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What India must do to create a billion entrepreneurs, according to Raghuram Rajan

Reuters/Paco Chuquiure
Go this way.
By Madhura Karnik
Published Last updated This article is more than 2 years old.

India’s billion-dollar unicorns may be proof of the startup boom in Asia’s third largest economy, but it’s still no easy country for an entrepreneur.

From his perch atop the central bank, Reserve Bank of India governor Raghuram Rajan has a bird’s eye view of the fledgeling sector and its intricate complications.

“Graduates increasingly want to start businesses or work for startups rather than join an established consultancy or a bank,” Rajan said. “What is now needed was to continue improving the environment so that everyone had a better chance.”

The problems are many: The regulatory framework is a morass, capital isn’t aways readily available, accessing international markets is difficult and, for those looking to take the plunge, there are few safety nets.

But Rajan also has a few possible solutions.

In an hour-long speech in Odisha’s capital city of Bhubaneshwar on May 21, the former chief economist at the International Monetary Fund explored a handful in some detail. Here are the edited excerpts:

Less regulations

Having light regulation is very important because a small enterprise is the least capable of navigating government or regulatory bureaucracies. They don’t have people who know what the rules are or have people who know how to respect them. Some work that I’ve done on regulation emphasises this. We looked at a number of European countries to see the kinds of regulations that were in place for small businesses.
We take two ends of the spectrum.
The UK, where the regulation is light, and Italy, where regulation is very heavy with lots of inspectors and inspections. Turns out, when you look at the firms that emerge in Italy versus the UK, firms emerging in Italy typically start out much bigger (these aren’t formal firms) while in the UK they start out much smaller. But in the UK they grow much faster and much bigger. In Italy, they stay small. So we tried to understand this, and after more research, the answer was the following: When you have a lot of regulation, most people try and stay informal. The few that become formal do so only when they have enough capacity to manage the regulations. But because of the weight of so much regulation they don’t want to grow very fast because regulations increase proportionately as you become bigger.
The cost of excessive regulation is excessive informality, which means you can’t get access to credit, proper trademarks and you cannot in a sense become legal and formal and that becomes a problem.
In India, we have come a long way in terms of regulations, and we have some way still to go but remember the days of license raj. We have come a long way from that. We did away with the license raj. Now what is left is what one might call the inspector raj. We have to diminish the inspector raj which is as soon as you startup, you have the factory inspector at your door.

Access to finance

One of the biggest inputs to an enterprise is the access to finance and what is extremely important is that they find access to finance, perhaps more important than the cost of finance. You have situations where very small enterprises are willing to pay enormous interest rates. If we can make access to finance easy even at higher interest rates—moderate, not excessive of course—they can buy the products they need.
…One of the findings from the research that I have done is that small banks tend to be much more comfortable lending to small enterprises. Large banks tend to be much less comfortable and entrepreneurs also tend not to go to the large banks to borrow.
The reason is actually quite interesting. For a large bank, which is headquartered say in Mumbai or Delhi, if you are making a loan in a village near Bhubaneshwar, and you are lending to an enterprise…the small enterprise doesn’t have accounts, (they are) barely audited, they may be entered on a spreadsheet or simply written on paper. There’s nothing formal about the structure. Your loan is being made on the basis of your assessment of the borrower’s character. How do you communicate trust in a loan form to the headquarters? This what economists call soft information. It can’t be captured in a profit line in an audited balance-sheet. On the other hand if your branch manager has the loan approval authority, then he can meet the entrepreneur. So typically organisations which are local who have local employees who understand local habits and who can judge more effectively, they tend to be more capable of lending.

Ability to sell

Often times, for small enterprises, the access to domestic or international markets to sell is very very difficult
We need access to input and output markets. One of the issues in access has been infrastructure. Take a village where someone has the idea of starting a poultry farm or dairy farming but but in order to do that you need access to an output market where you can sell the dairy products without the milk deteriorating on the way. And for that I think the ability to connect to infrastructure: roads, freight, to connect to international markets plus the logistics systems would be helpful to small enterprises. Large enterprises can sometimes start their own parallel networks—they can have their fleet of lorries or build a road out but small enterprises cannot do that and this where they need the government.
The access to marketing is also important. And this is where online websites such as the Amazons, the Flipkarts, the Snapdeals are going to be important since they give you access to international marketplaces….They (online sellers) have the scale to do this. So, I think the competition between these entities to bring handicrafts to the markets is extremely important.

Building skills

We can talk about reforms for a long time. We can talk about expanding competition. We can talk about bringing all sorts of new technologies. But people should have the capacity to actually benefit from those kinds of reforms. If people have no ability because they haven’t got the proper education, if they haven’t got the proper skill base to benefit from all the facilities that are made available for small and medium enterprises, entrepreneurship doesn’t have widespread political acceptance amongst the people. So, a very important task is to expand capabilities.
The example here I have in mind is the US today, where there is a lot of anxiety over the middle-class because they are not well equipped for the kinds of skills that enterprises need, and as a result you see a lot more people moving away. Why does Bernie Sanders in the US, who is an out and out socialist—which was not a party favoured in the US in the past—why is it (the party) being favoured today? Partly because he is sending the message that enterprise is not that great a thing. We need to think about that.

Providing a safety net

Entrepreneurs need to take risks. In order to take that risk you need to have some confidence if it fails, one, you can get out easily…but, two, there is a safety net that you can rely on some support.
In India, we are starting to create safety nets. Today we are starting to create minimum healthcare for all, we are also trying to create some minimum old age insurance. We are trying to create an unemployment insurance. NREGA of course provides an unemployment insurance in rural areas.
We need to create a safety net, not one which we can’t afford, but a minimum safety net that allows people to go out and take risks. And workers have the willingness to join small enterprises where there is a high risk of failure but knowing that if it fails they have something to fall back on.

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