These two facts are probably closely related: the fact that good firms cannot grow fast enough also helps explain why bad firms can survive. If the best firms were to grow fast, they would drive down the price of whatever they sold and therefore force out everyone except those efficient enough to make money even when the prices were low. By the same token, they would drive up wages and the cost of raw materials, further discouraging bad firms. In contrast, if they remain small and service only the local demand, a less efficient firm can easily survive in the market next door.
One natural culprit is the capital market. It clearly plays a role in the Tirupur example, where the most productive entrepreneurs in the most productive T-shirt cluster in India cannot borrow enough to catch up in size with the less productive local firms. In India and China, estimates imply that simply reallocating capital across firms would erase most of the TFP gap created by misallocation.101
This interpretation dovetails with a generally shared sense that the banking sectors in both China and India have serious problems. Indian banks are famous for trying to avoid lending to anyone except blue-chip borrowers (usually without recognizing that yesterday’s blue-chip firms are often today’s disaster waiting to happen). Chinese banks have undergone significant reforms since the 1990s, with the goal of allowing for entry of different actors and improving the governance of the state-owned banks, but the “big four” state-owned banks still tend to be all too willing to lend to dubious projects with good political connections.102 Finding money remains difficult for a young and ambitious entrepreneur with a good idea but no powerful friends.
Indian banks have very much the same problem, and in addition they are reputedly extremely overstaffed. Overstaffing means they need to put a large wedge between the rate at which they lend to firms and the savings rate they offer to depositors if they want to break even. As a result, bank lending rates in India are high relative to the rest of the world,103 even though depositors earn very little interest.104 This also discourages investment by those who need to borrow to do so and favors those with a rich relative to support them, like the Gounders of Tirupur. Bad banks hurt efficiency from both ends; because of them, savings rates are lower than they could be and savings are poorly managed.
In addition, companies need risk capital, funding that unlike bank funding protects them when they are hit by bad luck. Stock markets do this, but the Chinese stock market is yet to be widely trusted and the Indian one, while older and better run, is still very blue-chip dominated.
Poorly developed land markets are another reason why companies do not grow. In order to grow, a productive firm will need to acquire more land and buildings to make room to accommodate new machines and employees. In addition, land and buildings can be used as collateral for loans. This becomes a huge problem when land markets function poorly. To take a very common example, in many countries ownership of land and property is often disputed. A claims B’s land, the land gets placed under court authority, and it typically takes years to settle the dispute. A recent study suggests that in India land and buildings play a big role in misallocation.105 In fact, in about half the districts in India, more productive firms tend to have less land and buildings than the least productive ones! This is likely to be a large problem in many countries where property rights on land are not very clearly defined.
ONE LIFE TO LIVE
But there are other, more psychological, reasons why the best firms are not taking over India, Nigeria, or Mexico. Perhaps the owners like the idea of leaving their son a running business and prefer to avoid the risk of outside control that comes with outside financing; raising money on the stock market, for example, requires setting up an independent board of directors who might get in the way of the succession plans.
And perhaps ultimately the owners do not care enough about growth to put all they have behind that agenda. If no one else is growing fast, they are not at risk of being pushed out. They have a reasonable living and a place to work. Why make it more stressful by trying to grow? A very interesting recent study looks at management gaps in Indian firms.106 By the norms of what the United States calls good management, firms in developing countries are terribly managed. One might dismiss this as prejudice against other ways of managing. Indians in particular are very proud of their way of doing business on a shoestring, what they call jugaad.107 This requires being inventive in using what you have, and perhaps this is what the managers are doing. But managers are failing in ways that could not possibly make sense for them. For example, trash is allowed to accumulate on the shop floor, to the point that it becomes a fire hazard. Or unused materials are bagged and thrown into an inventory room, but nobody labels or lists them so it becomes virtually impossible to reuse them. When the researchers, one of them a former management consultant, sent (for free) a team of highly paid consultants to work for five months with the managers of a randomly chosen set of these firms, profits went up by $300,000 per firm, which even for these relatively large firms was not chicken feed. Moreover, most of the changes that made this happen were relatively simple things, like labeling inventories and removing trash. It is hard to see why the managers, if they wanted to raise profits, would need this rather expensive external help (the consulting would have cost them $250,000 had they paid for it). They undertake obvious changes if someone points them out and shames them into doing it, but not when left to themselves. It has to be that the owners ultimately don’t feel strongly about doing the best they can possibly do.
WAITING FOR FOREVER
Companies also need labor. One might imagine this at least would not be a problem in a labor-abundant poor country, but it is actually not true. Even unskilled laborers in Odisha, one of India’s poorest states, hold out for what they think is a fair wage, even if the alternative is not getting a job; workers who accept a lower wage are punished by others.108
According to the nationally representative National Sample Survey, in 2009 and 2010, 26 percent of all Indian males between the ages of twenty and thirty with at least ten years of education were not working. This is not because there were no jobs: the fraction of those under thirty with less than eight years of education who were not working was 1.3 percent. And, in fact, the fraction of those with ten years of education above thirty who were not working was about 2 percent.109 We see the same pattern in 1987, 1999, and 2009, so this is not because the young of today are less employable.110
There are plenty of jobs, just not jobs these young men want. They will eventually accept jobs they refused to take when they were younger, probably because the economic compulsions become stronger as they age (their parents, who feed and house them now, will retire or pass on; they will want to get married), and the job options shrink (government jobs, in particular, have an age cut-off that is often close to thirty).
Esther found something very similar in Ghana. A little over ten years ago, about two thousand adolescents were identified as having passed the (hard) exam necessary to qualify for higher secondary school in Ghana (corresponding roughly to grades ten to twelve) but had not enrolled in the first trimester for lack of funds.111 A third of them were randomly selected and offered a full scholarship for their entire time in secondary school. Before they were chosen for the scholarship, Esther and her co-authors asked their parents what they thought the economic benefit of enrolling in secondary school would be. The parents were generally optimistic. On average, they thought a person like their son or daughter could earn almost four times as much if they completed secondary school than if they did not start it. Moreover, they believed these gains would come because of greater access to government jobs, such as teaching and nursing. Not surprisingly, given these beliefs, three-quarters of the kids offered a scholarship jumped at the opportunity and completed secondary school, compared to only about half of the kids who did not get a scholarship. Esther and her colleagues have been following the progress of these adolescents ever since, interviewing them about once a year. They find many positives: the stude
nts learned useful things in school and it changed their lives in many ways; they all performed better on a test that measures their ability to apply knowledge to concrete situations; girls waited longer before starting a family and had fewer children.
The not so good news is that the impact on their average earnings was not very large, except for the few who got a government job. The parents were right about one thing: secondary education is indeed essential to get access to the college degrees that allow graduates to get coveted jobs. Secondary school graduates were indeed more likely to be teachers, to have other government jobs, or to have private jobs with benefits and fixed salaries. But where they got it wrong is that although secondary education is necessary, it is not sufficient. Secondary school scholarship winners (especially the girls) were more likely to go on to college, but the probability was still quite low (16 percent among scholarship winners as against 12 percent in the comparison group). And only a few of them managed to get a government job. The scholarship doubled this probability, but it went from 3 percent to 6 percent; that is, from really, really, small to really small.
Meanwhile, though they were already twenty-five or twenty-six, most of those who had gone to secondary school were still waiting for something better. A substantial fraction were not working at all: only 70 percent of the kids in the sample (treatment and control combined) had earned anything in the last month.
Intrigued by what these young people could be doing instead of working, we visited several of them. Steve, a young, affable, well-spoken man, received us in his home. He had graduated from secondary school over two years before but had not worked since then. He was hoping to go to college and study politics, with the aim of being a radio anchor one day, but his grades on the admission test had been too low so far. He kept retaking it. In the meantime, he was living off of his grandmother’s pension. He saw no reason to let go of his dreams yet. He probably will eventually, but as he sees it, he’s still young.
The flip side of this is that even in countries with frighteningly high unemployment rates, like South Africa (where 54 percent of those between the ages of fifteen and twenty-four say they are unemployed112), companies complain they cannot get the workers they want: workers with some education, a good attitude toward work, and a willingness to accept the wages on offer. In India, the government has invested an enormous amount of public resources on getting workers ready for the jobs the economy is generating. A couple of years ago, Abhijit collaborated with one of these businesses that does vocational training and job placement for the service sector. The company was worried they were not doing particularly well at placing their students. The data confirmed this. Out of 538 young men and women who signed up for a course, 450 completed it. Of those, 179 got job offers and 99 accepted their offers, but after six months only 58 were in the jobs the company had found for them, a hit rate of just over 10 percent. Another 12 were working elsewhere.113 What were they doing instead, we asked a group of those who had been offered a job but had either never taken it or quit more or less immediately. They were either taking what they called “competitive exams” (to get a government job or a job in a quasi-governmental organization, like a public-sector bank) or studying to complete their bachelor’s degree and then apply for a government job. Or just sitting at home, despite the fact that their families could ill-afford that.
Why did they not want the jobs they had been offered? We heard many answers, but it all came down to their not liking them—too much work, too long hours, too much time spent standing, too much going from one place to another, too little pay.
Part of the problem is a mismatch of expectations. The young men and women we interviewed in India grew up in families where post-primary education was still often a novelty; their fathers had on average eight years of schooling, their mothers less than four. They were told that if they studied hard they would get a good job, meaning mostly a desk job or a teaching job. This was closer to the truth in their parents’ generation than it is today (especially for historically disadvantaged populations like the lower castes who benefitted from affirmative action). The growth in government jobs slowed and eventually stopped in the face of budgetary pressures,114 but the population of the educated, even among the historically disadvantaged, kept growing.115 In other words, the goalposts have moved.
Something similar happened in countries like South Africa, and also in Egypt and other countries of the Middle East and North Africa, which were more developed than India to start with. There, it was not enough to have completed secondary school, but for a while having a bachelor’s degree served the same screening function: if you could show your BA degree you would walk into a government job. That is no longer true, but these countries are still producing millions of BAs in subjects like Arabic and political science, for which there is no market anymore. That today’s graduates do not have the skills employers want is of course a constant complaint the world over, including in the United States. But the situation is quite extreme in those countries.
The mismatch between reality and expectation is reinforced by the lack of exposure to the real labor market. With Sandra Sequeira, Abhijit evaluated a program in South Africa providing young workers in the townships (the erstwhile black ghettos of the apartheid era) with free transportation to look for jobs far from home. Those randomly chosen to get the transportation subsidy did travel a lot more, but there was no effect on employment. What did change, however, was their perception of the labor market. Almost everyone was too optimistic to start with; the salaries they expected to earn were 1.7 times higher than the actual salaries reported by employed workers similar to them. Being exposed to the actual labor market put a dampener on their expectations, and their wage expectation became closer to the truth.116
Labor markets frozen by this kind of radical mismatch are wasting resources. These young people are mostly waiting for jobs they will not get. In India, newspapers frequently write about the mad rush for government jobs; for example, that twenty-eight million people applied for ninety thousand low-level jobs in the government-owned railways.117
From the perspective of developing countries, some of these problems are purely self-inflicted. Part of the problem is that there are a small fraction of jobs that are much more attractive than the rest, for reasons having nothing to do with productivity. The best examples are government jobs. In the poorest countries, there is a large gap between the wages of public- and private-sector employees. In the poorest countries, public-sector workers earn more than double the average wage in the private sector. And this is not counting generous health and pension benefits.118
This kind of difference can throw the entire labor market into a tailspin. If government-sector jobs are so much more valuable than private-sector jobs, but also very scarce, it is worthwhile for everybody to wait around and queue for those jobs. If the process of queuing and screening entails, as it often does, taking some exams, people may spend most of their working lives (or as much as they are allowed to by their families, anyway) studying for those exams. If the government jobs stopped being quite so desirable, the economy would gain many years of productive labor, wasted in the pursuit of the mostly unattainable. Of course, government jobs are attractive in other countries as well, particularly because they often come with job security. But the wage gap is not quite as large and the queue not nearly as long.
Cutting wages in government jobs would probably be a battle, but it would not be so difficult, for example, to limit the number of times people could apply for government jobs, or to make the age cut-off more stringent. This would avoid the massive waste of everyone waiting around. It could add an element of luck to the job allocation process, but it is not obvious that the resulting allocation would be worse than under the current system, which favors those who can afford to wait. In Ghana, while Steve was twiddling his thumbs, some other young graduates had had to find something to do because they had no one to subsidize their lifestyle. They did not lack imagination: we met a
nut farmer, a DJ who specialized in funerals, a preacher in training, and two footballers on a minor league team.
The labor market problems in developing countries are not, however, limited to the outsized attractiveness of the government sector. In Ghana, secondary school graduates are also attracted by a class of private jobs that offers benefits, high wages, and a measure of employment protection. In many developing countries, the labor markets feature this duality: there is a large informal sector without any protection, with many people who are self-employed for lack of better options, and a formal sector where employees are not only pampered but also strongly protected. Some employment protection is of course necessary; workers cannot be at the whim of their employer. But labor market regulations are so stringent that they really put a chokehold on any efficient reallocation of resources.
EVERYONE WAS RIGHT, EVERYONE WAS WRONG
Where does all of this leave us in our understanding of economic growth? Well, Robert Solow was right. Growth seems to slow down as countries get to a certain level of per capita income. At the technological frontier, that is to say in the rich countries, TFP growth is largely a mystery. We do not know what propels it.
And Robert Lucas and Paul Romer were right too. For the poorer countries, convergence is not automatic. This is probably not mainly because of spillovers. It is more that TFP is much lower in poorer countries, to a significant extent because of market failures. And therefore to the extent that business-friendly institutions have something to do with fixing market failures, Acemoglu, Johnson, and Robinson were right too.
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