Home >opinion >The Make in India bubble

An economic plan to dedicate each man’s labour in a day equally between agriculture, services, and manufacturing to achieve “balanced" growth would be ridiculed by all but the most naive. Thankfully, that specialization and trade benefit the world through greater economic productivity is accepted without debate by even the most illiterate. But when some say the size of the manufacturing sector in India is too small to achieve “balanced" growth, the urgent need to revive the sector is bandied about.

Without the building of factories, the millions displaced each year from agriculture would go jobless, it is said. Thus now, supposedly, is the time for India to replicate the magic of the East Asian growth story. To fulfill this demand, Prime Minister Narendra Modi has come up with an industrialization plan for the country, driven by the slogan ‘Make in India’. Over the next few years, the government is set to spend a huge 20,000 crore to build manufacturing facilities and reduce India’s over-dependence on the services sector. Yet, the fact remains that there is no hard-and-fast rule on the ideal size of any sector for growth to be considered “balanced".

It is indeed true that structural barriers may be preventing the movement of resources to manufacturing and thus limiting its size. But factors like, for instance, lower wages per se is no reason for India to become the next factory of the world, as many believe. Much less warrant state policy favoring manufacturing over other sectors. The country may well use its labour to provide services to itself and the rest of the world if that is what is economically feasible. In other words, resource allocation to any sector should be determined entirely by market forces.

What Modi’s plan actually represents is one of state-led development mimicking the policy of East Asian countries near the end of the 20th century. This is more than obvious in his call for foreign investors to manufacture in India and export to the rest of the world, with state funding to support the activity. Not very different from this East Asian model is the Chinese one of export-oriented industrialization. Historically, support for such state-led development has come from development economists like Robert Wade (who expressed his desire in the book Governing the Market).

Examples of state-led development aimed either at export-promotion, sector-specific development or any other are plenty, ranging from Latin American import-substitution to Japanese policy of state favour for select industries. But each country or region has chosen a different course to implement its own specific policy. Both China and East Asia chose manipulation of their domestic currencies, coupled with credit allocation through the agencies of the state.

The East Asian nations, which had their currencies pegged to the dollar, experienced an export-led boom after the 1985 Plaza Accord. The dollar (and currencies pegged to it) was devalued against the yen and other currencies to promote US (and East Asian) exports. The bubble would eventually pop when artificial export demand vanished as the policy of currency devaluation was reversed in the mid-1990s. The Chinese experience with export-oriented industrial policy backed by a cheap yuan is similar. The country is already engineering a soft landing by gradually allowing the currency to find its natural value. As this happens, resources misallocated towards exports are directed to satisfy domestic demand.

Both these experiences, at their very root, draw from the ridiculous notion that the state and not consumer preference must dictate resource allocation. This was incidentally the policy that guided Nehruvian industrial planning as well, but looks like lessons are yet to be learned. Whether India will cheapen its currency to spur foreign demand remains to be seen, but there is already speculation in a Deutsche Bank report that a cheaper rupee would be an essential part of the export promotion strategy. More importantly, the report also calls for increased credit provision to fund manufacturing growth. This is in line with the general call for increased lending to revive economic growth.

If this dream of increased liquidity comes true, as it may when the country’s central bank finally decides to crank up the printing press to lend credence to Modi’s plans of state-led industrialization, India will be on the course of a credit-driven bubble similar to East Asia and China. The former witnessed heavy foreign inflows of capital to complement domestic credit, while the latter currently sustains the bubble mainly on domestic credit. But state intervention of any kind can only cause massive misallocation of resources while projecting the illusion of growth, which becomes apparent when the bubble pops. Does India, like East Asia and China, really wish to waste resources in fuelling an unsustainable boom?

None of this is to deny the growth that China and East Asia have experienced on the back of greater economic freedom. But it would serve us well to remember that these countries have grown despite the wastage imposed by the policy of state-led development, not because of it. In India, at the moment, there are other plans of misallocation already underway where similarity with the East Asian and Chinese experience is quite apparent. A 930-crore package was cleared by the cabinet recently to promote select industries in the capital goods sector and to set up research centers and industrial parks. Apparently, the government has also identified 25 key sectors to promote. Who needs markets when the government knows everything?

The ‘Invest India’ initiative, supposed to expedite the clearing of business proposals, could be another joke-in-the-making that will soon give bodies like the Foreign Investment Promotion Board and Department of Industrial Policy and Promotion a run for their money, at least when it comes to kickbacks. The Prime Minister will try his best to attract top business leaders from India and across the world to invest, but the attempt’s similarity with the East Asian model of crony capitalism cannot get any more striking—and, for the record, the result will be no different.

That growth is a function simply of investment in capital goods seems to be the belief of many, but there is more to sustainable growth that goes beyond cranking up the printing press and promoting select industries and their leaders. Growth, if it has to be sustained, has to come from reforms to increase economic freedom and allowing the market to determine resource allocation. For sooner or later, the market wins out over state manipulation as it did during the East Asian crisis and as it will in China.

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