For long, external demand has been the primary driver for industrial growth; at least since 1991, when trade liberalisation first began. This is evident from the close co-movement between manufacturing output and export growth, as the accompanying chart shows. In this while, Indian firms, especially micro, small and medium enterprises (MSMEs), have hooked on to the global supply chain network, inexorably linking the domestic-world industrial cycles.
This association spills over to the investment cycle, too; although exports directly account for around 15% of aggregate manufacturing output, machinery and equipment investment and export growth are strongly correlated. As the chart reveals, fixed assets creation is closely synchronised with global output growth, an association that strengthened further in the last decade.
So, when the world GDP growth boomed to a record 5% on average each year in 2003-07way above the previous decades average 3.2%Indias investment rate jumped nearly 10 percentage points in this short span. More than half the increase in private investment came from manufacturing; while real private investment grew an average 16% annually, machinery and equipment spending grew at double this rate, propelling the sectors share in aggregate investment to match that of the services segment at about 42%.
Notwithstanding this extensive capacity creation however, manufacturings share in overall GDP rose just one percentage point, to 16%, partly because the economy was then firing on all three cylindersagriculture, services and industryas the GDP grew an average 8.7% each year. It is this stagnant share, and the sharp fall in employment elasticitythis nearly halved relative to that in the preceding five yearsthat are todays concern.
In this light, what is the future potential for expanding the manufacturing base While productivity-enhancing reforms like relaxing constraints upon factors of production, lowering costs and ease of doing business, etc, will no doubt raise the sectors competitiveness, such structural change takes place slowly and bears fruit over longer periods. Then too, the external environment is the critical determinant. Three factors are significant in this context.
One, global growth rates are very unlikely to return to the pre-crisis path. The OECDs recent economic outlook reports a permanent loss of output across most of its group, 3.25%; it notes that even as these countries are recovering, the crisis has inflicted a permanent damage, with most nations facing loss of productivity too. This not just means lower foreign demand levels, but leads to the next important factorexchange rate movements. Currencies of most nations are much weaker, an offset to Indias own depreciation gains; in particular, prolonged monetary easing in the advanced countries and resulting exchange rate consequences has become a primary threatan issue the RBI Governor strongly raised at international fora in recent weeks. What do these imply for future replication of a 9.7% annual, average growth that Indian manufacturing clocked in the go-go years of 2003-07
By far, the greatest challenge is globalisation. Freer trade flows of goods and services across borders is causing fundamental changes in patterns and extent of industrialization in poorer (exporting) countries. Research by economists such as Arvind Subramanian and Dani Rodrik shows that worldwide, industrialisation peaks are shifting down and occurring at lower income levels than before. Rodrik (in a recent blog post) suggests this could be because of trade integration: exports of poorer countries are driven by consumption patterns of the rich (importing) countries; this has shifted towards more services than manufactured goods. Such demand shifts might be limiting industrialisation of poor, exporter countries, especially as rich countries retain certain levels of industry shares. Rodrik concludes that A direct implication of globalisationis that the industrialisation levels of the rich and poor countries must converge, irrespective of their income levels... (This) central logic is important and powerful. I am not sure it has been fully appreciated to date. And it has lots of implication for economic and political development in the poor countries.
This is not to dampen the enthusiasm for large-scale industrialisation efforts, a laudable objective in itself. But only to say that demand factors are possibly as important, if not more.
The author is a New Delhi-based macroeconomist.