Credit Contract Enforcement and Income Disparities across Indian States: A Heterogeneous Agents Framework with Formal and Informal Firms

Abstract: This paper evaluates the role of enforcement of credit contracts in explaining the income per capita disparities across Indian states—by studying its impact on access to credit and occupational choices of individuals, and therefore, the overall allocation of factors of production in state economies. First, I estimate the impact of credit contract enforcement on the occupational choices of the working population in India by exploiting the variation in implementation of a major judicial reform policy across Indian states in 2002. Then, I develop and calibrate for each state a heterogeneous-agents model with heterogeneous firms of formal and informal types. In the model, the state-specific ability to enforce credit contracts imposes an endogenous borrowing constraint—which affects the borrowing ability of individuals, the potential size of firms they can run, and the profits they can earn. Combined with labor market frictions and the general equilibrium effects on economy-wide wages and interest rates, individuals sort into different occupational types. Overall, improved enforcement of credit contracts reduces the misallocation of factors of production—entrepreneurial skills, capital, and labor across production units—leading to increased aggregate productivity and output per capita of the economy. Calibrating the model for each Indian state, with states varying on parameters of credit enforcement and availability of labor opportunity, I find that the model explains 19.74 percent disparities across Indian states in 2017-18.

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Spatial Structural Change in India with Priyam Verma and Xavier Bautista

Pre-Doctoral Research: “International Monetary System: Evolution, Problems and Future Possibilities” [M.Phil. Dissertation]