India?s new National Manufacturing Policy (NMP) is just around the corner. Newspaper reports have provided some glimpses of the thrust of policy changes, with stated goals of creating 100 million jobs and increasing the manufacturing sector share of GDP from 16% to 25% by 2025. Several innovative proposals have surfaced. One is to provide capital gains tax exemptions to small-scale enterprises, allowing them to raise equity by selling inherited land. Another is to create joint sinking funds in specified manufacturing zones, allowing speedier resolution of payments to labour that loses jobs. Much has been made of greater flexibility for environmental clearances. Unfortunately, this is probably going to result in greater social costs, and may not be the main culprit in constraining manufacturing growth, despite the recent attention given to this issue.
The villain of the piece instead remains India?s labour laws, not environmental regulations. It seems that the ministry of labour and employment remains reluctant to change, and this problem has to be overcome. The issue of labour laws has been debated for some time. But recently, Albert Bollard, a doctoral student at Stanford University, has provided a detailed and convincing empirical analysis of their consequences. He shows that labour regulations contribute to unduly high wages in the formal sector, and to the ?missing middle? of medium-sized firms in Indian industry.
But we know a lot more about Indian manufacturing than the negative consequences of labour laws. Nicholas Bloom, also at Stanford, together with various co-authors, has recently documented that management practices in India are often weak, by measurable criteria, and with measurable consequences in terms of reduced financial success. Several years earlier, Pankaj Chandra, now director of IIM Bangalore?again with co-authors?carried out a rich and detailed survey of India?s manufacturing competitiveness. Like Bloom, he found poor shop floor practices. More broadly, he also found lack of best practices in supply chain management and attention to innovation. Chandra and Bloom separately identify lack of trust along the value chain of Indian manufacturing, and specific practices that contribute to that lack of trust, such as delays in reimbursing suppliers. Hence, problems in India?s manufacturing go beyond the obvious problems in the policy environment.
There are several inferences to be drawn from these detailed surveys and analyses. First, inefficiencies in management are most likely indicators of lack of sufficient competition. India needs a more effective competition policy. More broadly, it needs an overhaul of the legal frameworks governing the doing of business in the country. This is happening, but slowly.
Second, a more robust system of financial intermediation needs to be built. There are two aspects of this. One is lubrication of the supply chain, through short-term credit from financial institutions?this needs to be complemented by more efficient legal enforcement of contracts and associated financial obligations. The other is better access to financing for investment and innovation. This will require innovations in legal structures for providing such finance, including venture capital. India?s financial sector needs to do a much better job of serving small and medium firms: this issue is outside the area of manufacturing policy, but critical to the success of manufacturing.
Third, what comes across in the studies, as well as in interviews with entrepreneurs in manufacturing, is the extreme shortage of skilled workers in India. (But Bollard shows that the wage premium in the formal sector is not entirely explained by returns to skills.) The problem extends from traditional education at all levels to a wide range of vocational and practical training. Manufacturing policy will not succeed without correcting this problem of skilling the population. The approach has to be broader than the envisaged training of rural migrants and the urban poor for employment in the new manufacturing zones.
So, the NMP helps to focus on a critical area for sustaining economic growth in India, and for creating jobs. It has glimmers of the right policy changes, including some innovations to increase access to capital and reduce transaction costs. But to succeed, complementary reforms in competition policy, financial sector functioning and education and training will be needed. This is different than the piecemeal measures included in the NMP: each of these areas needs broad and deep overhaul.
Finally, policymakers have to realise that active government policy has its limits. Plans for a Manufacturing Industry Promotion Board, and central guidance on the state governments? own industry policies, may be less effective in the Indian context than making sure that state-level policies are graded against best-practice benchmarks. India?s failure to make any significant progress in its ranking on the World Bank?s Ease of Doing Business Index?which provides such a benchmark?is telling. Active industrial policy cannot make up for policy-induced high costs of doing business.
The author is professor of economics, University of California, Santa Cruz