How India can enter global supply chains

Ajay Shankar | Updated on October 14, 2019 Published on October 14, 2019

India should engage with the world by inviting investment, rather than entering into FTAs. Labour rigidities need to be addressed

In the context of the growing trade friction between the US and China, one view often expressed is that it provides India with a major economic opportunity. But this opportunity, as of now, is more theoretical than real. For some years, wages in China have been rising rapidly, and consequently, low-wage jobs have been moving out — just as they did from the high-wage economies of the US, Europe, Japan, Korea and Taiwan a generation earlier — as a part of mobile global supply chains.

These jobs, whose numbers are not insignificant, are going to other destinations, rather than India, which are more attractive to investors. To get these jobs into India as part of global supply chains, we need more than ‘business as usual’.

Labour reforms

The government’s intention to move forward with the proposed four labour codes to replace the 40-plus labour laws is a welcome development. The easy one on wages has already been enacted. The complex one is on social security. Here, the intention is to provide universal coverage. The challenge would be to provide sufficient resources. Further, considerable ingenuity would be required to design a seamless transition of benefits in case of movement from self-employment to casual employment in micro and small enterprises, and then to the organised sector, and vice versa.

The code on industrial relations providing for labour market flexibility should be easier to navigate politically, if universal social security is in place. A modest initial step has been taken with the notification on Fixed Term Employment. It is not well-known that German Chancellor Otto von Bismarck introduced comprehensive social security in Germany in the 1880s, not because he was a socialist at heart, but because he felt that this would facilitate rapid industrialisation and the rise of Germany.

Indian firms have been able to manage the system and have allowed for de facto labour market flexibility by increasing the share of casual contract labour. This naturally appears daunting to a potential investor considering locating some part of his global supply chain in India, especially if it is labour-intensive. Labour market flexibility is intrinsic to global supply chains, given the increasing uncertainties in the global market driven by the faster pace of technological change.

Given India’s reputation for not being an easy place to set up a factory and employ a large number of workers in, it suited the commercial interests of MNCs to encourage India to get into FTAs, starting with Thailand, in the first decade of this century. Growing Indian demand could be then be met from existing efficient supply chains in these countries and there was no commercial need for relocating these to India. The theoretical case for preferential regional trading arrangements is a bit nebulous in any case.

It is also worth recalling that China was given conditional entry into the WTO only in 2000. But by then, it had already become the factory of the world, using a wide range of measures to succeed. Competitive advantage in the globalised industrial economy is not a natural endowment. It is created by firms. Intelligent state action can and does make a huge difference.

Attracting investment

The dominant ideology in India of the virtues of free trade comes in the way of considering pragmatic, WTO-compatible measures for getting investment into specific sectoral supply chains. In recent years, there has been some feeble discovery of the potential of policy. The result is the impressive number of mobile phones that are being assembled in India. But getting the supply chain for IT hardware manufacturing in India is turning out to be not easy. Nudging the process with changes in import duties appears attractive. But this goes against the principle of having low, predictable uniform tariffs across the board.

One unorthodox way around the problem would be to rework the idea of Special Economic Zones. Sales from these into the domestic tariff area should attract the lowest import duty applicable on these goods under any FTA. These Zones may have the benefit of duty-free imports of capital goods as well as raw materials, and components with the same value addition requirement that apply to FTA partner countries. Exemptions for taxes on profits need not be provided. Investment decisions in the brick-and-mortar economy are rarely taken on the consideration that there would be no taxes on profits. In any case, the recent reductions in corporate tax rates have been steep enough. The requirement of being net foreign exchange earners may also be dispensed with. Sales to the domestic tariff area would replace imports from other destinations and reduce foreign exchange outgo.

For this to work, the state would need to develop these Zones with private partnerships to the extent feasible. The infrastructure and logistical connectivity to the ports and the National Highways could be made to match those of competitive destinations in South-East Asia. Such quality infrastructure would need Central government financing. There is a good precedent of Central funding in the development of the Delhi-Mumbai Industrial Corridor. Land and infrastructure of a quality and price that is comparable with those of alternative destinations is naturally essential for success.

Art of negotiation

State governments in India have traditionally been competing for investments and have been negotiating attractive terms to get high-profile investments, such as the Nano car plant of the Tatas in Gujarat.

The Central government has been liberalising the FDI policy, but has not showed belief in negotiations. It is time for the Central government to adopt this approach selectively.

Negotiating with Walmart, Amazon, Apple, Sony and Samsung to get their supply chains to India is worth attempting. It was a negotiating process which brought Suzuki and its supply chain of auto components for the Maruti car into India; it was the last successful example in India of creating competitive industrial capacity through state policy. For comapnies like Amazon and Walmart, some changes in the e-commerce policy could work.

The key lies in determining how best to leverage the size of the Indian market.

The writer is Distinguished Fellow, TERI, and former Secretary, DIPP

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Published on October 14, 2019
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