Preferential credit? Ethnic and indigenous firms vie for equal access

Ethnic groups often remain segregated long after emigrating to a new area. Why, for example, do the Chinese in Southeast Asia and Africa or the Armenians in Russia remain excluded from mainstream business activities? However, ethnic enclaves, perhaps due to business skills passed down from older members of the community, run successful businesses. Is shared ethnicity crucial to building networks and trust, ensuring that business thrives? Research from Columbia University in the United States shows that it is indeed easier for business associates from a similar ethnic background to clinch and stick to a deal: if cheating does occur, the guilty party will suffer social sanction and exclusion not only from their network but the entire ethnic community. If ethnic firms’ advantage is the community how can indigenous firms compete on an equal footing?

How far do firms rely on communal enforcement? How important are ethnic networks in promoting trust? Little rigorous analytical work exists: cooperation is difficult to measure. A useful approach is perhaps to examine access to trade credit. A supplier may supply goods on credit to a firm downstream to reduce associated transaction costs and provide assistance in the face of liquidity constraints. As long as the supplier has ready access to capital, the cooperation will benefit both parties, increasing their joint surplus. Reneging on the loan is a risk – hence the need for trust in the absence of effective legal enforcement. If it is true that ethnic networks can curb the gains from dishonest behavior, then higher rates of credit access should be observed within ethnic enclaves.

Is communal enforcement the only reason behind the relationship between ethnicity and trade credit access? Perhaps members of ethnic minority business communities have other skills that may account for preferential trade credit access. To test for the existence of social enforcement in ethnic communities, the research analysed World Bank data on African firms (in Kenya, Tanzania, Zambia, and Zimbabwe), which included information on supplier relationships. Comparing credit access across different types of relationships whilst holding firms’ characteristics (such as firm size) constant, the effect of a supplier’s ethnicity became clear:

• Communal enforcement is a highly effective policing mechanism: an average firm within an ethnic enclave is more than twice as likely to obtain goods on credit from a supplier of the same ethnicity than from an outside firm.
• However, the findings also reveal that the preferential access to credit enjoyed by ethnic minorities is not directly attributable to network effects. Rather, minority-owned firms are of a higher quality, and therefore a better credit risk, than non-minority firms.

Why the quality difference? What is the true role of ethnicity? Ethnic networks are based on trust and familiarity and are crucial in promoting commercial enterprise, particularly in terms of credit access. Yet the picture is still unclear. One network advantage often observed - information sharing - is actually relatively small in an ethnic community. Perhaps ethnic firm success can be attributed to the training and skills development provided within a community. In this study, ethnicity only seems to have a positive relationship with credit – not necessarily for other business-to-business interactions: ethnic firms still search further afield for suppliers.

What does this imply for government policy in countries dominated by ethnic minorities? How can the differences in credit market outcomes be erased? Crucially, how can indigenous African firms gain access to credit on an equal level to ethnic firms? If firm quality is the issue, the policy choice is clear: training, directed at indigenous businesses, will help replace the skills-development freely available within ethnic networks and largely responsible for the greater access to credit enjoyed within ethnic enclaves.

Source(s):
Insights 34 Full document.
Ethnic enclaves and communal enforcement: evidence from trade credit relationships, paper presented at the CSAE conference, ‘Opportunities in Africa: Micro-evidence on firms and households’, by Raymond Fisman, Oxford (April 2000) Full document.

Funded by: Not known

id21 Research Highlight: 14 September 2000

Further Information:
Raymond Fisman
Graduate School of Business
Columbia University
New York, NY 10027
USA

Tel: +1 (212) 854 9157
Fax: +1 (212) 316 9219
Contact the contributor: rf250@columbia.edu

Columbia University (USA)

Other related links:
Search Eldis for sources on social capital