GST Is Softly Killing Sub-Optimal Firms, Boosting Formalisation And Impacting Short-Term Jobs Growth

If Narendra Modi is asked what is his achievement in jobs, he should talk quality rather than quantity. New evidence in job creation indicates that the National Democratic Alliance (NDA) government’s game-changing shift relates more to jobs formalisation than any significant quantum leap in net job creation.

According to a study of hiring trends in 1,610 companies by CARE Ratings, over the last two years (2016-17 and 2017-18) big companies created net new jobs while smaller companies destroyed them. A report in Business Standard summarising the CARE report says that 705 small companies – more than 40 per cent of the sample – cut jobs. The smallest among them (net sales below Rs 50 crore) reduced jobs by 3.9 per cent in 2017-18 over and above the previous year’s cut of 7.3 per cent. Clearly, demonetisation and the goods and services tax (GST), have made small companies wither at the roots, forcing formalisation and job creation in larger companies.

At the other end of the spectrum, the biggest companies (those with annual sales of over Rs 10,000 crore) saw jobs growth accelerate from 3 per cent in the year of demonetisation (2016-17) to 4 per cent in the year of GST (2017-18).

While this is not good news for any government in an election year, there is little doubt that over the long run, formalisation of jobs and the elimination of sub-optimal smaller companies that survive only by avoiding taxes or to grab small sector benefits, will put India Inc on a sounder footing.

As Manish Sabharwal of TeamLease, a manpower services firm, told me in an interview published in my book, The Jobs Crisis in India, our problem is wages, not jobs per se. Jobs are in plentiful supply at low wages, but not at levels where people are willing to take up work. This is reflected in the Centre for Monitoring Indian Economy’s Unemployment studies, which show a more than 4 per cent drop in the labour participation rate (which is those employed plus those actively looking for jobs) from 46.9 per cent in January-April 2016 (before demonetisation and GST) to 42.7 per cent in May-August 2018 (post-GST). Worse, this trend may be impacting the women’s labour participation rate more than that of men (see here).

Overall, though, if we assume that informal labour means exploitation and low wages, the trend towards formalisation is good over the long term.

Sabharwal told me: “In my view, there are two kinds of small enterprises: baby and dwarf. Both are small but the baby is going to grow and the dwarf isn’t. India is a nation of corporate dwarfs, not babies. You can have small enterprises, but people use small and informal interchangeably. Informal is illegal, small is beautiful. Illegal has to go. In India, there is a transmission loss between how the law is written, and how it is interpreted, practised and enforced. That is one reason why we have a wage problem. Informal enterprises cannot attract credit, they cannot attract talent, they cannot build brands, and therefore they are dwarfs. And dwarfs don’t pay proper wages. When everybody is working for dwarfs – dwarfs are synonymous with (low) productivity and informal dwarfs are even more synonymous with it - how will wages rise?”

The difference between India and China is that we have too many dwarfs, and too few small companies that want to grow. Sabharwal said: “If you look at the 90th and 10th percentile of companies by size (in India), there is a 24 times difference in productivity between big and small. If you have that much difference, why would a small company pay a wage premium? In China, that difference between the 90th and 10th percentile is six times. And 24 times is the difference between informal and formal (here). The point is, if you don’t pay the wage premium you will never be productive. You are stuck in this low-level equilibrium of too many enterprises, low productivity and no wage premium.”

What the CARE Rating study tells us is that we are on the right track. But there is no denying the short-term impact on net jobs growth, where sub-optimal enterprises are being forced to either up their game and productivity through formalisation or shut shop and leave the arena to more serious players.