The scale of India's economic challenge

The government shouldn't worry about the latest quarterly growth figures

Everyone is worried about the economic slowdown. In a 24x7 world of media, social media, hyper-connectivity and hyper-commentary, what matters most for observers of the economy is the latest quarterly GDP growth number or the latest monthly IIP release or which way the purchasing managers’ index is leaning. For constructive policy making, statistics which are discussed less frequently may present a more accurate picture of what ails the economy and therefore what is the appropriate medicine for recovery.

Two statistics, more than others, tell the story of India’s long-term economic challenge. First, manufacturing as a percentage of GDP is only 15 per cent and its share in GDP has been static since the 1990s. Second, the workforce engaged in agriculture is around 40 per cent of the total workforce —  and produces only 13 per cent of GDP. Thirty years ago, the percentage contribution to GDP may have been higher but so would have the workforce. The low productivity of agriculture has not changed. These two mostly unchanged facts in 30 years explain why India has failed to grow in double digits and why it has failed to generate enough good jobs. The inability to expand manufacturing has led to an inability to absorb the excess workforce in agriculture into more productive jobs. 

It is easy to achieve Make in India. All that is required is a trade policy which increases tariffs and other forms of protection. In fact, in the pre-1991 era, the percentage of manufacturing in GDP was close to 20 per cent. But the economy, particularly consumers, paid a heavy price for an inefficient and uncompetitive Make in India. What is required is Make in India For the World. India has to create a globally competitive manufacturing sector for which it must participate in global and regional value chains. None of our trade and industrial policies are really geared for that goal.

To the extent that they are in the form of open/free trade policies with some countries (Japan, Korea) and some blocs (ASEAN), they have only aided deindustrialisation. The reasons are well known. The fact is that the pace of external liberalisation has not been matched by the pace of internal reforms (in red tape, in labour, land and capital markets, in logistics/infrastructure). Indian manufacturing is engaged in a sprint with its legs tied. The government seems to be aware of the bottlenecks in each of these domains and has made strides in improving the scenario.

There is one dimension that has received insufficient or perhaps the wrong kind of attention. And that is scale. India remains shy about big, large-scale business. It continues to romanticise and indeed incentivise small scale (a majority of which are in fact micro scale) enterprises. Of course, all business begins at a small scale and needs nurturing. What it does not need is an incentive structure that deters it from becoming large.

The most prominent disincentive comes from the tax system. Five years ago, the government had committed to reduce the top corporate tax rate from 30 per cent to 25 per cent. That has happened but first for firms with a turnover of up to Rs 250 crore and then for firms with a turnover of up to Rs 400 crore (in the latest Budget), but not for larger firms. The problem with this is that only relatively large firms can be OEMs or even suppliers in global and regional value chains. And they are being forced to pay uncompetitive tax rates. Potentially, new and smaller firms that could become part of those value chains opt out by staying below the turnover limit for a higher tax. Some businesspersons run several small scale units instead of one large unit losing out of economies of scale for this reason.

It is not just the tax regime that discriminates against large firms. Labour laws do to. Fewer laws or even no laws apply to micro and small units. As firms become larger, they have to comply with cumbersome laws. Many opt out and remain small. And then there is the political economy stigma of big profits, inevitable in competitive large firms.

Unfortunately, small firms face the brunt of cheap import competition. It is these firms that have difficulty accessing cheap capital. It is these firms that the government takes pride in as the generators of maximum employment. But what is the quality of jobs these small units provide? And what is the competitiveness of these units? At any given point, these firms may be the backbone of the manufacturing sector but if they are never going to grow up, they cannot be the spine for Make in India For the World.

The government should stop worrying about the latest quarterly growth figures. It needs to do the right kind of structural reforms to realise the promise of sustained high growth and well-paid jobs.

The author is Chief Economist, Vedanta