Big is beautiful in India?

Excessive focus on the biggest Indian companies could be counterproductive for employment generation

E F Schumacher’s book, Small is beautiful: A study of economics as if people mattered, was first published in 1973. The annual Indian central government Budget was presented a few weeks back. In the past 12 months, the government and the Reserve Bank of India (RBI) have taken steps to provide capital and liquidity support to beleaguered firms, including a suspension in the application of the Insolvency and Bankruptcy Act (IBC) and moratorium on interest payments.

However, eyes are probably getting glazed from looking for specifics about how employment opportunities have been, or would be raised for those languishing at the extremely wide bottom of the Indian economic pyramid. It is in this context we appreciate the last few words in the title of Schumacher’s book — “economics as if people mattered”. Too often in recent years attention appears to be overly focussed on assisting larger firms through measures such as reducing corporate tax rates without adequate quid pro quo about fresh employment generation.

A growing conviction in the 1970s in the West was that larger companies in industrial agglomerations clustered around railheads and ports reduced production and domestic-international transportation costs. The expectation was that as the retained earnings of the largest companies grew, they would invest more in research and development, thus creating the environment for a virtuous cycle of innovative products and additional employment opportunities. Schumacher swam against this tidal wave of economic opinion of the 1970s to suggest that if economic policymaking were to focus mostly on larger companies, it would not necessarily be in the best long-term interests of shopfloor employees or national economies.

In India, in recognition of the need to promote smaller businesses a Micro, Small and Medium Enterprises (MSME) Act was adopted in 2006. According to the 2019-20 Annual Report of the Ministry of MSMEs, there are about 111 million employees in the manufacturing, trade and services segments of such enterprises. Of the total employment provided by MSMEs, the smallest of the three, namely micro-enterprises contributed about 97 per cent of the 111 million employees. The break-up of employees in MSMEs is 36, 39 and 36 million in manufacturing, trade and other services, respectively. These estimates of the numbers of employees in MSMEs are based on a National Sample Survey carried out in 2015-16. According to the RBI, the share of MSME output in gross domestic product or GDP was about 30 per cent in 2016-17 and 48 per cent in merchandise exports in 2018-19. Clearly, MSMEs are crucial in generating employment for semi-skilled and unskilled workers. To get a better sense of the employment generated and contribution to GDP, sample surveys of MSMEs need to be carried out more frequently.

In the absence of recent and specifically targeted government surveys, anecdotal evidence suggests that MSMEs are still reeling from the demonetisation shock. Micro and small units work mostly on a cash basis. It was logical for the government to try and get such businesses to move to digital payments and in due course pay taxes as applicable. Consequently, the introduction of a Rs 2,000 note along with demonetisation was illogical. It ran counter to any ostensible intention to promote greater transparency in financial transactions.

Illustration: Ajay Mohanty

A subsequent shock for MSMEs was when the Goods and Services Tax (GST) came into effect in July 2017. Initially there were software and other implementation difficulties, which should have been anticipated by the government. However, this reform in indirect taxes had been held up for decades. It is possible that the thin profit margins in the cash only businesses of the smallest among the MSMEs were eroded once GST payments had to be made. As of now, it is unclear exactly how MSMEs have fared after the introduction of GST. Further, to what extent the steady decline in GDP growth rates in the past few years and stagnation in exports of goods, worth $314 billion and $313 billion in 2013-14 and 2019-20, respectively, are due to a reduction in the number of well-functioning MSMEs.

As if demonetisation and convoluted GST implementation were not enough, the Covid-19 pandemic appears to be the final nail in the coffin of many MSMEs. Anecdotal and visual evidence indicates that in cities around the country many service-oriented enterprises have shut down. MSMEs located in urban areas were clearly impacted adversely by reverse migration to villages. There is little specific information on the Ministry of MSMEs’ website about the adverse consequences of Covid-19.

December 2020 numbers on profitability indicate a significant improvement in the performance of bigger companies. Indian stock indices, representing mostly large-cap companies, have risen by over 25 per cent from March 2020 levels. This optimism about the future earnings of the Sensex and Nifty companies can be partly attributed to the shifting of market share to better known listed companies. In the past six months, the largest listed companies have returned to profitability faster than was expected. To an extent this was due to a focus on cost cutting through reductions in employees if legally possible.

In the past, listed companies were usually not price competitive in the cash-only spaces of MSMEs. Covid-19 appears to have hastened the process of larger companies gobbling up space freed by shrunken or defunct MSME firms. With the benefit of hindsight, it is apparent that major companies were better able to work their way around demonetisation, GST and Covid-19 induced drops in demand, implementation complexities and paying off inspectors.

The government and regulators need to coordinate efforts to get a better understanding of current ground realities about MSMEs. It is only then that targeted actions can be taken to provide the required support and promote employment for those with little or no skills. To sum up, while the big firms are needed to be price and quality competitive at a global level, smaller companies are “beautiful” too and need support to promote employment for the weakest sections.

j.bhagwati@gmail.com

The writer is a former Indian ambassador, Ministry of Finance official and World Bank Treasury professional