Distortion Centrality and Industrial Policies in Production Networks
Previous title: Industrial Policies and Economic Development
Abstract: Many current and previously developing countries have adopted industrial policies that push resources towards certain "strategic" sectors, and the economic reasoning behind such polices is not well understood. In this paper, I construct a model of a production network where firms purchase intermediate goods from each other in the presence of credit constraints. These credit constraints distort input choices, reducing equilibrium demand for upstream goods and creating a wedge between the potential sales (“influence”) and actual sales of upstream sectors. I analyze policy interventions and show that, under weak functional form restrictions, the ratio between influence and sales for a sector is a sufficient statistic that guides the choice of production and credit subsidies. Using firm-level production data from China, I estimate my sufficient statistic for each sector and show that it correlates with proxy measures of government interventions into the sector. Using a panel of cross-country input-output tables and sectoral production tax rates, I show that the tax rates for developing countries in Asia also correlate with the model-implied intervention measure.
Keeping The Little Guy Down: A Debt Trap For Informal Lending (with Ben Roth)
Abstract: Microcredit has so far failed to catalyze business growth among small-scale entrepreneurs in the developing world, despite their high return to capital. This prompts a re-examination of the special features of informal credit markets that cause them to operate inefficiently. We present a theory of informal lending that highlights two of these features. First, borrowers and lenders bargain not only over division of surplus but also over contractual flexibility (the ease with which the borrower can invest to grow her business). Second, when the borrower's business becomes sufficiently large she exits the informal lending relationship and enters the formal sector – an undesirable event for her informal lender. We show that in Markov Perfect Equilibrium these two features lead to a poverty trap and study its properties. The theory facilitates reinterpretation of a number of empirical facts about microcredit: business growth resulting from microfinance is low on average but high for businesses that are already relatively large, and microlenders have experienced low demand for credit. The theory features nuanced comparative statics which provide a testable prediction and for which we establish novel empirical support. Using the Townsend Thai data and plausibly exogenous variation to the level of competition Thai money lenders face, we show that as predicted by our theory, money lenders in high competition environments impose fewer contractual restrictions on their borrowers. We discuss robustness and policy implications.
Growing Pains in Financial Development: Institutional Weakness and Investment Efficiency (with Daniel Green)
Abstract: Falling barriers to credit access have had some unexpected consequences. In the developing world, there is little evidence that the rapid expansion of microfinance has had a significant impact on poverty, but is instead increasingly associated with problematic multiple borrowing at high interest rates and high levels of debt and default. We develop a model that rationalizes these outcomes when the institutions supporting financial contracting are weak -- if entrepreneurs cannot commit to exclusive borrowing from a single lender, expanding financial access by introducing multiple sources of credit may severely backfire. Capital allocation can be distorted away from the most productive uses, generating a perverse incentive for micro-entrepreneurs to choose inefficient and limited-growth endeavors. These problems are exacerbated when borrowers have access to more lenders, providing an explanation of why increased access to finance does not always improve outcomes. Optimal policy in the model closely mirrors what was proposed and adopted following the recent microfinance repayment crisis in Andhra Pradesh, India.
Research in Progress
Manufacturing Underdevelopment (with John Firth)
Abstract: India's Freight Equalization Scheme (FES) aimed to promote even industrial development by subsidizing long-distance transport of key inputs such as iron and steel. Many observers speculate that FES actually exacerbated inequality by allowing rich manufacturing centers on the coast to cheaply source raw materials from poor central regions. Using the lifting of FES in early 1990s as a natural experiment and exploiting the state-by-industry variation in exposure to FES, we find empirical support to the conjecture. Specifically, industries that depend heavily on these materials, directly or indirectly, tend to experience faster growth upon the lifting of FES in the poor central regions, which have more abundant supply of the raw materials.