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Firm Transitions in Indian Formal MSMEs
Using a panel of formal manufacturing and service sector firms incorporated during 2000–08, and by following each firm for a period of five years (2007–15) after incubation, we analyse the relationship between firm transition, firm age, and firm size. The results show an inverted U-shaped relationship between firm transition and age consistent with the non-linear relationship between age and performance suggested in the literature. However, our interpretation suggests a different possibility. We also show that the choice of definition of firm size has a distinct impact on the transition patterns and size structures of firms in the manufacturing and service sectors.
The authors are grateful to an anonymous referee for comments that substantially improved the paper. They take responsibility for all the remaining errors.
Micro, small, and medium enterprises (MSMEs) in the majority of developing countries are characterised by a persistently skewed firm-size distribution. They have an overwhelming presence of small-sized enterprises and few large firms, with a conspicuous “missing middle.”1 This indicates a problem of firm transition wherein firms incorporated as micro or small tend to remain in the same size category and do not transition to a higher size category. The phenomenon of firm transition holds importance for the following reasons: (i) medium-sized firms offer better quality and are typically more productive than micro firms (Altenburg and Eckhardt 2006); (ii) relatively larger enterprises contribute more to growth indicators such as the gross domestic product (GDP) and employment compared to their smaller counterparts (Mead 1994; Ayyagari et al 2007); and (iii) the aggregate productivity of developing economies, as compared to developed ones, is low because of the presence of a large number of small enterprises (Hsieh and Klenow 2008).
What are the possible causes for the non-transition of firms? Why do some firms grow fast and transition into the medium- and large-sized categories while others prefer to stay small or fail to grow beyond a certain threshold? Studies in the areas of economics and business management have investigated the determinants of growth for firms and the structure of the size distribution of firms (Nichter and Goldmark 2009; Liedholm 2002; Mead and Liedholm 1998). A reading of this literature suggests several potentially important factors and drivers of change arising from different models. The empirical literature on the dynamics of firm size, firm growth, and economic performance (for example, productivity and job growth) based on data sets from developed countries has widely discussed two factors: firm size and firm age. However, empirical studies on firm transition in developing countries are few and slow to emerge because of data constraints and, therefore, are inconclusive. In this paper on firm transition, we examine the role of firm age and size in two key sectors in India—manufacturing and services. Further, we provide evidence for the distinctive implication of alternative definitions of firm size on transition patterns and, thus, on the size structure of firms across both sectors.
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