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The story of entrepreneurship that our numbers seem to miss

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The story of Indian entrepreneurship runs along two parallel tracks. On the first track are firms that have registered with government agencies. On the second track are informal enterprises that exist in the shadow of the formal economy. Making these two tracks meet is one of the most important policy challenges over the next decade. It is not an easy task.

The latest Economic Survey written by economists in the finance ministry says that the rate at which new firms are being registered has increased in recent years. The number of new firms in the formal sector has gone up from 70,000 in 2014 to 124,000 in 2018. A 10% increase in the registration of new firms in a district increases the gross domestic district product by 1.8%. New firm creation is also negatively correlated with unemployment rates in states, which means that those with more startups tend to have less joblessness. This is more so in agriculture and manufacturing, rather than in services. The fact that new firms are more likely to be established in the services sector rather than in manufacturing, agriculture and infrastructure may also help explain why job creation has been weak despite economic growth.

However, it is important to not get carried away by these numbers. The number of new firms registered should be seen in the context of the overall Indian population. The World Bank provides data on what it describes as “new business density”, or the number of new firm registrations per thousand people in the working age cohort of 15-64 years. The data is instructive. India created 0.14 new firm per one thousand people in the working age group. Some of the best numbers in terms of new business density are 28.59 in Hong Kong, 23.59 in Estonia, 15.65 in the UK and 10.01 in Singapore. Richer countries tend to create more new firms compared to poorer countries. Japan has a new business density of just 0.39, while South Africa has a score of 10.21. (The World Bank database does not provide numbers on China and the US.)

It is well known that most Indian enterprises are not registered firms. They operate in the informal economy. Some of the stylised facts about such micro enterprises feature in a very informative new paper by Seema Jayachandran of Northwestern University on micro-entrepreneurship in developing countries (bit.ly/2SxVU3C). The paper reviews recent research on tiny enterprises, including issues such as the effect of formalization on tiny enterprises, the impact of access to bank credit, barriers to hiring and the reasons why tiny enterprises exist.

Jayachandran defines micro enterprises as those that have either no employees or less than five. This is a useful definition in the Indian context, since the Sixth Economic Census conducted between January 2013 and April 2014 shows that two out of every three Indian enterprises outside of agriculture do not have any hired labour. Only a third employ six or more workers. The 58.5 million enterprises counted in the economic census employed just 131.29 million people. This means that the average Indian workplace employs 2.24 people.

Most people starting micro enterprises do it out of necessity, rather than inner drive. Many would prefer a job with steady wages. The larger impact of the prevalence of tiny firms is complicated. These enterprises offer economic opportunity to people who are unable to get good jobs in formal enterprises. That is a positive. Informality also means that low-productivity firms survive and perhaps restrict the growth of registered firms, as they enjoy an implicit subsidy by staying outside the country’s tax system. That is the negative. Research by the International Monetary Fund shows that there is a negative correlation between productivity growth in an economy and the degree of self-employment in an economy, a proxy for informality.

There are two complementary ways in which an economy such as India can grow through higher productivity. First, it has to move towards the global productivity frontier in the same way that many Asian countries broke away from mass poverty. Second, low productivity firms that exist in the informal economy need to move closer to the domestic productivity frontier. Policymakers will have to take both these into account.

A sudden push towards formalization could create unemployment, since a large chunk of Indian enterprises will not survive the costs of registration or paying taxes. There is no point in glorifying the millions of tiny enterprises that restrict productivity growth in the Indian economy. The ideal compromise is the gradual formalization of tiny enterprises with a helping hand from the government. However, as Jayachandran points out in her paper: “Overall, the evidence from studies that encouraged firms to formalise does not provide much support for the optimistic view that formalisation unleashes growth for micro enterprises. Most randomised evaluations do not find impacts of formalisation on firm profits.”

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

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