The small industries have been suffering since 2016. The credit given by the banking sector to micro and small industries was growing at the rate of 2.4 percent in January 2016. It declined by (-) 3.8 percent in June 2016. The decline of credit indicates that these are not able to compete with the big industries.
The small industries have some strength and some weaknesses. Their main strength is that their overhead costs are less. I had to buy a starter for the submersible pump at my home in Uttarakhand. Initially I bought a branded starter costing Rs 1,500. It burnt up anyway. Then I bought an unbranded one costing half the amount. It gave the same quality of service as the branded equipment. Small industries can also respond quickly to small orders from small companies. A small businessman making corrugated boxes can provide merely hundred boxes of a particular size within three days. A large company making the same boxes by automatic machines will require a minimum order of, say, 5,000 boxes.
Small industries also face many disadvantages. Large companies enjoy economies of scale. A large box manufacturer buys paper in bulk at a lower cost. His hi-tech machines produce boxes of same strength using less amount of paper. These machines use less amount of glue to paste the paper together. The cost of transportation of the raw material and finished goods is less for them because consignments move in truck loads. They can afford to pay high salary to a skilled labour. They can afford to establish an in-house laboratory and test that the paper purchased by them and the boxes made by them provide the specified strength. They can afford to employ an experienced accountant and a lawyer to deal with compliances with Registrar of Companies, Income Tax, Sales Tax, Factory Act, and other regulations. They can supply goods at cheaper cost if the quantity is more. The cost of production of large industries is less for these reasons. Conversely, the cost of production of small industries is more.
The main strength of small industries is that they can provide small quantities of goods. The integration of markets both nationally and globally means that one factory producing goods can supply across the country and the world. Large industries are increasingly able to supply goods in small quantities because they supply small lots across the country. The improved communication by internet and improved transportation means that they can lump together many small orders and supply them across the country. Thus the special advantage enjoyed by small industries is fast eroding. They survive only in those areas where for some reason large industries are not able to supply. For example, 20 years ago we used to get bread made from the street corner bakery. The integration of markets has meant that now we buy bread made by large manufacturers. Thus small industries are under pressure as indicated in the decreasing follow of credit to them.
Small industries have nevertheless survived because of tax concessions. They do not have to pay excise duty if the total value of production is less than Rs 1.5 crores. Similar concessions in sales tax are available in all states. The small industries were facing competition from large industries because they had to pay fewer taxes. The higher cost of production incurred by them was compensated by the lower taxes paid by them. They also paid fewer taxes because of sales in cash. They bought raw materials in cash and sold finished goods in cash thus avoiding paying taxes. Small industries have survived despite their inherent disadvantages mainly because of these tax savings.
The government has provided these tax reliefs to small industries for two services that they provide to the economy. First is employment generation. Small industries use more manual labour and generate most of the employment in the manufacturing sector. Second service provided by them is of entrepreneurship development. The tax concessions enable large numbers of budding entrepreneurs to enter the fray. Among them, some like Dhirubhai Ambani become big. Such development of entrepreneurship will only take place if entry to new entrepreneurs is made easy. As a policy, therefore, the government has provided tax concessions for employment generation and entrepreneurship development. The fact that credit flow to small industries is contracting despite these tax concessions means that the concessions are not compensating fully for their inherent cost disadvantages. According to data released by the Labour Bureau, India created only 135,000 jobs in 2015, compared with 419,000 in 2013 and 900,000 in 2011. The contraction of credit to small industries and contraction of employment generation are going hand in hand as is expected.
The government is seized of this situation and the need to revive small industries and jumpstart employment generation. Kalraj Mishra, the Union minister for micro, small and medium enterprises, said that four of its ongoing initiatives will help revise the small industries—the public procurement policy, the micro and small enterprises cluster development programme, the Prime Minister’s Employment Generation Programme, and skill development. These initiatives are in the right direction and welcome. But the efficacy of these is brought into question by the contraction of credit to the small industries reported above. The reason is that these measures are like firefighting. The basic disadvantage faced by the small industries due to the small scale production, use of antiquated technologies, and high cost of regulatory compliance is not overcome by these fringe measures.
Demonetisation has made the life of small industries difficult. The ministry of finance has unleashed a raid rage against black money. This means that small industries that were surviving by doing business in cash and evading tax will have to be shut down. One small businessman said that he used to pay Rs 500 per month ten years ago to the local excise inspector. Today he has to pay Rs 5,000 per month. The rates have more than doubled in the last 2 years of the present government. The enabling measures being implemented by the minister of small enterprises are being nullified by demonetisation.
The measures taken by the government to clean up the black economy are welcome. But these should be accompanied with an increase in tax exemption limit for small industries from present 1.5 crores to at least Rs 10 crores and simplification of procedures. Then small industries will be able to migrate from cash to cashless transactions without facing additional tax burden. Otherwise we shall see a widespread extinction of small industries, increase in unemployment and an overall increase in unrest in the country.
The author was formerly Professor of Economics at IIM Bangalore