageinformation (info networks, direct observation)  Akin to monopolistic competition. Cell phones introduce new substitutes, shift the demand curve facing any particular firm in.  This will tend to lower all prices.  High-cost producers can no longer earn a profit and exit.  As high-cost producers exit, low-cost producers face increased demand, increase price and quantity.
  • 15. Theoretical Motivation—Predictions  Overall impact on price depends:  Competitive pressure initially decreases prices of low-cost producers.  But, as high cost firms exit, competitive pressure decreases and firms can increase prices. This works in the opposite direction.  Market share and quantity of low-cost producers should increase.
  • 16. v QB v QB - pB S v QA v QA – pA S 1/2 m* v QA – pA * v QB – pB * v QB – pB m
  • 17. v QB v QB - pB S v QA v QA – pA S 1/2 m* v QA – pA * v QB – pB * v QB – pB m
  • 18. Welfare Effects  Net gains...  especially if there are returns to scale  ...unless market power becomes too great  Will be winners and losers  builders who shut down  builders who lose effective market power  some consumers previously had highest quality guy at low price, will lose
  • 19. Relation to the Melitz (2003) Trade Model  Melitz (EMA 2003) considers the impact of trade on intra-industry reallocations and productivity.  Opening up to trade can be thought of as analogous to an increase in information about non-local producers.  Before trade, can only buy from local producer.  After trade, can buy from anyone.  Melitz model:  Firms differ in production cost, must pay fixed cost to enter.  In closed economy, more productive firms are larger, charge a lower price, earn higher profits.
  • 20. Relation to the Melitz (2003) Trade Model  Opening the domestic market to trade is like reducing search costs to zero.  Low-cost firms export (i.e., sell to non-local consumers).  Low-cost firms that export increase profit and market share.  High-cost firms exit.
  • 21. Setting: Boat Manufacturing in South India  In Kerala, fishing is a big industry:  millions employed, 70+% consume daily.  Lagoons, rivers, inlets, streams, lakes, “backwaters” (vs. sea fishing)  Prawns, crabs, karimeen/pearl spot (green chromide)  Nets and traps  Water is brackish/briny  Boats  Wooden “rope boats.” Planks of anjili or Jack-Wood, fastened together with coir (fiber from the husk of coconuts) knots. Treated with ghee, fish oil or resin.  More recently, fiber glass boats have become available  Non-motorized (while fishing; small motors for traveling)  3-10 meters  1-5 people
  • 22. Data  No official data on builders available--firms small, unregistered.  Builder census: with local experts and NGO’s (e.g., SIFFS), visited every fishing village, landing spot and fish market in 2 districts
  • 23. Kerala Study Region
  • 24. Data  No official data on builders available--firms small, unregistered.  Builder census: with local experts and NGO’s (e.g., SIFFS), visited every fishing village, landing spot and fish market in 2 districts  Generated a list of name, address of every boat builder  Approximately 143 firms (1997). Nearly every fishing cluster had a person who built boats (home-based). Nearly 1:1 mapping of villages and builders.  Cannot rule out we missed some very small-scale builders (subsistence fishermen in non- fishing villages, maybe building own boats).  In our fishermen survey, no builders reported that were not in our census  Census  Labor, capital, output, sales, price (past month, past 6 months)  Also, an accounting of all boats sold (stock at start, flow after)  Conducted census every 6 months from Jan. 1998 to Jan. 2004
  • 25. Data  Fishermen survey every 6 months from Jan. 1998 to Jan. 2004. 20 randomly selected fishermen/landing  Brief Survey (emphasis was on builders)  Landing Canvas—all new boats at every landing spot, every 6 months.  Very brief survey.
  • 26. TABLE 1: Firm Attributes at Baseline Mean Standard Deviation Min Max FIRM ATTRIBUTES Number of employees 2.2 0.72 1 4 Production at dwelling 0.99 0.08 0 1 Boats produced per year 13.6 4.05 4 27 Market share (total market) 0.007 0.002 0.002 0.013 Estimated life expectancy 4.76 0.89 3.56 8.1 Price (5 meter boat) 3,930 270 3,550 4,150 Price/year (5 meter boat) 841 122 583 1,104
  • 27. Big Difference in Boats Across Builders Skill matters a lot. Better builders have longer lived boats  How well wood is shaped and fastened affects durability  Big threat from biofouling organisms (e.g., byrozoans & barnacles). Better treatment of wood affects vulnerability to these organisms.
  • 28. Measuring Boat Life Expectancy I  When we interviewed fishermen for builder census, asked about age of current boat and age of last boat when they replaced it.  Can use this to construct measures of life expectancy of boats for each builder  Limitations:  Only available with a lag. Quality of builder may vary over time.  Problem of new entrants (though are not that many)  Local fishing environment (and use) may affect life expectancy—organisms nearby, rocks, water calmness, etc.
  • 29. Measuring Boat Life Expectancy II  Hired auditor from short-lived government boat insurance program to assess quality (1:5) and life expectancy.  Assess quality of wood treatment, craftsmanship (fastenings, etc.)  Life expectancy from boats more objective. But this can factor in:  Diff builders may have diff life expectancy if local fishermen use boats differently (fishing envi (rocky, still, salinity, etc.), biofouling organisms, etc.).  Life expectancy only observed with some lag, and may have changed recently  Auditor assessment allows more contemporaneous measure, not need wait out life expectancy.  Also, we can assess how good the auditor is by comparing (with some error) their estimates to the objective measures (again, still a lag, and still can’t handle newer entrants)
  • 30. Measuring Boat Life Expectancy (an aside)  Boats are largely homogeneous, but length varies  Demand for boats of different length varies (by fishermen & place)-- might be easier to make smaller or larger boats last longer.  5 meters is the most popular size produced for all but 3 builders.
  • 31. Life Expectancy III  Is boat quality just skill (& experience), or also a choice variable? (imagine poverty & credit constraints). Some of quality may be endogenous—choice of wood (though not much), labor & quality of construction, etc.  Low quality producers may be intentionally making worse boats b/c, e.g., they sell in areas where fishermen are poorer & credit constrained. Can’t afford upfront costs of a better boat, even if they know it would be a lower price per year over the long run.  3rd measure: Like TFP, take residuals from a regression of life expectancy on total labor hours input (separately for adults & kids) and materials input
  • 32. Life Expectancy--final points  If we are still capturing something that is a choice variable and not underlying ability/skill/productivity, then we would not expect empirical patterns observe.  The “bad” builders will be able to produce just as good boats as the “good” builders and not be driven out.  Except, buyers may be imperfectly informed of role of choice in quality. So, you see another builder’s boat is better (worse) than your own, and think he’s better (worse), even if it’s choice.  Also, possible state dependence. Low demand for quality means you don’t get experience building good boats. So it’s not underlying skill (bad guys could have been as good) but more historical. Just a different source of skill difference, though.
  • 33. TABLE 1: Firm Attributes at Baseline Mean Standard Deviation Min Max FIRM ATTRIBUTES Number of employees 2.2 0.72 1 4 Production at dwelling 0.99 0.08 0 1 Boats produced per year 13.6 4.05 4 27 Market share (total market) 0.007 0.002 0.002 0.013 Estimated life expectancy 4.76 0.89 3.56 8.1 Price (5 meter boat) 3,930 270 3,550 4,150 Price/year (5 meter boat) 841 122 583 1,104
  • 34. Price Variation  No single price (even aside from bargaining/price discrimination)-- non-linear in size. Focus again on 5m boat.  Raw price variation is not very large  But very big differences in quality (life expectancy).  So effectively, big differences in price/boat-year.
  • 35. TABLE 1: Firm Attributes at Baseline Mean Standard Deviation Min Max FIRM ATTRIBUTES Number of employees 2.2 0.72 1 4 Production at dwelling 0.99 0.08 0 1 Boats produced per year 13.6 4.05 4 27 Market share (total market) 0.007 0.002 0.002 0.013 Estimated life expectancy 4.76 0.89 3.56 8.1 Price (5 meter boat) 3,930 270 3,550 4,150 Price/year (5 meter boat) 841 122 583 1,104
  • 36. Empirical Analysis: Mobile Phones in Kerala  First introduced in 1997  Staggered introduction throughout the state  Introduction centered on largest cities.  Did not penetrate further inland as of 2004
  • 37. Empirical Strategy Compare D in firms relative to staggered introduction of mobile phones.  Outcomes  Market (firm-level regressions): exit, market share  Production (firm-level regressions): output, employees, productivity.  Consumers (fishermen-level regressions): Price, life expectancy  Z (e.g., education, experience, whether father was a builder)  Controls for fixed differences across regions, time effects common to all regions, differential trends or changes common to all regions.
  • 38. Identifying Assumption  In the absence of mobile phones, there would have been no differential changes in these outcomes across the regions.  Certainly, phone placement/timing is non-random.  Spread to most populous, wealthiest areas first.  We’ll consider several key challenges…
  • 39. Empirical Strategy II Compare D in firms relative to staggered introduction of mobile phones. Define 3 regions
  • 40. I II III
  • 41. Empirical Strategy II Compare D in firms relative to staggered introduction of mobile phones. Define 3 regions Region I: Southern Coastal Kannur District: Kannur (June 6, 1998) + Thalassery (July 31, 1998) Region II: Northern Coastal Kasaragod District: Kasaragod + Khanhangad (May 21, 2000) Region III: Inland Regions Did not get phones during my survey period  Earlier regression is just a pooled-treatment version of this
  • 42. Figure III: Percent Fishermen Selling in Local Market
  • 43. Figure II: Number of Firms, by Region
  • 44. TABLE 4: Main Regressions--Market Constructed Life Expectancy Auditor's Assessment (1) Exit (2) Market Share (3) Exit (4) Market Share Phone 2.49*** -0.096*** 1.61*** -0.049*** (0.22) (0.039) (0.42) (0.018) Life Span 0.0002 -0.002** -0.0001 -0.008 (0.002) (0.0001) (0.0011) (0.0005) Phone*Life Span -0.37*** 0.020*** -0.23*** 0.013*** (0.14) (0.007) (0.096) (0.0055) Number of Obs. 1,606 1,606 1,606 1,606 75th percentile, ~7 years life span
  • 45. TABLE 6: Builders REGION I REGION II REGION III January 1998 January 2004 January 1998 January 2004 January 1998 January 2004 Number of employees 2.3 5.1 2.4 4.1 2.0 1.9 Boats produced/year 14.7 38.2 14.0 36.4 12.8 12.4 Wood Price (Rs.) 217 276 231 286 227 275
  • 46. Productivity # boats built largely un-D’d (boat*years/quality ↑↑), yet total labor ↓ # workers: Region I: 12196 (21%), Region II: 11886 (27%) Hours decrease even more --Material inputs largely unchanged --But...power tools. Experimentally, labor hours decline by about 4-6% with full array of power tools. increased productivity of ~20% (labor hours) in the two regions
  • 47. TABLE 7: Consumers (1) (2) (3) (4) Bought Locally? Price Assessed Life Expectancy Price/boat*year Region Has Phone -0.73*** 414** 1.33*** -117*** (0.21) (182) (0.54) (45.0) Time FE YES YES YES YES Village FE YES YES YES YES Time*Year FE YES YES YES YES
  • 48. Identifying Assumption In the absence of mobile phones, there would have been no differential change in these outcomes across the regions. We’ll consider several key challenges…
  • 49. Alternative Explanations 1. Differential trends by region  Timing of introduction clearly not random. Biggest/wealthiest first.  Control for fixed differences and linear trends over time. But maybe timing matched other changes going on—e.g., more rapidly growing areas, added first—maybe affected consolidation in market, demand for quality.  Timing of changes looks good: In Figures, no D for firms in regions that did not get phones, and no Ds in Region II until they got phones. And no differential change for more vs. less productive firms.  Can construct (noisy) pre-trends using recall data—at each canvas, asked fishermen about current & previous boat. Can look at # firms for many past years. Possible recall error--but use later rounds to investigate extent.
  • 50. Figure II: Number of Firms, by Region
  • 51. Alternative Explanations 2. What if fishermen migrated when phones came in, so demand shifted with them. Or phones led to differential fishermen entry/exit or change in demand for fish.  Jensen (2007) shows no such changes in mobility or quantity caught or location-quantity caught 3. Other changes around same time as phones added?  Largely based on licensing and capacity to roll out infrastructure  Hard to rule out all, but Jensen (2007) shows no obvious changes (roads, etc.)
  • 52. Alternative Explanations 4. A change in the demand for quality?  More travel now to sell fish  greater demand for quality?  Wouldn’t you always want the least expensive (per life year) boat?  Increased P of fishermen (Jensen 2007) greater demand for quality, more fishing or consolidation among firms for some other reason.  Income elasticity demand for quality (endogeneity concerns) close to zero (increased profitability was about 6%)  At baseline, fishermen don’t know quality of non-local firms.
  • 53. Alternative Explanations 5. Advertising. Still a demand channel. Seems unlikely--phones not effective advertising tool, esp. when there is no “fishermen phone book.” And little to no internet access at this time 6. Technical Knowledge. Anecdotally, not really going on. There is no store of knowledge or technical assistance. 7. Input Markets. Purchase inputs more easily or at lower prices. No evidence any effect on input prices. Wood & rope easily storable, so less P variation.
  • 54. TABLE 6: Builders Wood is >90% of material input costs REGION I REGION II REGION III January 1998 January 2004 January 1998 January 2004 January 1998 January 2004 Number of employees 2.3 5.1 2.4 4.1 2.0 1.9 Production at dwelling 0.98 0.56 1.00 0.62 1.00 1.00 Boats produced/year 14.7 38.2 14.0 36.4 12.8 12.4 Wood Price (Rs.) 217 276 231 286 227 275
  • 55. Alternative Explanations 5. Advertising. Still a demand channel. Seems unlikely--phones not effective advertising tool, esp. when there is no “fishermen phone book.” And little to no internet access at this time 6. Technical Knowledge. Anecdotally, not really going on. There is no store of knowledge or technical assistance. 7. Input Markets. Purchase inputs more easily or at lower prices. No evidence any effect on input prices. Wood & rope easily storable, so less P variation. 8. D’s in collusion? Phones make it more/less possible for builders to collude. No anecdotal evidence. Also, prices/boat-year declined.
  • 56. Alternative Explanations 9. D Credit Markets?  If builders were able to get credit they could not get before, maybe that is what allowed them to expand.  Phones may have lowered search & transactions costs. Maybe credit markets became more integrated.  No anecdotal evidence of this.  More importantly, no builders reported receiving loans, even at endline.  Separately, interesting that they were able to expand without credit.
  • 57. Underlying Mechanisms We argue phones led to increased demand/market size for individual firms, exit, market share, productivity, etc. Separately, which aspect of phones mattered, which made it possible for effective market size or customer base to expand?  Search costs (just learning about builders, existence, p & Q)  Reputation & trust (fishermen pay ½ upfront)  Transactions costs (changes, updates, delays & status, etc)
  • 58. REGION I REGION II REGION III Jan 2000 Jan 2001 Jan 2002 Jan 2000 Jan 2001 Jan 2002 Jan 2000 Jan 2001 Jan 2002 # boat builders know of 5.2 4.9 4.4 1.3 3.6 3.7 1.3 1.1 1.1 Best Known Alternate Builder Life Expectancy Error (s) 0.43 0.41 0.39 1.08 0.41 0.45 1.03 1.11 1.21 Table 9. Underlying Mechanisms
  • 59. Child Labor A lot of focus on poverty/credit constraints. Policy focus on bans. But labor demand side is likely to be very important as well. Production function with limited (one-way) substitution of skilled & unskilled labor. Expansion path more rapid in skilled labor. e.g., all master builders have one “gopher,” typically a child (& often underemployed). As scale up, typically still just need one gopher, so industry shifts to larger firms results in reduced child labor
  • 60. 52 17 44 17
  • 61. Children’s Outcomes  Confident there are fewer kids working in this sector. But, what were the displaced children doing?  Tried to find out what those kids were doing  Many of the reports come from ex-builders we could track  About ¼ were working in some other sector  Overall, slightly more likely to be enrolled than in control area  Many were already “enrolled”  For the rest, just less work.  Lower exposure to hazards, more leisure/study time  Loss of training/apprenticeships?
  • 62. Conclusions  Using a natural experiment & detailed micro data, we find that increased effective market size led to consolidation & firm growth in boat building sector  Competition  exit by worst builders.  Better firms grew.  And invested more in capital  All without changes in: access to capital, regulations, labor markets, etc  Big changes since then  Fiber glass boats became available  More profitable furniture manufacturing drew many builders out of the sector
  • 63. Caveats & limitations  Generalizability from one small, narrow sector may be limited  High quality data on a narrow product  Concrete studies of Syverson  There may be limitations to further growth  management, access to capital, etc.  This may not work as well in other settings  non-tradeables  Trust, etc.  Unique aspect here is that phones allowed buyers to learn about quality. In other settings, this may not happen  But objective here is not to talk about phones, or even search per se.  Objective is to test whether potential customer base is a factor in firm growth
  • 64. Next Steps & Extensions  Welfare effects  Decompose D in aggregate productivity in the sector into Ds due to exit, reallocation of market share towards more productive firms and improvements in productivity for survivors (scale, capital, etc.)  Increased specialization of labor within firms  Branding  Expansion and shadow costs of labor (family vs. non-family)