Prime Minister Modi’s call to arms on Independence day: ‘Start-up India, Stand-up India’, has received much attention. In the run-up to his visit to Silicon Valley this September, various Indian origin reporters working for global media houses wrote extensively on what start-up India should translate into and why the Silicon Valley success cannot be replicated in India. The prerequisite – a robust entrepreneurial ecosystem – would have to constitute enhanced investments in research and development by the state (and one might add, the private sector) and greater targeted government support for high-end technology development. However, these are secondary challenges.

Without delving deep into the scale of domestic challenges or the appropriateness of media reportage, it is important to point out that starting up India has to be premised on generating employment and increasing productivity at the same time. This is not an easy balance for any country to strike, particularly one which sees around half the population of Australia enter the workforce every year. The Indian state already has an enormous social responsibility and limited fiscal room to manoeuvre. With a USD 269 billion Union Budget, the government could potentially spend all of its money on meeting basic service delivery needs alone.

Since the financial crisis struck transatlantic shores, the international narrative on economic growth has been underpinned by the imperatives of wage growth and productivity. As a result, a number of global forums, including the G-20, have taken up these issues. Wage growth has failed to increase in line with labour productivity, particularly in developed economies. The widening gap between the two has resulted in a declining labour income share, and this has led to lower disposable incomes and aggregate demand. Consequently, the G-20 has called for policies that will reinforce the links between productivity wages and employment.

Meanwhile in India, GDP growth is largely accounted for by an expansion of capital rather than enhanced productivity. In pre-1991 India, capital creation through large industrial investments was the mantra for growth and this trend has continued despite economic ‘reform’ and growth of the services sector. To be clear, although the expansion of labour inputs has had an effect on GDP growth, its impact has been far less than that of capital.

Despite the emphasis on capital creation as described above, the Indian economy continues to be driven by self-employment and informal enterprise. And the informal sector in turn is characterized by low levels of productivity and low wages. While over 90% of the workforce is engaged in informal economic activity, their output only accounts for half of the national product.¹ Estimates on the size and efficiency of the informal economy are far and few. The PM’s call to ‘Start-up India’ must act as a catalyst for addressing the challenges faced by small businesses, particularly those operating within the informal economy. In the Indian context, a start-up could perhaps optimally be defined as a service or manufacturing firm that was started with limited resources at its disposal and is focused on achieving scale and socio-economic impact.

 

India’s unemployment rate is close to 5%, which means that a majority are able to find work. However, this would be a superficial conclusion. Recently, the Uttar Pradesh government’s recruitment drive to hire 368 ‘peons’ for the Secretariat elicited applications from over 2.3 million candidates. The eligibility criteria for the job: ‘a pass in the fifth standard and the ability to ride a bicycle’.² Nevertheless, as many as 2.22 lakh engineers and 255 PhD. holders applied. Crucially, the responses were solicited through online applications. There is a key takeaway here. There is an employment crisis brewing owing to a skills mismatch. Educated Indians cannot find jobs commensurate with their qualifications despite the efficiency of the internet.

Where does this leave policy-makers? Indian financial dailies are full of stories about the investment ambitions of various venture capital and private equity firms operating in the ‘tech space’. Around USD INR 15,600 crore has already been invested by venture capital firms into technology driven start-ups between January and July this year.³ And every engineering graduate now envisions being part of this wave which is looking to capitalise on India’s growing consumption demand. However, the IT sector had created only about 3.13 million jobs until 2013-14.⁴ This included jobs within IT services and exports, Business Processing Outsourcing, and the domestic market for IT and IT enabled services. The total number of jobs created equals less than a fourth of annual requirements.

Despite limitations from a job creation point of view, there is immense potential in the digital economy since it can leverage Information and Communication Technology (ICT) to deliver solutions to those at the bottom of the socio-economic pyramid. To wit, according to the Reserve Bank of India (RBI), nearly 90% of small businesses have no linkages with formal financial institutions.⁵ This challenge is particularly acute in low income states. On the savings front, ‘difficulties of access combined with an absence of a positive real return on financial savings, has accelerated the move away from financial assets to physical assets and unregulated providers.’⁶ A strong supply side response is required to address the gaps in financial inclusion. The recent introduction of ‘payments banks’ is one such ICT dependent solution that is being experimented with.

 

Some useful lessons can also be learnt from other countries in harnessing the internet to meet social objectives. The US ‘Jump-start Our Start-up Business Act’ (JOBS Act, HR 3606) modernizes century-old regulations applicable to small companies. The most important aspects of the act are contained within Title II, III and IV which provide exemptions for investing and crowdfunding in start-ups. The JOBS Act opens up ‘equity crowdfunding’ as a channel of raising capital for new businesses. According to Forbes, in the year following the enactment of equity crowdfunding under Title II, the new capital market grew to over USD 250 million in terms of publicly raised funds, with the service and technology sectors leading in terms of the amount of capital commitments.⁷ India has begun preparing for its own equity crowdfunding regulations. The Securities and Exchange Board of India (SEBI) released a consultation paper in 2014 ‘for ushering in crowd-funding by giving access to capital market to provide an additional channel of early stage funding to start-ups and SMEs’.⁸

In addition to unlocking such alternative channels of credit and investment, the digital economy has a critical role to play in the marketing and sales of goods and services. According to the Federation of Indian Chambers of Commerce and Industry (FICCI), small businesses need ‘to be provided better market access facilities in order to sustain and further enhance its contribution towards output, employment generation and exports.’⁹ Moreover, FICCI also reports that small businesses are ‘broadly unaware of technology solutions and tools available to cater to their marketing needs.’¹⁰ It is useful to point out here that the private sector must itself drive awareness generation initiatives in the informal sector and not wait for government intervention.

 

Much like any other sector of the economy, the defence production sector is also largely constituted of small enterprises. Yet, these businesses struggle to innovate or harness systems edge design processes and consequently a large number remain informal in the way that they function. And, therefore, they exemplify the technology challenges of small businesses in general.

 

India has historically been a defence importer – recently displaced as the largest in the world by Saudi Arabia. To enhance domestic participation, the government has an offset policy which is currently up for renewal. ‘Offsets’ refer to direct and indirect collaborations between defence suppliers and recipients. In defence procurement by governments, this is often achieved through arrangements such as joint or licensed production. It was expected that small businesses would be able to harness around INR 18,000 crore in offsets over the five year period following the promulgation of the government’s Defence Procurement Policy (DPP), 2013.¹¹ Very little of this, however, has been realized thus far. The DPP ascribes the responsibility of identifying and mapping ‘prospective agencies for undertaking development and/or manufacture’ to the Department of Defence Production.¹² It is, however, well recognized that the backward links in the supply chain are at best tenuous and the mapping of their specific competencies is inadequate despite clear terms of reference.¹³

Although the Department of Defence Production should have built robust links with small businesses, like in most other government departments, its capacity to do so is limited. The department could, however, aim to follow international best practices for diffusion of technologies to small businesses. Ready templates already exist such as the US Government’s Department of Defence Office of Small Business and the Singapore Government’s Defence Science and Technology Agency’s (DSTA) processes for integrating private businesses in government procurement. In the UK, the Ministry of Defence has also released an action plan to improve Small and Medium Enterprises (SMEs) participation in defence production. The accompanying table outlines the components.

 

It is worth re-emphasizing that an enabling policy environment is just the first piece of the puzzle. Even if the policy environment is supportive, capacity building through targeted and contextualized interventions remains a necessary prerequisite. The Federation of Indian Micro, Small and Medium Enterprises has recently suggested the setting up of a ‘MSME Interface’ at the Ministry of Defence to get such capacity building going for defence production.¹⁴ The question remains whether other sectors will follow and what effects the creation of new bureaucracies would have.

Perhaps more importantly, the government should start to think of policy innovations by way of a ‘National Offset Policy’ so that the technological diffusion envisioned through offsets can be leveraged by small businesses operating in sectors other than defence. Indeed, some of the most important and transformational commercial technologies have been developed first for the defence sector; including the development of the internet.

 

The ‘Make in India’ initiative of the government follows from a veritable consensus in the policymaking fraternity that employment generation would have to stem from the manufacturing sector. This in turn is based on the static assumption that India stands to exploit a competitive and comparative edge in manufacturing owing to its low labour costs and abundance of a semi-skilled workforce. The correctness of this notwithstanding, given the way global trade has evolved, it is evident that India’s services sector will continue to play a pivotal role in driving both economic growth and job creation.

Global value chains represented by fragmented production chains exemplify modern day trade. Today, different stages of the production process are located across different countries and this means that the optimization of production requires service sector inputs at each stage and this challenges the conventional wisdom on economic globalization.¹⁵ Services account for around 20% of trade in balance of payment terms, and around 42% of trade in value added terms globally.¹⁶ This difference is because most products have a service component in their production – the value addition of which gets hidden in the ultimate product cost. Notably, the service component of Indian exports case is over 50%.

 

The real challenge for small businesses and start-ups in integrating with global value chains will be the inevitable emergence of higher product and service standards as a result of Free Trade Agreements (FTAs). As of April 2015, the World Trade Organization had received notifications of some 612 FTAs. Currently, three ‘mega FTAs’ are also on the anvil. The Trans Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP) are being led in large part by the United States and the European Union, while ASEAN countries are leading discussions on the Regional Comprehensive Economic Partnership (RCEP). India is not a part of the TPP and TTIP – expected to cover a majority of world trade by value. Similarly, India is not a part of the Trade in Services Agreement (TISA), another trade agreement being negotiated between 24 members of the WTO.

Owing to India’s non-participation in the TPP, TTIP and TISA, small businesses with limited capacities or awareness will find it hard to respond to strict standards regimes and, therefore, also find it difficult to access global markets. Capacity building can help small businesses and in particular, start-ups with a clean slate, align business models with new trade realities. And capacity building must encompass awareness generation within industry, of the evolving ‘standards discourse’.

Given that goods and services are often closely tied in value chains of production, supply chain management will become increasingly important for firms to stay competitive in the global economy. And Indian firms have a poor historical track record of investing in their supply chain upgradation owing to sharp price sensitivities. The Indian government also has its work cut out. It will have to build requisite capacity to ready industry. One way to ensure higher industry standards could be through development of specialized clusters where services and manufacturing facilities are integrated. By following a ‘clustering to compete’ strategy, the government and the private sector could foster better standards through enhanced domestic competitiveness.

 

Policymakers must enable small businesses to address large structural problems. The narrow popular conception of start-ups centres on middle class consumption; examples abound in media reportage of companies looking for quick gains through high valuations based on the ‘potential’ markets for growth. A wider conception must focus on a re-imagination of start-ups as firms that aim to address the gaps in infrastructure and service delivery. Fortunately, the digital economy now allows for small businesses to achieve this in many ways as illustrated earlier. The government would also do well to usher in policy innovations that go beyond simplification of entry and exit norms for businesses, and single window applications for clearances. To wit, without serious thought on how technologies can be disseminated to small businesses through measures such as a National Offset Policy, a culture of innovation will remain suppressed.

While the government has to facilitate an innovation culture, the real drive needs to come from the private sector. This is true of both investments in supply chains as well as awareness platforms. In addition, the private sector has to seek ways to leverage a clustering approach. Through clusters of informal and formal firms, India can service global value chains and continue to harness its natural competitive advantage of availability of cheap and skilled labour. And this means that industry associations and large private sector firms need to take the lead in terms of informing not just policy decisions of governments, but investment decisions of the private sector. Clusters can become competitive if private firms can pool their resources to invest in infrastructure, training and channels of outreach to the global economy. The government on its part has to be secure enough to allow this to happen sustainably.

 

And finally, ‘starting-up’ the Indian economy requires not only an out of the box approach, it requires recognition of some fundamental economic realities as well. While there is greater focus on the ‘ease of doing business’, India has to contextualize this phrase through the lens of the informal sector. The Global Competitive Index, 2015 (GCI) released by the World Economic Forum, illustrates the challenges at hand. Although India’s overall ranking has jumped up 16 spots from last year to the 55th position, in terms of tax rates India is still ranked at the 123rd spot. While the issue of multiple indirect taxes is likely to be resolved by the imminent Goods and Services Tax, additional direct taxes such as corporate tax and income tax still present inordinately high tax burdens on start-ups. Without reform of its tax structure, Indian start-ups in the informal sector will hesitate from becoming formal. Policymakers have to decide on whether short-term revenues are more important than long-term investments and job creation. And this is the classic problem of the political economy of ‘short-termism’.

 

Footnotes:

1. http://mospi.nic.in/Mospi_New/upload/nsc_report_un_sec_14mar12.pdf

2. http://www.thehindu.com/news/national/other-states/23-lakh-apply-for-368-peon-posts-in-uttar-pradesh/article7660341.ece

3. http://articles.economictimes.indiatimes. com/2015-06-29/news/63937876_1_indian-startups-sequoia-capital-india-venture-capital-funds

4. http://deity.gov.in/content/employment

5. https://rbi.org.in/scripts/PublicationReport Details.aspx?UrlPage=&ID=732

6. Ibid.

7. http://www.forbes.com/sites/kaykoplo vitz/2014/09/26/equity-crowdfunding-at-year-one-whats-the-impact/

8. http://www.sebi.gov.in/cms/sebi_data/attachdocs/1403005615257.pdf

9. http://www.ficci.com/SPdocument/20143/Grant-Thornton-FICCI%20MSME.pdf

10. Ibid.

11. http://www.business-standard.com/article/news-ians/indian-msmes-set-to-battle-it-out-for-rs-18-000-crore-defence-pie-114120700384 _1.html

12. Ibid.

13. S. Verma, ‘India’s Defence Procurement Procedure: Assessing the Case for Review and Reforms’, IDSA Issue Brief, 17 October 2014.

14. http://fisme.org.in/msme-defence/documents/FISME%E2%80%99s-suggestions.pdf

15. http://www.oecd.org/sti/ind/global-value-chains.htm

16. https://www.wto.org/english/res_e/statis_e/its2013_e/its13_highlights4_e.pdf