A few days ago, this newspaper had a
report on the government providing the finishing touches to its policy on supporting start-ups. According to the report, the government would build an entire ecosystem and not just provide incentives. It would focus on manufacturing and innovation. The scheme is expected to be launched in January.
There are mixed opinions about governments having a start-up policy. Starting a business and closing one are business decisions. These decisions are made by entrepreneurs depending on their assessment of prospects for commercial success for their product and its inherent technology at a given price. If the government takes care of public goods such as infrastructure, health, education and has a reasonable tax policy, then businessmen and entrepreneurs will take care of the births and deaths of businesses.
Therefore, when governments invest their minds and money on specifically benefiting start-ups, they are ignoring the opportunity costs of training these resources on the more urgent and important priorities of the government. This is one view.
For an alternative view, I decided to seek out a conscientious and diligent venture capitalist for his views on this matter. I contacted Aru. Arumugam in Bengaluru. He knows a thing or two about this. He told me that there is enough empirical evidence on the positive role of public policy and support for start-ups from across the world. He drew my attention to his chapter in the India Venture Capital and Private Equity Report 2014, published by the Department of Management Studies of the Indian Institute of Technology, Madras. He makes a compelling case for government support for early-stage/venture funding for two reasons. Examples and insights are drawn from the experiences of the US, Israel, Singapore and Australia. In the case of India, venture funding is too small, even given the relative smallness of India’s economic size, compared to the US. Second, a disproportionately large share of the venture funding goes to a few sectors (70% of venture capital investing in India goes into enterprise software, digital consumer and engineering). However, two other messages stood out for me.
One is that Israel closed down its programme of supporting the creation of new ventures with government funding providing the spark with conditions attached. It was not an open-ended programme. In India, it is the rare government programme that comes with a built-in sunset clause. Second, he draws our attention to the unintended causality from programmes designed for other purposes (security goals in wartime, for example) to a successful and thriving entrepreneurship ecosystem, in the US.
Serendipity plays a big role in the design of public policy and its eventual success or failure. It takes humility to understand that. Second, it also takes a different form of reasoning to understand that a problem is sometimes best tackled by attending to other problems and that solutions can diffuse. It is worth spending a few minutes on how this can work in the case of India.
It is well known that India has a huge missing middle—whether it is in farms, factories or corporations. There are far too many micro and small enterprises and too few large ones with a big absence in the middle. A simple example will illustrate this. Let us assume the following: 100 firms that employ 10 people; 10 firms that employ 100 people and two firms that employ 500 people. These are small, medium and large firms, as is evident. The distribution of employment between small and medium and large firms is symmetric—3,000 employees in all, distributed equally. There is no ‘missing middle’.
However, the size distribution of the firms is hopelessly lopsided. 89% of the firms are small. This is the state of affairs in India’s farms, factories and corporations.
Hence, between the two challenges that the government in India is grappling with—creating a start-up ecosystem and addressing the ‘missing middle’, the latter is an urgent and important priority. If the government works on various fronts that facilitate firms growing in size, then quality start-ups will start to happen and many will even graduate to the next stage. So, what should the government do to address the ‘missing middle’ issue? Given space constraints, I will focus just on one area now. Subsequent columns will address other aspects.
If the government prioritizes learning outcomes and skills, the country’s manufacturing problem might take care of itself. The Economic Survey 2014-15 cited a labour ministry report that only 2% of the labour force in the country is formally skilled (paragraph 9.12, vol. ii). It is worth addressing this issue first.
This is, perhaps, the foremost of the so-called second generation of reforms. Improving learning outcomes and skilling of Indians in millions to equip them to operate in farms and factories and improve their productivity will also incentivize their hiring. This could turn out to be the serendipitous route to addressing the issue of the missing middle. Once firms know that their chances of growth are better, they may also start in greater numbers. The first and the most concrete step the government can take is to resume India’s participation in the triennial PISA (Programme for International Student Assessment) rankings.
V. Anantha Nageswaran is co-founder of Aavishkaar Venture Fund and Takshashila Institution.
