Do We Know What We Want With MUDRA Loans?

Towards the end of April this year, the Government of India released its Annual Survey of Industries (ASI) report for 2013-14. It is the most comprehensive survey and source of reference on the factory sector in India. It has been little commented upon, but we need to take a good look at it since it impinges on the policy of encouraging the personal sector. Even at the risk of making an exaggeration, it is fair to say that the evolution of the Indian economy in the future rides on finding the right policy response to the size of units in the Indian production system.

Balancing employment, capital and output

Let us first take a look at the opening paragraph of Section 7 of the document, ‘Annual Survey of Industries 2013-14 – summary results for the factory sector’.

“Statements 11A and 11B indicate a skewed distribution in the sense that there are larger number of factories with low employment size and a fewer with higher number of employment size.

For example, out of an estimated number of 1,85,690 factories in operation, 1,34,944 factories are found to employ less than 50 employees each.

Further, there is a, by and large, heavy concentration of various attributes like fixed capital, gross output, net value added etc., among the factories belonging to the higher employment size classes.

While the lower size classes (up to employment size of 50) has largest concentration of operating factories (72.68%), it utilizes only 7.06% of the fixed capital, provides employment to 15.62 % of the employees, produces 11.18% of the gross output and generates 7.71% of national income in the form of net value added by manufacture.

On the other hand, the operating factories, each of which employ 200 or more employees, constitute 9.06% of the operating factories, utilize 78.61% of the fixed capital, provide gainful employment to 61.44% of the employees, produce 71.15% of the gross output and generate 75.78% of net value added by manufacture.

The very large operating factories employing 5,000 or more employees each, constitute only 0.22% of the operating factories, however, engage 8.54 % of employees of industrial sector, utilize 17.85% of the fixed capital, produce 13.56% of the gross output and contribute 14.87% to the net value added.”

(Source: Paragraph 7.1.1, Section 7 (‘Distribution of Factories in Operation by Size of Employment’), page S7-1 or page 55 of the PDF document, ‘Annual Survey of Industries (ASI) 2013-14,’ released on 27 April 2016)

The factories that are included in the ASI are considered part of the formal sector. The observations immediately throw up challenges that the Indian economy faces. They are the twin challenges of capital/employment ratio and output/employment ratio. The large number of small units seem to be creating two jobs per unit of capital, whereas the tiny number of large units have exactly the reverse ratio for jobs per unit of capital. That, prima facie, vindicates the emphasis on labour over capital.

Further, if one accepted the fact that India’s savings rate is stuck at around 30 to 32 percent, and that importing foreign capital imports other problems as well, it makes sense to encourage those units that generate more employment per unit of capital than the other way around.

Measuring for outcomes

Unfortunately, things are seldom this straightforward. There is the output angle. There, the tiny units fare rather poorly. Their output/employment ratio is the reverse of large units and mid-to-large sized units (200 or more employees). Unfortunately, India does not have the luxury of choice. It has to ride both the horses because it is a latecomer to the game of achieving sustained economic growth. Its production system – farms or factories – have to create employment and generate output as well.

Of course, one may claim that small enterprises in the services sector are more productive. How does one measure that? Does India even collect the data to make such a claim?

One of the signature initiatives of this government is MUDRA loans and the Prime Minister’s stated ambition of creating the personal sector. On what basis are MUDRA loans being made to the micro, small and medium enterprises? What conditions are imposed on the enterprises to avail of these loans, in terms of efficiency, productivity, employment and output generation?

Some have cited anecdotal evidence to show that borrowers have added assets through loans availed of under the MUDRA loan scheme. Those stories are positive in the sense that the loan has not been used for consumption ends but for asset expansion. That is a good first step. The more important test is to see how these assets help them grow revenues – asset turnover, employee productivity are key metrics.

Further progress towards a larger size – from micro to small to medium to large – is key. There are also studies that show that incentives for small players have the perverse effect of keeping them small as they fear losing them once they grow out of those sizes. The ASI paragraph cited here suggests clearly that large factories utilise more assets and generate more output per unit of employment. Of course, the number of employees per unit is also high.

With any financing programme, there is always the question of opportunity costs of resources. The scheme may be electorally rewarding, but is this ‘personal sector’ approach a better bet for employment generation than incentivising and facilitating firms and businesses to grow bigger and disincentivising them from staying small?

There needs to be an open mind on this question, and it has to be decided on empirical data. It is important to track the systemic consequences and effects of MUDRA loans rather than tracking the amount of loans disbursed alone and the purpose for which the loans have been put to use. The outcomes are critical because this particular programme is almost the ‘do or die’ stuff for long-run economic prospects for the country.

Informality is an obstacle to economic progress

Lastly, international economic history over centuries is clear, and there is no ambiguity: no country has graduated to better economic status (lower middle income, middle income, etc.) with as big an informal sector as India has.

See Table I and Table III of the report here. India is one of the world’s largest informal economies. Table III on the labour force participation rate shows that India has the somewhat dubious distinction of having the third-lowest labour force participation rate. Only Egypt and Honduras are worse than India.

We should also pause to reflect on the following observations carefully. They have an extraordinary relevance and application to India:

Countries with large informal economies tend to experience more frequent growth crises and extreme growth events. Taken together, the two parts of the chart suggest that even though growth acceleration may occur more frequently in countries with larger informal economies, the risk of sudden stops and economic crises is also significantly larger in these countries, preventing sustainable long-run economic expansion. It should be noted that this illustration does not causally link the two phenomena but suggests an empirical regularity. [Link – Chapter 5]

Growth acceleration and sudden stops should sound very familiar to those who study India’s macroeconomy. That is why it is important not to fall back into the habit of celebrating small and personal sectors and implicitly encourage and entrench informality in the economy.

False choices and side effects

It is rhetorical to ask whether India needs to create 100 large units with each one employing 2,000 people, or ensure 20 million small businesses add one employee each. A country of 1.3 billion people cannot afford to exclude scale considerations. Scale is inevitable, even if not entirely desirable and carrying side effects. Post-independence, India made that false choice and favoured production in small-scale units while simultaneously placing obstacles on size. Such an approach has nothing much to show for it, in terms of either job creation or output generation. Indeed, such an approach does not address the aspirational needs of a young population. It militates against the upgrading of knowledge and skill. It could end up being a journey to the lowest common denominator.

In theory, the present government may not be against large businesses; but in reality, circumstances are pushing the country down that path. The corporate sector is over-leveraged and is still working off its debt load. Public sector banks are being recapitalised only slowly. They are not making loans to large businesses. That is why credit growth to industries has slowed considerably. Private sector banks are lending, but they are mostly personal loans, however.

With MUDRA loans from government-owned banks and personal loans from the private sector dominating the bank credit, Indian economy’s skew, imbalance and low productivity would worsen further.

The ‘personal sector’ approach is more suited to societies that are far more diffused, smaller and autonomous. Under certain assumptions and a certain social context and milieu, emphasising the personal sector may have been the ideal approach. But, we may be imposing an ‘idyllic’ solution without ensuring pre-existing conditions and context for it. It may even be impossible to create such a world.

Let us be very clear. It is important, essential and correct to help the marginal and small farms and factories. However, the goal must be clear. It must be to help them grow bigger and not to keep them loyal to their sizes at birth. A small baby is a joy to watch, but in adults, it signals poor health.