Why does microfinance fail in rural south-India? The social regulation of self-employment

There is now an increasing consensus that the effects of microfinance on self-employment are limited, with two common interpretations. The microeconomic approach suggests that the poor lack the skills, the resources and the motivation to start their own business. The macroeconomic approach argues that local markets are already saturated. In this paper, we use a political economy approach and first-hand data from rural south-India to explore a third explanation: the social regulations of markets. Drawing on a household survey, we find that the vast majority of households do not engage in entrepreneurial activities, despite taking up microfinance loans. We also find that women and lower castes have a significantly lower chance of starting up a business and when they do so, their businesses are smaller, less profitable and concentrated in very specific sectors. We then use qualitative insights related to the fabric and functioning of local economies to illustrate how caste and gender-based social regulations shape local markets, determining who can produce or sell what, to whom, and to some extent at which price. Our paper shows that the most vulnerable households are in fact the least likely to start up a sustainable income-generating activity.