Why policy needs to address the small entrepreneurs,help them scale up
It is surprising how frequently we limit our worldview to people like us. Nowhere is this more obvious than when commentators fret about a collapse in the economy because of a lack of job creation. It is indeed a tragic state of affairs when the hundreds of thousands of recently graduated engineers,MBAs,chartered accountants and lawyers struggle to find jobs; when graduates prefer to wash dishes because it pays more than a white-collar job,or when entry-level engineers in top IT firms take less cash home than taxi drivers.
But thats just one side of the story,and as we will discover,a small part of India. The world looks a much better place than it used to be if you are a dishwasher or a taxi driver. After all,each year over the past five to six years you have seen a 15-20 per cent hike in your income. And for the first time since Independence,your income growth easily beats inflation.
It shocks most people to hear that India had 42 million enterprises in 2005,but thats what the Economic Census found. This is when,even as late as 2012,India had less than a million companies. Ninety per cent of Indias workforce is engaged in the informal economy (that is,not in companies). About half of Indias GDP is informal (that is,not generated by incorporated enterprises).
In 2005,each enterprise on average employed a shockingly low 2.4 people. Almost 40 per cent of the enterprises were in trade (retail,wholesale,or repair of motor vehicles),with average employment of 1.7 people! Truly mom & pop,father & son,and one-man enterprises (the statisticians have a better name for them: Own Account Enterprises). Even in manufacturing,which is 20 per cent of all enterprises,the average employment is merely three: the average is brought down by the disproportionately high number of manufacturers who are one-man-shows: weavers,potters,etc.
As per the 2012 Employment Survey,only 18 per cent of Indian workers get regular wages,and those would include housemaids,cooks,and the like: people who do not have to find work on a daily basis but who lack basic economic buffers like an employment contract or a provident fund or pensions. Eighty-two per cent of Indian workers dont even get a regular pay cheque: 52 per cent are self-employed,and the remaining 30 per cent work as casual labour.
Given the spread of cellphones,roads and electrification/ automation,productivity growth has been the most dramatic in the informal side of the economy. For example,a casual worker has to find a job every few weeks: a cellphone sharply reduces the time taken to find the next opportunity,and a road to the village makes remote jobs more accessible. But if half of the GDP (the informal part) and 90 per cent of Indias workforce is seeing such dramatic changes,why is this not reflected in GDP growth?
This doesnt show up in the current GDP statistics because we dont measure it. Given the paucity of accurate data on the informal economy that can be collected with reasonable frequency,the national accounts team (that calculates GDP) uses assumptions and past surveys to estimate its growth. The assumptions for the most part do not build in productivity improvement: for example,the value added per worker (say,a carpenter,a plumber) or value added per vehicle (the output of a truck) are mostly unchanged since 2007. This means GDP growth is likely under-reported.
Corrections to productivity assumptions happen when a new series starts: since Independence,India has had seven GDP series. The current series started with the year 2004-05. When a new series starts,large surveys are done (for example,Economic Census,Services Survey,Employment Survey),and the assumptions underlying estimates of the informal economy are reset. Historically,this has led to an increase in prior-period GDP growth of 0.3-0.7 per cent per year. For example,the average annual GDP growth between 1980 and 1993 was earlier reported to be 5.1 per cent. But when the new series started,the 1993 GDP number was revised up by almost 9 per cent,suggesting that growth in 1980-93 was 5.8 per cent,about 0.7 per cent higher than earlier reported.
Given the dramatic changes in productivity seen in the last five to six years,we believe the 2012-13 GDP number is underestimated by almost 15 per cent,implying that growth in the past eight years has not been 8 per cent a year,as reported,but 9.8 per cent a year.
This has critical implications on policymaking,both monetary and fiscal. This partly explains why inflation and current account deficit continued to be high despite plummeting GDP growth: normally,they should have fallen with slowing GDP. As the bottom of the income pyramid changes its terms of trade with the rest of the economy,they are rapidly re-pricing their output: food and services. Middle/ high-income India was getting both of these at world-low prices,and now must pay more. This means consumer price inflation is likely to stay higher for longer.
On the monetary policy side,this is likely why the RBI keeps focusing on inflation rather than reported GDP growth. Inflation data in India have their own quality issues,but they are far less inaccurate than GDP growth,as they are surveyed much more frequently. But that said,it is a whole different question whether keeping interest rates high will bring down inflation when the source of it is the informal economy. Interest rates in the informal economy do not get affected by the RBIs policy rates.
On the fiscal side,what matters is that half of Indias productive economic activity happens outside of companies and therefore cannot be taxed. This is why we seem to have such a large and intransigent fiscal deficit problem. You cannot tax the formal economy any more: the reported tax to GDP of 10 per cent is not high,but as only half the economy is taxed,that half the formal part pays 20 per cent tax to GDP,one of the highest in the world. And you cant spend much less on attempting to provide the basic necessities to the whole population. This is why the GST bill is so critical for India: to broaden the tax net,and possibly increase the share of the formal economy.
On Indias global competitiveness,this also explains why,among other things,even Ganesh idols are now made in China. Subscale enterprises cannot compete globally. While focus on heavy infrastructure is much needed,given the challenges involved,channelling government energy into enabling the small entrepreneur to scale up may be more productive.
The writer is the India Equity Strategist for Credit Suisse