Why the answer to India's export and employment worries may lie in R&D

Even if 'China plus One' offers new labour-intensive opportunities, India's trading success may lie more in value-added exports, and spending on R&D and innovation will pave the way, writes T N Ninan

In his thoroughly engaging book (The Struggle and the Promise: Restoring India’s Potential), Naushad Forbes underlines the message that has been the focus of his monthly column in Business Standard: The importance of innovation, and research and development (R&D). Within that broader discussion, he looks specifically at how poorly India’s companies rank when it comes to R&D expenditure in relation to sales and to profits, and how much they now lag behind companies in other countries. This, despite India’s pattern of industrial development having started out as more technology- and skill-intensive than in the typical developing economy.

The book considers several reasons for this (restrictive government policy, small size of companies, etc) but seems to settle on the verdict by Ashok Desai (a former columnist with this paper), that a major reason for the lack of technological dynamism in Indian firms has been management. At the function to launch the book on Friday, there was a brief discussion on whether this had something to do with caste.

An article in The Economist magazine in January last year had looked at the caste composition of Indians who get to the top of big, tech-oriented American firms, with Brahmins scoring very well. This contrasted (the magazine had pointed out) with the caste composition of India’s “promoter”-driven corporate sector, where people from the Vaishya castes dominated. Could an explanation for the different approaches to R&D (the Forbes dichotomy, if you will), and which castes succeed where, lie in the knowledge-oriented nature of Brahmin occupations, compared to the Vaishya/Bania caste networks in India and their primary business focus on cash flow?

The author was not convinced, arguing that even the software services firms run in India by Brahmins spend very little on R&D. In his book, he gives the reason: They are services companies, not product firms. While he is right, it is true that these companies have steadily upped their revenue per employee to twice or even three times what it used to be. This tells us that they are doing much higher value-added work than in their initial days.

That cannot be said across the board for India’s corporate sector, although it is true that product quality has improved vastly (due in part to competition from foreign companies). On their part, India’s pharmaceutical firms have succeeded in reverse-engineering drugs coming out of patent protection; and the telecom firms have innovated to deliver their services at extremely low cost. But these remain the exceptions.

Why is this important? The answer is that India has followed, and is likely to continue following, a development path different from that of the countries of East Asia, which launched themselves with a flood of low-cost products from labour-intensive factories. Success in these industries is unlikely for India because there is scale manufacturing in only a handful of sectors, and they are not labour-intensive (like automobiles). There is also a peculiar duality: The poor educational attainments of much of factory labour co-existing with an abundance of cheap, educated, white-collar workers. The latter have underpinned the success of services exports, which have grown rapidly even when merchandise exports have stagnated. Thus, we have single-digit growth for merchandise exports in the last two years, but 60 per cent growth for services exports.

Ordinarily, the large deficit in merchandise trade would have pushed down the rupee’s external value and made low-cost, labour-intensive manufacturing competitive. But the increasing flood of dollars from services exports props up the rupee and loads the dice against labour-intensive manufacturing, which already suffers from higher-cost infrastructure and the absence of scale. Even if “China plus One” offers some new labour-intensive opportunities, India’s trading success may lie more with value-added exports, for which Dr Forbes’s point about innovation and R&D becomes crucial.

This may not provide the many millions of jobs India needs, but the failure on the jobs front is a by-product of the missed opportunities of the past. Today, the future of employment might lie, counter-intuitively, in agriculture if India can adopt higher-value, employment-intensive farming practices that will increase productivity, jobs, and wages. For success in world-beating manufacturing, India has to invest in firm-level R&D and innovation.