The Hindu Business Line : Stunting the SME

In truth, the government has placed SMEs in a Catch 22 situation. In order to prosper, they should grow; if they grow, they are killed by additional taxes, says P. V. INDIRESAN.

Currently, we are in the throes of self-doubt concerning the booming stock exchange and the soaring rupee caused by a flood of foreign investors. In situations like this, economists try to ‘cool’ things down, to slow the pace. On the other hand, clever administrators will treat the same situation as an opportunity to accelerate the economy. Relatively, India is led by cautious economists, China by adventurous administrators.

Economists are right to worry about fly-by-night speculators who come here only for short gains. At the same time, we have long-term investors too. So long as the latter are efficiently cultivated, the blips that speculators create will cause comparatively little harm. Concentrating on danger from speculators and discouraging genuine investors is like throwing the baby along with the bathwater.

We are unable to put to use foreign exchange because we do not have enough of (a) profitable projects and (b) skilled manpower. That is strange: A poor country like India has so far to go that there should be no dearth of investible projects. As for paucity of manpower, the truth is we have such a large surplus of ‘educated youth’ that their unemployment is the real problem.

The situation is so bad that Naxal groups are now openly advertising on the Web for educated recruits. Apparently, though they operate in the jungle, Naxalites can offer more attractive jobs for educated youth than the government and businesses can.

Education: a sick child

In the latest Vice-Chancellors’ conference, Mr Arjun Singh, the HRD Minister, candidly admitted that our higher education has become “a sick child either by design or by default” The Minister went on to describe lack of inclusiveness as the primary problem.

The Minister was mixing two entirely different issues. Higher education in India is sick because it has little relevance to what the economy needs; therefore its graduates are mostly unemployable.

Admitting more OBC students and recruiting more OBC teachers will not make any more of the students employable. Therefore, if higher education is sick, the fault is in the design itself, in the perception itself.

India can truly be proud of its rapid economic growth and the way our large businesses are spreading their wings abroad. That euphoria hides the fact that large businesses are finding it more profitable to invest available capital abroad rather than within our own country. Such migration of enterprise and capital would have been justifiable if our manufacturers and businesses had reached saturation point. That is not the case. The real reason is our Competitiveness Index is way down among the nations of the world.

Business front no better

If our higher education (strictly speaking, our entire education system) has been described as sick, we should admit equally candidly that our business climate too is sick. Just as our higher education is sick in spite of a few IITs making our nation proud, our business climate is sick in spite of a few outstanding businesses making India proud. If there is still doubt, consider the violent popular opposition special economic zones (SEZs) are facing. Consider also the litany of woes we hear in any gathering of SMEs. Then, let us consider two hypotheses: (a) India is unable to exploit available inflow of foreign capital because both its education system and business climate are too weak to digest that rich food, and (b) the problem is not that our youth or entrepreneurs are incompetent by nature but because they are not getting proper nurture.

For immediate relief, the government has rightly lowered interest rates. However, as explained in the previous article, interest rate manipulation is a palliative, not a cure. To find a reasonably quick-acting cure, I suggest we take a look at (a) job training and (b) promotion of SMEs.

‘Support-restrict’ system

With respect to SMEs, our government has a peculiar support-restrict system. On the one hand, SMEs enjoy a variety of tax sops and reservation in the manufacture of a number of products; on the other hand, all those support systems are available only so long as the SMEs do not grow. The sops are automatically withdrawn once the business crosses an arbitrary size. The transition is abrupt. Some years ago, in order to protect the Taj Mahal, the Supreme Court ordered metal foundries in Agra to stop using coal. The Department of Science and Technology developed efficient gas-based cupolas but the manufacturers strenuously resisted the use of gas even though it was not only cleaner but cheaper too.

They resisted the innovation because they could hide the amount they produced by using coal from informal suppliers whereas how much they were producing would become apparent when they used gas from the Gas Corporation of India.

It was said at that time that those small-scale industries were seeking to evade taxes. More accurately, they were afraid of losing tax benefits without which they could not survive. In truth, the government has placed SMEs, such as the Agra foundries, in a Catch 22 situation. In order to prosper, they should grow; if they grow, they are killed by additional taxes.

Some blame on large businesses too

Large businesses too should share the blame. When large businesses buy intermediate products from SMEs, they calculate how much that will cost as an SME and fix the price accordingly. In effect, the subsidies the SMEs get are ultimately passed on to large businesses.

If the SME expands to meet additional demand, the government takes away the subsidies but their large buyers will not accept the higher cost. Large businesses want to benefit from the subsidies the SMEs enjoy, and will not allow them to grow. Thus, both the government and large business jointly force SMEs to remain forever stunted.

Therefore, the fundamental problem of our policy towards SMEs is the government does not allow them to grow as well as they can. At a certain stage, too small to be satisfactory, the transition becomes abrupt, far too abrupt to bear. For a smooth transition, the government should phase out subsidies gradually either in time or by size, or both.

For instance, the government may levy excise duties (even corporate taxes) in multiple slabs with gradually increasing marginal rates.

Then, as an SME grows, its tax burden will increase gradually. It may be able to absorb that increase by the savings it makes from increased economies of scale. If there is also a tax holiday of a few years for the marginal increase in taxes, the SMEs will be able to grow even more smoothly.

SEZ threat to SMEs

In recent times, large businesses have managed to extract considerable tax holidays and other concessions when they form SEZs. That has eroded the advantages SMEs used to enjoy. Often, SMEs are more innovative than large businesses.

Large businesses can, and do, buy technology from abroad. SMEs cannot afford to do so and hence have to be more innovative than large businesses are. Hence, the country is losing a significant part of its innovative thrust. In the long run, it is innovation that absorbs best foreign exchange inflow.

A wise government will help SMEs to grow in a healthy fashion. Then the economy too will grow better; the economy will absorb available capital more efficiently. We will have fewer nightmares when foreign investors come flooding in. The education system too needs similar reforms.

(To be continued)

(The author is a former Director, IIT Madras. Response may be sent to indiresan@gmail.com)

This is 212th in the Vision 2020 series. The previous article was published on October 15.

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