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A little bit of handholding

Government must create a more welcoming climate for small businesses.

Written by Gulzar Natarajan | Updated: May 29, 2014 12:00:47 am

One of the biggest challenges for the new government is to reverse the declining trend in private investments. Gross fixed capital formation in the private sector has fallen precipitously, from 14.26 per cent of the GDP in 2007-08 to 8.46 per cent by 2012-13.

This should come as no surprise, given that India is one of the toughest places to run a business, with the problems of recent years exacerbating it. It ranks near the bottom, 134 among 189 countries in 2014, of the World Bank’s Doing Business (DB) survey and has been slipping down. Apart from boosting private investment, a focused campaign to dramatically improve this ranking could be instrumental to reviving growth and creating jobs.

The “revolution of rising expectations” that has accompanied the dramatic electoral success of the BJP demands that the new government create adequate productive jobs to absorb the millions underemployed as well as the nearly 12 million youth entering the workforce each year. The manufacturing sector has historically been the job-creating engine for countries moving up the development escalator. But it has been stagnant at about 15 per cent of India’s GDP for nearly three decades, far smaller than similar emerging economies, and has been eclipsed by construction as the second largest employer after agriculture.

Further, several studies from around the world have shown that both manufacturing value addition and job creation come not so much from the big firms, but from small start-ups as they grow into medium-scale enterprises. Further, while informal firms generally stay informal, small, and unproductive, it is the formal firms that expand and drive job creation and value addition. But, for a variety of reasons, India’s manufacturing landscape is characterised by the “missing middle” among firms and a disproportionately low share of formal start-ups.

Addressing this should be central to any serious effort to create productive jobs. In this context, the DB rankings provide a useful starting point. Consider seven generic transactions involving the government that an entrepreneur faces when doing any kind of business — registration of the business, purchase and registration of property, obtaining construction permits, getting power supply, accessing credit, payment of taxes, and contract enforcement.

Much of the discussion on improving our business environment focuses on macro reforms. To be sure, there are significant macro reforms that are essential to increase the ease of doing business. Infrastructure constraints amplify the cost of doing business. Labour market regulations like the Industrial Disputes Act place onerous conditions for hiring labour. Poor property titling systems make land transactions a nightmare. Long-drawn judicial proceedings render contracts incomplete.

All these reforms pose formidable challenges, involve state and Central government regulations, need political consensus, and, even in the most optimistic scenarios, will take several years to materialise. But even if these constraints are eased, it is unlikely to dramatically alter the business environment. That would require a transformation of the manner in which the Indian state interacts with business and delivers on its commitments. It is, of course, possible to mitigate transactional problems by minimising and simplifying regulatory layers, outsourcing public service delivery to eliminate interface with officials, and putting in place mechanisms like single-window clearances.

But even with such re-engineering, practical realities make it impossible for an entrepreneur to avoid contact with local officials, from revenue, municipal, police, commercial taxes, industries and so on. These interfaces are often repeated games, which go beyond one-time permits and provide officials, even in the most deregulated environments, with considerable continuing leverage over businesses in their jurisdiction. An oft-repeated anecdote is that, apart from paying wages to their own employees, businessmen also pay periodic, often monthly, rents to keep local officials satisfied.

This additional cost of preventing whimsical action and harassment adversely affects business competitiveness, especially of start-ups and smaller firms. A truant official can easily harass a business by issuing a notice by disingenuously interpreting one of the several provisions of any law. Even if the business finally manages to successfully contest the notice, the time, effort and resources expended would have been prohibitive, especially for a small firm.

There is a two-fold governance challenge. One is to create an environment where such harassment corruption is minimised. The second involves strengthening state capability so that it can effectively deliver on its commitments. Both require action by state governments.

Reforms, however dramatic and transformational, cannot be a substitute for simple good governance. As proof, one only needs to compare the performance of various states in the economic freedom index calculated by the Cato Institute. The most business-friendly states are also those which are widely acknowledged as the best governed. In fact, underlying Gujarat’s strong business-friendly environment was its strong commitment to plain good governance, ensuring that the state delivered business transactional services to a reasonable degree of satisfaction.

Improving general governance is part of a larger agenda. But a more limited agenda confined to business transactional services is more realistic. It is also the least the Central government can do to encourage entrepreneurs. In fact, most developing countries which have improved their business environment dramatically, with beneficial effects on growth, have been those where national leaders made it a top priority.

The new government should initiate a campaign to make India a top-20 business environment destination, as reflected in the DB rankings, over its five years. While it pursues macro-reforms, the Central government should proactively encourage states to focus on a handful of transactions that most adversely affect businesses. Chief ministers and heads of departments should be encouraged to review them as vigorously as with various national programmes. Hand-holding support for small businesses to overcome these challenges should become an administrative priority for district governments. A national portal that captures the workflow for these transactions could facilitate monitoring. The Centre should also foster competition among states for the best business environment. The positive multiplier from the creation of a welcoming business environment could be the foundation for the government’s ambitious growth agenda.

The writer is an IAS officer,batch of 1999,and a graduate student at the Harvard Kennedy School, US.
(Views are personal)

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