Nourishing Dwarfs to become Giants: Reorienting policies for MSME Growth

The Union Minister for Finance and Corporate Affairs, Smt. Nirmala Sitharaman tabled the Economic Survey 2018-19 in Parliament today.

For reorienting policies for growth in the MSME sector, the Economic Survey states that MSMEs that grow not only create greater profits for their promoters but also contribute to job creation and productivity in the economy. Our policies must, therefore, focus on enabling MSMEs to grow by unshackling them.

Job creation in India, however, suffers from policies that foster dwarfs, i.e. small firms that never grow, instead of infant firms that have the potential to grow and become giants rapidly. While dwarfs, i.e., firms with less than 100 workers despite being more than ten years old, account for more than half of all organized firms in manufacturing by number, their contribution to employment is only 14 per cent and to productivity is a mere 8 per cent. In contrast, large firms (more than 100 employees) account for three-quarters of such employment and close to 90 per cent of productivity despite accounting for about 15 per cent by number.

Size-based incentives that are provided irrespective of firm age and inflexible labour regulation, which contain size-based limitations, contribute to this predicament. To unshackle MSMEs and thereby enable them to grow, all size based incentives must have a sunset clause of less than ten years with necessary grand-fathering.

Way Forward – Incentivizing MSMEs

MSMEs that grow not only create greater profits for their promoters but also contribute to job creation and productivity in the economy.  Our policies must, therefore, focus on enabling MSMEs to grow by unshackling them.

Small firms that have continued to remain small despite aging, have low productivity and low value added in manufacturing.  In contrast, infants, i.e., small firms that are small when they are young but can grow to become large firms as they age, have high productivity and higher value added in manufacturing.  Therefore, while dwarfs consume vital resources that could possibly be given to infant firms, they contribute less to creation of jobs and economic growth as compared to infant firms.  This necessitates re-calibration of policy towards supporting infant firms as detailed below:-

Incentivizing ‘infant’ firms rather than ‘small firms:  With the appropriate grandfathering of existing incentives, they need to be shifted away from dwarfs to infants.  When such incentives are provided to firms irrespective of their age, the incentives create “perverse” incentives for firms to stay small.  Such perverse incentives would not be there if age is the criterion.  Misuse of the age based criterion can be easily avoided using Aadhaar.  For instance, if a promoter starts a new firm, utilizes the benefits for ten years when the age-based policy is available and then closes the firm to start a new one to avail the age-based benefits through this new firm, then the Aadhaar of the promoter can alert authorities about this misuse.  Therefore, given the benefits of Aadhaar, the age-based policies can be implemented to ensure removal of the perverse incentives.  Once small firms know that they would receive no benefit from continuing to remain small despite aging, their natural incentives to grow would get activated.  This will generate economic growth and employment.

Re-orienting Priority Sector Lending (PSL):  As per extant policy, centain targets have been prescribed for banks for lending to the Micro, Small and Medium (MSME) sector that exacerbates perverse incentives to firms to remain small.  As per PSL guidelines, 7.5 per cent of Adjusted Net Bank Credit (ANBC) or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher is applicable to Micro enterprises.  Under MSME’s PSL targets, it is necessary to prioritize ‘start ups’ and ‘infants’ in high employment elastic sectors.  This would enhance direct credit flow to sectors that can create the most jobs in the economy.

Sunset Clause for 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:  The manufacture of rubber and plastic products, electronic and optical products, transport equipment, machinery, basic metals and fabricated metal products, chemicals and chemical products, textiles and leather & leather products, are the sub-sectors with highest employment elasticities.  To step-up the impact of economy growth on employment, the focus has to be on such high employment elastic sectors.

Focus on Service Sectors with high Spillover Effects such as Tourism:  Developing key tourist centres will have ripple effects on job creation in areas such as tour and safari guides, hotels, catering and housekeeping staff, shops at tourist spots etc.  It is possible to identify 10 tourism spots in each of the larger 20 states and 5 spots in the 9 smaller states and build road and air connectivity in these tourist attractions, which would boost economic activity along the entire route and would also reduce the migration of the rural labour force who form a major proportion of the total labour force.