Lack of managers keeps India’s businesses small

Why do businesses in developing countries tend to stay small? A new study by Yale economist Michael Peters shows a lack of professional management plays a role.
Workers at a textile company in India.

Workers at a textile company in India. (Photo credit: Vestal McIntyre)

In today’s economy, American businesses often tap into professional management to grow. But most firms in India and other developing countries are family owned and often shun hiring non-relatives to manage their companies. A new study co-authored by Yale economist Michael Peters explores the effects that the absence of outside professional management has on India’s businesses and the country’s economy.

The study, published in the American Economic Review, uses a novel model to compare the relationship between the efficiency of outside managers and firm growth in the United States and India. It shows that the lack of managerial delegation factors significantly into why businesses in India tend to stay small and has wider implications on the country’s economy, constraining innovation, economic growth, and per capita income.

There’s been growing evidence that managerial services might be the key missing input for many firms in poor countries,” said Peters, associate professor of economics in Yale’s Faculty of Arts and Sciences. “Our analysis confirms that the absence of managerial delegation is a significant factor in why successful Indian businesses fail to grow, which reduces the overall productivity of the country’s economy.”

By growing, companies generate employment, promote innovation, and contribute to a countries’ economic productivity, the researchers say.

In developed countries, family-owned firms such as Walmart, Ford Motor Co., and the Lego Group, which all emerged from humble beginnings, grew into corporate behemoths, with hundreds of thousands of employees, by delegating key operations to outside managers. But businesses in developing countries rarely hire managers outside the owners’ families, the researchers note.

Peters and his co-authors, Ufuk Akcigit of the University of Chicago and Harun Alp of the University of Pennsylvania, focused their analysis on this disparity between developed and developing countries’ firm sizes. They created a quantitative model that centers the role of managerial delegation in firm growth. It incorporated plant-level data from the United States and India and was calibrated to recognize that business in India might face higher barriers to growth, such as having less access to start-up capital, than U.S. businesses.

In India, more than 9 out of 10 of manufacturing businesses have fewer than four employees, and those small firms account for more than half of total employment. In contrast, two-thirds of U.S. manufacturing employment is concentrated in establishments with at least 100 employees, and only one-third of firms have fewer than four employees, according to the study.

The researchers found that India’s economy suffers from “a lack of selection” — the process of creative destruction through which successful businesses expand while unproductive firms close or are swallowed up by competitors — allowing unproductive businesses to survive because successful businesses do not expand. Their analysis showed that the low productivity of outside managers in India, which they estimate to be substantially lower than in the United States, is one cause of the lack of selection and has negative consequences for India’s economy.

If Indian businesses used outside managers as efficiently as U.S. businesses, it would boost economic productivity in India and increase the country’s per capita income by about 11%, according to the study.

The study found a strong complementary relationship between the quality of outside managers and other factors affecting firm growth, such as access to capital or credit. Increasing the efficiency of managerial delegation to U.S. standards would increase average firm size by 3%, the researchers said. In contrast, if U.S. businesses had to operate with management practices common in India, the country’s average firm would shrink by about 15%. This disparity between the U.S. and India shows that the productivity of outside managers is not the only determinant of firm growth and that other forces prevent successful Indian businesses from expanding, Peters explained.

The complementarity between the efficiency of delegating managerial tasks and other aspects affecting firm growth, such as access to credit, is one of our key results,” said Peters, who is affiliated with Yale’s Economic Growth Center. “For improvements to managerial quality to have a large effect, other factors hindering growth must be addressed. If you repair a punctured tire, you still can’t drive if your other tires are flat.” 

A link to the paper and a detailed summary of its findings is available on the Economic Growth Center’s website.

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