Small firms in developing-country supply chains often provide trade credit to customers, allowing buyers to delay payment until after the delivery of goods. Despite the ubiquitous use of trade credit, which frictions inhibit trade credit provision, which firms have a comparative advantage in overcoming these frictions, and how their solutions affects firm size all remain unclear. In this project, we focus on the role of contracting frictions, as first explored by McMillan and Woodruff (1999): small firms may be better suited to selling on credit than large firms if they possess more knowledge about buyer default risk or are better at monitoring customers and enforcing repayment. If this is the case, in absence of public enforcement mechanisms – courts, credit scores, etc. – a relative inability to enforce repayment will then limit the customer base of productive firms while protecting unproductive firms from exiting. This paper asks four questions: (i) do firms face screening and enforcement frictions when selling on credit, (ii) can they (partially) overcome these frictions by forming repeated relationships, (iii) could a public enforcement mechanism (credit scores) further improve efficiency, and (iv) by relaxing enforcement constraints, how would widespread adoption of credit scores affect the firm size distribution? The project investigates these questions in the context of Indian interfirm trade.
Using novel administrative data, this study empirically documents the trade credit practices of 300,000 informal firm-customer relationships and quantify the effects on the aggregate economy through a structural model. The approach draws on a new data set of payment diaries collected by a digital bookkeeping platform (henceforth 'the platform'). The platform records both merchant transactions, including when goods are exchanged on credit and if/when payment is received; and enforcement efforts, including private reminders to repay and the placement of customers on a public within-app defaulter list. These data is complemented with an original survey of firms (pilot completed, full-scale survey design in progress).
The key policy contribution is to identify the development of a public ‘trade credit default list’ as a feasible low-cost method of contract enforcement. Ex-ante, the effectiveness of these scores is not clear; nevertheless our preliminary results show that effects of default reporting are large and immediate. Given the prevalence of both trade credit and contracting frictions in poor countries, this conclusion is likely relevant for supply chain contexts beyond India.
