Community origins of industrial entrepreneurship: Theory and historical evidence from India

The transition from agriculture to trade and the subsequent transition from trade to manufacturing are key stages in the development process. In countries where a substantial manufacturing sector exists, a few small communities often dominate it. Our objective in this project is to examine, theoretically and empirically, the role played by community networks in the transition from trade to industry.

The proposed research will theoretically derive conditions, which determine the timing and extent of transition from trade to manufacturing enterprises, in an economy where networks are active. We will assess the empirical validity of the theory using new historical data from India that we will compile from various sources. Internal and overseas trade in India under colonial rule was controlled by a relatively small number of communities. While most of these communities ultimately made the transition to manufacturing, they made this transition at very different points in time. Detailed firm-level information and aggregate economic conditions over a long period of time will be used to understand this staggered transition.

We will collect information on a comprehensive sample of firms, starting at a critical juncture in the development process and then moving forward in time (adding new firms as they enter the economy). This will enable us to examine the validity of the hypothesis that existence of trading groups is a necessary precondition for emergence of industrial enterprises in any given industrial sector. We will examine if this is a sufficient condition, and if so what are the factors that affect timing and extent of industrialization. We expect the research will show how the existence of community networks and historical shocks in trade opportunities matter critically in this regard.

The central objective of the theory is to characterize the transition from trade to manufacturing in an economy where networks are active. Payoffs from trade allow individuals to accumulate wealth over time. This wealth is necessary to finance an indivisible investment necessary to start a manufacturing enterprise, owing to missing credit markets.

Payoffs in trade evolve over time depending on exogenous shocks in the world economy. At some point in time, the wealthiest individuals in the economy will have acquired the wealth needed to move into manufacturing. In the decision to enter industry the skill or knowledge acquired in trade may be an important factor.

Networks can speed up the transition to manufacturing, by increasing the accumulation of wealth by their members in trade, while at the same time delaying the transition, by increasing the opportunity cost to moving. Where many trading networks are competing, wealth accumulation will be slow, but the propensity to transition is also greater, since firms earn smaller rents. When a single community (network) monopolizes trade, in contrast, a large negative shock will be needed to move it into manufacturing. An important objective of the theoretical analysis will be to formalize this intuition and fully characterize the relationship between network competition and the trade-to-manufacturing transition. The theory will be embedded in a general model of growth, allowing us to derive implications for welfare and inequality.

On the empirical side, we have identified three regions surrounding the metropolitan cities of Bombay, Calcutta and Madras to study the activities of the trading networks. The three regions differ in the commodity traded by the Indian traders and the degree of competition. The trading groups of Parsi, Hindu and Muslin merchants in Bombay traded mainly in raw cotton and therefore had faced a large increase in profitability at during the American civil war and a sharp a decline in the late 1860s as the war ended and demand shifted back to the American South. These trading groups entered into production of cotton textiles from the 1870s. The trading community of Marwaris in Calcutta traded in raw jute to the British jute companies and faced a decline in profitability in trade at the end of the First World War and became entrepreneurs in the jute industry in the 1920s. In Madras the community of Chettiar monopolized indigenous banking and became the main financiers of the rice trade in Burma. Their entry into occurred only in the 1930s. The Great Depression led to a decline in their business in Burma and saw their entry into modern business in Madras.

We are compiling data on the entry of all registered firms that are in the industrial sector from 1885. These firms were set up in cotton textiles in Bombay between 1870 and 1913, in the jute industry in Calcutta from 1918 to 1929 and in various industries in Madras in the 1930s.  Our data provides information on the community origin of all firms and will allow us to track entry of firms by community into industry. We propose to track the members by community back to their trading origins using regional almanacs and trade directories from 1840-1885.

We will use the rise in prices of commodities traded as a proxy of accumulation in trade and will treat the sudden decline in commodity prices as the point of possible exit from trade and entry into industry. Using the shock as our reference point we will track the entry of all industrial firms by community. We will use firm level information to get measures of capital required to start an industrial firm and the profitability in different industrial sectors. The empirical exercise will illustrate the conditions under which industrial firms were set up by the members of the Indian mercantile communities and explain the regional variation in entry using our theoretical framework.