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Mains Paper 3: Economy | Effects of liberalization on the economy, changes in industrial policy & their effects on industrial growth
From the UPSC perspective, the following things are important:
Prelims level: World Bank, OECD, Economic survey statistics
Mains level: The potential of HGFs in India and reforms required for their growth
Context
World Bank report on Indian industries
- 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
High growth firms in India
- 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 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
Challenges to HGFs
- 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
- 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
- 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
- HGF is something of a misnomer in that firms rarely exhibit such growth across their lifetimes but, rather, exhibit episodes of such growth
- 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
- The report shows that “the relationship between various measures of innovation and the probability of experiencing a high-growth event is generally positive”
- 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
Way forward
- By highlighting such structural issues and the importance of exports in boosting the chances of experiencing a high-growth episode the report provides useful guidance for crafting appropriate policy mixes
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