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Opinion: Small firms – Small is beautiful?

, January 19, 2018, 0 Comments

small-firms-marketexpress-inThe majority of workers in India are self-employed or run what economic census terms as “own account establishments”. According to sixth economic census, 131.3 million workers in non-farm sectors were working in whooping 58 million establishments out of which 71% were own account establishments and only 29% hired any worker.

Are millions of small firms in India holding back employment and growth potential of the economy?

Factories are no longer providing bulk employment. Sizes of factories in an organized manufacturing sector are becoming smaller over the years owing to the adoption of technology and automation. Only 28.5% workers worked in large factories employing more than 1000 workers.

The overwhelming majority of workers worked in mid-sized (46.5%) or small factories (25%).

Most of these small players cannot take advantage of economies of scale. Their costs are usually high and they lack pricing power.
As a result, labour and capital productivity growth of organized manufacturing sector has declined over the years. After global financial crisis (2008-09 to 2014-15), labour productivity growth in India has declined from 7.52% to 4.54%. Capital productivity growth has turned negative to -0.04% from 6.10% in previous period. (2000-01 to 2007-08)[1]

For gainful employment, it is important that people get jobs in sectors that have high labour productivity. However, people exiting agriculture are finding unskilled jobs in livestock, or trade. Sectors like trade, transport & storage, hotels & restaurants and education have not seen much labour productivity growth[2]

In fact, lower labour productivity growth explains why these sectors needed and could absorb more workers.
But the sectors with low labour productivity could not contribute substantially to the economic growth. Wholesale & retail trade, livestock and manufacturing had highest employment among non-farm sectors, but their gross value added per employee were very low.

To a certain extent, government’s emphasis on small and medium scale industries and startups is responsible for the fragmented economy and low productivity environment. The government has prioritised MSME sector in terms of taxes, credit availability and labour laws at the cost of large corporates.

However, a case needs to be made that unless any company reaches an optimum scale, it cannot reap the benefits of economies of scale, enhance productivity, reduce costs and be price, quality competitive in international market. There is a difference between factories that are tiny and factories that are in a nascent stage. Some will be able to scale up, some will never be able to. Policymakers need to differentiate such “dwarfs from babies” and create a policy environment where smaller firms can close or merge with bigger firms, when necessary. Flexible labour laws and insolvency code are of utmost importance for smaller firms to be able to close unprofitable business. At the same time, large firms should be given incentives based on the number of regular jobs they create.

Demonetisation and GST have already pushed numerous small firms to its boundaries. They must either remain competitive and tax compliant to survive or shut down. Large and mid-sized firms can take this opportunity and go for aggressive mergers and acquisitions to take benefit of economies of scale.

Another way of consolidating the employment in any sector is giving incentives to platform players or aggregators (like Ola/Uber/Airbnb) who essentially provide necessary ecosystem to the small entrepreneurs without having them to invest in the entire supply chain themselves. Such platforms eliminate the information mismatch in the market proving beneficial to consumers as well.

[1]- Author’s own calculations based on Annual Survey of Industries.
[2]- RBI KLEMS database on productivity