…Instead of chasing large, mature firms from other locations, India would do better to focus on its small enterprise sector
The role of entrepreneurship and start-ups in job creation has a long intellectual tradition. While the great giants of economic history recognized the link between start-ups and job creation, controversies remain. Do small or large enterprises contribute more to job growth? Do small entrepreneurs represent a “push” entrepreneurship, where entrepreneurs start a business out of necessity, rather than “pulled” in by great opportunities? Why do some cities attract more entrepreneurs? Are there big differences in business drive across male- and female-headed enterprises? What lessons can be drawn from India’s experience with entrepreneurship and start-ups?
Empirical evidence has shown that there is a very strong link between start-ups, especially small enterprises, and job growth in India (see ‘Who creates jobs’—Ejaz Ghani, William Kerr, and Stephen O’Connell, World Bank). There is a strong upward relationship between employment growth and the number of start-ups.
Evidence also suggests that the rate of new start-ups in India is too low, given the youth bulge, and its stage of development. A comparison of the new business registration density in India with the rest of the world confirms that the number of start-ups in India is low, although it is trended upwards and has improved. Demographic dividend and youth bulge in India has increased the need for a rapid increase in the number of start-ups to create more jobs. Nearly 1 million new workers will join the labour force every month for the next two decades. This is equivalent to the entire population of Sweden joining the labour force every year. So, the rate of start-ups need to increase to cope with India’s demographic trends.
Entrepreneurship and the rate of start-ups are more fluid in India compared to an advanced economy such as the US. This may be due to India being at a much earlier stage of development compared to the US. There is also huge heterogeneity in the spatial distribution of start-ups within India. What explains heterogeneity across cities and states? Anticipation of abnormal returns is not the key driving force, and demographics have limited explanatory power. The two key factors that predict the start-up rate are local education levels and the quality of local physical infrastructure. These patterns are true for both manufacturing and services.
Human capital, especially education, is more important for start-ups. Technology penetration, as measured by the number of internet users, is also strongly associated with more start-ups in services. Education improves skill and spreads ideas faster and wider. There are well-understood limits to the pace with which countries can accumulate physical capital, but the limitations on the speed with which the gap in human capital can be closed are less clear. Because of the strong link between human capital and entrepreneurship, policymakers should remove any constraints that restrict the growth in the quality and quantity of local educational institutions.
Physical infrastructure is more important for manufacturing than services. It is essential for supporting a modern economy. Goods and services cannot be produced and delivered without roads, electricity and internet. And moving people is as important, if not more important, as moving goods. Investing more in roads, bridges and schools is an essential part of developed economies. This is even more fundamental in developing countries, where there’s much more to be done than in advanced economies.
India’s employment growth in the manufacturing sector has displayed two under-appreciated facts. First, much of the employment growth has come in the form of small enterprises, accounting for over 80% of jobs in the manufacturing sector. Second, the rate of start-ups in the small and medium enterprises (SMEs) sector has increased in the tradable sector, but contracted in the non-tradable sector (see ‘Informal Tradable and Employment Growth of Indian Manufacturing’—Ghani, Kerr, Segura, World Bank). While it may not be surprising that manufacturing employment growth has followed from improved connectivity and trade reforms, the degree of imbalance towards SMEs is too strong to ignore. Globalization has promoted the rise of SMEs.
Reflective of its manufacturing prowess, Gujarat has shown the most robust growth across various dimensions of SME growth. SME growth is much stronger in the leading states, perhaps twice the rate of that in lagging states. However, the variation across states is much less than the differences observed between tradable and non-tradable industries.
What about women-headed new enterprises? Despite its recent economic advances, India’s gender balance in entrepreneurship and start-ups remains among the lowest in the world. Empirical results suggest that inadequate infrastructure affects women entrepreneurs more than men, because women are often responsible for a larger share of and, often, more time-consuming activities. In particular, transport infrastructure and paved roads within villages play an important role. Travel in India can be restrictive and unpredictable, and women face greater constraints in geographic mobility imposed by safety concerns and social norms. In addition, better electricity and water access may reduce the burden of women in providing essential household inputs for their families and allow for more time to be directed toward entrepreneurial activities.
There are several policy levers that can be used to increase the number of start-ups in India. Instead of being preoccupied with firm-chasing and attracting large mature firms from other locations, think small. Small enterprises are India’s strength, not its weakness, as they create more jobs, and the large number of SMEs has positioned India well to cope with potential twists and turns in globalization, rising inequality and disruptive technology. Job growth is predicted by higher concentrations of small and young establishments. Think small.
Ejaz Ghani is lead economist at the World Bank.