The Small-Scale Opportunity for Indian Business

A common view is that India missed the manufacturing bus because regulatory and other restrictions prevented it from scaling up and generating adequate employment from labour-intensive exports. Economies of scale were regarded as essential to lower costs enough to win in competitive export markets.

Even after the 1990s liberalising reforms, the share of manufacturing in GDP remained around the mid-teens. In most other countries, it increased to about 30% during growth transitions.

One reason was that liberalisation shifted to a difficult ‘import competition’ regime from the earlier inefficient import-substitution regime. Manufacturing could not compete with subsidised Chinese exports. The current regime of ‘export competition’ with time-bound conditional PLI subsidies and ongoing attempts to lower the cost of doing business is more conducive to developing dynamic comparative advantage. There are some successes, but it takes time to build efficient economies of scale.

Falling Optimal Scales
In many areas, however, optimal scale is shifting lower, making it easier for Indian manufacturing to achieve global competitiveness.

Consider textiles, the poster boy of scale-based labour-intensive exports. For speciality textiles, which have much higher value-addition and margins, the optimal batch size is small, because of strict quality control and special processes. Automated computer-aided production and vertical integration reduce costs. But labour requirements change to the skills required for these processes. Large-scale lines will not raise employment, but many start-ups may, as Indian firms venture into these areas. The design depth of Indian traditional handlooms can perhaps be married with technology to create new speciality textiles.

Standard textiles remain labour-intensive, but in Indian mills, low productivity prevented export penetration. Here also, if skills to improve line efficiencies expand, the new FTAs offer opportunities.

A major reason new technologies make smaller scales of production optimal is that they allow many functions that required large in-house investment to be more cheaply outsourced, to the cloud, to AI agents, etc. These sources also compensate for lacunae in external infrastructure. There are many companies providing a secure environment for data and open-weight agents that can be harnessed and distilled to suit context at lower costs. The small entrepreneur has access to knowledge, learning and skills that were out of her reach earlier and can compete with the large.

While climate change is a threat, substitution towards green energy has enormous potential for India. Apart from reducing dependence on oil imports, investment is creating many business opportunities for large industrial facilities but also for small-scale ventures.

The ones that have worked well are those that, by design, create a surplus to be shared by all who participate. Consider the PM-KUSUM scheme notified in 2019.

The component of standalone solar water pumps has been very successful. The cost of the subsidy given is soon recovered since states’ electricity subsidy sharply reduces, while the farmer gets non-polluting daytime power and income from surplus power that DISCOMS pick up at fixed rates attractive to the latter. As payment lags reduce, implementation is a viable business for many small firms. Active states have saved crores in subsidy payments.

Storage capacity is a constraint on network integration of surplus solar electricity and, apart from scale and land issues, has restricted feeder-level solarisation where an entire rural electricity line gets its power from a dedicated solar energy plant. Targets for this, and for grid-connected utility plants, lag, perhaps also because these require much larger scale.

Since production of solar power does not match electricity demand, inadequate expansion of storage is one reason the production of green electricity in India exceeds 50%, but usage is only about 30%. This, however, is also a business opportunity, with recoverable government subsidies financing an expansion in battery storage. While currently China dominates production of cells, much research is taking place in materials since storage does not require the charge boost that lithium cells give.

Green urea is another area where small-scale production is becoming viable. It can reduce agricultural and industrial waste as well as dependence on expensive imports. Local carbon capture and distribution save on storage and transport costs. Modular structures can be built at low cost.

Small Modular Reactors for nuclear power, whose optimal size is one-fourth of a traditional large reactor, have similar advantages. Captive plants for industry and data centres can be even smaller. They are safer since inherent passive safety features naturally cool the reactor core in a malfunction, without requiring an external web of water pipes and pumps.  An underground or submerged single thick steel vessel with limited radioactive material achieves a safe, stable shutdown without any operator action. On core overheating, the physical properties of the materials used naturally slow or stop a nuclear chain reaction. Good governance, regulations, systems and oversight remain essential, however.

Community-Led R&D
There are those who believe India should stop wasting scarce government resources on manufacturing and focus on its technology-led advantage in services exports. But technology may now also be creating a comparative advantage for Indian manufacturing.  Moreover, expansion of manufacturing is essential to be at the technological frontier, to create the variety of jobs required, as well as the diversity necessary to keep growing despite continual global shocks.

Private corporate firms under-provide R&D since they do not capture all the externalities from research. Multinational corporations normally outsource it to their home countries. So, government incentives have a critical role in increasing R&D spending. India’s digital public infrastructure provides externalities aiding private innovation.

With widespread production and use, diffused innovation can occur. While normally technology develops for goods that the rich consume and can pay for, the sheer scale of its use has led to rapid innovation in mobiles. It benefits all types of users.

The combination of AI applications with a digital public infrastructure creates powerful tools to empower the individual innovator. As Acemoglu has argued, it is when technology is inclusive and creates for the community that the wealth it generates multiplies sustainably. Modern technology is unusual in having this possibility, with supportive policy.