Manufacturing : From laggard to leader

The Indian economy seems to be moving out of the intensive care unit and it will be entering the recovery phase next year, but with some stresses and strains continuing because of the damage done during the crisis. Looking beyond recovery to rejuvenation, the key lies in rebuilding the confidence and dynamism of corporate India and small enterprises. The most crucial sector in this regard is manufacturing for sustaining a high gross domestic product growth rate, say, 8 per cent and over. Hence this column focuses on learning from the record of manufacturing growth in the post-liberalisation era.

The basis for this understanding has been provided by a coherent set of data on value-added, gross output, capital stock, employment and the use of intermediate inputs of materials, energy and services in 27 sectors of the economy in the KLEMS database, available at present for the period 1980-81 to 2017-18 (1). The table presents a summary version of the KLEMs data on manufacturing.

Taking the decade before the crisis as the benchmark for comparison and leaving out the two exceptional crisis years (1990-91 and 1992-93), the 25 years from 1993-94 to 2017-18 fall into four periods — a post-crisis recovery period from 1993-94 to 1996-97, a slowdown from 1997-98 to 2003-04, the major boom period from 2004-05 to 2010-11 and a slowdown from 2011-12 to 2017-18. The more limited data on manufacturing growth, investment, employment and exports in 2018-19 and 2019-20 suggest that the slowdown has continued.

The significant points emerging from the data are:

• The post-crisis recovery and the boom beginning 2004-05 show relatively high rates of export growth and a higher-than-average investment to value added ratio.
• The slower export growth in the slowdown may be due in part to the slowdown in world trade in manufactures.
• The growth in manufacturing employment in the post-liberalisation era has been below the pre-liberalisation decade and has fallen drastically below the average in the current slowdown period beginning 2011-12.
• Total factor productivity growth was poor before liberalisation but has improved since the 2004-05 boom and continued during the subsequent slowdown.
• The current slowdown shows a sharp drop in the investment ratio, export growth and employment growth. Outward orientation has been diluted with a growing tendency to provide tariff protection. Clearly the Make in India programme has not helped.
• Out of the 25 post-liberalisation years, 12 had a net value added growth rate above the pre-liberalisation average. For what it is worth, one notes that in eight of these 12, a Congress-led government was in power, in three a Bharatiya Janata Party-led government and in one a United Front government. The interpretation of this I will leave to each reader’s political inclinations!

The investment ratio in manufacturing is best thought of as a consequence of demand-led growth. Private consumption and investment demand are a product of growth. The two key autonomous factors affecting the demand that are not directly linked to growth are exports and public procurement, for instance, for construction or defence. Export growth in manufactures can lead a growth revival and have a multiplier effect by stimulating investment buoyancy.  How is this link best exploited?

It has sometimes been argued that India needs to follow an aggressive exchange rate strategy to boost exports and growth. In the 25 years between 1993-94 and 2017-18, the nominal rupee-dollar exchange rate doubled but the wholesale price index more than tripled over this period. After taking into account inflation in partner countries, the export weighted real exchange rate appreciated by 24 per cent, making exports less price competitive. Throughout these 25 years, the real exchange rate has tended to appreciate. However, this did not stop the growth in manufacturing exports in the boom years at a rate significantly above the pre-liberalisation benchmark. 

The difficulty in influencing exchange rate movements to reflect the needs of the real economy, particularly the exporting sectors, may be because of the growing importance of foreign capital inflows, which exceeded the current account deficit in 20 of the 25 years in this review. Given this and the limited evidence of an impact on exports, it is difficult to see incremental exchange rate management as the key to promoting exports. Substantial devaluations of the sort that took place in the crisis years 1991-92 and 1992-93 can boost exports but cannot be done frequently and have other management challenges.

Exports of manufactures depend largely on the competitiveness of product specification and quality vis-à-vis competitors, provided prices are within an acceptable range around the global average. Moreover, manufacturing exports cannot be based only on today’s competitiveness. They require technological dynamism to keep up with the standards set by competitors in terms of price and product specification. We need this not just in new areas but also in areas like pharmaceuticals, diamond cutting and software services exports where we enjoy a comparative advantage today. Without technological dynamism, today’s comparative advantage will disappear quickly.

Another important dimension of export orientation is to move rapidly from growing product exports to backward integration into growth in the production of manufactured inputs for these export products, a strategy that one can label “export-led backward integration”, which the high growth east Asians have followed.

 Our corporate sector may have built up some competence in cost-cutting innovations and reverse engineering. But to gain a growing share of global markets, Indian industry must come up with new products, processes and business models regularly to keep pace with its innovative competitors; and to do this it must invest much more in corporate research centres driven by market demands.

It could be argued that technological dynamism, which requires long-term commitments by companies, is not possible if the policy framework relies on a hands-off dependence on free-market forces.  The experience of Japan, China and Korea, which have become major players in the global market in manufactures, suggests that a policy of identifying potential winners and supporting them differentially is a necessary condition for this. If it is, then we are in trouble because in India political patronage of business is not based on performance potential but on the willingness of a business to support a politician or a party with money and media backing. It may be better in India to avoid political discretion and give incentives for exports and export-linked backward integration to all rather than just a chosen few. That, incidentally, will be particularly welcome for start-ups, which can then prove their potential in the market rather than to some bureaucrat. Unfortunately, the recently announced production-linked incentive scheme does not do that.

In summary, to promote high growth, we need policies to promote export-oriented backward integration and linked development of technological capacity in our manufacturing sector at all levels from large to small and from established companies to start-ups.

nitin-desai@hotmail.com

1. The KLEMS database is accessible at https://www.rbi.org.in/Scripts/KLEMS.aspx