Labor Rationing and Forced Entrepreneurship in Village India: Estimates from Experimental Aggregate Demand Shocks

There is a growing policy consensus that increases in firm productivity, especially a move from small to medium sized enterprises, is an important growth strategy. However, the means to accomplish this, and the main impediments that prevent this transition, remain less clear. A large body of work has centered on removing potential market frictions, with much of the focus on interventions in credit and skills sectors. In contrast, the functioning of the labor market has received substantially less attention, despite the crucial role it plays in allocating labor, the biggest factor input in production.

The theoretical implications of labor market distortions, such as labor rationing, have been widely discussed in the literature. For example, when individuals are rationed out of the labor market, this will not just decrease welfare. It can also alter the structure of productive activity because rationed workers may turn to less-productive self-employment activities. This behavior by rationed workers has been referred to as “disguised unemployment” and more recently as “forced entrepreneurship”. Consequently, rationing can create a misallocation of labor (and possibly capital) across firms, leading to lower aggregate output and productivity. For this reason, labor market failures can give rise to the prevalence of small enterprises and productivity malaise. These implications, however, depend on whether labor rationing is indeed large in magnitude and affects self-employment decisions.

Existing measures thus far are based on survey questions that ask about job search activity or hypothetical questions about whether the unemployed individual would have accepted work. In a development setting, where self-employment is high, an individual who cannot find work in the casual labor market may report spending time on his household enterprise, making it difficult to distinguish true productive self-employment from disguised unemployment or forced entrepreneurship. While these survey measures continue to be used, their reliability is unknown and has been widely debated. For these reasons, there is no clear consensus on the level of rationing, whether it exists, or even how to measure it reliably.

This project seeks to fill this gap by measuring the amount of rationing in village labor markets. We exploit aggregate labor market shocks which absorb up to 30% of a village’s labor force, while leaving local agricultural labor demand unchanged. We measure spillover effects on employment and wages on the rest of the labor force, and use these spillovers to quantify the degree of rationing. This project makes a methodological contribution by experimentally shocking aggregate labor demand in villages and subsequently employing a revealed preference employment outcomes approach to quantify and decompose rationing into involuntary unemployment and forced entrepreneurship.

The secondary goal of this project is to correlate these revealed preference employment effects with survey measures. This will allow us to determine how well our experimental estimates correspond to traditional survey estimates on rationing. Through this exercise, we will be able to validate inexpensive survey instruments that can be used by other researchers to measure these quantities, to precisely distinguish “forced” entrepreneurs from “true” entrepreneurs, and to better target firm interventions.