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Indian workers fleeing disguised unemployment in agriculture for a better life in industry usually end up in the construction sector, which is the biggest source of jobs, or they join the informal manufacturing sector, both activities with low productivity. Photo: Hindustan Times
Indian workers fleeing disguised unemployment in agriculture for a better life in industry usually end up in the construction sector, which is the biggest source of jobs, or they join the informal manufacturing sector, both activities with low productivity. Photo: Hindustan Times

Will India become like China or Mexico?

While we might want to become like China, the odds are high that we might actually end up becoming more like Mexico

Developing economies are besotted with the Chinese growth model. Or, rather, what they fondly imagine to be China’s growth model. Success has many fathers, and China’s extraordinary growth has led to many claims of paternity. The liberals believe it is China’s conversion to capitalism, red in tooth and claw only, that has fathered its growth miracle; social democrats believe it is the guiding hand of the Chinese state that has done the deed; and doubtless there are some deluded souls who put it down to “socialism with Chinese characteristics" or to the “harmonious society" or whatever bilge the Chinese authorities spout at the moment.

But most people are agreed that plugging into the global circuits of production and capital is important for growth. A combination of good infrastructure, a welcome mat and a helping hand by the government and inexhaustible supplies of cheap and docile labour is irresistible to multinationals, who will rush to set up shop in your country, paving the way for rapid export-led industrialization. So goes the theory, validated by the Chinese growth model.

Now consider another country that not only subscribes to this ideology but also has the added benefit of having a common border with a very rich, large, developed country. What’s more, the country has the blessing of oil. And, finally, it went ahead boldly where others feared to tread and signed a free trade pact with its developed neighbour. Yes, the country is Mexico, which joined the North American Free Trade Agreement (NAFTA) in 1994. Its success should be assured, according to the canon of export-oriented development economics. One should expect China-like growth rates from such an economy. When NAFTA was signed, economists extolled the wonders of the agreement. Politicians did, too, best illustrated by US presidential candidate Ross Perot’s warning of “a giant sucking sound" as US jobs went south of the border to Mexico.

After NAFTA, just as expected, US companies rushed to relocate, shifting production to Mexican maquiladoras, or free trade zones. Mexicans hoped for more jobs and higher wages. But, unfortunately, 20 years later, the reality is rather different. Between 1994 and 2014, Mexico’s gross domestic product, or GDP, increased at a compounded annual growth rate of a mere 2.4%. Contrast that with the country’s growth of 7% between 1961 and 1970; 6.5% from 1971 to 1975, and 6.9% from 1976 to 1981. What hurts is that those high growth rates happened when the economy was pursuing import-substitution-led industrialization. Having higher growth rates under an import-substitution regime and a low growth rate under free trade is little short of blasphemy, but, perhaps, a timely reminder that there’s much more to development than plug-and-play ideological models. Worse, Mexico’s per capita income in the 20 years after NAFTA crawled along at an annual growth rate of 1.14%. There seems to be much truth in the old adage, “Poor Mexico, so far from God, so near to the United States".

What is the problem? There are many reasons. One of them is that NAFTA spelt doom for Mexico’s small farms, sending thousands of unemployed young people into the welcoming arms of the country’s drug lords. Another is the rise of China, whose ability to keep its cheap labour under iron control proved to be a bigger draw for US firms than Mexico’s proximity. But the most important reason, according to a McKinsey study, is the dual nature of the Mexican economy, with productivity in the traditional sector being very low. More than two-fifths of the country’s workers are employed in small and informal businesses.

That should ring a bell. India is notorious for the small size of the majority of its firms, a big reason for the low productivity of its manufacturing sector. In 2005, the average size of an Indian manufacturing establishment using hired workers was 5.5 persons. The share of micro and small enterprises in manufacturing employment is 84% versus 27.5% for Malaysia and 24.8% for China. Small firms have difficulty getting funds, they cannot afford the latest technology or the best management. They cannot reap economies of scale and studies have shown that productivity is much higher for larger firms. In this respect, Mexico and India have much in common.

Indian workers fleeing disguised unemployment in agriculture for a better life in industry usually end up in the construction sector, which is the biggest source of jobs, or they join the informal manufacturing sector, both activities with low productivity.

In order to provide jobs to the masses who will join the labour force as well as those who are leaving agriculture, it is essential, therefore, that productivity is increased. Towards that end, providing better infrastructure and skills, making it easier to set up businesses, bankruptcy laws that speedily redistribute assets, the development of markets for land are all important.

Allowing firms to lay off workers is another imperative.

A 2010 Asian Development Bank study by Rana Hasan and Karl Robert L. Jandoc on firm size in India concluded, “Using available measures of labour regulations across Indian states, we find that in so far as labour-intensive industries are concerned, states with more flexible labour regulations tend to have larger-sized firms." In short, more labour “flexibility" is a must to have larger and more productive firms.

Whether India’s politics will allow these structural changes to be pushed through is anybody’s guess. While we might want to become like China, the odds are high that we might actually end up becoming more like Mexico.

Manas Chakravarty looks at trends and issues in the financial markets. Your comments and
feedback are welcome at capitalaccount@livemint.com

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