Lessons from China in industrial revival

The Indian economy has been experiencing declining rates of private investment for some years. The last quarter GDP growth rate has come down to less than 6 per cent. The just released employment numbers highlights the growing job creation problem.

Recognising these realities, government has constituted two Cabinet Committees; one to suggest measures for accelerating growth and the other for job creation.

Implicit in this is the acceptance that there are real problems which need state interventions. The policy so far has been ‘virtuous’ in maintaining commendable fiscal rectitude, having low inflation, trying to improve physical and social infrastructure and leaving markets free.

Wrong paradigm

The GST regime, a transformative reform, has also settled down. Then why is the economy not performing better? Are there limitations in the policy paradigm prevailing since the economic reforms of 1991?

Is there need to think afresh? Is it time to look at the extraordinary success of China and the policy instruments they used?

Are these at all relevant for India today? Does the state need to be more active and interventionist to try and get the market to deliver the desired outcomes rather than leaving it completely alone?

If so, what policy instruments are likely to work best? Trying to address these questions would enrich the ongoing policy discussion.

There has been a broad degree of consensus on the need to reduce real interest rates which have been at a record high. The RBI has just lowered the repo rate by 25 basis points again.

The problem with its approach has been that with the expectation of incremental rate cuts, rational market participants would much rather wait for further cuts before investing.

A big one time 200 basis points cut, with the announcement that there would be no more downward cuts thereafter, would have had a stronger immediate impact. Further, for an actual investment decision, the business case for investment has to be strong enough in terms of demand and profitability and in this calculus the interest rate makes a difference only at the margin.

For tradable goods, the business case for manufacturing investments in India has been declining. This needs to be recognised and remedial measures taken. The trade with China and increasing imports of the whole range of manufactured goods has been de-industrialising India.

More than ‘America first’ of US President Donald Trump, India needs ‘India first’. It needs to be recalled that China was allowed entry to the WTO only in 2000 and that too with conditions as it was not recognised as a market economy. But by 2000, China without being a ‘market economy’ was well on its way to becoming the factory of the world.

State intervention

It used the size of its large market and the full might of the state to become a globally competitive manufacturer using a variety of instruments. India has not attempted to create globally competitive manufacturing capacity with state support after Maruti.

That India has a globally competitive small car industry backed by a competitive auto component supply chain is due to the state driven success of Maruti in the 1980s and the maintenance of high tariffs for imports.

The essential difference between China and India was that India accepted the prevalent Western advice in favour of not having an ‘industrial policy’ as the state should not be trying to pick winners.

The Chinese heard the same advice, ignored it and went on to create winners. They used all the instruments they could to create globally competitive manufacturing across the spectrum.

While remaining in compliance with WTO commitments, there are a range of instruments that can be potentially used. Import duty rates are far below WTO commitments and therefore can be leveraged to protect and nurture domestic manufacturing. Public procurement can be used where it is large enough to create competitive manufacturing capacities.

For instance, bids can be invited for the supply of 1 GW of solar power panels every year for three years with the condition that the full value addition be done in India. The government can itself choose to invest in chip manufacturing in technological collaboration and partnership with a firm like Intel or Samsung to lay the foundation for the electronic hardware industry in India.

It could choose to design, develop and build a civilian medium size and range aircraft for the domestic market in a Public Private Partnership mode.

It could try and create a shipbuilding industry which is a classic labour intensive industry which has been moving to lower wage locations.

For all of these, the state would also need to create islands of globally competitive infrastructure. Software success was made possible by world class infrastructure including housing. Housing is essential for productivity. The state alone can drive its creation as the market is not creating the supply of rental housing for workers of decent quality near work places.

A critical factor which normally does not get the attention it deserves is the real exchange rate. Not allowing the real exchange rate to appreciate is a policy position that is long overdue. Trying to get the economy to grow at its full potential with an appreciating real exchange rate is like driving a car with the hand brakes on.

India has been doing precisely this flowing from a doctrinaire position that the exchange rate should be purely market determined. Large capital inflows of remittances in addition to periodic surges of foreign investments into equities cause market distortions which need RBI intervention.

The Japanese, then the Koreans, and recently the Chinese chose to artificially depreciate the currency to get higher growth. India should not think of artificial depreciation but preventing real exchange rate appreciation is essential and legitimate.

Industrial policy would need some creative thinking. A few major labour intensive sectors should be chosen initially. Each sector would need a comprehensive medium term strategy designed around the key principle of making private investment in that sector profitable enough along with sufficient mitigation of risks.

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

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