Time for MSMEs to go for economies of scale

As the Indian economy deals with the economic impact of the corona induced slowdown, an opportunity to make constructive changes to the economic policies has arisen.

India needs a long hard look at ways to deregulate the economy and businesses. Deregulation pertains to not just the legal frameworks at play but the overarching tax, law and business frameworks that drive business decisions and policies. Changes that can help reduce the regulatory burdens and hindrances to business will help businesses in India achieve the elixir of 'creating scale' to help them take advantage of economies of scale.

In a recent article, Paula Mariwala refers to the fact that if Adam Smith or Napoleon who referred to England as 'a nation of shopkeepers' were to stereotype India, they would arguably refer to us as 'a nation of entrepreneurs'. The article further goes on to state that 80 per cent of Indians find livelihoods in the informal sector.

The two biggest takeaways from the article are both the importance of small businesses to the Indian economy and the need to help support small businesses. While a lot is written and said about helping SMEs and MSMEs, the critical point that needs attention is how to assist businesses in India to scale to a larger size.

Taking advantage of the concept of 'economies of scale' is probably the most significant need for companies across the spectrum in India. While lack of access to credit has been a large contributing factor to the hindrances faced by small businesses in India, a more effective and less complicated regulatory regime is equally important, if not more.

A closer look at the issue will show that a lack of access to credit and complex regulatory ecosystem that hampers the growth of small businesses are closely interlinked. As has been oft-repeated, Indian businesses suffer from the vicious cycle of not being able to formalise due to the complexity of the regulatory regime and, therefore, lacking access to credit and thereby remaining small are unable to achieve economies of scale.

Essentially, the inability to achieve scale today inhibits the ability to achieve scale in the future. Therefore, the critical question is how does the government turn this vicious cycle to a virtuous one in which small businesses are incentivised to formalise, access credit more easily, achieve scale and generate returns and get the ever-important tax revenue that is needed?

Essentially, when making policy changes, one question that policymakers must keep in mind is whether the policy change will assist small businesses to achieve scale. While achieving 'economies of scale' cannot be the only determinant of policy decisions, it must surely be a major one.

For instance, for smaller businesses the concept of 'job work' whereby a larger business outsources some of its work to a smaller unit or a small unit outsources parts of the product creation to another small unit sounds routine but is of prime importance. Job work allows for economies of scale through specialisation.

As India moves ahead, especially intending to boost manufacturing, the ability of small businesses to achieve scale will be driven through their ability to specialise that will allow them to scale and add technology. In this case, compliances around concepts such as 'job work' must get more attention in terms of ease and compliance burdens on businesses.

While the concept of jobwork and related regulation at the surface seems standard, a searching look on how Indian small businesses will grow will reveal the importance of rules around concepts such as jobwork. As mentioned earlier, scale is needed for businesses to thrive as the classic economic theory dictates.

It is only after a threshold of scale is achieved that businesses can start enjoying the fruits of lower costs, greater profits, formalisation and access to credit, thereby further boosting growth. Indian SMEs have historically struggled for scale and the concomitant advantages that scale brings.

Therefore, as India emerges from the economic slowdown, significant attention must be paid towards the need of businesses to achieve scale. Capital flows, job creation and demand creation are all factors that revolve around the success and scalability of millions of businesses in India.

Policy creation and changes that keep a close eye on assisting Indian businesses to scale amongst other factors will have a significant contribution to putting the wheels back on India's growth story.