Size matters: Decoding Indian manufacturing’s problem of scale

One reason for the slowdown in disbursements is that the current lot of beneficiary firms are struggling to meet their production targets under the scheme—a pre-condition to receive incentives. For instance, in the textiles sector, companies must invest ₹300 crore and achieve a minimum turnover of ₹600 crore by the first ‘performance year’, 2024-25. According to the report, the textiles ministry has, for now, suspended a previous plan to expand the scope of the scheme to t-shirts and innerwear.

The textiles sector has turned out to be a missed opportunity so far. A recent World Bank report pointed out that India’s share of global exports of apparel, leather, textiles and footwear (ALTF) rose from 0.9% in 2002 to 4.5% in 2013, only to fall to 3.5% by 2022. Even as China’s dominance in the sector started to slow by 2015, with its share of global exports first levelling off and then declining, the benefits went to Bangladesh and Vietnam rather than India.

Why is textiles so important, especially when India’s performance in other sectors such as automobiles, and even electronics, has been much better, with Apple moving part of its iPhone manufacturing to India? As the World Bank report points out, in 2020, capital-intensive sectors (which would include electronics and automobiles) accounted for 70% of manufacturing value-added but 50% of formal sector manufacturing jobs.

In contrast, labour-intensive sectors such as ALTF accounted for 20% of manufacturing value-added, but 40% of formal sector manufacturing jobs. “These labour-intensive activities present vast opportunities for job growth, particularly for women (33% of workers in the apparel and textile sectors are female, compared to only 15% in non-textile and non-apparel manufacturing),” pointed out the report.

Why has the Indian textile sector’s share of global exports declined over the years? While a major reason cited by the World Bank report is higher tariffs on imports starting in 2017—higher prices for inputs causing costs for producers to rise as also for finished goods—it’s worth pointing out that India’s share of global exports in textiles had already begun to decline by around 2014.

Size does matter

As of 2019, the last date for which data was available, Bangladesh’s ALTF sector employed 2.45 million people, with 66% of those working in firms with 300 or more employees. This last statistic, about the proportion of workers working in large manufacturing units, is a crucial one.

Why does firm size matter? At a basic level, as firms grow larger, they are able to reap economies of scale. This enables them to reduce costs and increase competitiveness, both domestically and in foreign markets. As economies grow, more and more output in a given sector tends to be produced by the top few firms who then come to dominate the sector. Richer economies are dominated to a greater extent by larger firms, than poorer economies, in terms of overall output.

Smaller firms, especially those in the informal sector, face serious levels of economic uncertainty, especially from larger, cheaper competitors for the same products. Those who work in the informal sector tend to get paid far less than their counterparts in larger businesses.

But more importantly, from the broader perspective of the economy, larger firms are part of the formal sector. These are also the sectors where employees tend to be paid better, have more social security and have a better chance at economic mobility, at least in a relative sense.

Smaller firms, especially those in the informal sector, face serious levels of economic uncertainty, especially from larger, cheaper competitors for the same products. Those who work in the informal sector, where most businesses are extremely small scale, tend to get paid far less and face much more economic uncertainty than their counterparts in larger businesses in the formal sector who make the same products.

In a dynamic economy, many firms start out small and are unable to grow bigger. But a select few grow larger, and keep growing—and so does the proportion of labour force employed with them. The governments that really took this lesson on board were the East Asian tigers. Governments there took a conscious decision to promote national champions—large industrial conglomerates that could dominate the sectors they operated in.

Firm size in India

The consensus has been that, in India too, firms have been growing bigger. This was especially the case after a Supreme Court ruling in 2001 liberalised rules around contract workers, enabling companies to get around the supposedly ‘rigid’ labour laws, which kick in at the 100-employee mark. Prior to 2001, companies using contract labour had to absorb such labour into permanent employment—that was one of the interpretations of the Contract Labour (Regulation & Abolition) Act. The ruling clarified that this was not required. Following this, contract labour usage in companies rose.

Earlier research by Marianne Bertrand and others in 2021 found that the top 5% of firms by employee size saw a headcount increase of 43% in 2015 compared with 2000.

But a recent paper published by the Madras Institute of Development Studies, and authored by Abhishek Anand, Arvind Subramaniam, and Naveen Thomas, is more circumspect. They point out that the source data for much of firm size in India, the Annual Survey of Industries (ASI), allows companies with more than a single plant in the same state and making the same product to provide a single set of data to the government, without distinguishing between the output of the individual plants.

This leads to the data over-emphasizing the growth of large factories since they show up in the data as a single plant. So, for instance, two separate factories in a state, under common management, and making auto components, with 300 employees each, show up in the data as one factory with 600 employees. And while the data does provide information on exactly how many separate factories are covered by a single data point, it’s not possible to figure out separate metrics, such as employment or output, for each of those so-called ‘multi-plant’ units separately.

This narrow technical problem in the data has led to, the authors claim, an overstatement by various researchers of the extent to which firms have actually grown, especially those in the so-called ‘right tail’, i.e. the largest factories. “We find that between the early 2000s and the 2020s, the observed (i.e. mis-measured) data suggests an increase in the right tail. However, when the mis-measurement is corrected, the increase is smaller, and in some cases, there is no real increase in the right tail, and on some metrics, there is even a shrinking of the right tail,” the authors write.

And, as they point out, this has little to do with ‘rigid’ labour laws, since the cutoff mark for the Industrial Disputes Act is 100 employees. But even firms much larger than this have seemingly stagnated, and not grown.

As per data from the ASI for only single manufacturing plants, and excluding ‘multi-plants’, the share of employment in manufacturing as a whole has grown since 2011-12, but by just a few percentage points. In 2011-12, the share of the manufacturing labour force (including contract workers) employed in factories with 300 or more workers was around 45.2%. By 2022-23, this had grown to around 48.7% (chart 1).

But as the authors point out, the problem is worse for labour-intensive industries. The number of employees who work in the 100 largest factories, in absolute terms, in such industries has essentially remained unchanged between 2011 and 2022.

Chart 2 shows similar data as chart 1 for two sectors: ALTF, and computers and electronics (includes mobile phones). Again, this data only covers single plants, and excludes ‘multi-plant’ data. These present a very different picture. The share of workers in the textile industry, who work in factories with 300 or more workers, has actually fallen by 3.5 percentage points since 2011. Further, at 50.5%, this is far below the 66% figure for Bangladesh.

In sharp contrast, the share of workers in the computers/electronics sector who work in plants with 300 or more workers has risen steadily, from 50.4% in 2011-12 to 71% by 2022-23.

“Relatively large Indian plants did not become larger and did not account for a larger share of employment over two decades despite this being a period of dynamism over two decades (oughties and teens) and a veritable boom in the first decade,” the authors point out.

As an aside, it’s worth pointing out that even the ASI data, adjusted for the issue of multi-plant data, likely overstates the share of workers who work for large firms. This is because the data does not cover a huge volume of workers who work in very small-scale industrial units in the informal sector.

Export boost

There is one possible reason for the sharp difference between the structure of the Indian apparel and textile industry and that of Bangladesh—exports. The Bangladesh textile industry exports over 95% of its output, compared with around 37% by Indian plants. Could plants oriented toward the highly competitive global export market be, on average, bigger than their non-exporting counterparts?

In employment terms, that is the case. As a share of all export units in the sector, Indian plants with 300 or more workers account for 62% of employment, not far behind the number for Bangladesh. But even this statistic has barely changed since 2011-12, rising by just about 1 percentage point.

This is true of the electronics/computers sector as well. Units that export all or a part of their output, and which had 300 or more employees, accounted for 75% of the labour force in such units, compared with 71% for units overall (exporting and non-exporting). But interestingly, this share, in contrast to that of ALTF, has grown sharply from 63% in 2018-19 to 75% in 2022-23.

When we broaden our focus to look at all manufacturing units across sectors that export all or part of their output, the result is the same. In 2022-23, such units with 300 or more workers accounted for 67% of the labour force working in export units, compared with 48.7% of the manufacturing labour force for similar-sized units, but covering both exporting and non-exporting units.

Why do firms ‘choose’ not to grow bigger?

A chief executive of a large firm the authors of the MIDS paper spoke to admitted that the company would be more competitive internationally if its plant sizes were greater, but it deliberately chose not to grow because of the need to spread risks—legal and political—across multiple firms. A single large firm would be akin to a promoter putting all their eggs in one basket. “Risk spreading in a highly uncertain political environment is one reason why manufacturers chose not to become too big,” the authors say.

A company deliberately chose not to grow its plant size because of the need to spread risks—legal and political—across multiple firms. A single large firm would be akin to a promoter putting all their eggs in one basket.

It is not clear from the above quote what ‘uncertain political environment’ refers to. But if this were true, it would apply to all firms across all sectors—as we have seen, export-oriented units tend to be bigger in terms of share of employment. Perhaps, it is not supply-side or ‘institutional’ factors (like the political environment) that retard the growth of firms but just the size of the market itself. Firms exporting into international markets just have a bigger market to sell to and thus can grow bigger. Those focused on the domestic market, especially in an environment of high competition from small, informal sector units, just don’t have a similar incentive to grow.

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