Salary spiral

High-cost manufacturing is the government's creation

The government’s aim of increasing the manufacturing sector’s share to 25 per cent of gross domestic product (GDP) will likely remain just a dream. That’s because, even as the government sets up multiple entities charged with helping the manufacturing sector, it is itself creating a high-cost economy through policy, rules and regulations, and its own salaries. Achieving manufacturing growth will require first putting its own house in order by giving salaries that are in sync with the low productivity levels of its staff.

Being the largest employer, the government sets the benchmark for organised sector salaries. By setting blue-collar and lower-level white-collar salaries much higher than in the private sector, it has already set in motion a spate of wage hikes. Various pay commissions continue to increase this gap rather than decrease it. At the higher end, limited higher education combined with difficulty in hiring international workers has created a supply gap, leading to salary levels close to those in developed economies. Therefore, organised sector labour in India is too expensive and incommensurate with India’s productivity levels. Indian productivity across most sectors is lower than that in the economies India competes against for reasons including poor infrastructure and pointless rules. But, perhaps most important, poor education and vocational training options have been unable to deliver high-productivity human capital. So, on the one hand, the government keeps on increasing the salary benchmarks; on the other, it is unable to create an ecosystem that can deliver matching productivity levels.

The unorganised sector accounts for barely a tenth of India’s employment. But entities in the unorganised sector are unwilling to grow into organised sector units, since that would entail falling into the high-cost production trap being created by the government. They are, therefore, willing to forego access to credit and other help that the government and the organised private sector can provide. Consequently, high-potential sectors such as garments have already lost the battle to new competitors such as Bangladesh and Vietnam; jewellery has held up by remaining predominantly in the unorganised domain; the auto and light engineering sectors have seen early growth by venturing into the higher value-added space to compensate for high costs, but they remain a small segment internationally. Indian firms, small and large, today prefer to invest abroad in countries with three per cent growth, rather than at home. Even Indian firms would prefer imports to manufacturing the same goods here.

When the government creates distortions through policies, salaries or laws, it may help a segment for some time. But the benefits can never be durable. Inflation and depreciation will soon eat into whatever benefits are provided. Political pressures will again build up for more benefits and further distortions, which the government will be hard-pressed to refuse. Meanwhile, the productive sector will suffer and eventually be eliminated. This is already occurring in India. Growing the share of manufacturing in the country’s GDP to 25 per cent? Forget it; India will be lucky if it can hold it at 15 per cent.