McKinsey Report: How Informality in MSMEs Costs the Economy Billions

A groundbreaking report from the McKinsey Global Institute (MGI) has highlighted a staggering productivity gap in India’s labor market.

It reveals that workers in India’s Micro, Small, and Medium Enterprises (MSMEs) produce only 14% of the value added per worker compared to their counterparts in large firms.

This massive disparity, driven largely by extreme informality, is estimated to be costing the Indian economy billions of dollars in potential GDP growth.

The Productivity Chasm

While MSMEs are the backbone of the Indian economy—employing over 110 million people—the report suggests they are trapped in a cycle of low productivity.

In advanced economies, MSME productivity typically reaches 50% to 60% of large-firm levels.

India’s 14% benchmark is among the lowest globally, primarily because the sector is dominated by “micro-businesses” with fewer than 10 employees.

These units often lack the capital, technology, and managerial expertise required to scale, resulting in a fragmented industrial landscape.

McKinsey Report The High Cost of Informality

Informality is cited as the primary barrier to growth.

Many MSMEs operate outside the formal tax and regulatory net to avoid compliance costs.

However, this “informality trap” prevents them from accessing formal credit, government subsidies, and global supply chains.

The report indicates that transitioning the informal MSME workforce into formal, mid-sized firms could significantly boost the economy.

This shift could potentially add $500 billion to $1 trillion to India’s GDP by 2030.

Currently, the “missing middle” refers to the lack of mid-sized companies bridging the gap between tiny shops and massive conglomerates.

This absence stifles competition and innovation across the industry.

Bridging the Gap: Policy and Digitalization

To fix this “dual economy” structure, experts suggest a shift in policy focus from merely protecting small firms to helping them scale.

Key recommendations include:

• Digital Integration: Expanding digital public infrastructure to provide MSMEs with easier access to credit and e-commerce.
• Regulatory Simplification: Reducing the “tax on growth” that often penalizes small businesses when they expand their workforce.
• Supply Chain Linkages: Encouraging large corporations to integrate local MSMEs into their global production networks.

The report concludes that India’s path to becoming a developed economy depends on narrowing this 86% productivity gap.

Without formalizing the millions of workers stuck in low-output roles, the nation risks losing out on its demographic dividend.

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