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Growth Potential: Enable MSMEs to scale up

Dynamic SMEs scaling up and increasing the share of medium & large enterprises in the jobs pool over 2000-01 to 2015-16 shows policies must not incentivise enterprises to stay small.

MSME sector has continued to remain a thrust area for policymakers as it is argued that the sector is the ‘‘backbone of the Indian industry’.

By Radhicka Kapoor

Traditionally, India has supported and encouraged Micro, Small and Medium enterprises (MSMEs) as it is these enterprises that use labour-intensive methods of production thereby generating the much-needed employment opportunities outside the agriculture sector. Over the years, different policy initiatives have attempted to encourage MSMEs by providing them with subsidised credit, technical assistance, excise tax exemptions and preference in government procurement (Expert Committee on MSMEs, RBI, 2019). The Small Scale Reservation Policy (1967), which attempted to shield small scale units from competition by reserving the production of a number of products for them stands out in this context. In recent times, too, the MSME sector has continued to remain a thrust area for policymakers as it is argued that the sector is the ‘‘backbone of the Indian industry’.

However, there is little systematic data to understand how this sector has contributed to employment generation over time. In particular, the question of whether it is in fact MSMEs or large arms that have been significant contributors to employment over time, across states, across industries and across rural and urban areas deserves attention.

Combining establishment-level data for the registered/formal sector from the Annual Survey of Industries and informal/unincorporated manufacturing sector from the NSSO’s Enterprise Survey of Unincorporated Enterprises for the period between 2000-01 and 2015-16, we seek to answer this question in a recent study (bit.ly/3MagZMg).

We find that the distribution of manufacturing employment across firms of different sizes in India is marked by a bi-modal distribution wherein a large share of employment is concentrated in micro-enterprises followed by large enterprises (see graphic). While the existence of a “U” shaped (or bi-modal) distribution of manufacturing employment by enterprise size referred to as the “missing middle” is widely recognised in the literature, this study finds that over time, there has been an improvement in the employment distribution with the share of medium and large enterprises in total employment rising while that of small and micro-enterprises has been falling. The share of micro-enterprises (defined as those hiring one to ten workers) in total employment has declined by 8.5 percentage points, while that of large enterprises (i.e. those with 250 or more workers) has increased from 20.5% in 2000-01 to 30.3% in 2015-16. The share of small enterprises (i.e. those with 10 to 49 workers) in total employment has fallen from 21.6% to 17.2% over the 15-year period, while that of medium sized enterprises (i.e. those with 50 to 249 workers) has risen from 12.7% to 16%.

The rising employment share in large enterprises (of almost 10 percentage points over 15 years) is a positive development as these enterprises offer more productive and better paying jobs compared to smaller enterprises. Importantly, the improvement in the distribution of employment is seen not just at the aggregate level but also at a more disaggregated state and industry level.

The increasing share of large establishments in total employment merits attention. It could be a consequence of (i) entry of new large factories and/or, (ii) increase in size of factories that were already in the large category and/or (iii) expansion of small and medium factories that have graduated into large size group. Identifying the drivers of the changes in the employment distribution is important from a policy perspective.

We cannot examine the extent to which each of the above-mentioned factors explain the changes in the employment distribution as the survey design of the establishment surveys does not allow us to track the life cycle dynamics of MSMEs. However, examining stylised facts across firms of different sizes and age cohorts, it appears that the shift in distribution of employment towards relatively larger enterprises is driven, amongst other factors, by the fact that there are some dynamic MSMEs which are expanding and moving up the size distribution.

An important implication of the above observation is that for policies designed to support MSMEs to be effective in employment generation, they should seek to identify transformative enterprises, which have the potential to grow fast and provide them the necessary support to expand and graduate quickly up the size distribution. Policy support for MSMEs should not incentivise them to remain small. In particular, they should avoid indefinitely subsidising subsistence entrepreneurs, i.e., those who are compelled to resort to self-employment or own account employment as a survival mechanism to eke out a subsistence living. Significantly, OAMEs (i.e. those which operate without hired labour) have persistently accounted for 85% of total enterprises in the enterprise landscape, suggesting that such subsistence enterprises are not transitioning to large size categories and are unlikely to become engines of productive job creation.

While policy support should encourage and enable the more dynamic small enterprises to move up the size distribution, the ex-ante identification of such dynamic transformative enterprises from the factory level data available in India is indeed difficult. Nevertheless, it is an important exercise and warrants creative research as it is these potentially transformative enterprises (also referred to as constrained gazelles in the literature) that can build larger businesses and emerge as engines of job growth in the economy if given the right conditions and support.

(Author is a senior visiting fellow at ICRIER. Views expressed are personal and not necessarily that of Financial Express Online.)

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