In a new paper, we address this question using detailed manufacturing census data from India. India offers an ideal laboratory for testing the role of institutions on firm lifecycle given the large persistent differences in institutions, business environment, and income across different regions. Specifically, we examine the relationship between plant size, age, and growth and ask: how does local financial development influence the size-age relationship? Are there differences in the size-age relationship across different industry characteristics and between the formal and informal manufacturing sector and does this vary with the extent of local financial development? Does the role of local financial development on firm lifecycle vary with major regulation changes in India such as financial liberalization, changes in labor regulation, and industry de-licensing?
The first IFMR Financial Systems Design Conference was held in Chennai on August 5th and 6th, 2011. Hosted by IFMR and IFMR Finance Foundation, the conference aimed to take a step back from specific institutional frameworks, products and regulatory architectures and take a more fundamental and functional view of the financial system, and thereby attempt to understand what can be done to improve the ability of the Indian financial system to fulfil its functions effectively. The conference brought together a group of leading researchers and practitioners in the Indian financial system. In his introductory remarks, Dr. Nachiket Mor observed that “we are at a time when many of the historic imperatives which led to the current design of our financial systems are perhaps no longer valid and that, as a uniquely advanced but also very poor country urgently in need of sustained and rapid growth and development, we have the opportunity to do things in a way that other countries do not.”
To provide some context, while the Indian financial system has steadily evolved over the years, it continues to lag behind in terms of size (financial firms growing much slower than needs of the real economy), spread (80% of Indian villages do not have a bank branch in a 2 KM radius, more than 50% of small business financing happens through informal sources), scope (roughly 50% of the population has a bank account, about 10% have life insurance and less than 10% participate in equity markets in any form), innovation (securitisation, credit derivatives and corporate bond markets are tiny) and diversity of ownership (largest financial firms are Government owned).
Ask small farmers in semiarid areas of Africa or India about the most important risk they face and they will tell you that it is drought. In 2003 an Indian insurance company and World Bank experts designed a potential hedging instrument for this type of risk—an insurance contract that pays off on the basis of the rainfall recorded at a local weather station.
The idea of using an index (in this case rainfall) to proxy for losses is not new. In the 1940s Harold Halcrow, then a PhD student at the University of Chicago, wrote his thesis on the use of area yield to insure against crop yield losses. In the past two decades the market to hedge against weather risk has grown, especially in developed economies: citrus farmers can insure against frost, gas companies against warm winters, ski resorts against lack of snow, and couples against rain on their wedding day.
Rainfall insurance in developing countries is typically sold commercially before the start of the growing season in unit sizes as small as $1. To qualify for a payout, there is no need to file a claim: policyholders automatically qualify if the accumulated rainfall by a certain date is below a certain threshold. Figure 1 shows an example of a payout schedule for an insurance policy against drought, with accumulated rainfall on the x-axis and payouts on the y-axis. If rainfall is above the first trigger, the crop has received enough rain; if it is between the first and second triggers, the policyholder receives a payout, the size of which increases with the deficit in rainfall; and if it is below the second trigger, which corresponds to crop failure, the policyholder gets the maximum payout. This product has inspired development agencies around the world, and today at least 36 pilot projects are introducing index insurance in developing countries.
How much does management matter for economic performance? Despite a large industry of business schools, consulting firms, and airport books purporting to teach you the secrets of good management over the course of your next flight, the answer until very recently has been “we don’t know”. In a recent review, Chad Syverson goes as far as to say “no potential driving factor of productivity has seen a higher ratio of speculation to empirical study”.
Together with colleagues from Stanford and Berkeley, I have been working for the last couple of years to try and understand how much management matters by means of a randomized experiment among textile factories in India. In common with most firms in developing countries, the firms (with 300 workers on average) we were working with did not collect and analyze data systematically in their factories, had few systems for regular maintenance and quality control, had weak human resource systems for promoting and rewarding good performers, and had little control over inventory levels. The result was a high level of quality defects, large stockpiles of unorganized inventories, and frequent breakdowns of machines. 20 percent of the labor force was occupied solely in checking and repairing defective fabric (see picture).
Financial literacy has become an immensely popular component of financial reform across the world. As a response to the recent financial crisis, the United States government set up the President’s Advisory Council on Financial Literacy in January 2008, charged with promoting programs that improve financial education at all levels of the economy and helping increase access to financial services. In the developing world, the Indonesian government declared 2008 “the year of financial education,” with a stated goal of improving access to and use of financial services by increasing financial literacy. Similarly, in India, the Reserve Bank of India launched an initiative in 2007 to establish Financial Literacy and Credit Counseling Centers throughout the country which would offer free financial education and counseling to urban and rural populations. The World Bank also hasn’t been missing out on the trend – it recently approved a $15 million Trust Fund on Financial Literacy.
But what do we know about financial literacy? Does it work, and if so, through what mechanisms? Despite the money being ploughed into financial literacy programs, we know very little to address these important questions. While it is true that there is a large and growing body of survey evidence from both developed and developing countries that demonstrate a strong association between financial literacy and household well-being, we are still in the process of learning whether this relationship is causal.