As per the latest Census of SSIs, about about 40% of the registered SME units are not functioning. With greater levels of competition in the post reform period, and expected intensification of competition in the coming years, the concern over SSI sickness is but natural.   Most importantly, this ratio has been stagnant in the last three decades.  In other words, greater competition, expansion of the medium and large sector into what were SSI territories, imports, etc. have not affected it much at an overall level. Of course the variations are quite large within the sector.

Employment has doubled in the last 15 odd years to about 6 million employees in the registered SSI sector.  Some might say that this figure seems a bit too low.  But even the 1999-2000 SSI survey came up with a similar figure.  Not surprising given that per unit employment appears to be falling over the 30-year span fairly consistently.  This suggests that the basic character of the average small unit is changing – it is much smaller today and becoming smaller still.

The trends are very clear.  The small sector is moving on a path where smallness provides important advantages that larger firms cannot derive.  The biggest advantage is flexibility.  In a environment where conditions change rapidly, those units that can quickly change to changing conditions will tend to survive with greater likelihood.  Larger units on the other hand are not large enough to benefit from economies of scale and not small enough to benefit from nimbleness and flexibility. 

Sickness in SSIs is generally taken to be an avoidable condition that has to be avoided.  But that is more a result of our poor appreciation of the mechanics of SSIs.  Small firms are always more likely to fold up as they are more susceptible to the changing economic conditions.  Since they typically have lower surpluses, lower base of human capital, and lower access to specialists and consultants they are also less able to extricate themselves from sickness.  However, providing them with lower interest capital, preferences in government purchases, not to speak of reservations is a perfect recipe for greater sickness in the future.  Such preferences only weaken them. 

First, one of the main reasons why large numbers of SSIs remain sick is that it does not make sense for the entrepreneur to fold them up.   The insolvency procedures being what they are, entrepreneurs who declare bankruptcy have little options to start again.  In other words, the insolvency procedures for small industry are harming the growth of the small scale industry.  Since insolvent entrepreneurs are treated as common criminals, professionals and technocrats also rarely enter the SSI sector.  Most who enter are those who know how to play the system. 

Second, our policies do not recognize the importance of informal contracts.  Informal agreements, trust, faith, personal networks play an exceedingly important part in conducting smooth and stable transactions. Formal tools imply high costs of transactions, delays, etc. But policy tools rely on formal mechanisms. The greater the reliance on direct policy tools such as special privileges to a particular subset of industry, the higher are the transactions costs.  And greater is the loss to the SSI and the economy.

Third, in many sectors the SSIs tend to have lower unit costs because of their flexibility and the lack of full blown expensive administrative and managerial structures.  It is not that SSIs are less profitable, but they are more liquidity constrained.  A large part of the sickness is due to delayed release of funds either by the financial institution or the buyer.  The key success factor for SSIs is therefore liquidity management. However the government’s measures in boosting SSIs role in the economy have only increased liquidity constraints.  The fact that public sector credit through banks, SFCs, etc. takes months to arrive is only one example.  The transport conditions also do not help.  The fact that it takes 7 days to transport goods from Delhi to Mumbai is another example as it locks up precious liquidity.  Our slow judicial mechanism also translates into little recourse to delayed payments from large buyers.  All in all most SSIs are liquidity constrained for a host of reasons.  However, a combination of poor quality regulation and non-responsiveness of the financial institutions prevents other liquidity enhancing markets from evolving.

In short the policy direction is quite clear.  Give them better business conditions.  Better road conditions, better judicial mechanism, and easier recourse to market based alternatives.  Despite all of this SSIs will still get sick, but they will be able to get better as well.

Last 5 posts by Laveesh Bhandari

• Irrelevance of the State and Naxalites - September 25th, 2009
• Handling Naxalites - August 8th, 2009
• Trust and economic foundations of peaceful progress - August 8th, 2009
• What education? - August 7th, 2009
• Need for introspection - August 7th, 2009

Tags: entrepreneur, insolvency, Small and medium enterprises, SME

This entry was posted on Thursday, December 11th, 2008 at 12:08 pm and is filed under Indian Economy, Policy, Regulation and Competition. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.