To be the world’s factory, India must fix its manufacturing sector first

Initiatives ranging from a new manufacturing policy to ‘Make in India’ and production-linked incentives (PLI), have so far failed to produce robust manufacturing growth. (Photo: Mint)
Initiatives ranging from a new manufacturing policy to ‘Make in India’ and production-linked incentives (PLI), have so far failed to produce robust manufacturing growth. (Photo: Mint)

Summary

  • Manufacturing output as a percentage of GDP has remained stagnant at 14-17% of GDP for years as India’s industrial policy has consistently suffered from a bias towards capital-intensive industries

Estimates released by the National Statistics Office (NSO) show that the economy grew 4.4% in the October-December 2022 quarter, Q3. Growth in the previous quarter, July-September 2022, was estimated at 6.3%.

Economists have offered various explanations for the slowdown in growth. Chief among these is that a contraction of 1.1% in the manufacturing sector during the quarter has been a drag. High inflation has made inputs costlier, eroding profitability of manufacturing firms. It has also reduced the spending power of consumers.

The released estimates show that private consumption growth during the quarter moderated to 2.1%. There are also concerns, therefore, about whether the pent-up demand that supported consumption after the pandemic lockdowns were lifted will sustain.

Chief Economic Adviser V Anantha Nageswaran has rejected all of this. According to him, growth in the third quarter appeared “depressed" because of the higher base over which it was computed. But official estimates for the previous quarter show the manufacturing sector has contracted for the second consecutive quarter, after contracting by 3.6% in Q2.

Quarterly estimates are generally not given too much weightage in serious analyses of the economy because of the manner in which they are computed using rudimentary data sources, but more reliable data comes with lags. Even so, concerns about the health of the manufacturing sector should not be taken lightly, as national income accounts estimates have consistently shown that manufacturing is a part of the economy that is struggling.

This is a legacy issue. As a percentage of GDP, manufacturing output has remained stagnant at 14-17% of GDP for years. The UPA government’s efforts did not succeed in increasing it. The Modi government has also not succeeded so far.

The export basket has also shifted away from labour-intensive products. Between 2000 and 2015, the share of capital-intensive products in merchandise exports increased from 32% to 53%, while that of unskilled labour-intensive products declined from 30% to 17%. While Bangladesh and Vietnam have seen a sharp increase in their share of global clothing exports from 2.6% in 2000 to 6.4% in 2018, and 0.9% in 2000 to 6.2% in 2018, respectively, India’s share has risen marginally – from 3 to 3.5%.

The goal of raising the share of manufacturing to 25% of GDP, first set during the tenure of Prime Minister Manmohan Singh and re-emphasised by the Modi-led government, has remained elusive. Even before the pandemic, India’s manufacturing sector wasn’t performing too well.

Initiatives ranging from a new manufacturing policy to ‘Make in India’ and production-linked incentives (PLI), have so far failed to produce robust manufacturing growth.

The reason is that India’s industrial policy has consistently suffered from a bias towards capital-intensive industries, a feature it acquired soon after Independence. What India needs is an industrial policy that encourages labour-intensive manufacturing.

When more and more Indians get jobs, there will be a growing consuming class with spending power, creating a growing market for manufactured goods by removing a significant constraint on overall demand. This becomes even more important when the government’s ability to spend to spur demand is limited, given that the tax-to-GDP ratio has remained stuck at about 11.14% for years, and global demand is slowing down in response to coordinated monetary tightening by systemically important central banks.

Productivity of labour in agriculture, trade and tourism, and construction is lower than the economy-wide average. In manufacturing, it is higher. The sector can easily absorb low-skill, low-education labour. What is required, therefore, for sustainable GDP growth is a big push for labour-intensive industrialisation. But the government is going the opposite – extending policy support to capital-intensive industries.

Economist Radhicka Kapoor has argued emphatically that blaming the lack of progress on labour reforms is lazy analysis and fails to explain India’s unemployment and underemployment problem. Firms circumvent regulations by hiring workers on short contracts indirectly through middlemen and by paying half the stipulated wages. This is why – even in states where governments have amended labour laws, such as Rajasthan – there has been no significant effect on employment at the plant level.

Kapoor’s analysis shows what’s actually keeping the manufacturing sector from growing and generating more jobs – the size of the market, capital formation, credit availability, infrastructure, and government policies.

Policymakers have also erred by presuming that the large number of small firms and startups in India will take care of the employment constraint. If the manufacturing sector is to grow quickly and smartly, then large firms in labour-intensive industries should be encouraged as they will bring technology, capital, best management practices and economies of scale to the sector.

Simultaneously, the competitiveness and productivity of small enterprises in labour-intensive industries must be improved. Protection via high and increasing import tariffs isn’t the way out. Instead, constraints such as infrastructure availability, regulatory impediments, and the complex tariff structure, which hobble manufacturing firms by restricting their access to affordable inputs and preventing them from lowering their cost of production, will have to be addressed.

Fixing India’s manufacturing sector is the surest way to create more jobs and ensure a robust and sustainable economic recovery.

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