UPSC Civil Services Exam: MSME Growth As Explained In Economic Survey, Summary For IAS Aspirants (Part IV)

In the part II of this series, we had discussed “Dwarfs” as described by the Economic Survey 2019.

• The survey says that Indian Economy is dominated by “dwarf” firms, that never grow beyond their small size. It defines “dwarfs” as firms with less than 100 workers despite being more than 10 years’ old.
• “Dwarfs” account for half of all the firms in organised manufacturing sector, yet their share in employment is only 13.3 per cent, and share in NVA is a miniscule 4.7 per cent.
• Firms that are able to grow over time to become large are the biggest contributors to employment and productivity in the economy
• The Survey makes policy-suggestions to end the incentivisation of remaining a “dwarf” in Indian economy

Chapter 3 of the Survey is dedicated to the subject of MSME growth. It says that MSMEs need to be “unshackled” to produce the desired growth rate, productivity increase and job creation. There are two shackles that the survey discusses,

• size based incentives that don’t take into account the age of the firm like priority sector lending, GST composition scheme, exemption under central excise law, marketing assistance scheme, SSI reservation
• inflexible labour regulations which contain size-based limitations

The Survey also makes following observations.

• A well-paying job constitutes the best form of financial and social inclusion to not only the individual but also his/her entire family
• With population growing at more than 95 lakh per yer in the next decade, and labour force participation remaining at 60 per cent, India needs to create 55-60 lakh jobs per year in the next decade.
• Firms that grow up to be large are the greatest contributors to job creation and productivity. Dwarfs remain the lowest.
• The common notion that small firms produce the most jobs is a myth. They have higher job creation but also job destruction, therefore the net job creation remains low
• Both US and Mexico have, around 5 and 1.4 times respectively, higher ratio of employment at 40 years' firm age and employment when firm is newly set up. For productivity, the corresponding number is 2.5 and 1.7 times respectively.
• The Survey compares states which are “flexible” and “inflexible” in terms of their labour laws, and shows that former contribute more to labour, capital and productivity, on average, and growth rate of these indicators is also higher for the former.
• Due to rigidity in labour laws in “Inflexible” states, manufacturers prefer substituting labour with capital
• Rajasthan, after the reform of its labour laws in 2014, saw positive change in terms of employment, capital and productivity.

The Survey argues that Indian policies, across the board, promote “dwarfs” rather than “infants”. These policies create a “perverse” incentive for firms to remain small, whereas it is the “infant” firms, which are also more likely to be small, contribute more to labour, capital and productivity. Therefore, the policies discussed above, like SSI, cause misallocation of resources.

Incentivising ‘infant’ firms rather than ‘small’ firms

• Appropriate grandfathering of existing incentives, with use of Aadhaar to avoid misuse. Age-based policies can be implemented to ensure removal of the perverse incentives
• With appropriate grandfathering, every incentive for fostering growth should have a ‘sunset’ clause, say, for a period of five to seven years after which the firm should be able to sustain itself. The policy focus would thereby remain on infant firms
• Focus on high employment elastic sectors: reorienting Priority Sector Lending (PSL) to prioritise ‘start ups’ and ‘infants’ in such sectors. Rubber and Plastic Products, and Electrical and Optical Equipment are two examples
• Focus on service sectors with high spillover effects. Example, Tourism