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Photo: Hindustan Times
Photo: Hindustan Times

Expand the ‘missing middle’ to fix our problem of job creation

We need 100,000 mid-sized firms that are productive enough to employ Indians at decent wages

Job creation continues to be one of the main challenges for Indian public policy. There were some tantalizing moments in recent months when it seemed to get the attention it deserved. The sight of millions of displaced workers trudging back to their villages during the lockdown had generated a debate on the need for an urban jobs guarantee scheme. The recent election campaign in Bihar saw competing claims over providing more government jobs in the impoverished state. The latest fiscal package announced by the finance minister has given companies in the organized sector a time-bound incentive to hire more people at the lower end of the wage pyramid.

However, neither a job guarantee scheme nor an increase in government jobs nor temporary fiscal incentives will do the trick. India needs a massive expansion in small enterprises in the private sector over the next decade to absorb its growing labour force. Here is one way to frame the challenge: Can Indian entrepreneurs be encouraged to build 100,000 competitive small and medium enterprises (SMEs) over the next decade? Consider the reasoning:

The Indian economy needs to generate 100 million jobs over the next decade—or perhaps even more. There are three components to this big number. India has a growing labour force because of its young population. People are leaving farms for better opportunities in sectors with higher productivity. Women who left the labour force in recent years are likely to rejoin as social norms hopefully change. All these should ideally be absorbed in organized enterprises with decent wages as well as formal employment contracts.

Global experience shows that such an expansion in job opportunities usually happens through the growth of SMEs, say those employing between 100 to 500 workers. India is not well placed here. Economists have for long pointed out to the problem of the “missing middle" in our enterprise landscape—between large established enterprises at one end and tiny suboptimal enterprises on the other hand. India does not have enough firms in the middle of the distribution.

The average Indian enterprise is too small to be an engine of job growth, especially for jobs that are highly productive through strong links with the global economy. For example, the sixth economic census conducted a few years ago showed that the average Indian firm employs just 2.24 workers. Less than 2% of all economic establishments in India have more than 10 workers. The contrast with China is telling. In the garments sector, for instance, as my colleagues from IDFC Institute noted in a 2017 report prepared for Niti Aayog, most workers in India are employed by firms with less than eight people while most workers in China are employed by firms with 51-2,000 people.

Now to get back to the statement made earlier that India will need 100,000 competitive SMEs over the next decade if it is to create adequate quality jobs. Let us assume that half the new 100 million new jobs are generated by either large enterprises or tiny family businesses that hire little outside labour. That still leaves around 50 million jobs. If we also assume that a successful SME has 500 employees, then it means India needs 100,000 such enterprises over the next decade—be they existing tiny enterprises that scale up or new ventures that achieve success. That desired number increases in case the threshold is reduced to 250 employees.

The skewed distribution of employment in Indian firms—with a missing middle—also has implications for inequality. Bigger firms with multiple specialized tasks tend to be far more productive than tiny businesses that dominate the Indian landscape. They can offer higher wages as well.

In effect, this means that millions who have moved out of farming have not been able to fully transition to activities with higher productivity—the very essence of the development process. Productivity in an economy tends to be negatively correlated with the degree of self-employment in it, which is a proxy for the level of informality.

When they were at a similar level of development that India is at right now, Asian countries such as China, South Korea, Malaysia, Thailand and Indonesia had brought down the proportion of their labour force in agriculture to around 40%, which is comparable to the level India is at today. The difference is that their surplus labour in agriculture was absorbed by larger enterprises to a far larger extent than what has happened in India.

The upshot: India needs bigger firms if it is to absorb 100 million people into jobs that offer decent wages. The formal restrictions on size that restricted corporate expansion have been done away with many decades ago, and large Indian companies have fewer obstacles to growth. That is not so for smaller enterprises. There is a range of research that identifies their problems, ranging from credit constraints and tax arbitrage to labour laws.

The old strategy to reserve certain activities for SMEs cannot work in a world of global supply chains. Indian policymakers have to focus more on nurturing a new generation of competitive SMEs, for that is where the answer to the jobs challenge eventually lies.

Niranjan Rajadhyaksha is a member of the academic board of the Meghnad Desai Academy of Economics

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