MSMEs’ Competitiveness: Need to Move Beyond Labour and Compliance: Amit Kapoor, Chairman, Institute for Competitiveness

India’s MSMEs have historically leaned more on labour cost advantages than on building true productivity or innovation capabilities. Although vital to job creation and economic activity, micro and small enterprises face persistent challenges around low skill levels, limited risk tolerance, and aversion to formalisation -- often because of compliance-related challenges and not just credit.

Competitiveness of micro and small enterprises, in this context, is tied to social progress, economic development, and shared value, and not a GDP-linked metric, says Amit Kapoor, Chairman, Institute for Competitiveness (IFC).

Kapoor, who recently co-authored the report ‘Enhancing MSMEs Competitiveness in India’ for NITI Aayog, calls for a rethink of how MSMEs can be made more competitive. In an interaction with FE Aspire, he argues for a fundamental shift in how we support and scale MSMEs. He advocates redesigning cluster policies around core capabilities such as design and innovation, rather than limiting them to sectoral lines, while emphasising the need for states to lead ecosystem development.

Below are the edited excerpts from the interaction:

Beyond financial access, how do informal MSMEs view risk and formalisation, and how can policies be reimagined to align with those behavioural drivers rather than just economic incentives?

It is an important question to be understood from the perspective of competitiveness. When we talk about productivity as a competitiveness driver in the Indian context, we have observed severe issues not only around labour but also around how we use our resources. In fact, talking about labour productivity, India builds a model of competitiveness on labour arbitrage and not on labour productivity. For instance, the IT industry was effectively about labour arbitrage. Therefore, we have to understand that it is a labour arbitrage issue.

Another issue is around skilling. If we look at the Periodic Labour Force Survey (PLFS) data, we understand that there are four skill levels. While the first and second levels indicate low-skilled people, the third level has graduates, and the fourth level has PhDs and higher education people. Only 9.83 per cent of people in the age group of 19 to 59 are in the third and fourth levels.

This indicates that the working age population at levels one and two is not trained or educated enough. This leads to the question around the lack of risk ability. In the MSME space, the challenge is largely faced by micro and small units, where the lack of training also creates the inability to take risks.

Moreover, even today, entrepreneurship is a fallback mechanism in India. It is not a matter of choice and is often seen as a mark of failure by many if they fail to get a job. While change has been underway for the last 10 years, I think it will take a generation for entrepreneurship to be celebrated by all.

Do you think India's cluster policies, which are often sectoral, should be reconceptualised around capabilities such as design thinking, materials innovation, etc., rather than products?

How we look at clusters in India is a basic form of understanding what a cluster is. Any industrial agglomeration is assumed to be a cluster. The depth of clusters can be seen when there is knowledge-sharing and an ecosystem is built around it. For example, Kodak started in Rochester city in the US. The city also had visual technologies along with lenses, printing technologies and everything related to photography. All this was built around institutions like the Rochester Institute of Technology. This kind of ecosystem is lacking in India. 

Our IITs and IIMs have not been the drivers of the creation of clusters. While they are great institutions, they have not been well embedded within the industry when you talk about cluster development. We must move beyond our conventional thinking that clusters are merely one small agglomeration. We need to consider clusters as a larger concept. For instance, you have the Bollywood cluster in Mumbai which includes cameramen, musicians, actors, studios, dancers, etc., embedded into movie making. That is a real cluster of creative arts.

From a policy perspective, what needs to be done?

We need to identify industries doing exceedingly well and create ecosystems around them. Another important thing is that we are obsessed with the idea that the central government will do everything. The central government's role is to provide policy direction while it is the states which have to understand the right sectors and locations, and do what is needed. So, the absolute sector-driven policies must be built.

However, we are currently seeing that every state wants to do everything. Instead, they need to identify what they can actually do best and then focus in that direction. For instance, Maharashtra is good at finance and creative arts. These two industries are Maharashtra’s winners in creating clusters around them.

Given that a lot of enterprises are smaller than micro enterprises in India and also informal, is there a case for a new classification of nano enterprises in the MSME definition?

I think it could be a good idea but implementation might be a challenge. Will this be just another classification or will there be a real benefit accrued to it? It will be good if it eases the compliance burden, for instance, around taxation and GST. If not, then for a nano entrepreneur, it could be burdensome to manage compliances. If the government cannot reduce that compliance burden, it should find a way to shift it.

If we are able to reduce compliance, it will also improve their competitiveness because they will be able to make decisions in real time and grow. Today, enterprises are fearful of the idea that if they grow beyond their category (micro, small and medium), they will be engulfed in compliance. Hence, they want to keep themselves small.

Is the idea of competitiveness too GDP-centric for MSMEs operating in low-surplus, high-subsistence settings? Should we rethink what "success" means for them?

I think beyond GDP, competitiveness also embodies a lot of interesting things. A lot of times we look at competitiveness as a notion which from a country level will always be GDP per capita per se. However, competitiveness also includes social progress and quality of life. India's GDP per capita is 92nd in the world and on social progress we are ranked close to 100. There is also the whole constructive shared value notion to say how do we actually solve for society. So, social progress, economic development, and shared value are three big things when we look at competitiveness for MSMEs and not only GDP.

In the age of AI and digitalization, how can MSMEs become co-creators of tech solutions, not just consumers of big firms’ products?

When we talk about AI, there are questions around its impact on jobs and humans per se. While I think AI can actually make us very dumb but when we talk about enterprise creation, I don't think all sectors and areas will be affected by AI. However, AI can be used as a tool for creating new enterprises. Bill Gates recently said India does not have to create its own LLMs from scratch. There are models already created. The question is can we create solutions on top of them? This is where small enterprises can actually create the next wave of opportunity for themselves. So, I think AI is not going to diminish industries but only enhance them, similar to how computing has done so far.