The sickness in Indian manufacturing
The global financial crisis of 2008 seems to have hastened a structural shift in the global growth order. Among the various externalities it triggered is a slowdown in international trade because demand wilted.
The redoubtable Larry Summers flagged the crushed demand as “secular stagnation”, citing economist Alvin Hansen’s postulate of the 1930s—of the increasing propensity to save and decreasing propensity to invest.
Since 2012, global trade has grown only 3.1% annually, or half the rate attained in the three decades preceding. Not only is trade slowing, its intensity with respect to global growth has also come down. Meaning, trade outpaced gross domestic product (GDP) before the financial crisis, and then swung the other way, presenting a big worry for export-dependent economies.
Small wonder then that India’s export performance suffered. But our analysis shows the decline in exports is more than what was warranted by the global slowdown. When compared with other emerging Asian economies, especially the tigers of low-end manufacturing, such as Bangladesh and Vietnam, India’s decline has been alarming.
To be sure, exports had tanked across the world after the global financial crisis, but rebounded in 2010, albeit at a slower pace than before. However, India’s exports never really recovered, and have been experiencing negative growth since 2014.
India’s share in world merchandise exports fell in each of the past two years, while that of China, Vietnam and Bangladesh edged up. China remains the undisputed leader with the highest—and still rising—share in global exports. Interestingly, this is happening even as China’s exports are becoming a smaller component of its GDP. Vietnam is scoring well even on both counts: its share of goods exports in GDP reached about 85% in 2015.
Then what ails India’s exports?
Are we hobbling because of the sharp decline in commodity prices, especially crude oil—India’s biggest export item with about 20% share? Nope, because India’s non-oil exports have also fallen—by 4.4% and 8.7%, in 2014 and 2015, respectively.
Seven of the top 10 export categories of India declined in 2015, compared with three for Vietnam and two for Bangladesh. In segments such as electrical machinery, mechanical appliances, textiles and garments, Vietnam has run ahead of India, while in textiles and garments, Bangladesh has done better.
This suggests the decline in Indian exports isn’t merely cyclical, there are structural elements at play as well. The cyclical parts will rebound when cyclical factors (world GDP, prices) turn favourable, but structural factors, if not addressed through government action, will continue to drag down India’s export performance.
Both Vietnam and Bangladesh enjoy the benefit of favourable market access policies and relatively lower labour cost compared with India. For ready-made garments, Bangladesh enjoys duty-free access to the European Union under the Generalized Scheme of Preferences. Due to this cost advantage, Bangladesh’s share in the EU’s imports almost doubled from 9% in 2009 to 17% in 2015
(in euro terms).
India does not have any such advantage. Plus it has additional constraints such as challenges associated with land acquisition, rigidity in labour laws, and poorly skilled manpower.
On the other side, Vietnam seems to be following in the footsteps of East Asian economies by maintaining focus on increasing education standards of its citizens. Vietnam’s adult literacy rate reached 94.5% in 2015 compared with India’s 72.2%. Continued focus on education will help attract foreign investment and also help the economy overcome the challenges of automation in the manufacturing sector.
Though India needs to do a lot of work to increase its space in the international market, its own domestic market offers a significant opportunity. India has become the third-largest economy in purchasing power parity (PPP) terms, and is currently the fastest-growing large economy. Empirical evidence suggests when an economy is in the middle-income phase in purchasing power parity terms—which India recently entered—demand for manufactured goods accelerates with every unit increase in income (Towards More Balanced Growth Strategies In Developing Countries: Issues Related To Market Size, Trade Balances And Purchasing Power by Jörg Mayer; 2013). Thus, the Indian domestic market seems to be at the cusp of an expenditure boom.
However, the potential of the domestic market can only be realized if there is a catholic improvement in purchasing power. Unlike exports, which are determined exogenously, domestic demand is primarily dependent on domestic income.
Improved purchasing power need not be achieved by merely subsidizing the poor, but also by empowering them to participate in the growth process. Financial inclusion, education, fair property rights, and price stability are all catalysts to equitable growth.
And this is where the all-important “C” word comes in—competitiveness. Even when catering to domestic demand, local firms have to ensure their goods are competitive at a global scale. Since India is open to international trade, any rise in domestic demand without commensurate rise in competitiveness and adaptability of domestic firms will lead to an unintended consequence: increasing imports.
So the upshot is that whether it is Make In, or Make For, India, the economic rules followed by the giants of exports need to apply to us just as well: improve competitiveness, increase investments, keep improving the skills of the workforce according to the changing needs, and keep domestic manufacturing open to international trade. In this regard, India’s gradually improving rankings in competitiveness indicators offer some hope.
Dharmakirti Joshi, Adhish Varma and Pankhuri Tandon work with Crisil Ltd.