Understanding the ‘Missing Middle’ in Indian Manufacturing : The Role of Size-Dependent Labour Regulations and Fiscal Incentives

This paper studies the problem of missing middle in the size distribution of manufacturing plants in India as an outcome of threshold effects of labour regulations defined by employment size and fiscal incentives determined by turnover for small-scale enterprises. Two alternative avenues that firms could use to escape from higher adjustment costs of larger firm size are employment of non-permanent workers and subcontracting output to other firms. These two outcomes are measured by contract-worker intensity and subcontracting intensity. The study is based on a large unbalanced panel of manufacturing plants in the formal sector covering 25 states and 5 union territories of India spanning the period 1998-2008. Contract-worker intensity is found to be higher in size class 50-99 relative to others supporting the proposition that firms use non-permanent workers to stay below the size threshold of 100. Mean contract-worker intensity of factories in size group 50-99 is found to be higher in labour intensive industries located in states categorized as inflexible. Mean subcontracting intensity was found to be significantly high in the size group eligible for excise-tax exemption with turnover below Indian Rupees 50 million. The empirical results supported the threshold effects of size-dependent labour regulations and fiscal incentives