Illustration: Jayachandran/Mint
Illustration: Jayachandran/Mint

Opinion | Barriers to Indian firms achieving high growth

A new World Bank report sheds light on the importance of high-growth firms to the Indian economyand the barriers to having more of them

India’s business landscape poses myriad growth and productivity questions. The dominance of the informal sector and micro and small enterprises mean that much of the economy is off the books. Sectoral and job creation policies must consequently deal with many variables that are difficult to pin down. And then there is the dwarf enterprise syndrome—small companies that do not grow in time but remain stunted. A new World Bank report, High-Growth Firms: Fact, Fiction and Policy Options for Emerging Economies, sheds light on many of these issues.

The report’s premise is deceptively simple. The Organization for Economic Co-operation and Development defines high-growth firms (HGFs) as those that employ more than 10 workers, with employment growing at an average annual rate of 20% or more over at least three consecutive years. This is a fairly high bar in the Indian economic landscape. The sixth economic census, released in 2016, showed that 131.29 million people were employed in 58.5 million enterprises. That means the pool of HGFs is small indeed.

The World Bank report bears this out using two data sets. For large, registered firms, it uses the Centre for Monitoring Indian Economy’s Prowess database. For small, household enterprises on the other hand—that is, most of them—it uses the India Human Development Survey conducted in 2004-05 and 2011-12. The report finds that for the emerging economies it examines, HGFs account for 8-22% of the total number of firms; India falls somewhere near the middle with 14.3%. The interesting—and troubling—aspect is just how heavily disproportionate HGFs’ contribution to output growth is. Across the economies in question, this can range from 49% to a massive 83%. India fares relatively well, coming in at the lower bound of that bracket. That said, this still highlights important challenges.

First, while HGFs don’t appear to have much horizontal spillover, they do have vertical spillovers. This means they affect upstream and downstream enterprises positively. A World Bank paper by Ejaz Ghani, Stephen D. O’Connell and Gunjan Sharma, Friend or Foe or Family? A Tale of Formal and Informal Plants in India, bears this out using establishment data from 600 districts in India. This means that when small, informal enterprises and large, formal enterprises are able to integrate effectively in supply chains, the barriers that the former face in achieving high productivity growth are lowered.

However, there are several barriers here. Given their smaller balance sheets and less scope for accessing credit, micro, small and medium enterprises (MSMEs) depend to a large extent on timely cash payments from the large companies they supply to in order to function effectively. It often doesn’t work out this way. Given their poorer bargaining power and the costs of using the legislation for tackling delayed payments—the MSME Development Act, 2006—micro and small enterprises frequently face inordinate delays in receiving payments. And goods and services tax kinks related to input tax credit are further complicating the picture.

Second, the report makes two linked observations. HGF is something of a misnomer in that firms rarely exhibit such growth across their lifetimes but, rather, exhibit episodes of such growth. And, counter-intuitively, older, more established firms with resources to burn are not more likely to experience such episodes. Quite the reverse; in both manufacturing and services, age has a negative association with firm growth. Thus, a market that enables churn is important.

Unfortunately, among other considerations, factor market distortions—specifically, land misallocation, which is the most distortionary—make such churn difficult. Such misallocation has a dual effect. It enables crony capitalism and political subsidies, allowing inefficient firms to rise to the top of the pile. And it contributes to the credit squeeze small enterprises face since land is the primary form of collateral used in business loans.

Third, unsurprisingly, the report shows that “the relationship between various measures of innovation and the probability of experiencing a high-growth event is generally positive". Further, “high-growth events in manufacturing and services are driven by persistent rather than occasional R&D [research and development]". This is a problem. According to the Economic Survey 2017-18, India’s R&D spending over the past two decades has been stagnant at around 0.6% to 0.7% of gross domestic product. This is a worrying divergence from the trend of R&D spending increasing sharply as a percentage of GDP seen in East Asian economies as they have grown richer. And unlike many of those economies, in India, the bulk of the R&D spending is done by the government with private investment lagging by a fair distance.

In the years of the licence raj, the Indian state tried picking winners and losers when it came to enterprises. It didn’t work. That lesson holds when it comes to HGFs as well. But by highlighting such structural issues and others besides—the importance of exports in boosting the chances of experiencing a high-growth episode, for instance—the report provides useful guidance for crafting appropriate policy mixes.

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