A Missing Middle Within the Manufacturing Sector

Industries are said to be the backbone of an economy. The growth trajectory of any economy starts with agriculture, leading to industrial development and, finally, the emergence of a service sector. Industries, thus, provide a forward and a backward linkage to services and agriculture, respectively. 

The history of industrialization suggests that technological advancements have facilitated employment opportunities for the masses. This renewal of labor demand in emerging industries has engineered the process of urbanization. However, there is a gap between the concentration of industries, compared by firm sizes, in the developed and developing economies. For context, the mode (the statistical one) of employees within the manufacturing sector firms in the United States is 45, and one worker in India and Mexico.

The manufacturing sector in developing countries is a dichotomy of small-scale firms and large-scale multi-national corporations. The reasons behind this phenomenon are manifold. One is the scarcity of innovative and easy to access financing channels beyond traditional models of informal loans and bank credit for the low-income population who wants to start a home business but lack collateral and necessary paperwork. The promise that microfinance models would help transition these small-scale firms to mid-sized firms failed to deliver the extent of the positive impact that it visioned. 

Another part of the reason is a prejudiced institutional and policy environment that hinders the expansion of these small-scale industries. A case in point is the garment industry in India – a labor-intensive sector – that remains dealigned with the global value chain. Most of these firms lie in the industrial clusters spread across India, and a large share of them employs no more than ten employees. 

It is these small and medium scale enterprises that drive growth and innovation in the high-income developed countries. On the other hand, emerging economies house a sizable share of small-scale household-run businesses that own too little physical and human capital to drive innovation.

This trend does not remain restricted to industries alone. In India, the agricultural sector faces a similar problem. About 80% of the landholdings come under the categories – marginal and small landholdings – for which land size is under two hectares. Moreover, even less than one percent of landholdings categorizes as large, indicating the missing middle problem. 

The growth potential of emerging economies lies within their missing middle – the medium-sized businesses and industries. A 2001 McKinsey Global Institute report claimed that the most productive firms in low-income countries stand at par – in terms of productivity – with the firms in high-income countries. However, in low-income countries, such firms are scarce, as a large share of firms are the ones with low productivity. 

In many low-income countries, large and medium-sized firms face enormous fixed costs, a cause of resistance in the expansion of smaller firms. There is a lack of entrepreneurial rigor within the industrial sector. An inadequate education system and poor schooling outcomes compound the challenges of industrial growth.  

The rise of mid-size industries will lead to an increase in the middle-class consumer base. Middle-class consumerism falls short in such countries owing to high levels of poverty and weak state capacity. 

There is also a theoretical construct that amplifies the absence of the missing middle – the Lewis model. The Lewis model of economic development signifies a dualism in the agricultural and manufacturing sector – where small-scale firms exist with large-scale and capital-intensive industries. 

A paper titled – The Missing “Missing Middle” – by Chang-Tai Hsieh and Benjamin A. Olken asserts that it is not the mid-sized firms that are missing in developing countries but also the large ones, pointing to a missing ‘missing middle.’ Yet, the problems outlined above persist due to the absence of transformation from small-scale to large-scale industries. 

The development of the micro, small, and medium enterprises (MSMEs) should be an objective for emerging economies to make their exports competitive in the global supply chain. New financing models such as the emerging impact investment towards such enterprises could aid capital improvements and increase productivity. Encouraging philanthropy using appropriate tax incentives could also lead to a similar goal. Expansion of credit base by creating robust rural financing channels for easy access to low-interest loans would support household-run businesses increase capital. Knowledge of finance and risk-sharing, along with spaced loan repayment schedules for low-demand-inducing sectors, could help resist vulnerability. 

In developing countries, such as India, Indonesia, and Mexico, small enterprises lead the employment growth rate. However, a larger share of such small establishments creates a cluster of low-productivity firms attracting lower demands. These industries have the potential to increase their size by employing more capital and labor. As a result, the economy undergoes price adjustments due to the increasing competitiveness and innovation within the industrial sector. 

Building adequate infrastructure in rural areas to attract investments and consumer demand could be another step in the right direction. Lastly, there is a dire need concerning data collection and management initiatives by government and non-government agencies to help companies and policymakers make better market decisions.