How caste networks shape business ties and economic growth in India

Small businesses in developing economies often struggle to grow due to limited access to resources, networks, and business opportunities. A new study sheds light on how caste-based community networks play a crucial role in facilitating firm-to-firm trade and shaping production networks in India.

Report by CAGE Research Centre Intern Umar Hamid

Production networks are economic transactions between companies that make it possible for them to source inputs needed in the production process and share resources. An additional value of these networks is the sharing of knowledge and expertise. This can help businesses become more productive, increase their access to credit, and even boost their chances of survival. The research, conducted by Johannes Boken¹, Lucie Gadenne², Tushar Nandi³ and Marta Santamaria⁴, examines the impact of caste networks on economic interactions between firms. Caste communities, known as Jātis, are a fundamental aspect of Indian social structure, influencing various spheres of life, including professions and marital ties.

Using comprehensive administrative panel data on the universe of firms paying value-added taxes in West Bengal between 2010 and 2016, the authors mapped firm-to-firm transactions and identified the caste affiliations of firm owners. To determine caste affiliations, they matched firm owners' last names to an anthropological database containing over 2,200 caste classifications. This unique dataset covers over 106,000 firms from 723 distinct caste communities, encompassing over 200 million potential trade relationships.

Their analysis revealed striking findings:

• Firms belonging to the same caste community are twice as likely to trade with each other compared to firms from different castes.
• When firms from the same caste trade, their trade volumes are nearly 20% higher.

These effects persist even after the authors controlled for factors like firm location, products traded, and economic shocks over time, suggesting that caste networks play a significant role in facilitating business relationships and mitigating contractual frictions. The authors provide evidence that caste networks alleviate trading frictions, particularly for relationship-specific products and in areas with weaker contract enforcement. They found that the effects of caste on trade were larger in contexts where such frictions are more severe.

To quantify the aggregate impact of caste networks, the researchers extend a model of network formation to incorporate the productivity and cost advantages of intra-caste trade. Their counterfactual analysis reveals that extending the positive effects of caste networks to all potential supplier-client relationships could increase welfare by 32%. What drives these large welfare effects? The analysis found that caste ties alleviate trade barriers and costs. By enabling trust and cooperation, these traditional networks smoothed transactions in India's challenging business environment. Specifically, the counterfactual shows that weakening trading frictions for different-caste supplier-client pairs (over 96% of the potential supplier-client pairs) could increase firm-to-firm sales by 19%, reduce input prices by 22%, and promote a 63% increase in network transactions. However, the existence of caste networks can simultaneously lead to individuals transacting more within caste for preference-based reasons, leading to discrimination and ultimately resource misallocation as individuals’ economic opportunities is constrained if they do not belong to the ’right’ caste.

Overall, the study underscores the immense capacity of social ties to empower small entrepreneurs across the developing world. In markets plagued by red tape and weak institutions, informal networks can substitute for what formal mechanisms lack. Policymakers should take note - and explore ways to strengthen broad collaborative links between all businesses, regardless of creed or community.

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¹ University of Warwick
² Queen Mary University of London
³ IISER Kolkata
⁴ University of Warwick

References:
Boken, J. Gadenne, L. Nandi, T. Santamaria, M. (2022). Community Networks and Trade. CAGE Working Paper (No.649).