The Impact of Trade Liberalization on Micro Enterprises: Do Banks Matter? Evidence from Indian Manufacturing
| Date | 01 December 2015 |
| DOI | http://doi.org/10.1111/obes.12082 |
| Author | Asha Sundaram |
| Published date | 01 December 2015 |
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©2014 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd.
OXFORD BULLETIN OF ECONOMICSAND STATISTICS, 77, 6 (2015) 0305–9049
doi: 10.1111/obes.12082
The Impact of Trade Liberalization on Micro
Enterprises: Do Banks Matter? Evidence from Indian
Manufacturing*
Asha Sundaram†
†School of Economics, University of Cape Town, Rondebosch, Cape Town, 7701, South
Africa (email: asha.sundaram@uct.ac.za)
Abstract
This paper looks at the impact of trade liberalization on micro enterprises with differential
access to banks. I use Indian data on rural micro enterprises employing less than ten workers
in the manufacturing sector to find that trade liberalization, measured by a fall in the tariff,
is associated with a larger increase or a smaller decrease in output, capital–labour ratio and
labour productivity in districts with a larger number of bank branches per capita. Evidence
is consistent with strong complementarities between trade liberalization effects, and the
economic dynamism and access to financial intermediation associated with greater bank
presence in the enterprise’s location. The study underscores that trade liberalization can
be beneficial to micro entrepreneurs under certain conditions and emphasizes reallocation
resulting from trade liberalization. The study hence highlights the role for development
policy in exploiting gains from trade.
I. Introduction
In this study, I analyse the impact of trade liberalization on micro enterprises and examine
if trade liberalization effects differ with differential access to banks. The literature on the
impact of trade liberalization on firm performance has primarily focused on large, formal
firms (Nataraj, 2011).1However, small firms, and particularly micro enter prises, have an
*I sincerely thank the two anonymous referees for their comments. I also thank Devashish Mitra, Mary Lovely,
Louren¸co Paz, Rana Hasan, DaveRichardson, Jeff Kubik, Farzana Afridi, Lawrence Edwards,Vimal Ranchhod and
participants of the Dissertation and Trade Seminars, Syracuse University,the SALDRU seminar, University of Cape
Townand conference participants at the Indian Statistical Institute and the Delhi School of Economics, New Delhi, for
their extremely useful comments.Thanks to Seedwell Hove and Salma Kagee for their excellent research assistance.
The data for this paper were purchased from a grant by the Goekjian fund. I thank Shanthi Nataraj for her comments
and help with the unorganized enterprise data and Usha Thorat and Gopal Prasad from the Reserve Bank of India
for help with bank data. Special thanks are to Partha Chattopadhyay and officials at the National Sample Survey
Organization and Central Statistical Organization for answering myquestions about the unorganized enterprise and
organized sector data. All errors and omissions remain my own.
JEL Classification numbers: F16, J32, L24, O14, O17
1Nataraj’srecent study is a notable exception. She analyses the response of small and large firms in India to show
that trade liberalization led to greater average productivity among small firms in India.
Trade, micro enterprises and banks 833
important presence in developing countries. First, they account for a large share of man-
ufacturing. For instance, the share of the unorganized manufacturing sector (household
enterprises and enterprises hiring less than ten workers) in total manufacturing employ-
ment was 82% in 2000–01 for India (Chandrasekhar and Ghosh, 2003).2Second, these
enterprises produce differentiated goods that satisfy consumer demand largely among
poorer sections of the population. This sector, consequently, elicits numerous subsidies
from policy makers.3
Similarly, the role of financial inclusion in the performance of firms, particularly small
enterprises, is rarely disputed. Financial inclusion can be especially crucial for the perfor-
mance of micro entrepreneurs, given that they often operate in geographically localized
factor and product markets (Majumder, 2004), and lack access to equity or debt instru-
ments available to large, formal firms. However, few studies look at the role played by
better access to financial intermediation in determining how micro entrepreneurs adapt to
greater competition brought about by trade liberalization.
This study attempts to fill this gap in the literature by looking at the impact of trade
liberalization, measured by a fall in the tariff, on enterprise outcomes in the manufac-
turing sector, and by examining if these trade liberalization effects differ with differing
bank presence in the area where the enterprise is located. The focus of this study is en-
terprise outputs, though I also empirically examine trade liberalization effects in areas
with differential access to banks on factor use and labour productivity of micro enter-
prises. Given the significance of the micro enterprise sector for development, its impor-
tance in policy, and in light of the globalization efforts of developing economies in the
past few decades, notably in Asia and Latin America, I believe that this is an important
question.
This paper makes several contributions. First, it analyses the impact of trade liber-
alization on micro enterprises, thereby adding to a literature that is not as extensive as
the one on trade liberalization effects on larger formal firms (Harrison, 1994, for Cˆote
d’Ivoire; Tybout and Westbrook, 1995, for Mexico; Pavcnik, 2002, for Chile; Fernandes,
2007, for Colombia). Second, to my knowledge, it is the first study to empirically look at
complementarities between trade liberalization effects on domestic firms and bank pres-
ence. Third, results suggest that the impacts of trade liberalization on micro enterprise
output are greater in areas that were previously better-banked, indicating that trade might
promote growth only under certain circumstances (Bolaky and Freund, 2004; Topalova
and Khandelwal, 2011; Harrison, Martin and Nataraj, 2013), and that it also results in
reallocation between firms. The study hence has implications for development policy.
Finally, given that a greater number of bank branches per capita may be associated with
more local economic activity, my study finds evidence that micro enterprises located in
dynamic areas are differentially affected by trade liberalization. This has bearing on the
2ForTaiwan, Yan Aw (2001) notes that 30% of manufacturing firms between1981 and 1996 employed fewer than
five workers. Forsouther nAfrica, Daniels (2003) documents that 22% of the adult population 15 years or older was
employed in enterprises employing fewerthan 50 workers vs. only 15% in registered firms between 1991 and 1994.
3The WorldBank Group Review of Small Business Activities (2001) touts small enterprises as ‘a powerful force
for poverty reduction’.
©2014 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd
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