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Firm growth and barriers to growth among small firms in India

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Abstract

Empirical work on micro and small firms focuses on developed countries, while existing work on developing countries is all too often based on small samples taken from ad hoc questionnaires. The census data we analyze here are fairly representative of small business structure in India. Consistent with findings from prior research on developed countries, size and age have a negative impact on firm growth in the majority of specifications. Enterprises managed by women have lower expected growth rates. Proprietary firms face lower growth on the whole, especially if they are young firms. Exporting has a positive effect on firm growth, especially for young firms and for female-owned firms. Although some small firms are able to convert know-how into commercial success, we find that many others are unable to translate it into superior growth.

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Notes

  1. In reality, however, the competitive threat of new entrants appears to be quite limited because they enter at a small scale and many die shortly afterwards (Geroski 1995).

  2. It has even been argued that, in the case of India, better educated individuals are quick to leave self-employment and pursue alternative career paths, whereas less educated individuals have fewer opportunities to leave self-employment (Nafziger and Terrell 1996).

  3. Even in developed countries, however, many entrepreneurs are not ‘true’ entrepreneurs, in the sense that they do not bring innovations or bring about reform in stagnant markets (Santarelli and Vivarelli 2007). Many enter for less ‘noble’ reasons, such as overoptimism on the part of the founder, the pursuit of a relaxed lifestyle, or the flight from unemployment. In fact, many entrants are far less productive than incumbents (even taking into account their liability of small scale). The concept of new firm entry covers a particularly heterogeneous group of enterprises.

  4. Most of these items are foodstuffs and consumer products. For a complete list of protected items, see http://www.smallindustryindia.com/publications/reserveditems/resvex.htm.

  5. The term Small Scale Industry encompasses small firms with an initial investment of less than 10 million Indian rupees, an amount approximately equivalent to US$ 200,000 (http://www.dcmsme.gov.in/publications/circulars/circularmay1994.html#icoty, accessed on 25 October 2010).

  6. A recent contribution to this debate by Beck et al. (2005) examines the role of the small and medium-sized enterprise (SME) sector in 45 countries (not including India). They begin by reviewing the prior literature and conclude that “firm-level studies do not provide an empirical foundation for subsidizing SMEs.” (Beck et al. 2005, p. 201). In their empirical analysis, they observe a robust positive relationship between the relative size of the SME sector and economic growth, although the SME–growth relationship is not robust to the use of instrumental variables to control for endogeneity. Put differently, they write that “although a prosperous SME sector is a characteristic of flourishing economies, we cannot reject the view that SMEs do not cause growth.” (p. 224). They also fail to observe any significant relationship between the size of the SME sector and poverty alleviation.

  7. As such, there is some skepticism about the economic foundations of government support of small enterprises—“India is …exceptional in the extent and range of its policies that directly support SSEs. …They have been romantic, rather than economic.” (Little 1987, p. 232). SSE refers to small-scale enterprises.

  8. The database has information on the source of technical knowledge of the firm. Each firm in the database is asked if it has acquired technical know-how from foreign firms or domestic firms and scientific institutions.

  9. This body of literature is also related to the debate on formal–informal labor markets in less developed countries and the nature of self-employment in such contexts (Harris and Todaro 1970; Blau 1985; Maloney 2004; Fields 2005; Günther and Launov 2006; Tamvada 2010).

  10. A negative relationship between age and growth has been found by Fizaine (1968) for French establishments, Dunne et al. (1989) for U.S. establishments, Evans (1987a, b) for U.S. manufacturing firms, Variyam and Kraybill (1992) for U.S. manufacturing and services firms, Liu et al. (1999) for Taiwanese electronics plants, Sleuwaegen and Goedhuys (2002) for Ivorian manufacturing firms, Reichstein and Dahl (2004) for Danish limited liability companies, Geroski and Gugler (2004) for large European companies, and Yasuda (2005) for Japanese manufacturing firms.

  11. The survey was conducted on all registered small firms and was conducted by the Office of the Development Commissioner, Government of India. According to the Development Commissioner, India, “All the SSI units permanently registered up to 31-3-2001 numbering 2,262,401 were surveyed on complete enumeration basis, of which 1,374,974 units (61%) were found to be working and 887,427 units (39%) were found to be closed.” (http://www.dcmsme.gov.in/ssiindia/census/highlights.htm, accessed on 25 October 2010).

  12. The rapid transformation of the Indian economy from a state-controlled license regime to a liberalized regime is widely documented in the literature (we refer the reader to Aghion et al. 2005; Kochhar et al. 2006; Rodrik and Subramanian 2005). These economic transitions have had implications for industry-wide productivity and competition (see Krishna and Mitra 1998; Balakrishnan et al. 2006). India is the second-most populated country in the world, with a population exceeding one billion. For further indicators of economic development in India, such as gross domestic product (GDP), life expectancy, literacy rates, inequality, and the structure of Indian industry (shares of agriculture, industry and services), the reader is referred to Allen et al. (2006).

  13. By upper threshold, we refer to the upper limit of the investment of 10 million Indian rupees that is used to define small-scale firms in India. In order to check for the robustness of the results, we artificially lower this threshold to exclude firms that have initial investment greater than 9 million Indian rupees and find that the results are consistent.

  14. Growth is measured in terms of changes in gross output, rather than in terms of an alternative measure of firm size, such as number of employees, because of data constraints. For example, we only have data on firm employment levels for the single financial year 2001–2002, which means it is not possible to calculate employment growth rates.

  15. The Pareto distribution (also known as a power law distribution) can be represented as a straight line of negative slope on log–log axes.

  16. By definition, all firms in the survey have an investment in fixed assets in plant and machinery that is less than 10 million Indian rupees. This is the upper threshold for firms to be classified in the SSI sector in India at the time when the survey was conducted.

  17. Incidentally, this lends some support to the assumption of an exponential distribution of firm age in the model of the firm size distribution in Coad (2009). In this model, the lognormal distribution of firm size obtained from a Gibrat process is mixed with an exponential firm age distribution to obtain the Pareto firm size distribution suggested by a number of empirical studies.

  18. Self-reported data on the age of small businesses have been described by Phillips and Kirchhoff (1989) as being less than perfectly reliable, even in developed countries such as the USA. In the case of India, it should be remembered that many people do not know exactly how old they are! As such, there may well be a small degree of measurement error in the age distribution and, as a result, we do not seek to explain every feature of this distribution. Rather, at this preliminary stage, we merely wish to emphasize the broad shape of the distribution. For instance, the age distribution as represented in Fig. 1 is powerful enough to quickly dispel the myth that all small firms are young.

  19. In our baseline sample (e.g., in Table 2 column 2) we have around 700,000 observations.

  20. Previous work on growth rate distributions has suggested that the empirical distribution is well approximated by a unimodal ‘tent-shape’ distribution, in particular, the Laplace (or symmetric exponential) distribution. For a survey of growth rate distributions, see Coad (2009, Chap. 3).

  21. In a further analysis (not reported here) we also explored the robustness of our results using a 200% growth cutoff point, and obtained similar results.

  22. A similar approach can be found in Liu et al. (1999).

  23. For example, without removing outliers we would have 695,757 observations in column 2 of Table 3, but when outliers are removed, we have 671,159 observations. This corresponds to a loss of 3.535% of observations.

  24. This estimate is calculated as follows. From the summary statistics table (Table 1), we observe that the standard deviation of log(output) is 1.7610. Now, from column (2) of Table 2, we see that the coefficient on log(output) is −0.0159. Ceteris paribus, changing log(output) by one standard deviation changes the dependent variable by 1.761 × −0.0159 = −0.0279999. The dependent variable is loge(growth rate), and the change in loge(growth rate) is = −0.0279999. A log(growth rate) of −0.0279999 corresponds to a (conventionally-measured) growth rate of −0.0276115 (given that e(−0.0279999) − 1 = −0.0276115), which can then be rounded to −2.76%.

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Acknowledgments

We are grateful to the Ministry of Small Scale Industries, Government of India, for giving access to the data, and also to Wim Naude, Ulrich Witt, and participants at the UNU-Wider workshop on "Entrepreneurship and Economic Development" (Helsinki, August 2008), as well as to two anonymous referees and the editor (Marco Vivarelli) for many helpful comments. The usual caveat applies.

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Table 5 Variable definitions

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Coad, A., Tamvada, J.P. Firm growth and barriers to growth among small firms in India. Small Bus Econ 39, 383–400 (2012). https://doi.org/10.1007/s11187-011-9318-7

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