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Monitoring Costs, Credit Constraints and Entrepreneurship

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Author Info

  • Banerji, Sanjay

    ()
    (University of Nottingham)

  • Raj, Rajesh S.N.

    ()
    (Centre for Multi-Disciplinary Development Research (CMDR))

  • Sen, Kunal

    ()
    (University of Manchester)

Abstract

The vast majority of firms in developing economies are micro and small enterprises owned by families whose members also provide the labour to the units. Often, they fail to grow in size even with the relaxation of credit constraints. In this paper, we show that frictions in the labour market leading to monitoring costs tend to reduce the growth of the firm via two channels: (1) it forces the entrepreneur to devote more time on monitoring hired labour from outside family which curtails her time on productive activities leading to failures of firm's projects. (2) The need to pay a premium wage over the market rate in order to incentivize workers makes it costlier for the firm to expand in size via hiring outside labour. In this framework, we show that possibility of an inverted U- shaped relationship between the credit supply and the size of the firm, measured by hiring of non family labour, indicating frictions in the labour market may outweigh the effects of the easing of borrowing constraints of the firm. We then use a unique data-set comprising large nationally representative surveys of small and micro-enterprises in Indian manufacturing and find support for the existence of such a non-monotonic relationship attributed to both frictions in the credit and labour markets.

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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 6594.

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Length: 27 pages
Date of creation: May 2012
Date of revision:
Handle: RePEc:iza:izadps:dp6594

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Keywords: household enterprises; credit constraint; monitoring costs; entrepreneurship; India;

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  1. Tetsushi Sonobe & John Akoten & Keijiro Otsuka, 2011. "The growth process of informal enterprises in Sub-Saharan Africa: a case study of a metalworking cluster in Nairobi," Small Business Economics, Springer, vol. 36(3), pages 323-335, April.
  2. John Rand, 2004. "Credit Constraints and Determinants of the Cost of Capital in Vietnamese Manufacturing," Discussion Papers 05-01, University of Copenhagen. Department of Economics.
  3. Douglas Gollin, 2001. "Nobody's Business but My Own: Self Employment and Small Enterprise in Economic Development," Center for Development Economics 172, Department of Economics, Williams College.
  4. King, Robert G. & Levine, Ross, 1993. "Finance, entrepreneurship and growth: Theory and evidence," Journal of Monetary Economics, Elsevier, vol. 32(3), pages 513-542, December.
  5. repec:fth:wobaco:1083 is not listed on IDEAS
  6. Erik Hurst & Annamaria Lusardi, 2004. "Liquidity Constraints, Household Wealth, and Entrepreneurship," Journal of Political Economy, University of Chicago Press, vol. 112(2), pages 319-347, April.
  7. King, Robert G & Levine, Ross, 1993. "Finance and Growth: Schumpeter Might Be Right," The Quarterly Journal of Economics, MIT Press, vol. 108(3), pages 717-37, August.
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