Can India become the new factory of the world?

India has increased its link to global production structures, but it offers an inferior investor climate in comparison to other exporting countries


After the opening up of the Indian economy in 1991, manufacturing has become more integrated with the rest of the world. Photo: Bloomberg
After the opening up of the Indian economy in 1991, manufacturing has become more integrated with the rest of the world. Photo: Bloomberg

At a time when the Chinese economy is trying to undertake a transition from an export- driven economy to one focused on domestic consumption, whether or not India can emerge as the next factory of the world is a question worth billions of dollars. With a huge demographic dividend and lower wage rates compared to exporters in Southeast Asia and China, India definitely has an advantage on this count. Modi government’s Make in India programme is also meant to propel India into the trajectory of a manufacturing exporter.

Is the task achievable? The evidence, so far, suggests that India’s performance in manufacturing exports since 1980s has been a lacklustre one.

A recently released World Bank report titled South Asia’s Turn: Policies to Boost Competitiveness and Create the New Export Power House, (hereafter the report) has dwelled on the potential of South Asia to become the next factory of the world. The report cites increasing labour costs in China as the key factor which could lead to this transition. Increasing labour costs have been the major determinant of location of exporting industries historically. It was Japan which first challenged manufacturing in the West through low labour costs, only to lose to Asian tigers later, which subsequently lost out to China. However, it needs to be kept in mind that just low labour costs do not guarantee export success. Despite having higher wages, China has a much bigger share in the global apparel industry than south Asian countries.

Among other recommendations, the report also underlines the importance of integration into Global Value Chains (GVCs) for augmenting manufacturing in south Asia. While the emphasis on GVCs is not new, the renewed focus seems to be in the backdrop of trade facilitation agreement (TFA) which was arrived upon in the World Trade Organisation’s ministerial conference in Bali in 2013. TFA is aimed at harmonizing trade regulations such as custom clearance procedures, by drastically improving trade infrastructure in third world countries. The report identifies timely access to key imported inputs as an important factor for sectors such as apparel and electronics, something which can greatly improve due to TFA.

The role of GVCs in boosting a country’s export competitiveness is a widely debated topic in economics. Organisations such as the WTO, OECD (Organisation for Economic Co-operation and Development) and the World Bank have been arguing that GVCs can help a country boost its manufacturing exports, provided right kinds of reforms accompany them. Such policy prescriptions have focused more on labour market reforms and improvement in ease of business rankings, and remained critical of attempts to force domestic content requirements on players involved in GVCs. On the other hand, many developing countries have lamented the fact that thanks to GVCs, they have become stuck at low value addition activities without much income generation.

An earlier Plainfacts column had highlighted the fact that despite making impressive gains in global value added component of manufacturing, only the high-skilled workforce in India has been able to gain from such integration with global production networks.

What has been the impact of GVC integration on India’s manufacturing sector as a whole? As is to be expected, after the opening up of the economy in 1991, Indian manufacturing has become more integrated with the rest of the world. This has been accompanied by an increasing in share of manufacturing exports in India’s total export basket as well.

However it is also a fact that manufacturing’s share in India’s GDP has been more or less stagnant in the Indian economy. What explains this apparent dichotomy? A deeper analysis shows that India has been witnessing a decline in its value added in manufacturing in the post-reform period, something which appears to be a result of a large increase in imports of processed industrial supplies, which suggests increasing outsourcing of content requirements.

This point was highlighted in a 2014 Economic and Political Weekly article by Rashmi Banga, an economist with United Nations Centre for Trade and Development. Banga argued that declining value added share in Indian manufacturing was not a result of incidental factors such as higher fuel costs, but a result of increasing processed supply imports. Banga described the phenomenon of decline in value added share (due to increase in use of imported supplies) along with increasing export share of manufacturing as a hollowing out of India’s manufacturing sector.

The facts given above show that although increasing integration to the global economy has brought gains to a section of Indian manufacturing, India has ended up importing more from the rest of the world rather than exporting to it. India is not the only economy which is facing such problems. In 2014, Indonesia banned imports of raw materials, in order to increase domestic sourcing of its manufacturing activity. Such policies carry the twin risk of alienating investors as well as promoting inefficiencies within the economy in the name of domestic sourcing.

How can India overcome this predicament? The report underlines the need to improve investment climate in the south Asian regions vis-à-vis other manufacturing centres in the world. Although India fares much better than its south Asian peers, it is much behind countries such as China.

A tepid global economy and trade growth environment and rising protectionist politics in the advanced capitalist world is likely to make export led growth more difficult in the days to come. Unless India undertakes holistic reforms which equip its manufacturing sector to fully exploit the advantages of integration to the global economy, it is unlikely to realize the dreams of the becoming the next global factory.

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