India’s Small Firms Need Markets, Not Just Money

India’s informal economy is often discussed through the lives of its workers: low wages, insecure employment and the absence of social protection. All these issues matter. But there is another question that receives much less attention. What happens inside the millions of tiny enterprises that provide these livelihoods? And why do so few of them grow?

Recent evidence from successive rounds of the National Sample Survey Office and the Annual Survey of Unincorporated Sector Enterprises offers an important clue. India has continued to produce more small enterprises, but not necessarily enterprises that employ more people, generate substantially more value or move steadily towards a larger scale of operation.

Consider informal manufacturing. The estimated number of enterprises increased from about 17.2 million in 2010-11 to 20.1 million in 2023-24, an increase of roughly 17 per cent. Employment, however, declined over the same period, from around 35 million workers to 34 million. Real gross value added did rise substantially, but much of that improvement occurred before 2015-16. GVA increased by almost 50 per cent between 2010-11 and 2015-16, but by only around 12 per cent over the following eight years.

This pattern deserves more attention. India is sustaining a very large number of enterprises without a corresponding expansion in employment within them.

The picture becomes clearer when we look at the composition of the sector. By 2023-24, own-account enterprises, which rely largely on family labour rather than hired workers, constituted about 88 per cent of informal manufacturing enterprises. They accounted for roughly two-thirds of employment but generated less than 40 per cent of the gross value added produced by the sector. In other words, entrepreneurship in India’s informal economy should not automatically be interpreted as enterprise growth. For many households, establishing a tiny business may be an important means of earning a livelihood. But an increase in the number of very small firms is different from the emergence of enterprises that are able to employ more workers, expand investment and increase productivity.

The changing constraints facing small businesses

For many years, policies towards small enterprises have understandably concentrated on the supply side: electricity, credit, raw materials, skills, registration and infrastructure. The new evidence suggests that the relative importance of some of these constraints is changing.

Among unincorporated enterprises that reported a constraint,the proportion identifying falling demand as their most severe problem rose from about 26 per cent in 2010-11 to 51 per cent in 2022-23. Over the same period, the share identifying power shortages declined from around 13 per cent to less than 5 per cent. Finance continues to be an important constraint, reported by about 28 per cent of constrained enterprises in 2022-23, but its incidence has not increased in the same way as falling demand.

The picture becomes even more revealing when we consider both the most severe and the second most severe constraints reported by enterprises. Demand and finance together account for 51.3 per cent of the major combinations of constraints among enterprises reporting more than one obstacle. The connection between the two is not difficult to understand. A firm that is unable to sell enough of what it produces is also likely to face financial pressure. Weak sales reduce cash flow, make it harder to meet working capital requirements and discourage further investment. Additional credit can help a viable firm overcome a temporary financing problem, but borrowing alone cannot permanently solve the problem of insufficient demand.

The point, therefore, is not to choose between credit and demand. Small enterprises often face both constraints at the same time. The evidence suggests that policies which concentrate predominantly on improving access to finance while paying insufficient attention to markets may address only part of the problem.

There is no single “informal firm”

An equally important message is that India’s informal sector is extraordinarily heterogeneous. In manufacturing, urban enterprises recorded labour productivity about 1.6 times that of rural enterprises in 2023-24. Enterprises employing hired workers were almost three times as productive as own-account enterprises. Firms operating outside the household similarly recorded productivity approximately three times that of household-based firms. These differences are not merely statistical curiosities. They tell us something about the transition from livelihood activity to enterprise.

A household enterprise relying predominantly on family labour has very different requirements from a workshop employing several workers. A street vendor has different problems from a manufacturing establishment with permanent premises. A firm that maintains accounts, uses digital technologies and reaches customers beyond its immediate neighbourhood occupies a very different position from one that depends almost entirely on local demand.

Our statistical analysis reinforces these patterns. Even after accounting for differences across industries, states and years, enterprises in urban areas, those operating from permanent premises, hired worker establishments, registered enterprises, firms maintaining accounts and those using computers or the internet generally perform better. These relationships should not be interpreted mechanically as causal. Simply providing a computer, for example, will not automatically raise productivity. More capable firms may also be the ones more likely to adopt technology or maintain accounts. But the consistency of these associations tells us that scale, location and enterprise capabilities matter.

The implication is important: an enterprise policy designed around an imaginary “average small firm” is unlikely to work equally well for all of them.

Who gets to run the more productive enterprise?

There is also an important social dimension to this divide. The presence of women among informal manufacturing entrepreneurs has increased substantially. By 2023-24, women-owned enterprises accounted for nearly 59 per cent of informal manufacturing firms. Yet they accounted for only about 41 per cent of employment and 18 per cent of gross value added. This is a striking contrast. The increased presence of women in entrepreneurship has not translated into a proportionate share of value creation.

Women-owned enterprises as well as those owned by Scheduled Caste and Scheduled Tribe entrepreneurs also tend to record lower performance across several indicators. Social characteristics, location, scale, access to permanent premises and enterprise capabilities all emerge as important dimensions of differences in enterprise performance.

The policy question, therefore, is not simply how to create more entrepreneurs. It is how to enable entrepreneurs who are currently concentrated in low value, household based activities to gain access to markets, capital, premises, technologies and opportunities for expansion.

What the numbers look like on the ground

Our interviews with small entrepreneurs in Delhi and Kolkata help explain what these statistical patterns mean in practice. A handicrafts producer in Delhi, for example, makes products at home and moves between weekly markets because permanent selling space is expensive and insecure. Her earnings fluctuate, capital is scarce and machinery sometimes remains unused because she cannot finance the labour required to operate it. Credit provides some relief, but what she seeks above all is not spectacular growth: it is reliable selling space, fuller use of her productive assets and greater stability.

A family bookbinding enterprise in Kolkata faces a different problem. Mechanisation has improved efficiency but reduced employment, while the unit has little bargaining power against publishers. Digital printing, changes in procurement practices and declining volumes have placed further pressure on the business. These enterprises cannot sensibly be assisted by precisely the same intervention. That is exactly the point.

For some entrepreneurs, the immediate problem is capital. For others, it is access to customers. For still others, it is selling space, bargaining power, technology, labour or the declining market for the product itself. The informal economy includes enterprises with very different capabilities and very different prospects.

From helping firms survive to helping some of them grow

India has made genuine progress in areas that once imposed severe costs on small enterprises. The declining importance attached to power shortages is one indication. Credit access, infrastructure and digitalisation should certainly remain part of enterprise policy.

But the next stage needs a broader conception of what constrains a small firm. For enterprises facing weak demand, assistance with another machine will achieve little if that machine remains idle. A loan will have limited transformative effect if the entrepreneur cannot reach customers. Registration by itself will not create orders. Digital adoption is valuable when it connects firms to markets, information and capabilities rather than becoming another administrative target.

The evidence therefore points towards greater emphasis on market access, connections with larger firms and supply chains, local and public procurement opportunities, access to digital marketplaces and appropriate working capital support, alongside conventional improvements in finance, infrastructure and skills. It also requires differentiating between enterprises. Own account enterprises facing basic livelihood constraints need a different policy package from enterprises that have demonstrated the potential to employ workers and expand. Manufacturing firms face a different mix of problems from traders and service enterprises. Rural firms may face different financial constraints from urban ones.

None of this means that every tiny enterprise should be pushed towards becoming a large firm. Many exist because they provide essential household livelihoods and many entrepreneurs themselves may value stability more than rapid expansion. Nor should informality automatically be equated with failure.

But if India wants its enormous small enterprise economy to become a stronger source of productive employment, the test cannot simply be whether the number of enterprises is increasing. It must also be whether more of these businesses can reach more customers, raise productivity, employ workers and move beyond a perpetual struggle for survival.

The problem confronting many of India’s small firms, in short, is not simply that they need more credit. They also need the markets and opportunities that will allow them to grow.

(Rajesh Raj SN is with Sikkim University, and Kunal Sen is with the University of Manchester)