Why young, not ageing, firms can spur job creation

  • Contrary to popular belief, the Economic Survey 2019 says “dwarfs”—over 10-year-old firms with less than 100 employees—which account for a majority of firms in organized manufacturing, hold back job creation and productivity
  • Mint explains why it is so and the way out

How do small and young firms fare in terms of job creation?

The Economic Survey says the contribution of small firms to output and employment in the manufacturing sector is insignificant, though they make up around 85% of all firms. But it makes a crucial distinction: most young firms are small, but most small firms are not young, at least in the Indian context. It says the notion that small firms create jobs has prevailed because young firms, or “infants", which also happen to be small, generate employment, besides adding value to the jobs ecosystem. Small firms operating for over a decade typically destroy as many jobs as they create.

Are “dwarfs" peculiar to India?

The Economic Survey categorizes small companies older than 10 years as “dwarfs". It says such companies have continued to witness stunted growth despite surviving for over a decade. Though a company employing 100 workers is not large in the global context, in India it is. The inability of these small, but old, companies to create jobs is peculiar to India. An average 40-year old company in the US generates five times as much employment as its counterpart in India, observes the Economic Survey. Even an average 40-year old company in Mexico generates 40% more employment than its peer firm in India.

(Graphic: Paras Jain/Mint)
(Graphic: Paras Jain/Mint)

How do they survive?

The Survey says “dwarfs" in the US and Mexico employ more people and are more productive than their Indian peers. It explains that despite that, the Indian government’s policies protect “dwarfs" rather than “infants".

How do India’s policies restrict employment?

The Survey blames restrictive labour laws for discouraging more employment. For example, the Industrial Disputes Act, 1947, mandates firms to get government permission before laying off staff. This applies only to firms with more than 100 employees. Given the transaction costs inherent in complying with such norms, many firms maintain their staff strength under the threshold. Such labour laws create perverse incentives for firms to remain small. It leads them to make products that carry a certain protection and incentives.

What is the solution?

The Survey calls for labour reforms to address the problem of “dwarfs". It cites the case of Rajasthan, where flexible labour laws led to higher productivity and more employment. It calls for incentivizing “infant" firms rather than small ones. The incentives should be for a certain period, not indefinitely. It also calls for using the promoters’ Aadhaar ID so that they can’t use the benefits after the sunset period. The focus should be on high employment-elastic sectors such as rubber and plastic, electronics and tourism that have a large spillover effect.