Ease Of Doing Business: NITI Aayog-IDFC Report Shows Firms Not Feeling All Of Government’s Reforms

If there is one constant in the world of governance, it is this: a government’s policy will always appear rosier on paper than on the ground no matter how much effort is put into blurring the distinction. The best administrators understand this law of governance. This doesn’t mean they give up. They try even harder to move the needle and therein lies the recipe for success in public policy. Keeping an ear to the ground ensures that politicians don’t lose touch with the ground reality and the next election.

The current National Democratic Alliance (NDA) government has vowed to make doing business in the country easy. Prime Minister Narendra Modi wishes to see India break into the list of top 50 countries in World Bank’s Doing Business rankings in five years. The success of ‘Make in India’, the Modi government’s flagship programme, hinges on the level of ease the current administration can ensure in the opening and operating of firms in the country. Unease of doing business can reduce the avenues for making in India which can have drastic impact on job creation and that can be turn very ugly very fast.

The long and the short of it is that the importance of improving ease of doing business in India can’t be overstated. The central government has after all made it one of its top priorities. It understood from the beginning that working with the states is key. It didn’t force any reforms down their throats in a top-down manner. It chose the way of carrots rather than that of the stick. The Department of Industrial Policy & Promotion (DIPP) recommended best practices to states in various areas and then started ranking them on the basis of how well they implemented these reforms. Healthy competition has resulted in many states taking up difficult reforms in important areas like land and labour, which would’ve been impossible to pass with central legislation.

However, all these attempts proved short in making a dent and improving India’s position in World Bank’s Doing Business rankings. Some ministers said the World Bank failed to take note of the government’s stellar attempts at reforming the business climate. Such reactions are uncalled for. First, the government shouldn’t put such a high premium on World Bank’s rankings, which rates India’s performance based solely on surveys in two cities – Delhi and Mumbai. Second, instead of finding fault with the rankings, it should ask itself if the steps taken to improve business environment are actually translating on the ground or do they remain on paper alone.

DIPP and World Bank rankings both have a major flaw: they don’t survey the people with skin in the game, i.e., the firms and their managers, to know if the business climate is improving. DIPP bases its rankings on whether the states have implemented the reforms recommended to them while World Bank bases it on what experts, chartered accountants and lawyers in Delhi and Mumbai think about ease of doing business in India. What of the firms and the people running them? Aren’t they really the best judge of whether the reforms initiated by the government have materialised on the ground?

A report jointly published by NITI Aayog and the IDFC Institute, titled 'Ease of Doing Business: An Enterprise Survey of Indian States', tries to address this lacuna. The report documents views of more than 3,000 manufacturing firms across Indian states and union territories on how good the business regulations and the enabling environment really are. The findings of the survey prove the law of governance yet again.

First, firms in states with high growth rates are likely to face less regulations and enjoy a more enabling environment for business compared to firms in less developed states. This is not surprising. Since doing business in the former is easier, it puts them in a high-growth trajectory and they enjoy the fruits of being in a virtuous cycle.

Second, the awareness among the firms of government’s actions to improve the business climate is shockingly low. The survey found that only 20 per cent of the firms surveyed reported using single-window systems for setting up a business. Even a majority of well-established firms (59 per cent) didn’t know of this tool, which greatly eases compliance burden. It wouldn’t be wise to put the blame for this on the government alone. Businesses should know better, but a government committed to making a difference on this front should do more to disseminate information about its efforts in improving the business environment.

Third, unsurprisingly, our irrational labour laws remain a big impediment to job creation in the manufacturing sector. In the survey, labour-intensive firms reported to have found labour-related regulations “particularly onerous” and “finding skilled workers, hiring contract labour, and firing employees... a major obstacle.” These regulations have forced our firms to remain small. Over 98 per cent of the firms in India employ 10 workers or less and 44 per cent do not employ even a single worker except the owner himself. Only 16 per cent of India’s workforce is employed in medium and large firms with more than 50 workers.

This is a vicious cycle. Regulatory chains of the state do not let firms grow in size, which means their profits remain low and they can’t pay more to their workers. And these firms have no capital to invest in boosting their productivity. No wonder the manufacturing sector’s productivity in India is abysmal compared to other countries. As the report mentions, the wage in small enterprises in China is almost 60 per cent of that in large enterprises, whereas in India, it is only 20 per cent. The contrast in real wages is starker considering that the top wages in China are higher than that in India.

There seems to be a correlation between workforce employed in large enterprises and their productivity. In China’s apparel sector, around 57 per cent of the workforce is employed in firms, which have more than 200 workers, and the country’s exports stood at $187 billion in 2014. In India, only 5 per cent are employed in large enterprises. Is it any surprise then that its exports were a measly $18 billion – less than 10 times that of China.

The report thus rightly calls for changing labour laws “to allow enterprises to grow larger and reap economies of scale, generating productivity improvements, job creation, and higher growth.”

Fourth, enterprises in high-growth states on average reported that monthly power shortages were 10 hours less than those reported by low-growth states. This gap is significant, and the states stuck in the vicious cycle of low-growth in a difficult business climate can try making it a priority area to be addressed.

Fifth, startups are springing up in high-growth states rather than low-growth ones and hence incurring lower costs in regulatory and compliance processes. This again creates a virtuous cycle for high-growth states which are more open for business. The low-growth states must lower the entry burden for new players if they wish to get out of their vicious cycle.

Sixth, larger firms disproportionately share compliance and regulatory burden compared to the smaller firms. This difference is likely to persist for obvious reasons, but states should try to reduce the burden on the larger firms as much as possible.

Seventh, 50 per cent of the firms surveyed do not borrow from financial institutions. Thirty-three per cent of those surveyed reported that a lack of access to finance was a major obstacle. Hence, the states which move to address this lacuna will be better placed in the scheme of things.

The NITI Aayog-IDFC report is an important addition to the literature available for policymakers. It gives great insights by offering the viewpoints of those who have skin in the game.

Major takeaway? Greater the ease of doing business, better the chance for states to enjoy higher economic rates of growth. The states have their work cut out for them.