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The weak underbelly of Indian manufacturing

The weak underbelly of Indian manufacturing

So many people talk of China and India in the same breath these days that it’s easy to forget they’re structurally very different economies.

For example, micro-enterprises, or establishments that employ less than five workers, account for 61% of manufacturing employment in India and 44% in Indonesia, but only around 8% of manufacturing employment in China. This is important because these tiny enterprises suffer from all kinds of constraints and productivity growth is very low.

Also Read Manas Chakravarty’s earlier columns

The study finds that labour productivity in micro-enterprises is on average around 33% of small enterprises, or firms that employ less than 50 workers. Researchers La Porta and Shleifer (2008) have analysed manufacturing sector enterprise-level data using the World Bank Enterprise Survey supplemented by information on micro-enterprises and small firms belonging to the informal sector. They conclude that, in so far as the manufacturing sector is concerned, “the hope of economic development lies in the creation of large registered firms, run by educated managers and utilizing modern practices, including modern technology, marketing and finance". In other words, they believe that very small is certainly not beautiful.

Wages in small enterprises are much less than in bigger firms. Average annual wages in 2005 in small firms in India were $587 (Rs28,587) compared with $1361 for medium firms (50-100 workers) and $2,699 for large firms (200 or more workers).

Interestingly, the difference in wages between large and small firms is much lower in China, according to the study. They find that in 2005, small firms in China paid an average annual wage of $1,144, medium firms $1,315 and large firms $1,898. Note that wages in both medium and large firms in India were higher than firms of a comparable size in China. However, since the majority of employees are in small firms in India, the average wage is much lower than in China.

This size distribution has implications for inequality within countries. Says the ADB study: “Wage differentials between the smallest and largest groups are quite large in these two countries (India and Indonesia)—21% of large firm wages for India and 32% in Indonesia. In contrast, these differentials have typically been smaller in the other economies (for example, wages of small firms in Korea and Taipei... are 50% and 56% of wages of large firms, respectively). Moreover, the large percentage of employment accounted for by the smallest (and lowest paying) class of enterprises, along with a missing middle, amplifies the extent of inequality. For example, the distributions of employment and average wages generate Gini coefficients of 0.44 in India, 0.32 in Korea, and 0.22 in Taipei." A Gini coefficient is a measure of inequality. A low Gini coefficient indicates a more equal distribution.

But it’s not just the impact on inequality that’s an issue. Productivity levels are very low in small enterprises. For instance, the study says that in 2005, value added per worker was $1,450 in small firms in India, $5,223 in medium-sized firms and $13,089 for large firms. In Indonesia, value added per worker is higher in the small and medium firms than in comparable Indian firms, although lower in large firms.

The report points out: “A pattern characterized by a large fraction of employment generated in small, low-productivity and low-wage enterprises not only has obvious adverse implications for poverty, it can also have adverse implications for growth prospects. There are two channels through which this may happen: the effect on the growth of markets for modern goods and services whereby a lack of jobs in the more productive and better paying enterprises limits domestic demand for modern goods and services and prevents the formation of a virtuous cycle of increasing labour demand, wages and production; and the impact on skill formation in the labour market whereby the scope for on-the-job training is limited because of the prevalence of rudimentary and traditional technologies in small enterprises."

The problem is that almost all net employment creation in China, Vietnam and Indonesia in the last few years has been in SMEs. In China and Indonesia, large firms have been net job destroyers as they downsize. So while removing the constraints of growth on large firms, such as restrictive labour laws, is important, ways must also be found to make SMEs more productive. Clearly, while size matters, so do other factors, infrastructure being the most obvious challenge in India.

The ADB study points out that the cost of power in South Asia is nearly double that in East Asia. Further, the average number of days affected by power outages in small enterprises in South Asia in a year was 109.8 compared with 6.17 for East and Southeast Asia.

That SME productivity can be increased is proved by Korea and Taiwan. Not all small enterprises have low productivity. Value added per worker in even small enterprises in Taiwan and South Korea is higher than value added per worker in large enterprises in India. While that is depressing, it also demonstrates the extent to which Indian manufacturing can improve, given the right policies.

Manas Chakravarty takes a weekly look at trends and issues in the financial markets. Your comments are welcome at capitalaccount@livemint.com

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