Testing a 3rd Party Contract Enforcement Solution in a Peruvian Textile Cluster

Firms in Peru’s Gamarra – Latin America’s largest garment cluster, with 20,000 firms, $1.2 billion in annual sales, and 100,000 employees – face a dilemma. Previous reforms lowered entry barriers to such a point that they incentivized firm creation, which increased anonymity, weakened existing contract enforcement mechanisms, and hindered specialization. Fierce competition, shrinking profit margins, underutilized capacity, and the lack of trust have become the biggest barriers to growth. Gamarra’s firms are forced to stay small because they are squeezed: on the one hand, they are pushed to integrate activities within the firm to overcome the lack of contract enforcement in the market, yet there they confront internal agency costs, which pushes firms back into the marketplace to sub-contract activities. In the end, firm owners often opt to do the work themselves – and productivity suffers because they cannot achieve gains from specialization. Gamarra – like many emerging market SME clusters with contract enforcement issues – needs not more firms but more firm growth. This study will test an online contract enforcement platform mechanism for emerging market SMEs. In partnership with Corporación Financiera de Desarrollo (COFIDE), it will add a user-driven ratings and punishment mechanism to an existing SME services portal and will assess its impact via a randomized evaluation. If successful, the mechanism could expand the extent of the market for SMEs and help them capture gains from trade through increasing specialization. Although the research would take place in a Peruvian garment cluster, the contract enforcement mechanism would have applications in SME marketplaces in other emerging markets.