Why India Has So Many Small Firms

Why most Indian manufacturing firms stay very small, the "missing middle" of mid-sized firms, and what this means for productivity and jobs.

A striking feature of Indian manufacturing is the very large number of tiny firms. Most manufacturing enterprises employ only a handful of workers, many of them family members. Relatively few firms grow into medium or large employers.

The missing middle

Economists describe a missing middle: many very small firms and some large firms, but relatively few medium-sized firms. In countries like China or the United States, successful firms tend to grow much larger over time.

Firms that do not grow

Research by Chang-Tai Hsieh and Peter Klenow, published in 2014, compared how firms grow over their life cycle. They found that in the United States, a typical 40-year-old manufacturing plant employed around seven times as many workers as when it was young. In India, plants barely grew at all over their lives. This lack of growth means fewer productive jobs and slower improvement in productivity.

Why Indian firms stay small

Economists have suggested several reasons:

Regulation thresholds: labour laws and other rules applied more strictly to firms above certain sizes, such as the 100-worker threshold for layoffs, which may discourage growth.
Access to finance: small firms struggle to get loans to expand.
Infrastructure: unreliable power and poor logistics raise costs.
Informality: staying informal helps avoid taxes and regulations.
Management: many family firms lack modern management practices. A study by Nicholas Bloom and co-authors in Indian textile firms found that introducing better management practices raised productivity substantially.
Small markets and contract enforcement problems.

Why it matters

Larger firms tend to be more productive, pay higher wages, export more and invest more in technology. Helping productive small firms grow could create more good jobs.

The textile firm and management

In a famous experiment, consultants helped Indian textile firms adopt basic management practices, such as tracking inventory, recording quality defects and organising factory floors. Productivity rose by around 17 percent in the first year. Many firms had not adopted these practices because owners did not know about them or doubted their value.

Thinking small firms are always inefficient

Many small firms are productive and innovative. The concern is that productive firms often fail to grow, limiting job creation and productivity gains.

Key takeaways

Most Indian manufacturing firms are very small, with a missing middle of medium firms.
Hsieh and Klenow found Indian plants barely grew over their life cycle, unlike U.S. plants.
Regulation thresholds, finance, infrastructure, informality and management limit growth.
Better management practices raised productivity in Indian textile firms by around 17 percent.