Reform and incentives

Govt must seek to benefit manufacturing more broadly

The Union Ministry of Electronics and Information Technology last week moved forward with the production-linked incentive (PLI) scheme for mobile phone (and certain specified other) manufacturing companies. Sixteen companies were told that their plans for participation in the scheme were approved — the firms including some of the corporations that make Apple’s iPhones on contract, such as Foxconn. The idea behind the scheme is to entice these manufacturers to invest in India and increase production through incentive payments over the course of five years. The incentive rate will begin at 6 per cent and go down to 4 per cent over the life of the scheme; the government says it will cost about Rs 41,000 crore over the duration. The belief, however, is that production in India will be a multiple of this amount. Naturally, industry says it is enthused by the possibilities. Other sectors have also put their hands out, asking for similar schemes to be implemented. In the pharmaceuticals sector, it has been reported that over 24 companies have applied for the equivalent PLI schemes for active pharmaceutical ingredients and medical devices. Textiles and textile machinery manufacture are possibly the next focus of attention for PLI programmes.

The government’s intentions are laudable, and the mobile phone PLI scheme will hopefully induce some companies to give production and investment in India a try. Embedding such companies in the Indian manufacturing networks will be a victory even if not at the scale the government hopes for. Yet it should be clear from the outset that such incentive systems can only be temporary, to overcome some shifting costs and corporate reluctance. In the end, manufacturing in India will depend upon competitiveness. In other words, PLI schemes and other forms of import substitution mechanisms will be only as welfare-increasing as the gains in productivity they provide. India does not need a government-subsidised, high-cost manufacturing industry that produces purely for the local market and does not export — which has historically been the end point of such schemes without competitiveness enhancements on the ground. Wider productivity-enhancing reforms will be needed.

In this context, the recent moves to make the labour market more flexible are notable and should be lauded. Certainly, rigidity in terms of formal employment has long been identified by economists as a serious disincentive to increasing investment in manufacturing. But the government needs to continue to support the overall manufacturing sector rather than trying to find individual sectors to promote. After all, why should mobile phones benefit and not, say, automobiles, where corporations have recently complained bitterly about the tax regime that they have to endure under goods and services tax? Such interventions can never be forward-looking. “Picking winners” through industrial policy can lead to as many misses as hits — and India cannot afford too many misses. It is far better to let global demand and comparative advantage work together with a reformed and flexible business-friendly domestic environment to produce export champions.

Policy intervention must be focused on the overall export side. It is only through producing for export that proper growth can be achieved, particularly at a time of weakening domestic demand. The government’s sole criterion must be how a policy aids in integrating India into global value chains. A stable and realistic exchange rate must also be part of this economic environment.