Market Size and the Growth of Firms: Evidence from a Natural Experiment in India

1. Market Size and the Growth of Firms: Evidence from a
Natural Experiment in India
Robert Jensen
Wharton School
University of Pennsylvania
Nolan Miller
University of Illinois at Urbana-Champaign
NBER

2. Firms in Developing Countries
1. On average very small (Tybout 1998, Hsieh-Klenow 2012)
 e.g., Hsieh and Klenow (2012)
Avg. manufacturing firm in U.S.: 42 employees
Avg. manufacturing firm in India: 2.6 employees
2. Often do not grow as they age
 Compared to firm < 5 years old, avg. 40 year old firm has:
U.S.: 8X employees Mexico: 2X employees India: < 1X employees
3. Much less productive than in rich countries (Tybout 1998, Bloom et. al 2010).
4. Productivity varies widely across firms (a puzzle, as in rich countries)
 Firm size & growth important for economic growth & development
 Returns to scale, productivity, competitiveness, etc.

3. Many Possible Explanations for Small Firm Size
 Limited access to credit
 Regulations, taxes, permits/licensing may apply if grow more
 Institutions (legal, etc.)
 Labor markets (esp. as try to expand beyond family labor)
 Infrastructure (power, water, transportation, communication)
 Organizational factors/management

4. In this paper...
 Test whether limited demand/market size for any given firm’s output,
arising from information problems, limits growth (and productivity).
(highly localized demand)
 Take advantage of a natural experiment created by spread of mobile
phones in Kerala, India
 Related to previous work, Jensen 2007
 Focus on boat manufacturing, using 6 yrs of firm-level census data

5. Setting: Mobile Phones & Arbitrage
 In previous work (Jensen 2007), show that fishermen use mobiles to
check price in different markets. Welfare-improving arbitrage.
 Similar results in Aker 2010 and others.

6. Figure 1. Region of Study
Source: Reproduced from SIFFS (1999).

7. Table 1. Prices and Excess Supply and Demand in 15 Beach Sardine Markets
Tuesday, January 14, 1997 Tuesday, January 21, 1997
Price
Excess
Buyers
Excess
Sellers Price
Excess
Buyers
Excess
Sellers
Kasaragod District
Hosabethe 6.2 0 0 4.3 0 0
Aarikkadi 4.0 0 0 5.9 0 0
Kasaba 0.0 0 4 5.9 0 0
Kanhangad 9.9 15 0 0.0 0 9
Thaikadappuram 0.0 0 11 6.1 0 0
Kannur District
Puthiangadi 9.8 12 0 5.0 0 0
Neerkadavu 6.9 0 0 7.7 0 0
Ayikkara 8.4 1 0 0.0 0 13
Thalassery 4.3 0 0 5.7 0 0
New Mahe 6.2 0 0 0.0 0 5
Kozhikode District
Chombala 8.7 2 0 1.9 0 0
Badagara 9.7 11 0 5.2 0 0
Quilandi 7.2 0 0 0.0 0 8
Puthyiyangadi 0.0 0 5 6.2 0 0
Chaliyam 6.4 0 0 9.7 8 0

11. Large Changes in Fish Marketing
20011997

12. Large Changes in Fish Marketing

14. Phones, Effective Market Size and Firm Growth
 Now, fishermen visiting different markets learn about different boat
builders and their prices and quality
 Experience good, quality difficult to observe. Particularly, life expectancy.
 Reputation, develop ties to others, trust.
 Phones may also reduce transactions costs (updates on schedule, payments,
modifications/adjustments to costs or design, etc.)
 We argue that mobile phones increased the effective market size or
demand for any given builder:
 Prior to phones, builders sold almost all of their boats locally. Firm demand
limited by local market.
more learning leads to shifts in demand towards better builders.

15. Phones, Effective Market Size and Firm Growth
 Provided there are no barriers to trade or bigger limitations on firm
growth/output, we expect increased competition, D demand
 Increased market share for more productive, highest quality
manufacturers.
 Growth & increased output of high quality manufacturers.
 Possibly exit of least productive or lowest quality manufacturers

16. Theoretical Motivation—Basic Setup
 Producers differ in their location and in the cost of producing a boat (-year).
 There is also some fixed cost of production.
 Low-cost producers are higher quality (i.e., their boats last longer), Qf. Life
years of the boat.
 Consumers can perfectly assess the price and quality of their local producer.
u = v QA – pA – x ; u = v QB – pB – (1 – x)
 Before cell phones, consumers have no information on non-local producers.
Experience good. No direct opportunities for learning.

17. Theoretical Motivation--outcomes
 In this environment, all producers charge monopoly prices for their boats.
 Low-cost producers charge lower prices (per boat-year) than high-cost
producers (with same local demand curve).
 Due to lack of demand, high-quality producers remain small.
 Due to lack of competition, low-quality producers can survive.
 Quality/productivity/cost dispersion can persist in equilibrium.

18. Theoretical Motivation—Introduce search/learning
 Now introduce cell phones—suppose makes it possible for consumers to
learn prices (per boat-year) or quality of other nearby producers.
 Thinking of it here more as phonesarbitrageinformation (info networks, direct observation)
 Akin to monopolistic competition. Cell phones introduce new substitutes, shift
the demand curve facing any particular firm in.
 This will tend to lower all prices.
 High-cost producers can no longer earn a profit and exit.
 As high-cost producers exit, low-cost producers face increased demand,
increase price and quantity.

19. Theoretical Motivation—Predictions
 Overall impact on price depends:
 Competitive pressure initially decreases prices of low-cost producers.
 But, as high cost firms exit, competitive pressure decreases and firms
can increase prices. This works in the opposite direction.
 Market share and quantity of low-cost producers should increase.

20. v QB
v QB - pB
S
v QA
v QA – pA
S
1/2 m*
v QA – pA
*
v QB – pB
*
v QB – pB
m

21. v QB
v QB - pB
S
v QA
v QA – pA
S
1/2 m*
v QA – pA
*
v QB – pB
*
v QB – pB
m

22. Welfare Effects
 Net gains...
 especially if there are returns to scale
 ...unless market power becomes too great
 Will be winners and losers
 builders who shut down
 builders who lose effective market power
 some consumers previously had highest quality guy at low price, will lose

23. Relation to the Melitz (2003) Trade Model
 Melitz (EMA 2003) considers the impact of trade on intra-industry
reallocations and productivity.
 Opening up to trade can be thought of as analogous to an increase in
information about non-local producers.
 Before trade, can only buy from local producer.
 After trade, can buy from anyone.
 Melitz model:
 Firms differ in production cost, must pay fixed cost to enter.
 In closed economy, more productive firms are larger, charge a lower
price, earn higher profits.

24. Relation to the Melitz (2003) Trade Model
 Opening the domestic market to trade is like reducing search costs to zero.
 Low-cost firms export (i.e., sell to non-local consumers).
 Low-cost firms that export increase profit and market share.
 High-cost firms exit.

25. Setting: Boat Manufacturing in South India
 In Kerala, fishing is a big industry:
 millions employed, 70+% consume daily.
 Lagoons, rivers, inlets, streams, lakes, “backwaters” (vs. sea fishing)
 Prawns, crabs, karimeen/pearl spot (green chromide)
 Nets and traps
 Water is brackish/briny
 Boats
 Wooden “rope boats.” Planks of anjili or Jack-Wood, fastened together with coir
(fiber from the husk of coconuts) knots. Treated with ghee, fish oil or resin.
 More recently, fiber glass boats have become available
 Non-motorized (while fishing; small motors for traveling)
 3-10 meters
 1-5 people

27. Data
 No official data on builders available--firms small, unregistered.
 Builder census: with local experts and NGO’s (e.g., SIFFS), visited
every fishing village, landing spot and fish market in 2 districts

28. Kerala
Study Region

29. Data
 No official data on builders available--firms small, unregistered.
 Builder census: with local experts and NGO’s (e.g., SIFFS), visited
every fishing village, landing spot and fish market in 2 districts
 Generated a list of name, address of every boat builder
 Approximately 143 firms (1997). Nearly every fishing cluster had a person who
built boats (home-based). Nearly 1:1 mapping of villages and builders.
 Cannot rule out we missed some very small-scale builders (subsistence fishermen in non-
fishing villages, maybe building own boats).
 In our fishermen survey, no builders reported that were not in our census
 Census
 Labor, capital, output, sales, price (past month, past 6 months)
 Also, an accounting of all boats sold (stock at start, flow after)
 Conducted census every 6 months from Jan. 1998 to Jan. 2004

30. Data
 Fishermen survey every 6 months from Jan. 1998 to Jan. 2004. 20
randomly selected fishermen/landing
 Brief Survey (emphasis was on builders)
 Landing Canvas—all new boats at every landing spot, every 6
months.
 Very brief survey.

31. TABLE 1: Firm Attributes at Baseline
Mean Standard Deviation Min Max
FIRM ATTRIBUTES
Number of employees 2.2 0.72 1 4
Production at dwelling 0.99 0.08 0 1
Boats produced per year 13.6 4.05 4 27
Market share (total market) 0.007 0.002 0.002 0.013
Estimated life expectancy 4.76 0.89 3.56 8.1
Price (5 meter boat) 3,930 270 3,550 4,150
Price/year (5 meter boat) 841 122 583 1,104

33. Big Difference in Boats Across Builders
Skill matters a lot. Better builders have longer lived boats
 How well wood is shaped and fastened affects durability
 Big threat from biofouling organisms (e.g., byrozoans & barnacles).
Better treatment of wood affects vulnerability to these organisms.

36. Measuring Boat Life Expectancy I
 When we interviewed fishermen for builder census, asked about
age of current boat and age of last boat when they replaced it.
 Can use this to construct measures of life expectancy of boats for
each builder
 Limitations:
 Only available with a lag. Quality of builder may vary over time.
 Problem of new entrants (though are not that many)
 Local fishing environment (and use) may affect life expectancy—organisms
nearby, rocks, water calmness, etc.

37. Measuring Boat Life Expectancy II
 Hired auditor from short-lived government boat insurance program
to assess quality (1:5) and life expectancy.
 Assess quality of wood treatment, craftsmanship (fastenings, etc.)
 Life expectancy from boats more objective. But this can factor in:
 Diff builders may have diff life expectancy if local fishermen use boats
differently (fishing envi (rocky, still, salinity, etc.), biofouling organisms, etc.).
 Life expectancy only observed with some lag, and may have changed recently
 Auditor assessment allows more contemporaneous measure, not need wait out
life expectancy.
 Also, we can assess how good the auditor is by comparing (with some error)
their estimates to the objective measures (again, still a lag, and still can’t
handle newer entrants)

38. Measuring Boat Life Expectancy (an aside)
 Boats are largely homogeneous, but length varies
 Demand for boats of different length varies (by fishermen & place)--
might be easier to make smaller or larger boats last longer.
 5 meters is the most popular size produced for all but 3 builders.

39. Life Expectancy III
 Is boat quality just skill (& experience), or also a choice variable?
(imagine poverty & credit constraints). Some of quality may be
endogenous—choice of wood (though not much), labor & quality of
construction, etc.
 Low quality producers may be intentionally making worse boats b/c,
e.g., they sell in areas where fishermen are poorer & credit
constrained. Can’t afford upfront costs of a better boat, even if they
know it would be a lower price per year over the long run.
 3rd measure: Like TFP, take residuals from a regression of life
expectancy on total labor hours input (separately for adults & kids)
and materials input

40. Life Expectancy--final points
 If we are still capturing something that is a choice variable and
not underlying ability/skill/productivity, then we would not expect
empirical patterns observe.
 The “bad” builders will be able to produce just as good boats as
the “good” builders and not be driven out.
 Except, buyers may be imperfectly informed of role of choice in quality. So,
you see another builder’s boat is better (worse) than your own, and think
he’s better (worse), even if it’s choice.
 Also, possible state dependence. Low demand for quality means you don’t
get experience building good boats. So it’s not underlying skill (bad guys
could have been as good) but more historical. Just a different source of skill
difference, though.

41. TABLE 1: Firm Attributes at Baseline
Mean
Standard
Deviation
Min Max
FIRM ATTRIBUTES
Number of employees 2.2 0.72 1 4
Production at dwelling 0.99 0.08 0 1
Boats produced per year 13.6 4.05 4 27
Market share (total market) 0.007 0.002 0.002 0.013
Estimated life expectancy 4.76 0.89 3.56 8.1
Price (5 meter boat) 3,930 270 3,550 4,150
Price/year (5 meter boat) 841 122 583 1,104

42. Price Variation
 No single price (even aside from bargaining/price discrimination)--
non-linear in size. Focus again on 5m boat.
 Raw price variation is not very large
 But very big differences in quality (life expectancy).
 So effectively, big differences in price/boat-year.

43. TABLE 1: Firm Attributes at Baseline
Mean
Standard
Deviation
Min Max
FIRM ATTRIBUTES
Number of employees 2.2 0.72 1 4
Production at dwelling 0.99 0.08 0 1
Boats produced per year 13.6 4.05 4 27
Market share (total market) 0.007 0.002 0.002 0.013
Estimated life expectancy 4.76 0.89 3.56 8.1
Price (5 meter boat) 3,930 270 3,550 4,150
Price/year (5 meter boat) 841 122 583 1,104

44. Empirical Analysis: Mobile Phones in Kerala
 First introduced in 1997
 Staggered introduction throughout the state
 Introduction centered on largest cities.
 Did not penetrate further inland as of 2004

46. Empirical Strategy
Compare D in firms relative to staggered introduction of mobile phones.
 Outcomes
 Market (firm-level regressions): exit, market share
 Production (firm-level regressions): output, employees, productivity.
 Consumers (fishermen-level regressions): Price, life expectancy
 Z (e.g., education, experience, whether father was a builder)
 Controls for fixed differences across regions, time effects common to
all regions, differential trends or changes common to all regions.

47. Identifying Assumption
 In the absence of mobile phones, there would have been no
differential changes in these outcomes across the regions.
 Certainly, phone placement/timing is non-random.
 Spread to most populous, wealthiest areas first.
 We’ll consider several key challenges…

48. Empirical Strategy II
Compare D in firms relative to staggered introduction of mobile phones.
Define 3 regions

49. I
II
III

50. Empirical Strategy II
Compare D in firms relative to staggered introduction of mobile phones.
Define 3 regions
Region I: Southern Coastal
Kannur District: Kannur (June 6, 1998) + Thalassery (July 31, 1998)
Region II: Northern Coastal
Kasaragod District: Kasaragod + Khanhangad (May 21, 2000)
Region III: Inland Regions
Did not get phones during my survey period
 Earlier regression is just a pooled-treatment version of this

51. Figure III: Percent
Fishermen Selling in
Local Market

52. Figure II: Number of
Firms, by Region

54. TABLE 4: Main Regressions--Market
Constructed Life Expectancy Auditor's Assessment
(1)
Exit
(2)
Market Share
(3)
Exit
(4)
Market Share
Phone 2.49*** -0.096*** 1.61*** -0.049***
(0.22) (0.039) (0.42) (0.018)
Life Span 0.0002 -0.002** -0.0001 -0.008
(0.002) (0.0001) (0.0011) (0.0005)
Phone*Life Span -0.37*** 0.020*** -0.23*** 0.013***
(0.14) (0.007) (0.096) (0.0055)
Number of Obs. 1,606 1,606 1,606 1,606
75th percentile, ~7 years life span

55. TABLE 6: Builders
REGION I REGION II REGION III
January
1998
January
2004
January
1998
January
2004
January
1998
January
2004
Number of employees 2.3 5.1 2.4 4.1 2.0 1.9
Boats produced/year 14.7 38.2 14.0 36.4 12.8 12.4
Wood Price (Rs.) 217 276 231 286 227 275

56. Productivity
# boats built largely un-D’d (boat*years/quality ↑↑), yet total labor ↓
# workers: Region I: 12196 (21%), Region II: 11886 (27%)
Hours decrease even more
--Material inputs largely unchanged
--But...power tools. Experimentally, labor hours decline by about 4-6% with full
array of power tools.
increased productivity of ~20% (labor hours) in the two regions

57. TABLE 7: Consumers
(1) (2) (3) (4)
Bought Locally? Price
Assessed Life
Expectancy Price/boat*year
Region Has Phone -0.73*** 414** 1.33*** -117***
(0.21) (182) (0.54) (45.0)
Time FE YES YES YES YES
Village FE YES YES YES YES
Time*Year FE YES YES YES YES

58. Identifying Assumption
In the absence of mobile phones, there would have been no
differential change in these outcomes across the regions.
We’ll consider several key challenges…

59. Alternative Explanations
1. Differential trends by region
 Timing of introduction clearly not random. Biggest/wealthiest first.
 Control for fixed differences and linear trends over time. But maybe timing
matched other changes going on—e.g., more rapidly growing areas, added
first—maybe affected consolidation in market, demand for quality.
 Timing of changes looks good: In Figures, no D for firms in regions that did
not get phones, and no Ds in Region II until they got phones. And no
differential change for more vs. less productive firms.
 Can construct (noisy) pre-trends using recall data—at each canvas, asked
fishermen about current & previous boat. Can look at # firms for many past
years. Possible recall error--but use later rounds to investigate extent.

60. Figure II: Number of
Firms, by Region

61. Alternative Explanations
2. What if fishermen migrated when phones came in, so demand
shifted with them. Or phones led to differential fishermen entry/exit
or change in demand for fish.
 Jensen (2007) shows no such changes in mobility or quantity caught or
location-quantity caught
3. Other changes around same time as phones added?
 Largely based on licensing and capacity to roll out infrastructure
 Hard to rule out all, but Jensen (2007) shows no obvious changes (roads, etc.)

62. Alternative Explanations
4. A change in the demand for quality?
 More travel now to sell fish  greater demand for quality?
 Wouldn’t you always want the least expensive (per life year) boat?
 Increased P of fishermen (Jensen 2007) greater demand for
quality, more fishing or consolidation among firms for some
other reason.
 Income elasticity demand for quality (endogeneity concerns) close to zero
(increased profitability was about 6%)
 At baseline, fishermen don’t know quality of non-local firms.

63. Alternative Explanations
5. Advertising. Still a demand channel. Seems unlikely--phones not
effective advertising tool, esp. when there is no “fishermen phone
book.” And little to no internet access at this time
6. Technical Knowledge. Anecdotally, not really going on. There is no
store of knowledge or technical assistance.
7. Input Markets. Purchase inputs more easily or at lower prices. No
evidence any effect on input prices. Wood & rope easily storable, so
less P variation.

64. TABLE 6: Builders
Wood is >90% of material input costs
REGION I REGION II REGION III
January
1998
January
2004
January
1998
January
2004
January
1998
January
2004
Number of employees 2.3 5.1 2.4 4.1 2.0 1.9
Production at dwelling 0.98 0.56 1.00 0.62 1.00 1.00
Boats produced/year 14.7 38.2 14.0 36.4 12.8 12.4
Wood Price (Rs.) 217 276 231 286 227 275

65. Alternative Explanations
5. Advertising. Still a demand channel. Seems unlikely--phones not
effective advertising tool, esp. when there is no “fishermen phone
book.” And little to no internet access at this time
6. Technical Knowledge. Anecdotally, not really going on. There is no
store of knowledge or technical assistance.
7. Input Markets. Purchase inputs more easily or at lower prices. No
evidence any effect on input prices. Wood & rope easily storable, so
less P variation.
8. D’s in collusion? Phones make it more/less possible for builders to
collude. No anecdotal evidence. Also, prices/boat-year declined.

66. Alternative Explanations
9. D Credit Markets?
 If builders were able to get credit they could not get before, maybe that is
what allowed them to expand.
 Phones may have lowered search & transactions costs. Maybe credit markets became
more integrated.
 No anecdotal evidence of this.
 More importantly, no builders reported receiving loans, even at endline.
 Separately, interesting that they were able to expand without credit.

67. Underlying Mechanisms
We argue phones led to increased demand/market size for
individual firms, exit, market share, productivity, etc.
Separately, which aspect of phones mattered, which made it
possible for effective market size or customer base to expand?
 Search costs (just learning about builders, existence, p & Q)
 Reputation & trust (fishermen pay ½ upfront)
 Transactions costs (changes, updates, delays & status, etc)

68. REGION I REGION II REGION III
Jan
2000
Jan
2001
Jan
2002
Jan
2000
Jan
2001
Jan
2002
Jan
2000
Jan
2001
Jan
2002
# boat builders know of 5.2 4.9 4.4 1.3 3.6 3.7 1.3 1.1 1.1
Best Known Alternate Builder
Life Expectancy Error (s) 0.43 0.41 0.39 1.08 0.41 0.45 1.03 1.11 1.21
Table 9. Underlying Mechanisms

69. Child Labor
A lot of focus on poverty/credit constraints. Policy focus on bans.
But labor demand side is likely to be very important as well.
Production function with limited (one-way) substitution of skilled &
unskilled labor.
Expansion path more rapid in skilled labor.
e.g., all master builders have one “gopher,” typically a child (&
often underemployed). As scale up, typically still just need one
gopher, so industry shifts to larger firms results in reduced
child labor

70. 52
17
44
17

71. Children’s Outcomes
 Confident there are fewer kids working in this sector. But, what
were the displaced children doing?
 Tried to find out what those kids were doing
 Many of the reports come from ex-builders we could track
 About ¼ were working in some other sector
 Overall, slightly more likely to be enrolled than in control area
 Many were already “enrolled”
 For the rest, just less work.
 Lower exposure to hazards, more leisure/study time
 Loss of training/apprenticeships?

72. Conclusions
 Using a natural experiment & detailed micro data, we find that increased
effective market size led to consolidation & firm growth in boat building sector
 Competition  exit by worst builders.
 Better firms grew.
 And invested more in capital
 All without changes in: access to capital, regulations, labor markets, etc
 Big changes since then
 Fiber glass boats became available
 More profitable furniture manufacturing drew many builders out of the sector

73. Caveats & limitations
 Generalizability from one small, narrow sector may be limited
 High quality data on a narrow product
 Concrete studies of Syverson
 There may be limitations to further growth
 management, access to capital, etc.
 This may not work as well in other settings
 non-tradeables
 Trust, etc.
 Unique aspect here is that phones allowed buyers to learn about quality. In
other settings, this may not happen
 But objective here is not to talk about phones, or even search per se.
 Objective is to test whether potential customer base is a factor in firm growth

74. Next Steps & Extensions
 Welfare effects
 Decompose D in aggregate productivity in the sector into Ds due to
exit, reallocation of market share towards more productive firms and
improvements in productivity for survivors (scale, capital, etc.)
 Increased specialization of labor within firms
 Branding
 Expansion and shadow costs of labor (family vs. non-family)