The Hindu Business Line : The primacy of manufacturing

Even as the massacre on Wall Street demolishes cherished economic beliefs, the Prime Minster’s advisory council on manufacturing has submitted a groundbreaking report. It must be treated with the seriousness it deserves, says ASHOAK UPADHYAY.

A pattern of economic development based on services does not create a resilient economy, much less create jobs, in quite the same way that manufacturing does.

An unintended fallout of the worst Wall Street crisis since the Great Depression that is receiving increasing attention is the impact of the collapse of iconic institutions and the Paulson-Bernanke bailout plan on two economic principles that became the cornerstone of western economies with renewed force since the 1980s. One of these, perhaps the more obvious, is the belief that the free market knows best and that self-regulation is indeed the best form of governance of ev en the seamier side of human behaviour — greed.

Both Martin Wolf and Samuel Brittain, doyens of conservative financial journalism and economic analysis acknowledge the limits to that founding principle of western economies since Margaret Thatcher and Ronald Reagan loosened regulations and oversight in the 1980s.

Neither Republican nor Democrat will admit it but the idea is increasingly growing, in large part because of jumbo-size government interventions planned in America and executed in various parts of Europe with increasing frequency. Nationalisation, government oversight, stricter monitoring, all the hallmarks of governments after the Great Depression are back in style.

The second premise of mainstream western economic philosophy may not have been articulated as clearly as de-regulation but it became a post-facto rationalisation of the need of American enterprise for cheap labour. The export of manufacturing to less developed countries, in America’s backyard and to China most notably, led mainstream analysts to believe that the organic decline of manufacturing and the heady rise of the sophisticated, and as it turned out, arcane, financial sub-structure was indeed to be welcomed.

Let the Third World do the dirty work; wealth generation through financial production was less polluting and more rewarding. It seemed to work perfectly with cheap imports from China and Mexico feeding the voracious appetites of a surging prosperity. In 2006, the height of the boom, US services, of which real estate and financial services were dominant, contributed 67.8 per cent to GDP, compared to 19.8 by manufacturing.

The domino effect

In retrospect, it is a matter of relief that India did not become a crucial link in the international division of labour generated by the migration of manufacturing to developing countries such as China. The People’s Republic is arguably the strongest manufacturing nation today but its strength lies essentially in its capacity to produce cheap products for the western consumer.

With the Western economies perilously heading for recession — unless credit lines open up or, more critically, asset prices rise — China and the East Asian trade-dominated economies are bound to suffer dents in their exporting capacities.

It is hardly surprising that the central banks of China, Indonesia, and the Philippines are reducing interest rates, even with inflation at uncomfortable levels.

With a historically weak domestic market, export-dependent nations such as China, or more so the Philippines, will have nowhere else to turn to other than local demand primed through fiscal and monetary policy to prevent growth rates from unwinding.

In that respect, India is fortunate, both as a result of history and policy. With a strong domestic market, Indian manufacturing not only predates industry in East Asia or even China, it has a greater capacity for robust growth. Despite high interest rates or, to put it in the RBI’s verbiage, “withdrawal of monetary accommodation” Indian industry has performed remarkably well, though the slippages in the last three quarters should worry policy-makers.

Just as it is foolish to consider a drop in GDP growth rates from 9 per cent to 7-8 per cent of little consequence, so too should dips in manufacturing not be dismissed. Each dip creates its own spiral of expectations; if monetary policy is so geared to inflationary sentiment, all the more reason for public policy to stay tuned to drops in real output.

Public policy for India

The revival of the old-fashioned idea of a solid structure of production, on which a financial superstructure rests , however inarticulate, should serve India well for the future just as the downward trend in manufacturing output serves as an early warning.

In the short term, the RBI must consider a softer interest rate policy and a stronger rupee to prevent a further slide in the current account. Global commodity prices are weakening but just how long oil prices will stay soft is debatable; already oil has climbed to above $100 a barrel. Winter is a few months away and America’s involvement in its disastrous wars shows no let up.

But public policy can play a far more critical role in ensuring that India’s manufacturing stays vibrant, blessed as it is with a domestic market that can more than compensate for sluggish exports. A little over a fortnight ago, the National Manufacturing Competitiveness Council, submitted its report to the Prime Minister who had asked it in January to suggest how manufacturing could be beefed up. With Mr V. Krishnamurthy, ex-chief SAIL, heading the group it, the report must be treated with the seriousness it deserves.

At the outset, the NMCC reasserts some basic truths. The 7 per cent growth witnessed between 1991-92 and 2007-08 is not enough; to engender GDP growth of 9-10 per cent industry will have to speed up to 12-14 per cent annually. Moreover, a pattern of economic development based on services does not create a resilient economy, much less create jobs in quite the same way that manufacturing does.

Activist role

At the heart of the NMCC blueprint is the government. The Council assigns to it a role that could be viewed as interventionist; a better word would be ‘activist’. The NMCC relies on the East Asian/Chinese model of governments shaping the macro-economic scaffold for higher investments and technological assimilation across industry by products and size, according to a pre-assigned priority.

This is in sharp contrast to the perceived wisdom of the last two decades that discounts government role of any kind other than essential regulation.

If the government is to provide the context for growth, the main actor is domestic enterprise. The NMCC draws on the East-Asian and Chinese stress on the importance of local industrial promotion through technological and capital investment and an FDI policy that encourages it.

So the Council does not think 100 per cent subsidiaries are a good idea, just as it doubts an FDI policy that measures success through capital inflows more than technology diffusion. It recommends a Technical Committee oversee the real as distinct from the monetary benefits of FDI on prioritised sectors.

At the core of its recommendations is the premise that simply opening up the economy does not constitute proactive reforms as much as leveraging the opportunities that open doors allow. Tax and trade policies have to build competitiveness that contributes to domestic value addition — a philosophy that does not inform much of trade policy today.

The Council, for instance, suggests a rethink of the policy that permits exports of good grade iron ore and the import of steel. Undoubtedly, value addition has taken place; the question is where?

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