Firms in Rural Economies

Many firms in the developing world operate in economies that are primarily agricultural, where a large fraction of the population resides in rural areas and agriculture accounts for a substantial share of production and employment. Existing work has overlooked the linkages between firms and the agricultural sector, and paid little attention to the way in which the rural setting shapes small and large businesses' operations. This dissertation examines three related dimensions of enterprise activity in rural settings and sheds light on business performance and growth potential in low-income countries.;Chapter 1: "Firms and Farms: The Impact of Agricultural Productivity on the Local Indian Economy" How do agricultural productivity shocks propagate through the local economy and affect firms? I combine firm, household and district-level data from India, and exploit weather-induced agricultural volatility, to estimate the response of manufacturing firms to changes in agricultural productivity. I show that negative agricultural productivity shocks reduce firm production and employment. This holds true even though the local wage decreases. The effect is driven by firms that produce locally-traded goods, suggesting that the decrease in local demand induced by lower incomes plays a key role. I then examine whether the introduction of a large-scale rural workfare program affects the response of the local economy to agricultural volatility. I show that the program acts as a stabilization policy and attenuates the pro-cyclical response of local wage, consumption, and firms' outcomes to agricultural productivity shocks. The results highlight the importance of local rural demand for a large share of manufacturers and underscore how rural development policies that target households can strongly affect the industrial sector because of general equilibrium effects.;Chapter 2: "Buy from Your Kin: Microenterprise Customer Base, Productivity and Market Power" This chapter studies whether social and kinship ties influence the productivity and market power of small businesses via their influence on business' access to customers. In contexts where kinship identity matters, consumers may value social proximity to the business owner and be willing to trade off such proximity for other product attributes such as price and quality. This guarantees businesses from large social networks access to a large set of loyal customers, and thus puts them at an advantage relative to equally or more productive competitors that belong to smaller networks. A model of product differentiation a la Hotelling --- in which physical distance to firms is replaced by social distance to firms' owners --- captures the mechanisms proposed and delivers testable predictions on the behavior of firms and consumers, as well as on market outcomes. I provide preliminary evidence in support of customer kinship loyalty using microenterprise and social network data from India. Existing data, however, lack information on customers and transactions, and hence limit the possibility to address questions related to market structure. A full test of my hypothesis will rely on a unique matched business-customer dataset that I collect for a sample of large Indian villages (in progress). The new data will also provide the basis for potential future interventions that vary the productivity of a subset of businesses and examine whether market shares reallocate in a pattern consistent with customer kinship loyalty.;Chapter 3: "Does Agricultural Volatility Change the Selection into Entrepreneurship ?" A large fraction of households in low-income countries owns enterprises that are informal and very small. In this chapter, I shed light on the motivations that drive households to participate in enterprise and study the role of agricultural volatility. I examine whether households resort to microenterprises as a response to agricultural income shocks, and assess the implications that this has on selection into entrepreneurship and business type. Using employment and firm data from India, and exploiting variation in agricultural incomes induced by seasonality and weather, I provide evidence for the following selection dynamics. First, I show that a decrease in agricultural productivity significantly raises the probability of running a microenterprise (extensive margin) as well as the time spent working in the enterprise (intensive margin). That is, engagement in enterprise behaves counter-cyclically. Second, and consistently with a selection mechanism based on entrepreneurial ability, I show that average ability among active entrepreneurs decreases when agricultural productivity is low, and that microenterprises that operate cyclically are different from their permanent counterparts across a number of dimensions, including size and profitability. Third, I find that most of the cyclical entry-exit takes place in services rather than manufacturing. This result suggests that households that operate businesses intermittently do so through activities that require lower start-up costs and fewer specific skills.