Insights into Editorial: Why an industrial policy is crucial
The impact of industrial reforms is reflected in multiple increases in investment envisaged, both domestic and foreign.
At the time of Independence, Indian economy was facing severe problems of illiteracy, poverty, low per capita income, industrial backwardness and unemployment.
After India attained its Independence in 1947, a sincere effort was made to begin an era of industrial development.
The government adopted rules and regulations for the various industries. This industrial policy introduction proved to be the turning point in the Indian Industrial history.
The all-around changes introduced in the industrial policy framework have given a new direction to the future industrialization of the country.
Need of New Manufacturing Policy:
The contribution of manufacturing to GDP in 2017 was only about 16%, a stagnation since the economic reforms began in 1991.
The contrast with the major Asian economies is significant. For example, Malaysia roughly tripled its share of manufacturing in GDP to 24%, while Thailand’s share increased from 13% to 33% (1960-2014).
In India manufacturing has never been the leading sector in the economy other than during the Second and Third Plan periods.
Key reasons for a Industrial policy in India:
Industrial policy is a document that sets the tone in implementing, promoting the regulatory roles of the government.
It was an effort to expand the industrialization and uplift the economy to its deserved heights. It signified the involvement of Indian government in the development of industrial sector.
First, there is the need to coordinate complementary investments when there are significant economies of scale and capital market imperfections.
- For example, as envisaged in a Visakhapatnam-Chennai Industrial Corridor.
Second, industrial policies are needed to address learning externalities such as subsidies for industrial training (on which we have done poorly).
- Industrial policy was reinforced by state investments in human capital, particularly general academic as well as vocational education/training aligned with the industrial policy, in most East Asian countries.
- However, a lack of human capital has been a major constraint upon India historically being able to attract foreign investment (which Southeast Asian economies succeeded in attracting).
Third, the state can play the role of organiser of domestic firms into cartels in their negotiations with foreign firms or governments, a role particularly relevant in the 21st century after the big business revolution of the 1990s.
Fourth, the role of industrial policy is not only to prevent coordination failures (ensure complementary investments) but also avoid competing investments in a capital-scarce environment.
- Excess capacity leads to price wars, adversely affecting profits of firms — either leading to bankruptcy of firms or slowing down investment, both happening often in India (witness the aviation sector).
- Even worse, price wars in the telecom sector in India have slowed profits (even caused losses), which hampers investment in mobile/Internet coverage of rural India where access to mobile phones and broadband Internet, needs rapid expansion.
- The East Asian state managed this role of industrial policy successfully.
Fifth, an industrial policy can ensure that the industrial capacity installed is as close to the minimum efficient scale as possible.
- Choosing too small a scale of capacity can mean a 30-50% reduction in production capacity the missing middle among Indian enterprises is nothing short of a failure of industrial strategy.
- Contributing to the missing middle phenomenon was the reservation of products exclusively for production in the small-scale and cottage industries (SSI) sector (with large firms excluded) from India’s 1956 Industrial Policy Resolution
- By then, small scale and informality had gotten entrenched in Indian manufacturing. Incentivisation to remain small in scale cost India dearly.
Sixth, when structural change is needed, industrial policy can facilitate that process.
- In a fast-changing market, losing firms will block structural changes that are socially beneficial but make their own assets worthless.
In this quest for increased exports, economies of scale are critical. Such economies were not possible with the policy-induced growth of micro-enterprises and informal units (the unorganised sector accounts for 45% of India’s exports).
How does an industrial policy help?
It is widely agreed that government intervention is crucial in the case of market failures which may include –
- deficiencies in capital markets, usually as a result of information asymmetries
- lack of adequate investments inhibiting exploitation of scale economies
- imperfect information with respect to firm-level investments in learning and training
- lack of information and coordination between technologically interdependent investments
Given the present economic situation in India, these are good reasons why an economy-wide planning mechanism is needed.
However, the Indian state should shift away from the “command and control” approach that was the case in pre-1991 days.
Lessons can be learnt from IT taking root:
Without the features below, the IT success story would not have occurred:
- First, the government invested in creating high-speed Internet connectivity for IT software parks enabling integration of the Indian IT industry into the U.S. market.
- Second, the government allowed the IT industry to import duty-free both hardware and software. (In retrospect, this should never have continued after a few years since it undermined the growth of the electronics hardware manufacturing in India.)
- Third, the IT industry was able to function under the Shops and Establishment Act; hence not subject to the 45 laws relating to labour and the onerous regulatory burden these impose.
- Finally, the IT sector has the benefit of low-cost, high-value human capital created by public investments earlier in technical education.
These offer insights to the potential for industrial policy when a new government takes over soon.
If evidence is still needed that the state’s role will be critical to manufacturing growth in India, the state’s role in the success story of India’s IT industry must be put on record.
Manufacturing will create jobs; its share in total employment fell from 12.8% to 11.5% over 2012 to 2016.
Unfortunately, the potential role of industrial policy has been consistently downplayed in developing countries outside of East Asia ever since the early 1980s after the growing dominance of the orthodox paradigm with well-known consequences in much of India, Latin America and also sub-Saharan Africa.
One of the objectives of China’s industrial policies since the 1990s has been to support the growth of domestic firms (examples being Lenovo computers, Haier home appliances, and mega-firms making mobile phones).
The East Asian miracle was very much founded upon export-oriented manufacturing, employ surplus labour released by agriculture, thus raising wages and reducing poverty rapidly.
This outcome came from a conscious, deliberately planned strategy (with Five Year Plans). India has been practically left out of Global Value Chains.
Increasing export of manufactures will need to be another rationale for an industrial policy, even though India has to focus more on “make for India”.
The growing participation of East Asian countries in global value chains (GVCs), graduating beyond simple, manufactured consumer goods to more technology– and skill-intensive manufactures for export, was a natural corollary to the industrial policy.