Why Do Firms in Low-Income Countries Grow Slowly? An Investigation of Demand-Side Mechanisms

Authors
Anna Vitali

The building of a customer base is a key driver of demand accumulation over the life cycle of a firm. Accessing new customers may be especially difficult in lower-income countries due to two types of constraints: the presence of high search costs for customers that limit quality observability ex-ante and the lack of institutions that can enforce quality standards ex-post leading to moral hazard problems as firms are able to over-price lower-quality goods. Despite the increasing evidence showing that consumers face important informational constraints when searching for high-quality goods, the mechanisms through which such constraints affect firm access to demand and long-term growth are still largely unexplored.

In this project, Anna Vitali will collect data from 300 firms in the manufacturing sector in Uganda on firm-customer relationships, product quality and prices in order to study the source of search and contracting frictions related to asymmetric information on quality. Data on consumers’ buying patterns and their knowledge about different producers will provide evidence on the incidence of search frictions in the market. To shed light on moral hazard, a lab-in-the-field experiment will be used that will reveal the extent to which consumers are able to detect the quality of products prior to consumption. Analysing the dispersion of the products' price and quality will be informative of the ability of firms to charge similar prices for goods that may differ in terms of quality. Exploiting the matched nature of the firm-customer data, the project will also examine whether firms can sustain longer-term relationships by offering high-quality products, and whether this gives them access to a wider customer base. Finally, the data collected in the field will be used to motivate and estimate a structural model of search with unknown quality that will permit counterfactual analysis to quantify the relative importance of search and contracting frictions on firm and employment growth, entry/exit dynamic, and the distribution of quality.

Understanding the frictions consumers face when searching for goods, and how they affect firm behaviour in equilibrium is key for the design of policies aimed at stimulating growth and employment in lower-income economies. The structural approach of this study allows examination of the mechanisms through which policies reducing asymmetric information may affect market outcomes in a general equilibrium framework. This can be informative of the type of interventions that would be most effective at tackling specific policy objectives. In particular, the two main counterfactual analyses of this research can shed light on the effectiveness of policies aimed at reducing search versus contracting frictions. The first counterfactual will speak to the potential impact of programmes that enhance customers’ knowledge of the firms operating in the market, such as increasing access to information technology or reducing transport costs. The second counterfactual will provide insights on the effect of policies facilitating access to information on product quality or strengthening the power of institutions that are responsible for enforcing quality standards.

Authors

Anna Vitali

University College London