Credit Contract Enforcement and Income Disparities across Indian States



Journal Title

Journal ISSN

Volume Title



This dissertation is comprised of two essays which study the impact of credit contract enforcement in explaining per capita income disparities, by studying its impact on the occupational choices of individuals and the allocation of factors of production (talent, capital, labor) in the economy. In the first essay, I estimate the impact of credit contract enforcement on occupational choices of the working population in India. I consider three broad occupation categories - formal firm owner, informal firm owner, and worker. The identification strategy I use involves the use of difference in differences—I exploit the cross-state variation in the implementation of a major judicial reform in India 2002. The datasets used for the occupational and other characteristics of individuals in the regression exercise are the NSS employment and unemployment surveys for years 2000 and 2005 (which are the pre-year and post-year respectively around the policy reform). I find strongly significant effects of credit contract enforcement on occupational choices, and a more efficient allocation of talent across occupations with improved credit contract enforcement. In the second essay, I develop and calibrate for each state a dynamic, heterogeneous-agents, three-occupation type model with differently-sized firms of formal and informal types. In the model, 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 the labor market frictions and general equilibrium effects on wages and interest rates, individuals sort into different occupational types between formal firm owner, informal firm owner, and worker. 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. Calibrating the model for each Indian state, with states varying on key 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.



Misallocation, Economic growth, Indian States, Heterogeneous agents