December 18, 2023 ☼ The Intersection ☼ social capital ☼ economic history ☼ public policy ☼ Information Age ☼ hyperdiversity
Credit flows remain constrained by boundaries of caste and community. Public policy must address this problem.
This is from The Intersection column that appears every other Monday in Mint.
Ranade’s essays are preserved on archive.org. He was among the first to argue that India must industrialise to lift itself out of poverty.
A century later, the German economic historian Dietmar Rothermund came to a similar conclusion. Lacking financial institutions, Indian surpluses in the second half of the 19th century went into gold and land. Meiji Japan, in contrast, was able to “gather small savings and to channel them into the mainstream of the national economy” enabling the country’s industrialisation.
See my essays on the negative effect of hyperdiversity on social capital.
We can blame the British Raj for not creating financial institutions that were necessary for India’s industrialisation. But it does not answer why Indians didn’t — or couldn’t — take the initiative to do so. Part of the reason why 19th century India failed to develop financial institutions, and why Indians bought up gold and land, was inadequate social capital arising from hyper-diversity. Capital stayed within caste-communities, which zealously guarded their business interests and saw themselves in competition with each other. When there was more capital than they could invest within their own community, they put it into gold and land. Physically owning your assets meant that you didn’t have to depend on governments for contract enforcement. The colonial government, in any case, had little interest in creating trust and social capital in Indian society.
See Netscribe’s report(pdf) on the MSME credit market. IFC’s 2019 study offers some good insights.
This bit of economic history is important because the basic picture for capital allocation remains the same. Avendus Capital estimates the MSME credit gap to be around $530 billion, with only 14% of the 64 million enterprises have access to formal credit. Over half of these are considered unaddressable by the formal financial institutions. Over 99% of the MSME sector comprises of micro-enterprises, around 80% of which borrow from informal sources. A 2019 study by the International Finance Corporation found that “friends and family” constitute an important part of the informal sources. Every government of independent India has attempted to make capital available to entrepreneurs. Yet, even after eight decades, the distribution of financial capital remains constrained by social capital. People invest money where they can trust, and this generally means within one’s own community.
It follows that if India’s entrepreneurs are to fuel its growth and prosperity, public policy has to make domestic capital available to domestic enterprises. Ranade’s prescription remains valid today. The question is how do we go about it?
Whatever their other failings, public sector financial institutions have helped reduce caste bias and break through the caste-community barriers to capital allocation. Using data from the 2011-12 round of the India Human Development Survey Sunil Mitra Kumar and Raghupathy Venkatachalam find that while caste-wise differences exist in the application for farm loans, but for those farmers who applied the approval rates were almost uniform across caste segments. Indeed, for small farmers, the “caste-based differences in loan application and approval rates are largely muted.” This is not perfect, but it is meaningful progress. Now compare this to MSME loans. Ashay Kadam, Prakash Singh and Jayati Chatterjee find that “while entrepreneurs from lower castes are more likely to obtain credit from the formal financial system…(those from) lower caste communities receive significantly lower loan amounts.”
From these studies, we can say that banks seem to show lower caste-bias for farm loans, but more for business loans. Now this could be because farming does not depend on business networks as much as MSMEs do, and loan officials price social capital into their loan approvals. An entrepreneur from a non-dominant community will find it harder to succeed in a new business because she does not have the network. This is not to say that caste prejudice is not a factor, but that our entrepreneurs remain trapped by the limitations of social capital.
Caste-affirming identity politics will make things worse. It will strengthen bonding social capital within a caste-community and weaken bridging social capital across communities. Financial capital will follow suit and remain sub-optimally allocated within thousands of caste-communities, instead flowing into more productive investments across Indian society. Government schemes cannot change this beyond a point. We have to change our sense of “us”.
Technology holds promise. I hope the Open Credit Enablement Network (OCEN) takes off in the way UPI has done. It has the potential to enable lending and borrowing, completely agnostic to caste affiliations, across the country. It’s success will be historic. For the first time ever, India will have a national market for business credit. It can unlock the economic potential that Ranade envisioned. However, for it to happen OCEN will have to cross the chasms of trust: between citizen and technology, citizen and government and ultimately citizen and citizen. Like Caesar’s proverbial wife, OCEN will have to be trustworthy and be seen as trustworthy. At least as trustworthy as a member of one’s own community.
There are many more The Intersection columns here
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