In 1970, the US manufacturing sector was 25 times bigger than that of China. After just four decades, China is about to become the world’s largest manufacturer, overtaking the US. Such is its prowess that even if its growth halves, Chinese manufacturing could still be nearly five times its US counterpart in another 40 odd years. How would India fare relative to China in 2050?
If our manufacturing growth rate stays at around 8% per annum, as it has in the last decade, and China’s halves to 5.5%, India’s manufacturing would still only be around one-fourth of Chin’s in 2050. India has a daunting task ahead if it ever hopes to catch up.
What about services? Is India faring better in service sector growth? Contrary to expectations, in each of the last four decades, China’s service sector has expanded more rapidly than India’s, with the gap narrowing somewhat in the last decade. As a result, while India’s service sector was twice the size of China’s in 1970, the latter is now twice the size of the former. How has China outperformed India in services too?
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The answer may partly lie in the spillover effect from manufacturing to services. The service sector in China has primarily grown to meet the needs of the fast-growing industrial sector. While the inter-linkages between manufacturing and service sectors are two-way, the expansion of certain manufacturing activities boosts specific service industries.
Many modern manufacturing companies outsource technical and business-related services such as research and development, financing, marketing, branding and logistics. Manufacturing industries such as mechanical and electrical engineering or even textiles depend crucially on services such as technical and design support, data processing, customer services, and advertising. As manufacturing firms grow and become more specialized, services tend to get more and more incorporated into their value chain.
Manufacturing expansion spurs the development of physical infrastructure such as roads, ports and railways, which are critical inputs to improve manufacturing productivity. In turn, demand for infrastructure-related services such as transportation, telecommunication and financial intermediation grows. Manufacturing growth, therefore, gives a boost to services.
Since India has lagged behind China in both manufacturing and services, the gap between the two economies has widened. In 1970, the Indian economy was larger than the Chinese. Today, the China’s economy is thrice the size of India’s. In 1970, income per person in India and China, at just over $100, was almost the same. In 2009, China’s per capita income of nearly $3,800 was nearly three-and-half-times more than that of India.
Relying only on services to narrow the gap between the two economies is unlikely to work. As China moves away from an export-led model, other countries such as Indonesia and Vietnam are stepping in to fill the gap in global supply. If India is to increase its share of global manufacturing exports and bridge the gap between the two economies, it would have to create a supportive environment to increase the productivity of its manufacturing sector.
Rapid growth in manufacturing would provide employment opportunities for our vast working age population. As per the employment and unemployment survey of 2009-10, only around nine out of every 100 jobs are in manufacturing. One of the oft-cited reasons why Indian manufacturing firms are discouraged from expanding their scale of operations and increasing employment is the lack of labour market flexibility.
Labour market regulations related to job security restrict the ability of firms to lay off labour during times of economic slowdown. As a result, existing manufacturing firms are reluctant to expand their employee base, and new firms are unwilling to enter the market. Given the lack of sufficient flexibility, firms tend to convert formal work into informal work by deploying more temporary workers. An obvious outcome is an increase in informal employment, resulting in a large number of workers without rights such as social security and paid leave.
Apart from labour market regulations and the poor state of physical infrastructure, which constrain manufacturing growth and thereby employment generation, another crucial challenge the manufacturing sector will face as it expands is skill mismatch. India has a shortfall of skilled manpower required for the expansion of both labour- and capital-intensive manufacturing industries.
Producing high-tech goods requires a skilled workforce, which cannot be created overnight. Even relatively low-tech manufacturing such as leather and textile industries requires workers who are more skilled than those employed by service industries such as personal and social services. And while it has been relatively easy to manage a move to high-skilled services such as IT/ITES with well-established higher education and engineering colleges, it might be more difficult to train India’s workforce in skills required for manufacturing. Creating manpower with technical and vocational skills, more than formal education, would be the way forward.
While India is unlikely to catch-up with China in the foreseeable future, the importance of manufacturing to the Indian economy cannot be downplayed. In addition to a policy thrust on providing quality infrastructure and dismantling labour market rigidities, a focus on skill development would be crucial to transform India into a manufacturing hub. Let us hope that the much-awaited national manufacturing policy underscores this point.
Vidya Mahambare is senior economist, Crisil Ltd.
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