Sixty years ago, at India’s independence, economic development was seen as a process of modernization and structural change. The consensus then was that government had a crucial role to play in guiding, even leading, this process. The economic success of East Asia may illustrate the virtues of governing the market, but in India, government intervention became distorted and counterproductive: Reform has meant freeing the market. Many reform ideas have come from the “Washington consensus”, which emphasized sound macroeconomic management, with a nod to microeconomic efficiency (including tax reform, deregulation, privatization, and protection for property rights).
In these debates, the changes in the workings of India’s enterprises are missed: Some argue that reform has just allowed India’s established business conglomerates to expand their empires. Pessimistic assessments are supported by often-lacklustre manufacturing growth and anaemic job creation numbers. In reality, Indian industry is changing dramatically. Understanding this process helps identify where policy can play a role. Accelerating the transformation of India’s enterprises is crucial to achieving the structural changes and productivity improvement at the heart of economic development.
The success of India’s IT and ITES firms is obvious: Many are world class, even world-beaters. Multinationals in India are also bringing in new efficiencies in operations. Beyond these basic observations, spurred by the country’s recent economic success, numerous empirical studies of Indian firms have emerged. Unsurprisingly, there is room for efficiency gains by reallocating labour and capital across firms. Chang-Tai Hsieh and Peter Klenow conclude this from data on thousands of manufacturing plants, estimating that productivity could double with better input allocation (though this data is for 1994-95—early in the reforms).
What lies behind the heterogeneity in firms’ productivity? One explanation is differences in management. Nicholas Bloom and John Van Reenen surveyed management practices in US and European firms, and found considerable differences within, and across, countries. The worst management practices existed in family firms inherited and run by eldest sons. They are still extending their work to India and China, but extrapolating, and combining this result with what one knows about family ties in Indian business, one might argue for policies that raise competition, entry and exit, and management training.
Smaller, family-run firms are also constrained in their financing—this is supported by a survey by a team led by Sankar De at the Indian School of Business. They suggest that practical weaknesses in the legal system (e.g., delays and corruption) undermine corporate investor protection laws that look strong on paper. This would be an important part of a mammoth, necessary reform of India’s court system. Other studies conclude that day-to-day obstruction by local and state officials remains a problem.
Studies also find that India’s small firms have been adapting to liberalization. Manju Tewari documents the successful transformation of the knitwear cluster in Ludhiana in the 1990s, with firms adapting to the demands of new markets through organizational learning and work practice changes—these were complementary to, even necessary for, successful equipment upgrading. Aya Okada identifies significant skill upgrading at automotive component firms in the 1990s, spurred by their association with newly -competitive automobile manufacturers. In both cases, production networks promoted positive changes. So did government policies, when they improved information exchange and competition. Policy matters directly, but also through its effects on infrastructure. Disaggregated studies have found that labour market regulations and quality of infrastructure affect industrial productivity. There is still great scope for states to spur industry in their jurisdictions through policy reforms and infrastructure investment, without resorting to special economic zones and tax giveaways.
These studies look at firms that have CEOs, employees and formal structures. Even micro-enterprises at the bottom of the pyramid can be analysed empirically. Jake Kendall and I looked at rural Internet kiosks franchised by n-Logue, the brainchild of Professor Ashok Jhunjhunwala of IIT-Madras. Operators receive assistance in obtaining financing, and training in operations and marketing, but act as entrepreneurs. Women did as well as men in running the kiosks, controlling for a host of other factors. Education beyond the selection threshold did not matter for success, but caste did—a signal of India’s continuing social fragmentation.
The success of such enterprise-creating efforts depends on enabling laws, regulations and policies. Infrastructure also matters—in the Internet kiosk case, the opening up of the telecom sector has been crucial. This example also illustrates current limitations—policies still make rural telecom access more costly than need be. Some work suggests that public-sector banking has helped the rural poor and disadvantaged, but it has failed to do enough. Financing constraints for rural micro-enterprises are even more severe than for formal small-scale firms. The conclusion from these new analyses is that the country’s policies need to support its enterprise revolution—creating new firms, new jobs, and accelerating innovation. The studies can help identify beneficial policy interventions at the micro level.
Nirvikar Singh is professor of economics, University of California, Santa Cruz. Do write to us at firstname.lastname@example.org