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.
• The perception of small firms being significant job creators pervades because job destruction by small firms is ignored in this calculus: small firms find it difficult to sustain the jobs they create.
• In contrast, large firms create permanent jobs in larger numbers. Also, young firms create more jobs at an increasing rate than older firms.
• 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.
• Deregulating labour law restrictions can create significantly more jobs, as seen by the recent changes in Rajasthan when compared to the rest of the states.

1. Job creation in large numbers remains an urgent imperative to provide financial and social inclusion in the country.
2. India’s working-age population will grow by 97 lakh and 42 lakh per year in the 2020s and 2030s respectively.
3. With the Labour force participation rate (LFPR) at about 60% in the next two decades, about 55-60 lakh jobs will have to be created annually over the next decade.

• Small firms: Those employing less than 100 workers.
• Relatively Large Firms: Those employing 100 or more workers.
• Infants: Firms that are small and less than 10 years.
• Dwarfs: Firms remaining small and are older than 10 years.

According to the Annual Survey of Industries (ASI) 2016-17:

• Dwarfs account for half of all the firms in organized manufacturing by number, 14.1% of the employment and only 7.6% of the Net Value Added (NVA).
• In contrast, young large firms account for only 5.5% by number but contribute 21.2% of the employment and 37.2% of the NVA.
• Large, but old, firms account for only 10.2% by number but contribute half of the employment as well as the NVA.
• Thus, large firms are the biggest contributors to employment and productivity in the economy. However, Dwarfs dominate the Indian economy and holds back job creation and productivity.
• This contradicts the notion that small firms generate the most employment. higher levels of job creation in small firms co-exist with job destruction, thereby leading to lower levels of net job creation.

• Young firms account for about 30% of employment and 50% the NVA. This share trend downwards with an increase in firm age.
• Thus, it is the young firms that contribute significantly to employment and NVA as compared to the small firms.
• The average 40-year-old firm in the U.S. and Mexico generates 5 and 2 times more employment than the average 40-year old Indian firm, respectively.
• The average productivity level for 40-year-old enterprises in the U.S. and Mexico was more than
• 2.5 and 1.7 times more productive than the average 40-year old Indian firm.
• Thus, the comparison with other countries highlights that both employment creation and productivity do not grow adequately as firms age in India.

Role of Policy that incentivize Dwarfs       

• India has a plethora of labour laws and regulations, both at the centre and the state levels that exempts smaller firms from complying with these legislations.
• The transaction costs in complying with such regulations creates incentives for firms to remain small.

State-wise trend

• The state-level survey that was conducted by OECD and updated in 2013-14 classifies states as flexible and inflexible based on the restrictiveness of the labour regulations.
• The Flexible States, on average, contribute more to labour, capital and productivity (in terms of workers, capital and NVA per factory) and are increasing at a faster pace than the Inflexible States.
• Also, Inflexible States prefer substituting labour with capital due to rigid labour laws.
• Thus, it is evident that the inflexible states are unable to create enough employment, attract adequate capital and their wages are lower due to low productivity.
• But, flexibility in labour laws creates a more conducive environment for growth of industry and employment generation. For example, on average, plants in labour-intensive industries and in flexible states, such as Uttar Pradesh, Gujarat are 25.4% more productive than inflexible states like West Bengal or Chhattisgarh.
• Also, Post labour reforms in 2014-15, the average number of large firms have increased at a significantly higher rate in Rajasthan than in the Rest of India.
• This clearly shows the effect of labour regulations that incentivize the small firms over large firms.

The Small-Scale Industries (SSI) reservation policy was introduced in 1967 to promote employment growth and income re-distribution by reserving certain products for these firms.

Impact

• The size of the plant and machinery, the criteria which was used until recently to define MSMEs, increased the most among firms just below the threshold for being considered as a small-scale industry (SSI).
• Thus, the small-scale reservation limited the firms to grow as it would mean losing out the benefits.
• It also caused substantial misallocation of resources and productivity losses to the Indian economy as
  • It substantially lowers the average capital to labour ratio when compared to the efficient level.
  • It creates lower capital accumulation, lower demand for labour and low market wage rate than the efficient level.
  • It results in inefficient allocation of managerial talent, which in turn affects productivity.
  • The inefficient allocation of resources increases the price of manufactured products, which makes them uncompetitive in a global economy.

De-reservation of SSI

• From 1997 to 2007, several product categories reserved for small-scale firms were eliminated in a phased manner.
• Empirical evidences suggest that lifting of the SSI reservation policy would increase output per worker by 3.2%, capital per worker by 7.1% and Total Factor Productivity (TFP) by 0.8% in India.

• Job creation: Maximum among the largest firms (500+ employees), especially the new firms that started producing de-reserved products and least among the small firms (50-99 employees).
• This is attributed to the removal of constrains such as the ceiling on production of the SSI reservation policy.
• Job destruction was the maximum among the smallest firms both old and young and less among the large firms.
• Thus, Net job creation increased with firm size and decreased with firm age.
• Overall, it shows that infants, not dwarfs, contribute significantly to job creation and productivity in the economy.

• MSMEs that grow not only create greater profits for their promoters but also contribute to job creation and productivity in the economy.
• Hence, our policies must focus on enabling MSMEs to grow by removing the above-mentioned barriers.
• Some suggestions are as below;
• Incentivizing ‘infant’ firms rather than ‘small’ firms by removing the Incentives that are provided irrespective of age using Aadhar based identification of firm owners.
• Sunset Clause for all incentives with a certain time frame after which the firm should be able to sustain itself this will help foster growth by focusing on infant firms.
• Re-orienting Priority Sector Lending (PSL) by prioritizing ‘start ups’ in high employment elastic sectors which would enhance direct credit flow to sectors that can create the most jobs in the economy.
• Focus on High Employment Elastic Sectors that would increase employment such as 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.
• Focus on Service Sectors with high multiplier effect on job creation such as Tourism in all states by building road and air connectivity in key tourist centers will boost economic activity and reduce the migration of the rural labour force.