A tale of India’s two big export industries: And a lesson on incentives
- We’re talking about petroleum and IT service exports. Policymakers must not distort incentives too much in favour of industries, but aim to create a level playing field.
India boasts of vast production capacity in one industry. The country is the world’s third largest exporter of its industrial products, which are essential for any economy to function. This is a distinction that no other sector in India can claim. One disturbing fact, however, is that it benefits very few Indians. Over 90% of the value generated in this sector accrues to capital owners. Thus, the positive wealth effect of these exports is limited. As it is one of the least labour-intensive industries, it employs only around 300,000 people. Almost all its raw material is imported, resulting in the highest foreign value-added content in Indian exports among all industries, and low employment generation via backward linkages.
It appears unthinkable for this to have occurred. But it did. This is India’s refined petroleum industry, which contributes more than 20% to our merchandise exports in value terms. Contrast this with India’s leading services export: information technology (IT). Today, its exports in value terms are 1.5 times that of petroleum exports. Back in 2012-13, both were at nearly similar levels. The domestic value-added content of IT exports is among the highest. The labour share of value addition is only a bit less than 50%, compared to under 10% in refined petroleum. Close to 60% of employment in the sector is related to exports. Direct employment by IT services in India is estimated at 5.1 million, so about 3 million jobs are export-related. IT services have backward and forward linkages in sectors like transport, hospitality, security and housekeeping services, personal services, apart from the demand their employees generate for real estate, consumer durables, etc.
While refined petroleum and IT are poles apart in their import content of exports, employment generation and the share of labour income, their evolution is a classic example of the two most important words in economics: incentives matter.
Entrepreneurs in both sectors realized that by entering these, they can avoid dependence on India’s poor physical infrastructure, stringent labour laws and multiple licensing requirements with lengthy delays. In the early 2000s, the government relaxed its domestic price cap on refined petroleum products. But it continued providing subsidies to public sector oil companies so that they could retail fuel below market-driven prices. It refused subsidies to the private sector, so it became unviable for the top private player, Reliance Industries, to sell refined petroleum products domestically. It shut all local petrol pumps in March 2008. Later, it would open selective petrol pumps on days when crude oil import prices fell sufficiently for it to make profits by selling petrol locally. It was a textbook example of the principle that a business should stay open if and when it can cover its variable costs.
Reliance focused on the export market instead. Its Jamnagar refinery complex in Gujarat can access shipping routes and is not over-dependent on road or rail infrastructure. Refined petroleum does not need much labour and its refineries are anyway in export processing zones where less stringent labour laws are applicable.
Similarly, India’s services industry is outside the purview of the Factory Act. Also, IT workers usually have payroll jobs, not permanent jobs. Either side can exist the work contract based on a mutually agreed notice period. Therefore, firms in the IT sector have an incentive to expand their workforce; labour cost can be reduced if demand falters. IT exports are not dependent on physical infra beyond the transportation needs of workers. Unlike manufacturing, it takes less time and effort to get business and environmental licences. India’s IT employment will continue to flourish if it survives the impact of artificial intelligence (AI) on the industry. However, millions of Indians do not have the requisite skills for an IT job.
In policy circles, a hunt is on for a manufacturing equivalent of the IT sector: with a low import requirement and balanced income share of capital and labour, but higher labour intensity with lower labour skills needed than IT. None of our manufacturing sectors currently fulfils these criteria. Also, factory processes have become more tech-oriented and automated. Further, domestic raw material is often difficult to obtain at globally competitive prices.
Is there a service sector that can replicate the success of India’s IT sector but needs lower labour skills, has higher labour intensity and also forges worthy backward and forward linkages? There may be one that has remained neglected for a long time, except in a handful of Indian states: the tourism sector. India currently accounts for only just over 1% of global tourism. India’s rank on the Global Travel and Tourism Development Index in 2021 was 54th.
Developing the tourism sector would need streamlining visas and entry requirements, improving transport infrastructure to enhance in-land connectivity, developing and maintaining high-quality accommodation facilities as well as efficient healthcare and safety services, boosting the food processing sector, and integrating sustainable practices, among other developments.
It is always a good idea to diversify one’s bets. So also in the case of Indian exports. The best that policymakers can do is not distort incentives too much in favour of specific industries, but create a level playing field by focusing on good physical infrastructure, human capital and lower import tariffs, and also easing the burden of excessive licensing requirements.
