Informal enterprises should be encouraged
Productivity boosts in such enterprises that have supply linkages with large, organized enterprises increase the latter’s real output
There is a school of thought that is concerned about the extremes of capitalism that have given rise to morally reprehensible practices by large enterprises. These range from predatory lending and market manipulation in the financial sector to tech companies’ abuse of personal data and emissions cheating in the automobile industry. They threaten trust and cooperation, which is the foundation of well-being and productivity. An alternative to these extremes is to expand and embrace the broad base provided by small enterprises, which is the biggest segment. This will not only provide a foundation to their well-being, but also increase productivity and jobs. There is another school of thought that small is not beautiful. Small enterprises are not productive, create bad jobs, and are not connected with the rapidly changing forces of urbanization, globalization, and technology. Which of these two schools of thought will better shape India’s future? Are small and large enterprises friends or foes? Do the two sectors nurture or cannibalize each other?
To understand whether small is beautiful or ugly, we examined how small entrepreneurs interact with large entrepreneurs, using establishment data from 600 districts in India (Friend Or Foe Or Family? A Tale Of Formal And Informal Plants in India, by Ejaz Ghani, Stephen D. O’Connell, and Gunjan Sharma). Do the interactions between small and large enterprises play any role in driving India’s growth and job creation? Until recently, labour market channels were considered the key link between small and large enterprises. The popular perception is that small enterprises are a diversion from creation of good jobs.
Small and large and informal and formal enterprises are linked with each other through many other channels, besides the labour channels. These include product market linkages, input market linkages, spatial linkages, innovation, gender and fiscal linkages. If there are strong product market and input-output linkages between small and large enterprises, then the existence of small enterprises in the unorganized sector is not necessarily a bad thing. These linkages across enterprises, small and large, can boost productivity growth and jobs.
How have formal enterprises impacted informal enterprises in India, and vice versa? Empirical evidence suggests that there are strong positive linkages, and spillovers, between small and large enterprises. They are friends and not foes. Small firms in the unorganized sector are important suppliers of inputs to large firms in the organized sector. Employment and output in the organized sector are greater in those states in India that have a greater presence of unorganized suppliers of inputs. A 10% rise in employment of unorganized sector suppliers increases the employment of organized sector buyers by 16%.
Higher quality in small enterprises does not squeeze the size of the large firms by providing an incentive for enterprises to stay small. Instead, boosts in total factor productivity of small enterprises in the unorganized sector in supplying industries in turn boosts the real output in the organized sector. And sectors that depend on large enterprises tend to have more productive small enterprises of the unorganized variety. This is because as large enterprises get more productive, they also demand higher quality inputs from smaller enterprises. Small enterprises respond by expanding their employment.
An important concern for policymakers is that growth in the manufacturing sector is turning out to be “jobless growth”. Large- scale manufacturing enterprises tend to be more skill and capital-intensive. Most of the employment generation occurs in small and medium enterprises, in organized and unorganized sectors, and in ancillary plants that are linked with large-scale factories. Even in highly industrialized states like Gujarat that have attracted and retained large-scale manufacturing, employment growth has been disappointing, as ancillary plants have not grown.
The future of jobs
Small enterprises account for the majority of jobs in India. Much of India’s urbanization is occurring through small, informal enterprises as they move into cities in search of better infrastructure. Conversely, large enterprises—especially land-intensive enterprises in the manufacturing sector—are moving out of cities and into rural areas in search of lower land costs to remain competitive. Thus, an inclusionary rather than exclusionary approach to the urban informal economy is needed. There should be adequate provision of city infrastructure to aid informal enterprises. Cities should find ways to ensure that urban informal jobs are integrated into urban plans, land allocation, and zoning regulations, that the urban informal workforce gains access to markets, and that organizations of informal workers are invited to participate in procurement schemes and policymaking processes. The more that Indian cities recognize this influx, and design appropriate policies and investments to support it, the more effective the policy interventions will be. A bottom-up approach will be more effective than a top-down approach.
The biggest challenge is skilling India. The country needs many more entrepreneurs with digital and technical skills, as well as more soft skills. Although there are many existing skill initiatives that are being implemented by different ministries and departments, they need a better interface with the private sector. They also need to build more linkages between large and small enterprises. Popularizing mass-scale entrepreneurship has the potential to take advantage of India’s time-bound demographic dividend.
Ejaz Ghani is lead economist at the World Bank.
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