Subir Gokarn: Nipped in the bud

Inappropriate policy, excessive regulation, and inadequate support dog the small-scale sector

From the time our economic policy regime came up with the concept of "small-scale industry", our approach towards this sector has been, to say the least, schizoid.

At the level of rhetoric, we have placed it on a pedestal--our unique solution to the simultaneous problems of satisfying mass consumer demand and generating mass employment.

However, at the ground level of day-to-day operations, we have managed to tangle it up in a horribly sticky web of regulation, managing to divert the entrepreneur from his core functions to all kinds of unnecessary and unproductive activities.

Ridding the small entrepreneur of this burden is the goal of the Small Enterprises Development Bill of 2002, which is yet to be enacted, but appears to have received some priority from the government.

It intends to streamline the entire regulatory framework governing the sector so as to free up the entrepreneur to pay attention to all the things that would make his business survive and grow.

But, as well intentioned as the approach may be, any reasonable assessment of this sector will inevitably reach the conclusion that over-regulation and the costs of complying with it are only part of the problem plaguing the sector.

People looking for enduring solutions will benefit from a thorough analysis of the Third All-India Census of Small-Scale Industries, 2001-02, published by the ministry of small-scale industries.

This article highlights some of the more striking features of the Census findings and explores their policy implications. As of 2001-02, there were 1.05 crore units in the sector, of which 13.8 lakh units were registered with the development commissioner, SSI.

Such registration is necessary to avail of several benefits--access to finance, fiscal concessions, and technical and extension services--offered to this sector.

The fact that the remaining 91.5 lakh units were unregistered should ring some alarm bells about the attractiveness of the entire promotion and development system.

In a sample survey, unregistered units were asked as to why they had not registered. About 40 per cent said that they were simply not interested.

Apparently, the benefits to which, they might have had access were outweighed by the costs of regulatory compliance. Apart from easing the burden on registered units, this is the target segment of the proposed legislation.

Assuming that potential benefits remain where they are, a substantial reduction in regulatory pressure will presumably make some units change their minds.

However, the most striking feature of the survey was that about 53 per cent of unregistered units said that they were not even aware of the registration process. Applied to the population, this translates into about 48 lakh units.

This reflects rather poorly on the efforts being made by the central and state governments to spread the word about all the benefits available to this sector.

There is a wide range of institutions supposedly playing this role. It is, clearly, time that we began re-inventing the whole system.

Another important finding of the Census is the significant increase in the proportion of service, as opposed to manufacturing, establishments in this sector.

In the registered segment, about 34.5 per cent of the units were engaged in service activities. In the previous Census, carried out in 1987-88, manufacturing accounted for about 96 per cent of registered units.

This is another piece of evidence pointing to the stagnation in the country's manufacturing sector. Large manufacturing operations are not born out of thin air; they grow from successful small ones.

These numbers suggest that, over the last decade, there have been far fewer manufacturing start-ups than those in the service sector. Macro-level perceptions about the relative competitiveness of India's manufacturing and service sectors are strongly reinforced by evidence from the establishment level.

I am of the opinion that the critical differentiator between the two sectors as far as small enterprises are concerned is labour market flexibility. The simple fact is that service enterprises have it, while registered manufacturing units that employ more than 100 people don't. This suggests a strategy to either avoid manufacturing altogether or stay small enough to be exempt from job security regulations.

Taking all registered units into account (no distinction is made between manufacturing and services), the number of establishments having more than 100 employees accounts for just 0.17 per cent of the total.

This segment accounts for about 8.3 per cent of the total employment of 61.6 lakh people, about 8.1 per cent of the total fixed capital, and about 12.1 per cent of the total output. However, it accounts for about 38 per cent of total exports, indicating that even with all the disadvantages associated with growing to this size, export competitiveness simply cannot be achieved in large measure at smaller sizes.

The virtuous link between competitiveness, export growth, and employment appears to be significantly diluted by the strong incentive that units have to remain below the threshold of 100 employees.

The reservation of products for small enterprises has also been a hotly debated policy issue, but the status quo has prevailed thus far. Among the top 200 products from the sector in terms of value of output, only 25 are in the reserved category.

My reading of these numbers would be that there is a whole bunch of goods and services in which small-scale production is inherently competitive; relatively few of the reserved items fall into this category.

By persisting with the reservation of these items, the policy regime is actually hindering the achievement of competitiveness of producers of these items.

Looking specifically at reserved items, the top 100 in terms of value of output (out of a list of about 800) account for about 10.2 per cent of the registered segment's value of output and about 14 per cent of its employment.

We are not told what proportion of these aggregates the entire 800 account for, but it is unlikely to strengthen the case for persisting with reservation.

Small enterprises can, under the right circumstances, be an important driver of growth, employment, and competitiveness. At least as far as manufacturing is concerned, we have simply not provided the right circumstances.

A sector willing and able to contribute has been nipped in the bud by a combination of inappropriate policy, excessive regulation, and inadequate support. If small enterprises are to play their legitimate role in the country's development process, all three constraints have to be lifted simultaneously.

(The author is chief economist, Crisil. The views expressed are personal)