India’s quest for manufacturing growth

Veeramani Choorikkadan

Since the second five-year plan of the mid-1950s, Indian policymakers have strived to expand the country’s manufacturing base. But India’s economic growth process continues to bypass manufacturing. In 2018, the share of manufacturing in India’s GDP was 15 per cent compared to China’s 29 per cent.

While skill-intensive services are bigger drivers of Indian growth, manufacturing has a greater potential to absorb the large pool of surplus labour that still remains in agriculture.

Currently, there are about 200 labour laws in India. The rigidity of these laws create severe exit barriers, discourage large firms from entering labour-intensive manufacturing, make it difficult for firms to adjust their employment in response to changes in demand, limit the flexibility of firms in moving workers across tasks and encourage firms to remain small and informal.

A provision in the Industrial Disputes Act (IDA) 1947 specifies that factories employing 100 or more regular workers must seek prior consent of the state government before any retrenching or closing. This provision does not apply to firms operating in skill-intensive service sectors, making it possible for these sectors to exploit the opportunities of buoyant external demand.

Since 2014, the governments of Rajasthan, Haryana, Madhya Pradesh and Maharashtra have amended their labour regulations. The amendments included an increase in the threshold for worker retrenchment without government approval from 100 to 300. The union government also introduced important reforms to improve the transparency of labour laws, eliminate the discretionary power of labour inspectors and make compliance easier for firms. While these are steps in the right direction, the threshold size for retrenchment should be raised to a much higher level. Any reform that provides greater labour market flexibility should be accompanied by new and better forms of social protection.

The structure of the financial system also plays an important role. While India has well-functioning equity markets, the markets for corporate bonds are much weaker. The banking sector is plagued with governance issues and rising nonperforming assets. This structural imbalance creates a bias against traditional manufacturing industries as they are more reliant on debt finance, while skill-intensive sectors are more closely tied to equity finance.

The Insolvency and Bankruptcy Code 2016 simplified the process whereby firms in financial distress can seek a resolution or an exit in a time-bound manner. The Modi government introduced the Banking Regulation (Amendment) Bill in July 2017 for handling stressed assets in the banking system. It also announced a major recapitalisation package to strengthen the balance sheets of public sector banks. Though corporate bond issuances increased significantly, there is a clear need to broaden the investor base by relaxing the quantitative restrictions on investment by institutional investors, such as insurance companies and pension funds.

Other constraints for manufacturing growth include the inadequate supply of physical infrastructure and highly inefficient land acquisition procedures. To address these bottlenecks, the Modi government is in the process of setting up dedicated industrial and freight corridors across the country. Implementation of various regulatory reforms contributed to the improvement of India’s rank by 65 positions since 2014 in the World Bank’s Ease of Doing Business index. It is now ranked 77 out of 190 countries.

Given India’s comparative advantage and the importance of creating employment for a growing labour force, there are two groups of industries that hold the greatest potential for growth and job creation. First, there is significant unexploited potential in India’s traditional labour-intensive industries such as textiles, clothing and footwear. Second, based on imported parts and components, India may emerge as a major hub for final assembly in a range of products such as electronics, where production processes are internationally fragmented.

While global value chains (GVCs) in several industries are primarily controlled by big multinational enterprises (MNEs), local firms play a significant role as subcontractors and suppliers of intermediate inputs to MNEs. For example, firms in auto ancillary industries supply components to larger manufacturers. Participation in GVCs requires not only trainable low-cost unskilled labour, but also middle-level supervisory manpower. Concerted efforts are needed to improve the quality of education at all levels, expand vocational training and facilitate large scale apprenticeship programs.

Because of the productivity and scale effects

 of producing for the world market, participation

 in GVCs leads to higher absolute levels of domestic

 value addition and employment. Greater integration

 of domestic industries in GVCs is imperative for the

 success of the ‘Make in India’ initiative

The move by the Modi government to increase import duties for some goods including several intermediate inputs, partly in retaliation to the recent US tariff hikes and partly to boost the ‘Make in India’ initiative, is not a move in the right direction. According to the 2017 UNCTAD database, the import-weighted average tariff rates for intermediate inputs were already high for India at 9.23 per cent compared to 4.41 per cent for China.

If India wants to become an export hub, it needs to participate in GVCs and reduce import tariffs, particularly for intermediate inputs. Apple, for example, demanded duty-free access for imported parts and components as a pre-requisite for its expansion in India. Studies show that the US–China trade war is causing major adjustments in GVCs and firms are now looking for alternative locations for their operations. These developments provide an opportunity for India to attract MNEs and strengthen its participation in GVCs.

Some policymakers assume that high domestic value addition per unit of exports is a necessary condition for reaping gains from trade and increasing the size of domestic manufacturing. They do not support the idea of strengthening participation in GVCs, as it implies that the domestic value addition per unit of exports is smaller than when most inputs are sourced locally.

But because of the productivity and scale effects of producing for the world market, participation in GVCs leads to higher absolute levels of domestic value addition and employment. Greater integration of domestic industries in GVCs is imperative for the success of the ‘Make in India’ initiative.

Veeramani Choorikkadan is a Professor at the Indira Gandhi Institute of Development Research, Mumbai