Small and Medium Enterprises – a Yardstick for Ease of Doing Business

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Ease of doing Business
CFO-India | Ease of doing Business

India had much reason to celebrate when the World Bank Group released the Doing Business (DB) 2018 report in October 2017. The report commends India for implementing reforms in a number of areas. In fact, India is the only heavyweight among the 10 economies that showed the most improvement in their DB rankings this year. This sounds almost impressive considering that an economy of its sheer size and scale has managed to implement gigantic reforms to improve the Ease of Doing Business (EoDB), except that it has not.

Doing business the wrong way

One cannot blame DB for the normative indicators or the simple methodology it employs to making a global-scale report. The criticisms hurled at DB are mostly aimed at these two aspects, and miss the most obvious of all, the top-down design of the suggested reforms. The immense political pressure the global report puts on governments often forces incumbents to make policy disruptions along such top-down designs based on inputs from DB alone. Such reforms, when reverberated through the institutional machinery, expose both institutional inabilities and practical challenges. Even though the Goods and Service Tax (GST) reform was not factored in for DB 2018, it would be fitting to bring out the crux of this argument through its example. The entire GST apparatus was presented prepared and infallible before its rollout, however; the challenges that ensued implementation arose not just from institutional inabilities but from the oversight of ground realities as well. While institutional inability was overcome by constitutional amendment and further by the formation of the GST Council, state and central authorities, the complications that resulted from the monthly filing of returns, the impact of reverse charging mechanism on small businesses, to name a few, were avoidable if not for the top-down design it followed.

SMEs over FDIs

The leaning towards global reports for reform inputs often rests on the assumption that while competing with global markets, the impact of reforms can be measured with FDI influx. Reforms aimed at improving FDI rates lead to more foreign players competing with domestic SMEs that reap little to no benefit from global-model reforms because of greater compliance costs. The unfair advantage FDIs have over domestic investments may even put SMEs out of business in some sectors. Let us draw an example from the Insolvency and Bankruptcy Code, 2016 (IBC). While IBC may work for large companies, there is no similar apparatus for SMEs that form the lion’s share of defaulters, by number, in the share of borrowers. The insolvency proceedings for large companies will not work for SMEs because of the fundamental differences in capital and organisational structures. While IBC has been able to somewhat restore the banking sector’s confidence in large companies, no steps in this direction have yet been taken for SMEs, which has significant impacts on SMEs’ access to credit. This could put SMEs at a competitive disadvantage against large companies when it comes to exit.

The argument here is not to shield SMEs from foreign competition or to prioritise them while framing policies. The argument is that a bottom-up design with ground level requirements of SMEs for inputs could be a better alternative than the top-down approach. After all, the increased presence of SMEs would lead to better competition, innovation, employment generation and growth.

Labour laws

Labour regulations is only one of the pressing reform areas that impacts the growth of SMEs but it is one that DB circumvents for various political reasons. Anachronistic labour laws do not require institutions to evolve to modern market practices or allow modern methods of compliance that could improve EoDB considerably. Instead, they increase the compliance costs and often SMEs hold the short end of the stick. The cost of complying with rigid labour regulations is higher for SMEs, due to the lack of procedural justice in the regulatory ecosystem. Multiplicity in definitions, social security and working conditions exacerbate the issue, questioning the rationality and efficacy of labour laws.

Signs of change

While outdated labour laws that are detached to modern market realities raise the compliance costs for SMEs, the Model Shops and Establishments Act of 2016 signals a change in the attitude towards the shops and establishments sector, which is largely dominated by SMEs. The Act exempts shops and establishments with less than 10 employees from registration and compliance. It allows online registration, electronic record keeping, web-based inspections for transparency, and lets shops and establishments choose their own opening and closing times. The Act also lets warehouses and packaging centres to run 24/7, which means supply chains can now be made more efficient to lower the operating costs and time incurred. This move could enable domestic investments in traditional retail to innovate or build capacity, especially when SMEs in traditional retail are facing severe competition from e-commerce. This could provide a level-playing field in the market and help augment India’s retail sector.

The Model Act quashes institutional discrimination against women by removing restrictions on women working after 7 pm in shops and establishments. This could improve female workforce participation rates, thereby putting more money into households and stimulating local economies by catalysing consumption. However, the onus is on employers to provide transportation and ensure security of women employees.

The Act should take notes from the textile boom in the 80s through the 90s, which was driven by many things, but two factors that deserve a mention here – the decentralisation of SMEs in the informal sector, and participation of women in the SME workforce (UNCTAD 2004). Decentralisation was a market response to the tax and labour regulations on capital-intensive investments, which forced large businesses to distribute operations to a parallel economy where no tax and labour regulations applied. This deregulation and operational freedom of SMEs in the informal sector was one of the greatest drivers of employment generation in the sector. It was largely owing to this fact that the sector grew to be the largest employer of women in the country. Lakhs of jobs were created for women without any interference from labour laws at a time when services offered by the market were far too few compared to today. Such contentious issues must be discussed with all stakeholders involved and a consensus reached if such Model Acts are to be adopted.

Top-down designs do irreparable damage to institutions and SME approach requires the institutions involved to be strengthened, restructured to modern practices and incentivised to do so. The Model Act may recognise the contemporary demands of SMEs. However; change does not happen nor should it end with a single Act, but it may very well begin with one.


Also published on Medium.