Making SMEs Aatmnirbhar Again
By Aman Agarwal & Aanandi Arjun
Introduction
As of 15th May 2020, over 4.6 million people have tested positive for the Coronavirus with more than 3 lakhs lives lost. The disease which reportedly began in the Chinese province of Wuhan back in December 2019 has now spread across the globe, putting healthcare facilities to test. Without any approved treatment available, many nations have put into effect stringent lockdown regulations aimed at containing the spread of this highly infectious disease. While such policies are imperative to avoid ruin (here: death), they have also distorted global supply chains and brought economic activities to a standstill. Such a situation is bound to have both short and long term impacts in the form of massive unemployment and increasing poverty, which the IMF predicts may be ‘the worst economic fallout since the Great Depression.’
China, having contained the spread of the virus may come out of the pandemic as a ‘winner,’ both in terms of keeping the ‘reported’ death toll relatively low and becoming a global supplier of medical equipment to overwhelmed healthcare systems. However, many countries including China’s allies have demonstrated their lack of trust in China for having concealed the onset of the pandemic leaving nations unprepared. Donald Trump, the President of the United States, has repeatedly attacked China and the World Health Organisation (WHO) for their failure in ringing an alarm that could have otherwise prevented this ongoing tragedy. Mr. Trump recently referred to China’s actions as an ‘attack worse than Pearl Harbour and 9/11.’
Considering a shift in corporate outlook in light of geo-political situations in the last few years, Sino-American relations, the rise of south-Asian countries as viable alternatives and recently Covid -19, many firms are looking to move their production units out of China. Possible alternatives for foreign investors apart from India include Vietnam and Bangladesh. Although India is endowed with factors of production such as land and labour in abundance, foreign investors can only be lured by continued business friendly laws and uncomplicated regulations.
According to a report by The Economic Times, the Union Government has reached out to 1000 companies in the US to encourage them to shift production to India. With Japan and South Korea on their heels, India has also started looking inward to make the shift easier for companies.
With the ongoing debate surrounding the steps taken by the government including the announcement of the economic package as a part of the Atma-Nirbhar Bharat Abhiyaan, the future prospects in manufacturing need to be scrutinised.
Manufacturing & the Missing Middle
Developing economies, endowed with a large low-income labour force have tremendous potential for growth. Adequate policies and a systematic plan of growth can help bring prosperity to these economies mostly by a focused approach to the manufacturing sector. Manufacturing units are generally classified into Small, Medium, and Large Scale Industries based on metrics such as capital invested and workers employed. Different protocols and guidelines apply differently to units based on their scale of production. The general trend observed is that there is a gradual movement of Small and Medium sized industries towards a Large unit taking advantage of economies of scale.
However, the progress of the manufacturing sector in most developing economies is hindered by a problem known as the ‘Missing Middle’ meaning between the two extremes of micro and very large firms, there are very few SMEs (Small and Medium sized enterprises). A study by Dun & Bradstreet (D&B) India reveals that for every 100 entities in India, there are over 95 micro enterprises, four small & medium and less than one large entity. However, in developed countries, around 50–55 entities are micro and 40 are small & medium enterprises. These mid-sized firms generally employ workers in the hundreds, with a turnover of $2 million to $100 million.
Source: Asim Khwaja, Center for International Development at Harvard University (Image taken from PovertyCure)
In his book ‘Reset: Regaining India’s Economic Legacy,’ Dr Subramanian Swamy emphasized that the socialist ideology that informed the economic policies of the post-independence era caused a “monumental loss of opportunity.” India could have taken the path that countries like Japan, South Korea and Singapore took where the governments based their economic strategies on “incentives based on reasonable taxation of the individual.” Arvind Subramanian in his works like ‘Of Counsel: The Challenges of the Modi-Jaitley Economy’ and ‘The Economic Survey 2017–18’ highlighted that efforts had begun to shift India away from a prevailing mindset he described as “stigmatised capitalism,” which, in turn, had earlier replaced one of “crony socialism.” Post-independence, the emphasis of growth was on industrial manufacturing which then shifted towards agriculture and finally a service-led economy without adequate manufacturing capabilities. Unlike other Asian economies that can trace their economic ascent to export-led manufacturing, India has never been able to develop this sector of its economy and thus, to reap the benefits of export-led growth. The fact that India, unlike South Korea or Japan, was unaligned and thus unaided by the United States during the Cold War also prevented the related economic benefits.
Small & Medium Enterprises (SMEs) contribute significantly to the economic and social development of a country by fostering entrepreneurship and generating the largest employment opportunities at comparatively lower capital cost. While most owners of micro businesses in India dream of following the upward trajectory towards SMEs, they are simply unable to grow. Understanding the reasons why these micro enterprises fail to grow and the need to address the problems are imperative to unleash the true potential of manufacturing in India. Lower taxes, reduced regulation and a friendlier business environment will help address the problems in the manufacturing sector. This will make easier the transformation of micro and small firms into medium sized enterprises hence solving the missing middle problem.
Why India lags behind
The Indian industry has been deprived of investment funds and there was never adequate investment in infrastructure — especially power, roads, ports and airports. There has been a lack of focus in those manufacturing sub-sectors where India has an inherent advantage and no sector-specific policies or packages to attract investment. For a long time India ignored manufacturing as a potential tool for growth and has relied on services sector which include software and IT enabled services. However this approach cannot boost potential income and help the existing workforce because employment in manufacturing only requires on-the-job training whereas employment in the formal services requires at least college-level education. Hence, since growth is dependent on the services sector to a larger extent requires a large portion of the workforce to be imparted with the necessary high-skilled education. However, considering the inadequacies of higher education in India, there can be no skipping the secondary stage, i.e. manufacturing.
Due to the various stringent labour laws, smaller firms operating on the margin are incentivized not to expand the workforce so that they are able to circumvent these laws. On the other hand, if the laws become more flexible and business-friendly, their execution becomes easier because of the willingness of all businessmen to implement it. Stringent labour laws, being rarely executed, are detrimental to the interests of workers as they cannot reap any benefits from such regulations. According to Jagdish Bhagwati and Arvind Panagariya (2013), India has been unsuccessful at creating jobs in the formal economy, especially manufacturing, in part because of a choking jumble of 200 national and state-level labour laws.
The Economic Survey 2019–20 under the title Entrepreneurship and Wealth Creation at the Grassroots states that, ‘As the manufacturing sector has the greatest potential to create jobs for our youth, enhancing ease of doing business and implementing flexible labour laws can create the maximum jobs in districts and thereby in the states.’
Based on a study, the Economic Survey 2018–19 makes a crucial assertion that three of the regions in the highest quintile of entrepreneurial activity in manufacturing — Gujarat, Punjab and Rajasthan — were classified in a prior economic survey as states with flexible labour laws whereas states with inflexible labour laws such as West Bengal, Assam, Jharkhand, Kerala and Bihar were classified in the lowest quintiles of entrepreneurial activity. Hence, there is conclusive evidence to state that there exists a strong positive correlation between the flexibility of labour laws and growth.
Reverse Migration — A New Opportunity
The COVID-19 pandemic has brought human activities (economic or otherwise) and daily human activities around the world to a standstill. India has also observed a stringent lockdown, which has also come at a high economic cost. As production has come to a standstill and businesses have no source of revenue, producers are constrained to either reduce wages when there is no capacity to hire more workers or to terminate their employment.
With the lockdown and layoffs coming into effect, a large mass of formerly stable, albeit barely working populace finds itself helpless. A large share of migrant workers returning to their native towns is from Uttar Pradesh, Bihar and Madhya Pradesh. Thus these states find themselves responsible for the well-being and survival of an additional number of workers , many of whom may continue to stay back even after the lockdown is lifted due to a potential loss of livelihood. Uttar Pradesh alone may see an influx of at least 15,00,000 workers. Reducing regulatory burdens for small and micro enterprises, would pave the way for them to hire some of these workers, even if only in the aftermath of the pandemic.
The laws in Uttar and Madhya Pradesh have been repealed for 1000 days (approximately 2.5 years) to not only make the process of setting up of industrial units easier but also to help the existing small production units operating at the lowest scale of production. While many may visualize the suspension of these laws as ‘unconstitutional’, there is a need to take into consideration the fact that it is equally important to protect the small producers who are burdened by these regulations with the lockdown making matters even worse. While it is not in dispute that it is the state’s responsibility to ensure the survivability of all its citizens, such a function cannot be transferred in totality to small businesses especially those with no immediate source of revenue . The government needs to consider the interests of producers and labourers, so that a ‘balanced’ plan of action is put into place to support all sections found wanting as a result of the pandemic. There is no denying the importance of a revamp in labour laws and better synchronization of the needs of the employer and employee.
With respect to labour laws, another important aspect is the Industrial Relations Code 2019, the report of which has been submitted by the Standing Committee in April 2020. The Code provides for the recognition of trade unions, notice periods for strikes and lock-outs, standing orders, and resolution of industrial disputes. It subsumes and replaces three labour laws: the Industrial Disputes Act, 1947; the Trade Unions Act, 1926; and the Industrial Employment (Standing Orders) Act, 1946. The Second National Commission on Labour (2002) found existing legislation to be complex, with archaic provisions and inconsistent definitions. To improve ease of compliance and ensure uniformity in labour laws, the Bill was introduced in the Lok Sabha in November, 2019 and while it is yet to be voted on in the Parliament, it shows the intent of law makers to ease the process of and reduce compliance costs.
Coda — Atmanirbharta?
As per the earlier definition from the MSME Act, 2006, manufacturing units were classified based on their investment in plant and machinery. So, a micro-unit was one with investment of up to Rs 25 lakh, a small enterprise with investment between Rs 25 lakh and Rs 5 crore and a medium one with investment between Rs 5 crore and Rs 10 crore. While enumerating the details of the economic package within what is termed the Atma-Nirbhar Bharat Abhiyaan, Finance Minister Nirmala Sitharaman announced revisions in this definition on 13th May2020. Now, a micro firm is one with investment up to Rs 1 crore and turnovers of less than Rs 5 crore. A small firm is defined as having an investment of up to Rs 10 crore and turnover up to Rs 50 crore while a medium-firm will be one with an investment of up to Rs 20 crore and turnover under Rs 100 crore. This change in classification is important because the low threshold in the old MSME definition prevented them from growing as the benefits of size expansion were outweighed by the cost of regulatory compliance. Regulations applicable to firms above the threshold size incentivized the firms to stay put below that threshold.
The package allocates Rs 3 trillion for collateral-free loans. The loans have a four-year tenure with no payments due for one year. It also allocates Rs 20,000 crore for subordinate debt aimed at helping currently stressed MSMEs along with a further infusion of Rs 50,000 crore in equity funds for MSMEs. These announcements are important as it will most likely have a significant impact in helping as many as 45 lakh MSMEs pay salaries and keep their heads above the water even though demand has been slowing down.
While the relief measures would indeed be a welcome step for the SME sector, it faces several other issues that need to be addressed to not only ensure their survival amidst the lockdown but also to facilitate growth once normalcy is restored. A localist approach aimed at addressing issues specific to units operating in a particular region and to reap benefits of factor abundance and geographic conditions to its comparative advantage is advocated by the authors. Proper implementation of schemes such as ‘One-district-one-product’ will ensure economic growth, decentralization while also making smaller administrative units self-reliant.
Ultimately, there is a need for public commentators and policy makers to realize that the consequences of the virus and the lockdown are for all and such consequences are dynamic and interlinked, even if with different intensities. The relief package is an indication that steps are being taken in that direction. The preparation for ‘normalcy’ (if we see a return to how things were before) must be made with prudence and reforms must not be restricted to easing out the burden during the pandemic alone. While uncomplicated regulations and easier compliance is indeed welcome, India still has miles to go on these fronts. Rahm Emanuel’s words on “never [letting] a serious crisis go to waste” must not mean enacting policies merely for a crisis and then letting slip any possibility of a reform for the future. To serve political narratives while ignoring tangible economic considerations, one of which remains India’s missing middle will be an error — and one India cannot afford to make.
About the Authors
Both authors are students of Economics at Shri Ram College of Commerce. Aman is a research intern at the IYEA.
