As the government undertakes various initiatives for manufacturing, it is important to understand what type of firms drive employment growth in the sector. Based on data on registered firms from the Annual Survey of Industries from 2000-2016, this article highlights the importance of older, larger firms in creating jobs. It suggests that policies should encourage entry of new medium-sized plants and facilitate growth of dynamic, incumbent small and medium firms.

Questions pertaining to the distribution of employment in India’s manufacturing sector, and its evolution over time, have attracted considerable interest among researchers and policymakers. Identifying and understanding the drivers of change in the employment distribution is important from a policy perspective. Specifically, the subject of whether it is Micro, Small and Medium Enterprises (MSMEs) or large firms that have been significant contributors to employment deserves attention. In addition, determining whether younger or older firms drive employment growth is critical. This is especially relevant as the government undertakes a series of initiatives to accelerate the growth of the manufacturing sector through programmes such as Make in India, Production Linked Incentive (PLI) scheme, and Start-Up India. 

The distribution of employment in India’s manufacturing sector, when combining data from both the organised and unorganised enterprise surveys, is bimodal. In this distribution, a large share of employment is concentrated in micro-enterprises. Following this, there is a notable concentration of employment in large enterprises, while the share of small and medium enterprises (SMEs) is considerably small (Krueger 2013, Hasan and Jandoc 2010, Mazumdar and Sarkar 2013). 

Formal manufacturing: How employment distribution has evolved over time

In a forthcoming study, we focus exclusively on the registered/organised sector for which annual data are available from the Annual Survey of Industries (ASI) and examine how the employment distribution has evolved over time. Examining data from the ASI for 16 years, we find that small firms (defined as those employing 10-49 workers) account for the smallest share of employment; while large firms (defined as those having more than 250 workers) account for the highest employment share. Significantly, over time, the share of large firms in total employment increased from 51.1% in 2000-01 to 58.5% in 2015-16. While the share of SMEs in total employment was comparable to that of large enterprises in 2000-01, it declined by about 7 percentage points in 2015-16. Consequently, large firms accounted for the highest share of employment by 2015-16. This is indeed a positive development as larger plants offer higher wages compared to smaller plants. The link between size and wages has been the subject of economic research, both from a theoretical and empirical lens. The literature typically finds that workers at large firms receive higher wages, on average (Brown and Medoff 1989, Troske 1999, Hasan and Jandoc 2010). 

It is crucial to identify and understand the drivers of the rising employment share in large plants and declining employment share in small plants. This is particularly important when determining whether this shift is attributed to the expansion of previously smaller plants and their transition to larger size bins, or to the entry of new larger plants driving the uptick in employment in the large size bins. If it is the former, there is a strong case for supporting SMEs through special support programmes that provide small industry finance, extension and advisory services, infrastructure and training programmes for managers and workers. However, if it is the latter, there is a compelling case for focussing on encouraging the entry of new plants. 

Figure 1. Distribution of employment (%) in the formal sector by size bin

Addressing the above questions require us to be able to track the growth of factories over time. Although the ASI provides a panel dataset with a unique identifier for factories, the sample design does not permit us to track the growth and life cycle dynamics of all factories over time. The sampling strategy is such that only the larger factories (that is, those factories which are in the ‘Census Scheme’ of the sample and typically have 100 or more workers) are surveyed each year. The remaining smaller units which are in the ‘Sample Scheme’ cannot be tracked every year. Therefore, we are unable to consistently track factories in all size bins in the ASI. 

Our study seeks to understand the catalysts for changing the employment distribution over time using a two-fold approach. First, we study approximately 3,000 plants that are captured during all 16 years in the ASI surveys. We then examine if there is any evidence of transition amongst these plants from lower size bins to higher size bins. We find that all these plants have 100 or more employees and a quarter of those plants that were reported to be in the large size bin (that is, had 250 or more employees) in 2015-16 had been surveyed as a smaller plant in at least one earlier year. Furthermore, since not all plants that were captured in these yearly surveys for the first time were new plants, they could have started as smaller units before they were included in the survey. Likewise, some of the large plants that were surveyed in all 16 years could have started as smaller plants in the years prior to the time period of our analysis (that is, before 2000-01). Therefore, the estimate that a quarter of large plants in 2015-16 transitioned from being smaller plants in the earlier years is a conservative one. This finding presents evidence of plants transitioning across the size distribution and becoming large over time. Therefore, there is a case for supporting SMEs that have the potential to grow, expand and transition to larger size bins through schemes and programmes that improve access to credit, markets, skilled workers and infrastructure, amongst other factors.  

However, looking at the factories in the Census Scheme of the ASI sample which appear in all 16 years of the panel alone is not enough, as these factories typically have 100 or more employees. To understand what is driving the change in the distribution, we need to examine the remaining firms as well. In the absence of panel data for MSMEs that allow the study of firm life cycle dynamics, we use an alternative approach. We construct a panel dataset at the ‘size-bin’ level by aggregating the plant-level data provided in the ASI surveys for each year across the following size bins: 1 to 9 employees; 10 to 19 employees; 20 to 49 employees; 50 to 99 employees, 100 to 249 employees, 250 to 300 employees and 300+ employees within each of the available 3-digit NIC¹ (2004) in each state. This new panel helps us to consistently track the set of plants in specific size bins across 16 years.
Our analysis shows that size-bins which witness higher employment growth are typically those that have a higher share of plants in rural areas, have a higher share of contract workers in the workforce, and a higher share of female workers in their directly hired workforce. Not surprisingly, we also observe that states that are more industrialised and have better infrastructure facilities witness higher employment growth.

Figure 2. Employee distribution by age of firms

Source: ASI plant-level data. 

The findings vis-à-vis the share of the young firms in a given size-bin are of particular interest. We observe that the higher is the share of newly established plants, the lower is the growth of employment in a size bin. This indicates that it is not the younger firms, but mature plants that are driving employment growth. The only size bin where we find the contrary results is the 100-249 employee size bin. These results appear to suggest that in the 100-249 size bin, employment growth is likely to be driven by young plants, while in the size bin of 250+ employees, it is the mature plants that drive employment growth. It further indicates that in addition to creating an enabling environment for the growth and expansion of incumbent SMEs, it is important to encourage and facilitate the entry of new medium-sized firms. Over and above this, our analysis also highlights the importance of older large firms as they account for a sizeable share of employment in the organised manufacturing landscape and drive employment growth in the large size-bins.   

Policy implications

To formulate policies to reduce underemployment and foster economic growth, factors that are conducive to generating such high-growth plants contributing to the employment creation need to be identified. While we are still far from understanding the most effective policy levers that stimulate high-growth plants, our analysis suggests that a two-fold approach is required. One, encouraging the entry of new plants, particularly medium-sized; and two, amongst the incumbents, facilitating the growth of dynamic small and medium-sized firms to expand. The latter can be achieved through policy instruments that do not incentivise firms to remain small by restricting support to enterprises that are below a certain threshold of investment, employment, or turnover, as defined in the current architecture of MSME programmes. 

Views shared are personal and do not necessarily reflect those of the institutions the authors work for.

 A version of this post was first published as a Policy Brief of the Isaac Centre for Public Policy, Ashoka University. 

Note:

1. Sectors are defined according to National Industrial Classification (NIC) codes. NIC codes are a statistical standard for developing and maintaining a comparable data base for various economic activities, developed with an intent to ascertain and analyse as to how each economic activity is contributing towards national income.

Further Reading 

• Hasan, R and K Jandoc (2010) ‘The Distribution of Firm Size in India: What Can Survey Data Tell Us?’, ADB Working Paper No. 213, Asian Development Bank.
• Krueger, AO (2013), ‘The Missing Middle’, in NC Hope, A Kochar, R Noll and TN Srinivasan (eds.), Economic Reform in India: Challenges, Prospects, and Lessons, Cambridge University Press.
• Mazumdar, S and S Sarkar (2013), Manufacturing Enterprises in Asia: Size, Structure and Economic Growth, Routledge, Delhi.
• Brown, Charles and James Medoff (1989), “The Employer Size-Wage Effect”, Journal of Political Economy, 97(5): 1027-1059.
• Troske, Kenneth R (1999), “Evidence on the Employer Size-Wage Premium from Worker Establishment Matched Data”, Review of Economics and Statistics, 81(1): 15-26.