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Mainstream, VOL 61 No 46-47 November 11 & November 18, 2023

MSMEs in India: Nation’s Progress Depends on Them | Arun Kumar

Saturday 11 November 2023, by Arun Kumar


Introduction: Diverse Economy

Indian economy is the most diverse in the world. The usual sectors primary, secondary and tertiary are there but these are further sub-divided between public and private and organized and unorganized sectors. The primary, secondary and tertiary sectors are further sub divided into agriculture, manufacturing, finance and so on. So, there are roughly 27 sectors to contend with.

Beyond these sub-divisions there are the large, medium, small and the micro sectors in non-agriculture sector. In agriculture there are the large, medium, marginal farms and the landless. The technologies they use and the productivity they have are also vastly different so that the incomes differ widely across sectors. The divides are also between the rural and urban areas and backward and advanced states.

The largest sector in GDP is the tertiary sector, then the secondary and lastly the primary sector. Agriculture provides 46% of the employment but only contributes 14% of the GDP. Since it is largely in rural areas, they have a much lower income than the urban areas. Unorganized sector of which agriculture is an important part employs 94% of the work force but contributes 45% to the GDP. Thus, incomes here are very low compared to the organized sector where 6% of the workers work and produce 55% of the output.

Agriculture has a large amount of disguised unemployment since work on the farm is declining with mechanization in agriculture. More use of tractors, harvester combines and threshers are displacing labour. Such labour has nowhere to go since non-farm employment is not available. Unorganized sector in non-agriculture is often a residual sector because those who do not find work resort to some kind of self-employment to sustain their family.

Unorganized Sector: Issues

The share of employment in the unorganized sector has hardly changed in the last 30 years. This is a result of the increasing mechanization and automation in the modern organized sectors. While most of the investment goes there, it generates little work. So, people remain stuck in the unorganized sector. In this sector to, while investment is low it is also mechanizing, like, in agriculture. So, employment generation here is also inadequate.

The unorganized sector consists of the small and the micro sectors. The average employment in a micro sector unit is 1.7 workers. In agriculture every small farm (below 5 hectares) has the entire household involved. Consequently, there are no scale economies and they mostly depend on low technology, resulting in low productivity. They also do not have the wherewithal to upgrade technology. They also lack marketing and finance. Often, they have to borrow at high interest rates from the informal money markets. The result is high costs and low profits. To increase profits, they have to squeeze wages.

The unorganized sector producers supplying to the large and medium scale businesses do not pay them in time and squeeze the sector, resulting in working capital shortage. It could ultimately lead to closure of the unit.
In brief, the unorganized sector constitutes a low profit and low wage island in the economy. Due to the low per capita income, they consume very little. This reduces demand in the economy. The impact is substantial since it employs the vast majority. That slows down the economic growth.

Role of Education and R&D

Imports from China are impacting the market for both the organized and the unorganized sectors. This is because the Chinese are able to produce at scale and their labour is highly productive so that they are able to produce cheaply. Not only are they producing high technology goods like APIs but also India’s cultural symbols, like Ganesh statues and Diwali lights.

Technological up gradation and entrepreneurship depend on the quality of education. The vast majority of children get poor education. This is testified to by the ASER reports since 2005. Many businesses say that youth is unemployable. According to NHFS-5 literacy has risen in the country to about 80%. Most children are in school but teaching and infrastructure are poor so that very few enter higher education and its quality is found wanting. The definition of literacy needs to be changed to `capacity to absorb modern technology’ and not just ability to read and write.

R&D is not only weak, investment in it is small by world standards. Consequently, we mostly import technology. That further sets back R&D in the country. It leads to a) inability to absorb modern technology, b) innovate, c) weak entrepreneurship and d) lack of employment. There is also `Jugad’ and poor quality production.

Mechanization and Artificial Intelligence are already posing a challenge to the unorganized sector. Due to their small scale of operations, they cannot afford to adopt it even if they had the skill to do so. This challenge is only going to grow in the coming years and one needs to prepare for it from now.


Of late, this sector has been hurt by policies. First, demonetization in 2016, then structurally faulty GST in 2017, NBFC crisis in 2018 and the sudden lockdown in 2020. Each of them damaged the unorganized sector while favouring the organized sector. It has not recovered from these shocks. Unfortunately, this decline in the contribution of this sector to GDP is not measured. It is assumed fallaciously that the unorganized sector is growing at the same rate as the organized sector. That may have been true prior to the shocks but not after that. The methodology of measurement of GDP needed to be changed but it has not happened. The result is that the contribution of the unorganized sector is overstated.

Since GDP growth is overstated it looks good. Consequently, the government has not taken special steps to boost the unorganized sector. The result is that this sector is marginalized in data and therefore in policy. Not only this, Government’s focus in on boosting big industry and businesses. That shows in the rise in stock markets which have become the barometer of the health of the economy. The unorganized sector is not represented in the stock market which consists of only a few thousand companies. The unorganized sector has 6 crore entities.

As demand shifts from the unorganized to the organized sector, it is like colonization by the organized sector. The result is the narrowing of the base of the economy’s growth. Consumption and private investment slow down. The economy then gets dependent on the other two engines of growth – net exports and public expenditures. These two helped in achieving high growth between 2003 and 2008. After that there is has see-sawed due incorrect policies.

Consequences of Neglect of Unorganized

The growth of the organized sector at the expense of the unorganized sector has huge consequences. Because the latter employs 94% of the workers, its decline has led to growing unemployment. Even before the pandemic, official data showed that unemployment had reached a 45 year high. Labour force participation rate is abysmally low. 190 million individuals in the relevant age group have stopped looking for work. The position of women and educated youth is particularly worrisome.

Consequence can also be seen in the dramatic rise in inequality in the economy with a large number of billionaires in a poor country. India is at 139 position in the world rankings of per capita income. The result is economic, social and political instability which spoils the investment climate. The government argues that the UN, IMF and Moody’s also certify that the economy is doing well. But these are not data gathering agencies. Their analysis is based on the official data and they replicate the errors in the official data.

Reforms required

The above points to the linkage between the various problems facing the economy and the decline in the unorganized sector. Most of these problems are policy induced. So, there is urgent need to change policies and support the unorganized sector. Currently policy is promoting the organized sector and doing little for the unorganized sector.

There is need to support the unorganized sector by promoting access to finance, technology and marketing. Cooperatives need to be formed to enable this to happen. Government’s steps in this direction are rather inadequate. Expenditures on education and R&D need to be sharply increased. GST is a last point tax. So, it should be collected at the last point only and not at each intermediate point of production and distribution. That will simplify the tax without causing any loss of revenue. As Arun Jaitley used to say 5% of the units pay 95% of the GST. The complications associated with ITC, e-way bill and so on will then get eliminated, business climate in the country would improve and the unorganized sector will revive.

(Author: Arun Kumar, is a retired Professor of Economics, JNU, New Delhi, and is the author of ’Ground Scorching Tax’. 2019)

[The above text from ’Communique’ Pp.35-39 Annual. September 2023. (Magazine of Apex Chamber of Commerce and Industries of NCT Delhi) is reproduced here for educational and non-commercial use]

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