Professional Documents
Culture Documents
Arti Singh*
Abstract:
Small and Micro producers are crucial in developing economies, and their role is even
greater in the largely rural economies of South Asia. In India as well, the sector is the
second largest employer, after agriculture, and accounts for nearly 6 percent of the
country's GDP. India was an exception in that it gave the small scale sector large
incentives, and protection, in the period 1948-1991, going to the extent of reserving
certain production lines solely for the sector.In the historical context of this, this paper
shall attempt to analyse the issues peculiar to a 'small scale of production' in India in an
increasingly globalised scenario. It shall also look at some of the other issues plaguing
the sector such as credit availability and maintaining quality standards.
1. Introduction
In the changing scenario of globalization and liberalization, it is crucial to take a long and
hard look at the small scale sector in India. What the numbers; 6% of GDP, 35% of
exports, 30 million employed and so on, hide, is a sector rife with bureaucracy,
overregulated and over protected, and facing an uncertain future. The small scale sector
in India is very diverse producing over 8000 products, from traditional handicrafts to high
end technical instruments. Generalizations are also difficult because though there are
firms which are growing rapidly, there also exist 1, 38,000 sick units within the sector.
This paper attempts to look into some of the problems which this sector faces in India.
The paper focuses largely on the issue of Government policy as it is difficult to have any
discussion on the small scale sector in the Indian context without analyzing the effect of
the policies that surround it. The first three sections of the paper give a brief introduction
to the small scale sector, and more specifically the sector in India. The next section
examines the issue of government policy, the focus area of the paper. The fourth section
is an examination of some of the other issues that small scale producers in India face. The
last section is a summary of the findings and results, and presents some points for the
beginnings of an alternative approach.
(a)Growth: Small firms are often said to grow faster than large firms, thus making the
size distribution shift in favor of small firms would allow the economy as a whole to
grow faster. However empirically what one sees is that though some small firms may
have high growth rates, they as a group have a high death rate, that is, many firms do not
last very long. This means that the total effect on the economy may not be much greater
than that of relatively larger firms. Also an important point to note here is that historically
only a very small percentage of small firms have grown into large ones.
(c)Efficiency: Productivity is often said to be the highest in small firms. This however
varies greatly, both within and across industries. Studies also seem to suggest that it is not
small firms which are the most efficient; in fact they are the least, but medium-scale
firms. Small and medium scale firms do however have the advantage of being more
dynamic and flexible than larger firms, thus giving them the ability to offer more
customized products to their customers.
Intervention by the state is often argued on the grounds that small firms are more
efficient, contribute to more equitable distribution of income, and generate employment.
Empirical data however does not always support these claims. It is undeniable however
that the small scale sector exists, and is a very sizable sector, often employing large
proportions of the work force. This in itself should give the state a reason to be concerned
with the sector. Its interventions however should be aimed at correcting market
inefficiencies and failures rather than a paternalistic approach of protection, which often
results in actually stinting the growth of the sector. The affects of this ‘paternalistic’
approach are further analyzed in the Indian context, where the small scale industry has
been, and still is largely protected.
No. of Products
Manufactured 8000
2004-2005 figures
Source- Business Today, September 10, 2006.
The above table shows quite clearly that the small scale sector is anything but small. It
accounts for nearly 40 % of our industrial output and 35% of our national exports, while
employing nearly 30 million people, the second largest after agriculture. The table also
shows that the small sector has been growing rapidly, even in the face of growing
competition, internally and globally, and decreasing protection levels. However this is not
to say that there are no shortcomings within the industry, or in public policy relating to it.
There are numerous problems that small scale units face today like maintaining quality
standards, access to credit, over- regulation etc., all of which are looked at in the
following sections.
4. Government Policy
(a)Introduction, Origins and Nature of Policies
The small scale sector, has since independence enjoyed a special status regarding
government policy. It was, in the pre 1990 protectionist era, further cocooned with extra
protection measures, and even today post liberalisation, continues to enjoy numerous
privileges. The reason given for this was primarily two-fold, one being the beneficial role
the sector plays in employment generation, and income dispersion, and secondly because
of the market imperfections the sector faces.
The policy regulations relating to the small scale sector are such that they ensure that
units stay just that, small. In the second plan (1956-61), the importance of the small scale
sector was highlighted and it was felt that as this sector, due to its importance in “a)
creation of broad-based employment opportunities and b) wide dispersal of industrial
production.” The policies proposed then, were, and remain the main backbone of public
policy relating to the small scale sector. What we see however is that this policy has been
largely unhelpful, if not detrimental to the development of the sector. This section
analyses the effect of the government’s misdirected policies on the sector.
The Industrial Policy Resolution 1956 clearly stated that “…the aim of state policy will
be to ensure that the decentralized sector acquires the sufficient vitality to be self
supporting…. The state will therefore, concentrate on measures designed to improve the
competitive strength of the small scale producer.” This shows how, though the sector was
seen as crucial in increasing employment and increasing dispersion, it was also felt that
they would be able to do so only if they were economically viable. The policies were
meant to aid the development of the sector by rectifying some of the market failures it
faced, and not to shelter it to such an extent that it was stifled.
What actually transpired was a set of policies designed to make the sector dependant on
outside help, economically unviable, and with perverse incentives to stay small. The
policies have all aimed at helping the small scale sector, but instead of tackling the real
problems, only circumvented them, or in some cases created bigger ones. The policies
have been largely protective instead of promotional, continuous instead of one shot, and
non-discretionary instead of discretionary, all which have given positive disincentive to
improve competitive strength.
Promotional measures aim to increase the efficiency and economic viability of small
units by providing infrastructure facilities and improving access to markets. On the other
hand, protective measures give small units preferential treatment. Government policy has
been largely of this kind, and reservation for small scale production, purchase preference
by the government, lower interest rates etc. are all examples of this kind.
Continuous measures are those benefits which a small unit may avail of as long as it falls
under that category, while one-shot are those which may be availed of only once, and
tends to be discretionary in nature. Most policies like preference in government
purchases; lower interest rates etc. are continuous in nature.
Discretionary measures are those which require an examination on a case by case basis
and are not blanket measures available to all units which fall under the definition of
small. Non discretionary, by implication, are those measure which are based on some
objective criteria and are applicable to all units that meet the criteria.
(c)Credit Market
There are primarily two market imperfections the small scale sector faces regarding the
credit market:
1. Capital costs faced by SSEs (Small Scale Enterprises) are typically higher because of
market imperfections in the availability of information for investors and lenders.
2. Transaction costs in bank lending exhibit pronounced economies of scale with respect
to loan size. Thus, the unit transaction costs for SSEs are higher than those for large
firms. Moreover, provision of collateral or other risk-reducing securities is often difficult
for SSEs.
In the credit market, small scale units face a disadvantage due to the greater behavioral
risk of default as well as the higher cost of lending. To solve this, the aim of the
government should have been to aid the credit market in developing techniques and
practices specific to the sector which would have reduced risk and cost of lending. The
government attempted to counter the problem by enforcing mandatory credit allocation to
the sector. It did this, in an already protected environment, by offering the sector lower
interest rates and through the requirement that at least 15 percent of all bank credit was to
be allocated to the small scale sector. This ensured that the sector not only got used to
‘easy money’ and very often remained economically unviable, but also that those units
which most deserve credit did not necessarily get it as banks were only looking to fill
their quotas. The government also set up specialized lending institutions for the small
scale sector at the state level. These however were rife with bureaucracy and
irresponsible in their lending, as visible in their recovery record: an average of 37 percent
over the past thirty to forty years! What the protectionist stance of government policy has
ensured is that productivity is not really a concern for small units selling in the local
market. Their concern is not so much with labor productivity as with utilizing the various
concessions given to small enterprises –reservation of production lines, excise duty and
interest concessions, or even evading excise duty altogether. The profits of small-scale
units are more related to what is nowadays called ‘rentseeking’ than to productivity. This
distorts the market mechanism in the small scale sector and ensures that numerous small
units are set up instead of growth of units vertically, into larger units. Undoubtedly the
small sector is poised for change and a big leap; but this will not happen without a
forward-looking policy which will push the sector, against its own will perhaps, out of its
state-designed protective rut.
(c)Marketing
One of the most difficult challenges that small scale units face is marketing their products
effectively. These units often lack the economies of scale required to undertake large
marketing initiatives. This is one area which has also been neglected by the sector due to
the disincentives to grow that exist in the system of reservations and protection. However
rising pressure to de reserve products and increasing imports of these products mean that
the sector will now be forced to look at the matter of marketing more seriously if they
wish to survive. This is also one problem which most government policies do not tackle
directly but try and solve by circumventing it through reservations and preferential
buying by the government. This is not really a long term solution to the problem, and in
fact may give rise to further problems, as already shown.
What the sector needs are associations within the sector itself which will help in building
common brands and marketing initiatives so that they may be able to compete with larger
firms. Instead of competing severely against each other through undercutting in prices,
the small manufacturers could try a collaborative approach by setting up marketing
consortia. The small- and medium-scale bulk drug manufacturers based in Hyderabad
have jointly set up a company to facilitate execution of large export orders which they
were not able to do individually. A similar step has been taken by four small leather
goods manufacturers in Calcutta. This will allow them to grow and reach out to larger,
newer markets and at the same time share the costs and expertise required for marketing.
E-commerce too is an interesting avenue that has opened up recently and may provide a
cost effective solution for small scale marketing initiatives.
6. Conclusion
An analysis of the small scale sector in India is in some ways both heartening and
disconcerting at the same time. What one sees is a sector with enormous potential, and
which seems to be growing despite the restraints on it. It is a sector where, after
liberalization, only 20 of 700 toy manufacturing firms in Delhi managed to stay out of the
red, due to Chinese competition, and yet in a matter of less than five years had regained
their lost ground, driving even the dreaded Chinese out of the toy market. This is an
example of the unleashing of the potential of the sector, something which hasn’t really
been allowed to happen yet.
What therefore should be the outlook for the sector in the future? Where are its growth
opportunities and how can government policy help it reach there? What the focus of the
sector, and the policies surrounding it, needs to be is to isolate the advantages and
strengths it enjoys, and work on those. Small-scale industries enjoy certain inherent
strengths such as lower over-head costs, flexibility in production, informality in labour
relations, exploitation of local resources and skills, capacity to execute small orders and
to offer customized services. The small scale sector is often able to offer the niche
services which the larger manufacturers are unable to. For example, countries such as
China, Bangladesh, Malaysia, Philippines, Sri Lanka have no reservation for the garment
industry and yet the small-scale units, are thriving. The large units specialize in executing
large orders of institutional garments while the small units take on smaller orders of high
fashion, seasonal garments. Collaborative relations between the large, medium and small
units through subcontracting arrangements are well established. This can be used in the
Indian context as well. The government’s policies should seek to strengthen and promote
such collaborative efforts rather than keep them apart through protectionism.
To counter competition in the long run and to be economically viable, the small scale
sector needs to improve its productivity and quality, reduce costs (given the higher
qualities) and innovate. Government policy should promote the small scale sector by
helping them increase their efficiency and competitiveness within a market driven
economy. For this it is essential that it no longer follows a protectionary stance, as that
has already been shown to be harmful to the sector. What is required is an enforcement of
time bound concessions, emphasis on core advantages of small scale sector, emphasis on
innovation, an increasing of the amount of credit information on the sector, and
strengthen local associations of small units as collectively they can counter many of their
problems. Till date however, the policies have been paternalistic in nature, leading to
dependency. The skewed approach of the government ensured that small units had no
incentive to actually solve their common problems of inadequate finance and lack of
information. Instead the policies only created perverse incentives for these units to
remain small, while being unable to provide infrastructure and to remove the basic
problems of small units such as limited access to markets and finance. New approaches
like the cluster approach or harnessing the power of industry associations should also be
encouraged. Undoubtedly the small sector has enormous potential, and is a crucial aspect
of the Indian economy. However for the sector to fully realise its potential, it is essential
that it firstly wakes up to the new reality of a liberalising India and therefore the need to
get out of its state-designed protective rut, and secondly that the Government realises the
urgent need for a shift in policy regarding the sector, so as to allow it to flourish.
Tables and Figures
1967 47
1970 55
1974 177
1978 504
1980 833
1986 863
1989 836
Source: GOI(2002)
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