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The ‘Missing Middle’ Problem in Indian Manufacturing
What has happened?
India’s manufacturing sector is on a high growth trajectory. As targeted by the National Manufacturing Competitive Council (NMCC), it is set to contribute 25% to the GDP by 2025. However, a very few firms are found in the mid-size category of the firms in the Indian manufacturing sector.
This brings to questions of manufacturing sector in India and related issues. In this article we will discuss the following:
- What is the role of manufacturing sector in India?
- What is “Missing Middle” in manufacturing sector?
- What are the constraints for mid-sized manufacturing industries?
- What are the possible solutions to remove these constraints?
What is the role of manufacturing sector in India?
- Manufacturing industries are those that engage in the transformation of goods, materials or substances into new products. The transformational process can be physical, chemical or mechanical.
- In other words, it is agglomeration of industries engaged in chemical, mechanical, or physical transformation of materials, substances, or components into consumer or industrial goods.
- Manufacturers often have plants, mills or factories that produce goods for public consumption. Machines and equipment are typically used in the process of manufacturing.
- Manufacturing holds a key position in the Indian economy, accounting for nearly 16 per cent of real GDP in Financial Year 2012 (FY12) and employing about 12.0 per cent of India’s labour force.
- Growth in the sector has been matching the strong pace in overall GDP growth over the past few years. For example, while real GDP expanded at a CAGR of 8.4 per cent over FY05-FY12, growth in the manufacturing sector was marginally higher at around 8.5 per cent over the same period.
What is “Missing Middle” in manufacturing sector?
- “Missing Middle” is the idea that industries in developing countries like India tend to be dominated by a large number of tiny enterprises and a few large firms, but disproportionately few small and medium enterprises.
- In terms of distribution, it is seen to be expressed in terms of a U-shaped curve whereby small and very large enterprises would dominate over medium-sized enterprises in terms of number of factories, number of workers, or share of output.
- Such a feature has typically been attributed to various institutional features:
- for example, the difficulties of obtaining bank credit for expansion;
- More importantly, the plethora of regulations, especially labour protection regulations and laws that restrict the ability of firms to hire and fire at will, and that do not allow profitable firms to expand to medium size.
- World Bank: In a study produced in the 1980s (India: Industrial Regulatory Policy Study)
- World Bank has argued that barriers to both entry and exit are high for large firms, but significantly lower for small and tiny ones. Most of these barriers were seen to result from industrial regulation and its mode of implementation.
- Also, according to the World Bank these barriers have resulted in notable losses in terms of potential efficiency and productivity gains for industry and for the economy as a whole.
- It was further argued that “cross-country and Indian experience indicates that medium size firms often enjoy better labour relations and higher labour productivity than large firms, and respond more effectively to changing technological and market requirements. Their policy-induced absence has added an element of rigidity and contributed to the slowness of technological progress and structural change in Indian industry.”
What are the constraints for mid-sized manufacturing industries?
- Infrastructural: Poor infrastructure was the second-largest investment climate obstacle, affecting the most productive firms relatively more.
- Land: According to Sandip Sarkar research paper (Prospects and constraints of manufacturing growth in India), most of the industrial plots available in the industrial estate at best can accommodate 200-300 workers. Further growth of medium sized units into large would require availability of adjacent industrial plots, which in most of the cases is either not available or only can be purchased at a prohibitive price.
- Power: An Electricity shortage is one of the biggest obstacles identified by manufacturing firms. Power supply remains erratic and the cost per unit charged to industry remains prohibitively high, much higher than rates charged in competing countries such as China.
- Productivity is important for the growth and the competitiveness of the manufacturing sector, but the sector is characterized by low productivity. Indian manufacturing performs poorly both compared with other sectors (agriculture and services) of the Indian economy.
- There has been little change in the distribution of firm size between 2000–01 and 2010–11.
- However, the economic distance between small and large firms is substantial: firms in the 500+ category were about 13 times more productive (in 2010–11) than firms in the 6–9 size category in 2010–11.
- Creating the institutional environment to help small firms grow to become mid-size firms can improve the manufacturing sector’s growth and productivity, and it calls for identifying the constraints to the growth of firms in terms of size and scale.
- Skilled Manpower: It has been found that the access to skilled labour suggests that it is harder for medium and large firms than small firms to find educated and skilled workers and it is a more serious constraint to growth.
- Credit constraints:
- Access to finance is identified as a major obstacle to firm growth. Although most firms had a bank account, very few had a loan. Getting a loan from a bank took almost a month on average after all the documents had been submitted.
- Firms that were able to borrow from formal financial institutions had 37 percent higher labor productivity than firms that were not.
- Tax Administration:
- Tax administration is also costly: a representative company needs to make 60 payments a year and will spend 271 hours doing so.
- Informal payments are widespread, and dealing with government officials is also time-consuming: firms pay, on average, 4.9 percent in bribes, and managers spend, on average, 12.6 percent of an average week dealing with government officials.
- Firms need to have stable regulations or need advance notice of change to order and make rational investments. Frequent changes in the tax regime have introduced uncertainty in operational planning.
- Corruption: Red tape, corruption, and crime had the largest negative impact on firm productivity, real wages, and exports. It accounted for percentages ranging from 16 to 28 percent.
- Ease of doing Business: Despite being regarded as ‘the engine of economic growth’ MSMEs in India are still facing several issues like infrastructural bottlenecks, lack of proper market linkages, and challenges in terms of flow of institutional credit among others.
What are the possible solutions to remove these constraints?
The domestic regulatory regime needs to be eased, especially pertaining to labour issues and provision of improved infrastructure.
- Infrastructural reforms:
- Simplify land acquisition- Simplification of land acquisitions is required as it remains complex, because of the difficulties in establishing legal ownership and a ‘clean’ holding for purchase.
- Electricity: getting electricity of ease of doing business has improved significantly. Government has taken many steps to make getting electricity easier, faster and cheaper, such as procedures for internal wiring inspection by the Electrical Inspectorate (in Delhi) have been eliminated. In Delhi, service line charges have been capped to INR 25,000/- in electrified areas for Low Tension loads up to 150 KW. However further tariffs need to be reduced to promote business of mid sized firms.
- Municipal service offerings and support services to industrial estates should be improved to pave the way for efficient production and transit of goods.
- Labour Reforms:
- Rigid labour laws lead to inefficient resource utilization. Three areas that need to be looked into and modified according to the changing needs of the manufacturing sector are:
- Excessive regulation of industrial relations.
- Restrictions on hiring and firing as per optimum needs.
- Restrictions on relocating a worker even within the plant.
- Fiscal Reforms: The government also needs to undertake a number of fiscal reforms to alleviate the situation.
- Operational Improvements: While the government pursues investment-friendly growth-oriented economic policies backed up by the creation of world-class infrastructure, organizations must give adequate attention to have the necessary internal systems in place to make themselves globally competitive.
- Skill Man-power:
- Labor skills, quality, and innovation have a smaller effect on productivity but are more important for efficient firms. Improving the labor quality available to enterprises and stimulating innovation has the potential to raise productivity.
- Manufacturing companies will have to focus on gaining unique comparative advantages. These advantages will come by when they begin to focus on factors that are within their domain and develop strategies to manage their unique resources.
India has the capability to push its manufacturing contribution to GDP to 25% by 2025. The stage has been set and the initiatives rolled out. The initiatives taken to promote the manufacturing sector will benefit all the other segments of the economy. The overall growth momentum of the economy offers incentives not only to the domestic entrepreneurs but also the foreign investors. The Indian manufacturing sector will slowly but surely gain the foothold in the coming years.
Mains Practice Question:
What is the ‘Missing Middle’ problem in Indian Manufacturing Sector? Suggest ways to overcome the ‘missing middle’ problem. (15 Marks) (250 words)