A startling fact is how the bane of 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.
For the analysis in this section, firms employing less than 100 workers are categorized as small, and firms employing 100 or more workers as relatively large. Though a firm employing 100 workers is not large globally, as we show below, firms employing 100 workers are relatively large in the Indian context.
Firms that are both small and older than ten years are categorized as dwarfs as these firms have continued to be stunted in their growth despite surviving for more than ten years. While dwarfs account for half of all the firms in organized manufacturing by number, their share in employment is only 14.1%.
Large, but old, firms (firms that have more than 100 employees and are more than 10 years old) account for only 10.2 percent of firms by number but contribute half of the employment as well as the NVA. Thus, firms that can 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.
Why Do Indian Firms Remain Dwarfs? Exploring the Economic Puzzle
In recent decades, India has emerged as one of the world’s fastest-growing economies. However, beneath this impressive growth narrative lies a structural anomaly: a vast majority of Indian firms remain “dwarfs” — small in size, productivity, and scale — despite their prolonged existence.
This phenomenon poses significant questions about the sustainability and inclusiveness of India’s economic growth.
The “Dwarf” Dilemma
In economic terms, a “dwarf” firm is one that remains small in terms of employment, revenue, and output over its lifecycle. In India, data reveals that firms with fewer than 100 employees dominate the landscape, contributing disproportionately less to overall productivity and growth compared to their larger counterparts.
A stark contrast emerges when comparing India to advanced economies like the United States, where small firms often grow into larger, more productive enterprises.
Factors Behind the Persistence of Dwarfs
- Regulatory Challenges: Indian firms face a labyrinthine regulatory framework. Labor laws, for instance, become increasingly restrictive as firms expand. The Industrial Disputes Act, 1947, mandates government approval for layoffs or closures in establishments employing more than 100 workers, discouraging firms from scaling operations. Consequently, many firms deliberately limit their workforce to avoid crossing these thresholds.
- Access to Finance: Small firms often face significant challenges in accessing formal credit. High collateral requirements and limited financial literacy push them toward informal and often expensive financing options. Without adequate capital, these firms struggle to invest in technology, infrastructure, and skill development, perpetuating their small size.
- Fragmented Market Structure: The Indian market is highly fragmented, with informal and unorganized sectors accounting for a substantial share of economic activity. This segmentation limits economies of scale, as smaller firms often operate in isolated niches without integrating into larger value chains.
- Lack of Innovation and Skill Development: A significant number of small firms operate in traditional industries with minimal innovation. The absence of skilled labor exacerbates this issue, as many small enterprises lack the resources to invest in workforce training or adopt modern technologies.
- Policy Bias Toward Small Enterprises: Government policies often prioritize protecting small-scale industries through incentives like tax breaks and subsidies. While well-intentioned, these measures can create perverse incentives, discouraging firms from growing beyond the thresholds that qualify them for these benefits.
Consequences of a Dwarf-Dominated Economy
The prevalence of dwarf firms has far-reaching implications for India’s economy:
- Low Productivity: Small firms are generally less productive due to limited resources and outdated practices.
- Employment Challenges: While small firms provide a significant share of employment, the quality of jobs tends to be poor, with low wages and minimal benefits.
- Inefficient Resource Allocation: Resources get locked in low-productivity firms instead of being channeled to more dynamic, growth-oriented enterprises.
- Missed Opportunities for Global Competitiveness: The inability to scale restricts Indian firms’ participation in global markets, limiting export potential.
Addressing the Dwarf Syndrome
- Simplifying Regulatory Frameworks: Reforms in labor laws and compliance procedures are essential to encourage firms to grow without fear of punitive regulations. Simplified rules can lower the barriers to scaling operations.
- Enhancing Access to Finance: Expanding credit schemes, encouraging fintech solutions, and promoting microfinance institutions can bridge the funding gap for small enterprises.
- Promoting Skill Development: Investment in vocational training and industry-specific skill programs can enhance labor productivity, making small firms more competitive.
- Encouraging Formalization: Incentivizing small firms to transition to the formal sector through tax benefits, easier registration processes and support for digital transformation can foster growth.
- Rethinking Policy Incentives: Instead of subsidizing small businesses, policies should reward productivity and innovation, encouraging firms to scale sustainably.
Conclusion
India’s economic potential hinges on its ability to transform its vast base of small enterprises into dynamic, growth-oriented firms.
By addressing the structural and policy barriers perpetuating the “dwarf” syndrome, India can unlock a new wave of inclusive and sustainable economic growth. The time is ripe for a paradigm shift from merely supporting small firms to enabling their growth into robust engines of the economy.
(Saveetha College of Liberal Arts & Sciences; Views expressed are personal)
