Moving out of the bottom of the economy? Constraints to firm transition in the Indian informal manufacturing sector

Rajesh Sn Raj,Kunal Sen

doi:10.1186/s40175-016-0056-8

Rajesh Sn Raj, Kunal Sen

Open Access

https://doi.org/10.1186/s40175-016-0056-8

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Abstract

The predominant type of firms in developing countries is small family firms and the self-employed in the informal sector. Very few family firms make the transition to larger firms employing non-family labour. In this paper, we examine the reasons for the low presence of firms employing non-family labour in the informal sector, using a firm-level data set drawn from nationally representative repeated cross-sectional surveys of the Indian informal manufacturing sector. We find that the key constraint to firm transition is firm capabilities, followed by the level of urbanisation, access to electricity and roads, and human capital, with financial constraints playing a lesser role. JEL codes: O17, L25, D22

Highlights

The predominant type of firms in developing countries is small family firms and the self-employed in the informal sector, which contribute to the bulk of production and employment in the economy (Gollin 2008).1 These firms tend to be the least productive among all firms in the manufacturing sector, and the individuals that own, manage and work in these enterprises comprise a large proportion of the urban working poor in developing countries
We use firm-level data drawn from representative all-India surveys of informal firms in the Indian manufacturing sector which are repeated cross sections for the years 2000–2001, 2005–2006 and 2010–2011 to examine firm transition in the Indian informal sector—that is, the extent to which access to finance, firm capabilities, infrastructure, and human capital can explain the likelihood of a firm being a mixed household enterprises (MHEs) or non-household enterprises (NHEs) as compared to a pure household enterprises (PHEs)
Confirming the positive role of human capital on firm transition, our results suggest that firms located in districts with higher proportion of individuals with postsecondary education have an 8 per cent and 4.5 per cent greater chance of becoming MHEs and NHEs, respectively, as compared to those located in other districts

Summary

Introduction

The predominant type of firms in developing countries is small family firms and the self-employed in the informal sector, which contribute to the bulk of production and employment in the economy (Gollin 2008). These firms tend to be the least productive among all firms in the manufacturing sector, and the individuals that own, manage and work in these enterprises comprise a large proportion of the urban working poor in developing countries. We assess the role of financial constraints, firm capabilities, location and geographical factors, and infrastructure and human capital in explaining the transition of firms in the informal sector from small family firms to larger firms employing wage labour. We use firm-level data drawn from representative all-India surveys of informal firms in the Indian manufacturing sector which are repeated cross sections for the years 2000–2001, 2005–2006 and 2010–2011 to examine firm transition in the Indian informal sector—that is, the extent to which access to finance, firm capabilities, infrastructure, and human capital can explain the likelihood of a firm being a MHE or NHE as compared to a PHE. 3.3 The model We use econometric analysis to formally test the role of financial constraint, firm capabilities, locational and geographical factors, and infrastructural and human capital variables on the upward progression of firms in the informal sector in India. We estimate the model using the maximum likelihood method. In all these estimations, we use firms as units of analysis

Descriptive statistics and results

Findings

Conclusions