Determinants and Impact of Subcontracting: Evidence from India’s Informal Manufacturing Sector

Abstract

There are two divergent perspectives on the impact of subcontracting on rms in the informal sector. According to the benign view, formal sector rms prefer linkages with relatively modern rms in the informal sector, and subcontracting enables capital accumulation and technological improvement in the latter. According to the exploitation view, formal sector rms extract sur- plus from stagnant, asset-poor informal sector rms that use cheap family labour in home-based production. However, direct, rm-level evidence on the determinants and impact of subcon- tracting is thus far lacking in the literature. We apply a modi ed Heckman selection model to Indian National Sample Survey data on informal manufacturing enterprises (2005{06). We nd that home-based, relatively asset-poor, and female-owned rms are more likely to be in a subcontracting relationship. Further, we perform selectivity-corrected Oaxaca-Blinder Decom- position and calculate treatment e ects to show that subcontracting bene ts smaller rms, rms in industrially backward states and rural rms; it is harmful for larger rms, rms in industri- ally advanced states, and urban rms. Our results suggest that the e ects of subcontracting are more complex than those predicted by the divergent perspectives. Policy-makers need to engage with this complexity.