Madan Sabnavis: Can India’s economy count on manufacturing as an engine of growth?

The theory of economic transformation talks of how countries start off with rudimentary economies that are largely agrarian, and then transition through an industrial revolution before achieving a services orientation. This is the pattern witnessed in several developed countries.

However, in the case of India, we have more or less skipped the intermediate phase of rapid industrialization, with services having already come to the forefront as the economy’s dominant sector. There is nothing amiss in such a model, but it also means that the amount of capital formation required to ensure sustainable future growth would tend to lag.

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This is so because services are typically less capital intensive than manufacturing. While we have been talking of achieving a major manufacturing take-off that would see this sector making up 25% of gross domestic product (GDP), this goal seems even more distant today.

In a globalized set up, there is nothing wrong in having a more developed services sector, but the worry is that our dependence on imports will tend to increase if we do not create the domestic capabilities needed for a manufacturing upsurge.

The accompanying graphic offers a look at the share of manufacturing in India’s macro aggregates at two points in time a decade apart: 2013-14 and 2023-24.

It shows that the importance of the sector per se seems to have come down, as seen from various points of view. In terms of gross value added (GVA), which denotes output, its share has come down from 16.5% in 2013-14 to 14.3% in 2023-24.

The sector faces hurdles on both demand and supply sides. Freer trade has meant that it is easier to import products, which could make domestic manufacturing secondary. For example, mobile phones are largely assembled in the country now, and while the government’s production-linked incentive (PLI) scheme does encourage indigenous production, it is still some distance away from making a sizeable difference. 

In general, Indian consumers have liberally been buying imported products. In most product categories, a shift to domestic manufacturing is still a work-in-progress.

On the demand side, two things have happened. The first is a change in the composition of final consumption. The share of manufactured goods has come down quite sharply over the decade under review from 57.2% to 48.8%, while that of services has gone up. Even in case of food items, their share has declined over this period. Within services, the shares of health, transport and education have gone up, reflecting a general preference among households for better-quality lives. Such a consumption shift may also be reflective, albeit to a limited extent, of higher incomes being earned by households.

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The second change is that within consumption, the share of non-durable goods has come down, while that of durable goods has only increased marginally from 2.8% to 3.2%. Therefore, weak demand accounts for the diminishing importance of manufacturing to a large extent.

This also impacts investment. The share of manufacturing in India’s gross capital formation is down from 17.3% to 15.7%. Clearly, big investments are not going into this sector. As demand is the clinching factor, it needs to rise. Low investments also indicate surplus capacity in several sub-sectors. 

Meanwhile, large investments have gone into services, as can be seen by the share of construction going up from 4.8% to 8.1%, which can be linked to housing demand and the government’s push for new roads and other infrastructure. Trade, hotels, restaurants, transport communication, etc, have increased their share from 15.3% to 22.2%. The share of railways has gone up from 1.3% to 2.7%, which can again be linked with government capital expenditure. 

Hence, manufacturing is not leading to much capital formation. Services remain the country’s chief driver of investments.

The same picture emerges if we view capital formation from the perspective of contributions from different entities. The share of private non-finance corporations has come down from 36.6% to 32.4% during the period under analysis. Here, another interesting parameter shown in the graphic is the ratio of value added to gross output, which reflects productivity in a sector. This ratio has come down for manufacturing over the period from 21.6% to 20.6%. This ratio is much higher for construction, electricity and all services.

It is against the backdrop of these developments that we should evaluate the government’s efforts. The ‘Make in India’ campaign was a big move to boost manufacturing in particular and turn Indian industry more competitive, while other initiatives were taken to ease the business environment. 

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Next, the PLI scheme was launched as a potential game changer for manufacturing, with budget outlays to incentivize industrial growth. These aggressive supply-side measures have been supported through fiscal concessions, such as a lower rate of corporate tax and the rationalization of commodity taxes over the years.

However, the demand side remains exogenous to this approach, as households take spending decisions based on their preferences. Upward mobility among young members of the corporate-sector workforce has played a discernible role in the economy’s shift to services. Manufacturing must work hard to seize the consumer’s attention with innovative and cost-effective products to ensure that demand is kept ticking.

These are the author’s personal views.

The author is chief economist, Bank of Baroda, and author of ‘Corporate Quirks: The darker side of the sun’