DRI Working Paper No. 96
By: Rajeev Dehejia, and Nandini Gupta
Financial development and occupational choice: Evidence from India
Theory suggests that capital market frictions might inhibit entrepreneurship, and that financial market development is likely to be associated with an increase in self-employment. But what are the effects of increasing access to finance in developing countries where the bulk of the self-employed work in micro-enterprises? Evidence from a large survey of over one million randomly selected Indian households suggests that opposite effects may be observed in developing countries where workers work in household enterprises that do not pay a regular salary. Access to finance eases credit constraints for the formal sector, creating job opportunities that move workers out of self employment into formal sector jobs. Examining survey data on more than 400,000 firms in the service sector in India, which has experienced high growth in the last two decades, we find that firms located in districts with greater access to finance, borrow more. Access to finance is also associated with increased productivity, wages, and, employment, with the effects concentrated in larger firms, and firms located in urban areas. Our results describe a mechanism by which financial development facilitates economic growth and reduces poverty: by moving workers out of micro-enterprises and self-employment into more productive employment in the formal sector.