No monkey business

Why ‘right to entrepreneurship’, promised by Congress manifesto, is a bad idea.

Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice; all the rest being brought about by the natural course of things. All governments which thwart this natural course, which force things into another channel or which endeavour to arrest this progress of society at a particular point, are unnatural, and to support themselves are obliged to be oppressive and tyrannical.” — Adam Smith (1776).

In its 15-point agenda for socio-economic and political transformation, the Congress manifesto pledges the “Right to Entrepreneurship that will protect and assist all those who seek to become entrepreneurs”. Following the seminal works of William Baumol, my mentor from early research years, there is a general acceptance today that the institutions — legal, political and cultural — within which entrepreneurs operate strongly influence the economic development of a country. Institutions provide a framework that guides entrepreneurial activities within a country. These are the explicit and tacit “rules of the game”, which reduce uncertainty and determine the success of entrepreneurship in an economy. How can any government then extend a “right” to entrepreneurship without transforming the public institutions that are struggling to keep pace with a rapidly evolving society and economy?

From a policy perspective, therefore, we are interested in exploring how to promote entrepreneurship. In a research paper entitled “Entrepreneurship Development in the Micro, Small and Medium Enterprise Sector in India: A Policy Analysis” (2013), we studied the growth of entrepreneurship in India by focusing on the micro, small and medium enterprises sector (MSME), which has often been called the engine of growth for developing economies. There are some strong lessons from India’s experience post liberalisation in 1991. Our research findings suggest that general improvements in physical and financial infrastructure have contributed significantly more to the growth of entrepreneurship in India than specific targeted policies of the government, such as directed financial subsidies and the creation of special economic zones to promote entrepreneurship. These policies, which are aimed at developing entrepreneurship, have had very marginal impacts over the last two decades in comparison.

Within the Indian context, the MSME sector is a growing and significant segment of the economy. Based on official figures from the MSME ministry (2008), this sector contributes 8 per cent to the national GDP, comprises 50 per cent of India’s total manufactured exports, 45 per cent of India’s total industrial employment and 95 per cent of all industrial units. Post economic liberalisation in 1991, there have been major policy changes at the federal and state levels, aimed at consolidating and developing this sector.

We analysed data on all 35 states and Union Territories, starting from 1991 and going up to 2006, and measured performance through outcomes such as the number of MSME units in a state, output per unit, employment per unit and total exports from the MSME sector within a state. We attempted to find an explanation for what has contributed to growth of entrepreneurship within the MSME sector in the Indian economy since 1991.

In our analysis, we compared two sets of government policies. First, we studied the general development policies of each state by looking at the total state expenditure on infrastructure, the number of bank branches and offices there and total per capita tax in the state, which includes direct and indirect taxes. Second, we explored some specific government policy interventions targeted towards entrepreneurship development in the MSME sector. Here, we scrutinised the state outlays and financial subsidies, total investment in industrial parks, the number of clusters set up for MSMEs in each state as well as total expenditure to support technology in the sector.

Beyond government policies, there are large variations in the business environment across states. So in our analysis, we accounted for factors such as differences in labour cost, the general wealth levels of states measured in per capita state GDP and literacy rates of states.

The main story underlying the results points to the fact that while state governments devise special policies targeting the growth of the MSME sector and channel significant resources into these, it is the general development policies that are having a big impact. Our results indicate that improving general access to finance has a bigger impact on the growth of the MSME sector than targeted financial subsidies. We also found that broader improvements in infrastructure of a state go much further in the development of MSMEs than setting up SEZs for the sector. Except for the positive effect on MSME exports that parks, clusters and expenditure on technology support have, specific targeted state policies showed no impact on any of the performance measures.

The result that is particularly interesting concerns financial subsidies to the MSME sector. We found that pumping more financial subsidy into a sector is not necessarily the best way to encourage its growth. In fact, the result yields a deeper insight when we juxtapose it against the strong positive impact that the availability of bank branches has on MSME development within a state. The increased presence of banks and raising subsidies to a sector are ultimately aimed at improving access to credit for entrepreneurs within that sector. But the subsequent impacts that they have on entrepreneurial outcomes are very different. The data revealed that while banks improve the growth of MSMEs, government subsidies are negatively related to all performance measures.

What can explain the drastically opposing effects that banks and financial subsidies have on entrepreneurship? In my opinion, it could be the nature of credit targeting. While banks are providing finance to viable businesses, government subsidies might be channelled into unproductive and non-feasible ventures. Contract theory would also point to various other inefficiencies that emerge when credit is available at below market rates. Jointly, the results strongly suggest that the role of the government should be that of a facilitator, improving access to finance by encouraging more banks and other financial institutions to enter the local markets, instead of an active player disbursing credit.

The results imply the core competence of the state lies in improving the general environment through investments in physical and financial infrastructure and strengthening institutions which provide a framework to guide entrepreneurs within India. When a country has clear explicit and tacit “rules of the game”, uncertainty is reduced, which then helps in nurturing entrepreneurship.

Several perception-based measures of the quality of institutions reflect a significant and steady decline in Indian public institutions over the last two decades. Hence, a good starting point for promoting entrepreneurship is the rehabilitation of public institutions, rather than bestowing the “right to entrepreneurship” on citizens and leaving them to develop creative jugaads to work around them.

This column first appeared in the Indian Express, on May 1, 2014.

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