Can India Make it Without Manufacturing?

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Electric fan factory in India. Image: Jorge Royan/Wikimedia

This article was originally published by the East Asia Forum on 26 October, 2015.

There’s one school of thought in Indian academic and policy circles that India represents a completely new model of development on the way to prosperity. India, it’s claimed, will be a services-led growth model, built on the spectacular international success of its IT hub in Bangalore, and its supply of English-literate back office services to the world.

This way of thinking eschews the experiences of Japan, South Korea, Taiwan and indeed China in East Asia that saw prosperity built on investment in competitive manufacturing and skills, and eventually a world-class manufacturing base. No need to try to emulate the Japanese or South Korean industrial powerhouses or Global Factory China in this model: skip all that and go straight to the top of the ladder.

This is no idiosyncratic Indian thought bubble. Its articulation in an extreme form may be confined to narrow circles. But the germ in the idea infects the way in which some of India’s top policymakers think about how, for example, the country should position against what is frequently conceived as the challenge of Chinese competitiveness. There is little conception in many Indian policy circles of the transformation that is taking place in East Asian manufacturing, where China is moving into higher-value manufacturing and vacating its labour-absorbing end to others, including potentially India.

India, unlike China, has one of the world’s youngest populations, with some 260 million people below the age of 25, and its economy is once again growing quickly. At 7 per cent growth it is one of the world’s fastest-growing economies as of August 2015. It also has one of the world’s largest concentrations of poor people, with more than 723 million people in 2011 living on less than US$2 a day and its per capita income, at US$1596 in 2014, is much lower than that of the East Asian economies.

There is no doubt that India needs a strategy on how it will compete in a rapidly changing global market for manufacturing as well as services, a market that is shaped by global supply chains, distributed sourcing and processing, and technologies that are constantly changing. India also has a low female labour force participation rate — around 33 per cent in 2012, compared to an East Asian average of 63 per cent — and it needs to draw more women into the organised workforce. It need look no further than its neighbour Bangladesh to see what a dramatic impact opening up can have on moving towards these policy targets.

The reality is that it is manufacturing that has contributed most strongly to economic growth in developing countries like India. Internationally competitive IT services play an important role in the economy, but it is small and unlikely to be able to absorb the wave of new labour that will come on to the Indian labour market over the coming decades.

On any objective measure, India has a comparative advantage in low-skilled labour-intensive manufacturing. But the opportunities for its deployment in the formal sector have been frustrated by restrictive labour laws and a less than welcoming environment for foreign investment, essential to effective participation in international production networks. The formal manufacturing sector in India currently uses skilled labour more intensively. This sector is crucial to absorbing the vast, informal labour force. Otherwise, manufacturing will struggle to provide the productive employment opportunities India sorely needs. And growth in the formal manufacturing sector as a share of national output seems to have stalled well before India as a whole has fully industrialised. The data suggests that only in Gujarat and in Himachal Pradesh is the formal manufacturing sector’s share of value added increasing.

There are more than 140 overlapping labour laws in India: 44 at the federal and about 100 at the state level. States with overly restrictive laws have experienced weaker industrial growth and have benefited less from investment delicencing. This burdensome regulatory environment is part of the reason why the growth of India’s manufacturing is stunted. Land acquisition laws are another.

This week’s lead essay from Anthony D’Costa is sceptical about whether Prime Minister Narendra Modi’s ‘Make in India’ strategy provides the answer. While it’s a catchy and visionary idea, he suggests, it looks rather too much like a reworking of the Nehruvian policy of import-substituting industrialisation. Modi’s strategy and Nehru’s are both aimed at increasing local content (fewer imports), although they do differ in significant respects. More imports alongside more exports are essential to lifting incomes via efficient integration in the global economy today. India’s and the world economy are no longer the same as they once were. The economic importance of agriculture has declined substantially, while that of services has increased dramatically. But Indian industry is still stagnating. Employment in agriculture remains high at nearly 50 per cent of India’s 475 million-strong workforce. Industries and services both have roughly 25 per cent.

‘Most of India’s employment is in the informal sector, where employment is low paying, precarious and unregulated’, D’Costa points out. ‘The services sector is a mixed bag, with both low-paying domestic work and high-salaried IT professionals. The interrelated tasks for Modi are: to make agriculture productive; raise rural incomes; and effectively reduce rural dependence, while expanding industrial and services jobs’.

The best bet for ‘Make in India’ lies in labour-absorbing manufacturing, like that of China, as D’Costa argues. On this, Modi has made some headway with foreign investors. But that won’t do the job alone.

The political economy of Indian reform in most areas is difficult, particularly because of the regulatory overlap with different levels of government. The Modi government’s plan of decentralising policymaking, backed by a large increase in the states’ share of tax revenue, is one way of providing incentive for the states to implement reforms themselves in order to compete for investment. Competitive federalism is potentially critical to momentum in Indian reform that looks outward, and gets rid of the regulatory burdens on internationally competitive manufacturing.

D’Costa is right that it will need more than ad hoc exhortations of foreign investors for the success of Modi’s Make in India campaign. Yet the Modi government has shown that it understands better than any government before it the scale and breadth of the task at hand — even if it is still yet to articulate fully the reform strategies that will deliver the growth of incomes and employment in manufacturing that it will need to satisfy the aspirations of India’s youth over the coming decades.

Peter Drysdale is editor of the East Asia Forum.

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