The Economic Survey 2018-19 presented to Parliament on Thursday has called for a drastic restructuring of the strategy in the MSME sector for higher generation of jobs in the coming year’s underlining that the smaller firms in the sector have to grow fast through induction of technology and latest expertise. The Survey is not convinced about giving special incentives to the labour intensive sectors since what matters most is whether or not investment enhances productivity.

The Survey wants to adopt a completely different approach in respect of taking policy initiatives in the MSME sector since the policy makers who prepared the Survey believe that capital investment fosters job creation as capital goods production, research and development and supply chains also generate jobs. International evidence suggests that capital and labour are complementary when high investment drives growth.

Thus the economic think tank of the Finance Ministry gives no special favour to the labour intensive sectors for larger job generation, their understanding is that unemployment decreases with greater gross capital formation and labour and investment complement each other. The Survey ignores the experience of the last five years and observes that job creation can indeed be fostered by just encouraging investment.

The Survey finds that in the MSME sector the dwarfs which are defined as small firms that never grow beyond their small size, dominates the Indian economy and holds back job creation and productivity. The data in the Survey show that while dwarfs account for half of all the firms in organised manufacturing by number, their share in employment is only 14.1 per cent. In fact their share in net value added (NVA) is a miniscule 7.6 per cent despite them dominating half the economic landscape..

In contrast, young large firms who have more than 100 employees and are not more than ten years old, account for only 5.5 per cent of the firms by number but contribute 21.2 per cent of the employment and 37.2 per cent of NVA. Large but old firms that have more than 100 employees and are more than ten years old, account for only 10.2 per cent of the firms by number but contribute half of the employment as well as the NVA.

Thus, firms that are able to grow over time to become large, are the biggest contributors to employment and productivity.\ in the economy. In contrast, dwarfs that remain small despite becoming older, remain the lowest contributors to employment and productivity in the economy.

According to the Survey, the above findings dispel the common notion that small firms generate the most employment. Small firms may generate a higher number of new jobs. However, they destroy as many jobs as well. Thus, higher levels of job creation in small firms co-exist with job destruction, thereby leading to lower levels of net job creation. This common perception also stems from the fact that the effect of size confounds the effect of age. Specifically, most young firms are small (though most small firms are not young, at least in the Indian context). Absent careful distinction between the effect of age versus that of size, the notion that small firms create jobs has prevailed because it is the young firms, who also happen to be small, create the most jobs.

As compared to the small firms, it is the young firms that contribute significantly to employment and value added. Firms less than 10 years of age account for about 30 per cent of employment and about half the NVA. In fact, the share in employment as well the share in NVA trend downwards with an increase in firm age. This is despite the fact that young firms are on average smaller than older firms. Thus, young firms account for a disproportionate share of employment and productivity.

As per the Survey, the average productivity level for 40-year old enterprises in the U.S. was more than four times that of the productivity of an enterprise that is newly set up. In contrast, the average productivity level for 40-year old firms in India was only 60 per cent greater than the productivity of an enterprise that is newly set up. Thus, once they survive for forty years, the average 40-year old firm in the U.S. is 2.5 times (=4/1.6) more productive than the average 40-year old Indian firm. Mexico does far better than India on this dimension as well. The average productivity level for 40-year old firms in Mexico is 1.7 times that of the productivity of an enterprise that is newly set up. Thus, the comparison with other countries highlights that both employment creation and productivity do not grow adequately as firms age in India. The pointers given in the Survey suggest that 2019-20 budget to be presented on Friday will contain proposals that will completely restructure the way the MSME sector is operating now.