Is there a manufacturing turnaround?

It is a puzzle that during India’s period of higher catch-up growth, the share of manufacturing remained around the mid-teens. In most countries, during similar transitions it increased to about 30 per cent. Our large potential market, demographic advantage and ability to improvise and adjust ( jugaad ) have not so far resulted in higher manufacturing growth rates. What is changing?

During the post-Independence import-substituting regime Indian manufacturing settled into a comfortable high-cost, low-quality outcome in a protected market. Liberalisation was an import competition regime that manufacturing found difficult to survive given its high costs and unfair government subsidised competition from China. After experimenting with these unproductive extremes, the economy seems to be settling into a more sustainable regime, which I call ‘export competition’.

Manufacturing has to export, compete internationally and, therefore, become efficient. But it will be protected from unfair competition and helped to develop economies of scale under a broad set of policies that lower costs of doing business.

For example, the various free trade agreements (FTAs) that India has entered into with East Asian economies have resulted in large net imports into India. They are being retooled for easier exports of goods and services in which India has comparative advantage, even as the general costs of production are brought down.

Costs of doing business

The focus on ease of doing business has seen India steadily climbing the World Bank rankings, although deeper improvement is required. India’s advantages in technology can be leveraged for this. E-governance helps coordinate across government departments and reduce logistics costs.

The compliance burden remains very high for Indian industry due to multiple regulators but moves to create automatically populated central repositories of information that all regulators can access can reduce the burden. This is one-window compliance.

Cross subsidisation is a major source of high costs for industry; in electricity charges, rail freight or water. Reforms are in progress that would replace price distorting subsidies with direct benefit transfers and income support for the poor. As lower costs allow industry to expand employment, the need for income support should fall.

India’s per capita income in 2017 reached the level beyond which price-based interventions that distort resource allocation are no longer compatible with its WTO obligations. Neither is industry specific support. Improving conditions for all industries is WTO compatible. So, policy has to perforce shift into this mode.

GST led domestic integration into one market and continuous improvement in infrastructure lowers transport costs. There is systematic work on reducing the cost of all factors of production for industry. Labour law reform gives more freedom in decision-making and by reducing an unwieldy set of laws into four codes again simplifies compliance. Efforts towards reducing the cost of capital have been continuing over the last decade. The financial sector has reached a level of reform and diversification where multiple sources of funding are available and interest costs are coming down.

Improvements in corporate governance and disclosure, which are in industry’s hands, are necessary to further revive the corporate bond markets. After Covid liquidity is going to be plentiful, and there is no need for anyone to hoard it. Industry must pay suppliers promptly.

Trust matters

The non-performing asset cycle together with suspicions of public funds and resources being siphoned off by private promoters lead to sustained investigations over the last decade that vitiated the atmosphere for industry. But today while the Indian bankruptcy code has improved the credit culture, the distinction between commercial and criminal losses is increasingly being understood and enshrined in law. For example, the Prevention of Corruption Act (1988) that defined criminal misconduct by a public servant to include obtaining a pecuniary advantage for anyone where no public interest is involved put many bankers under investigation. But it was modified in 2018 so that a case is only possible if assets are disproportionate to income. The 2013 Companies Act has also been amended in 2020 to replace criminal offences by civil ones that can be settled with a fine. The aim is for policy certainty, without flip-flops such as retrospective taxation. The government is committed to providing a broad smooth road for industry to run on.

More generally the Covid shock has shifted policy-makers perspectives. They are ready to work with industry to revive the economy. Aid from the government and regulators can address current as well as old wounds, revive trust and help society pull together once more. But it will be a combination of discipline and support, not the old-style lobbying and special favours.

The world has realised that depending on one country is dangerous. Diversification of supply chains from China is an opportunity for India. More generally, the tensions on the border are leading industry and government to work together to build local clusters and economies of scale, for example in the pharma industry to reduce dependence on China. There is also some consumer boycott of cheap Chinese goods.

Opportunities after Covid-19

Covid presents challenges but there are also opportunities for manufacturing. Work-from-home can save costs as can faster adoption of digital processes. Many new products have been introduced in home services, consumer goods, edutech, and local startups. There is a switch from a service to a product — restaurant meals to packaged food, barber services to electric hair trimmers. The restructuring of the public sector towards providing public goods while business activities are privatised will give many opportunities, as will agricultural reforms, for example in food processing .

But for the opportunities to manifest industry has to act responsibly to build a vibrant ecosystem. It has to invest in labour skills and well-being, in local communities through its CSR obligations, build supplier clusters with upfront payments to smaller firms as well as develop environmentally sustainable practices with zero waste. When jugaad is no longer against obstacles, but part of a non-zero sum game in a growing economy, it can release a burst of creativity and productive innovation.

The persistence of the virus is an unknown negative. Some industries cannot recover until it passes. But micro-containment strategies and gradual unlocks are keeping the curve of infections down. Arbitrary lockdowns that did the most economic damage are less likely. Unlock 4 in early September clarified there will be no restrictions on interstate movement, so supply chains have a chance to recover.

The writer is professor IGIDR, Mumbai. This is an edited version of an address to CII Northern Region on 25 September. Views are personal

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