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In my last column I had tried to explain how China’s manufacturing boom and export surge was in large part a result of the subsidization of producers through cheap capital, low wages and disciplined labour, combined with the latest technology brought in by foreign direct investment. I had not mentioned the role of the Chinese armed forces and local governments. The People’s Liberation Army (PLA) regularly places orders on emerging domestic enterprises to generate economies of scale and be globally competitive. They also transfer technology to these firms. Local governments acquire land for both domestic and foreign enterprises and often contribute the proceeds as equity capital, thereby becoming partners and assuring the investors against any future political risk.

Can India follow the same model? Clearly not in its entirety. However, the land acquisition law, inherited from colonial days, can be immediately junked and replaced with one that enables our farmers to have a direct stake in the venture for which the land was purchased directly by the entrepreneur. But as I had argued in my last piece, the Chinese model for pushing manufacturing sector growth may not have been sustainable had the US not obliged with an extraordinary increase in its current account deficit. And the model does look susceptible. So which is the way ahead for India? Before I answer that question, I want to give a real-life story.

Metro Playing Card Co. was established in Mumbai in 1948 by a young man, who like a million others had landed a few years earlier in Bombay, penniless and without any connections. His diligence led the firm to prosper and it became one of the leading playing card manufacturers in the country. During the 1980s, it established a plant in Nepal as well. Then in January 2005, the family’s second generation shifted the entire production to Yuwe in Hangzhou province in China! They had stoically borne the difficulties of an erratic power supply, calls by the inspectors, logistics problems and inadequate credit for five decades. The trigger to shift was the refusal by its workers—who had been recently unionized by a rising regional party—to learn new skills and adopt modern technology, without which Metro could not hope to remain competitive against cheap imports from China. So Metro decided to become an importer and rentier instead. It now procures all its supplies from Yuwe, at a comfortable and clear 14% return per container of imports (no questions asked). At the same time, it earns Rs8 lakh a month as rental income. This example, which captures the story of the ongoing hollowing out of India’s manufacturing sector, is unfortunately not an isolated one. Manufacturing capacities are being routinely shifted out of India. This trend will surely accelerate as we sign more free trade agreements (FTAs) allowing zero-duty imports. Many potential domestic investors are simply not even bothering to start ventures in India, and like the Mittals, they are looking to other countries as possible locations. The worrying part is that no one seems to care whether it is the small guys such as Metro or the conglomerates such as Mittal, Sony, Infosys and Wipro which prefer to establish capacities abroad rather than in India. Instead, we tend to bask in the glory of our non-resident successful talents. I know that even those who had so far strongly resisted the idea of Indian capital and talent being used to generate employment abroad when our own poverty and unemployment levels are so high are now finally succumbing to “phoren" attractions. They are being driven out by the difficult investment climate at home. If this trend of conversion of entrepreneurs to rentiers and importers continues, India will certainly be unable to absorb the rising tide of educated but unemployed youth in value-adding jobs. The fabled demographic dividend could be converted into a nightmare in a short time.

But this can be prevented. We need to pay urgent and focused attention to improving the investment climate in the country. The issues to be tackled are too well-known to merit repetition here. But one which is often not discussed is the manner in which we effectively tax our corporate and producer sectors to subsidize consumers. Industrial electricity tariffs are higher because they are used to cross-subsidize domestic consumers. Railway freight charges are used to subsidize passenger travel. Petrol and diesel prices are higher so that cooking gas and kerosene can be subsidized. Interest rates cannot be brought down because the government must run a huge fiscal deficit to fund subsidies directed at raising consumption. The deficit pre-empts national savings and keeps market interest rates high. All this is done in the name of the poor when the beneficiaries are clearly only the middle class. To this we should add the transaction costs that result from the plethora of dysfunctional procedures and governance. Do we seriously believe that manufacturing can achieve global competitiveness under these conditions? I have heard senior policymakers argue that it does not matter if growth comes from manufacturing or service industries such as software, Bollywood or tourism. I hope readers will see the dangerous fallacy in this line of thinking.

Rajiv Kumar is director and chief executive of the Indian Council for Research on International Economic Relations. These are his personal views. Comment at differentangle@livemint.com

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