Industrial growth: The right policy mix for success
November 26, 2020 5:05 AM
India’s industrial policies have tended to be doctrinaire. We need a heavy dose of pragmatism to achieve our full potential
In some industries, commitment of procurement of full production for a few years would suffice to get investment.
By Ajay Shankar
The goals of the Make in India initiative and now the AatmaNirbharBharat Abhiyan are driving a major shift in policy. Import duties are being raised. Production-linked incentives are being offered to firms across a wide canvas of 10 priority sectors. This is welcome. We are finally implementing an ‘industrial policy’. At the same time, there is considerable unease at the rolling back of trade liberalisation. India gained so much from globalisation. Old-fashioned protectionism was tried till the 1980s. It failed. There is no point in repeating the mistakes of the past.
This binary is not very useful. Pragmatism and freedom from theoretical dogmas of faith in the free market or in the efficacy of state intervention are better for the development of effective policy instruments. The fact is that in the industrial age competitive advantage is developed and is not a natural endowment. This is the key lesson from the rapid industrialisation of South Korea, followed by China.
It would still take India many years to develop its physical infrastructure to the levels required for international competitiveness. Until then, large industrial parks for textiles, electronics, toys or shipbuilding need to be developed by state agencies with soft financing to create globally-competitive infrastructure internally and connectivity to the highway network, freight corridors and the seaports. Competitive logistics are essential. This was critical for the success of the information technology (IT) industry where world-class infrastructure was created within the software parks. High-speed broadband real-time connectivity to the US market was provided through public investment. This was done well before general telecom modernisation began.
While industrial corridors and zones have been under development, long-term financing for world-class infrastructure is still a gap. The central government need not keep waiting for a long-term debt market to emerge. It can either use one of its existing financial institutions, or create a new development financial institution to provide long-term low-interest rate debt for the creation of world-class infrastructure for competitive manufacturing in select industrial zones. The sovereign needs to provide risk-mitigation through an implicit guarantee. It can afford to do so. The other prerequisite is to prevent real exchange rate appreciation.
A 10% real exchange appreciation is equal to an across-the-board 10% tariff reduction. Before considering specific increases in import duties, real exchange appreciation should be undone. This would have the effect of raising tariffs across the board. This is being advocated by many economists, including Arvind Panagariya, the former vice-chairman of the NITI Aayog. It is high time the government and the Reserve Bank of India (RBI) agreed on this objective. That we had some industrial growth in spite of a 19% real exchange rate appreciation over a decade is quite creditable.
Then, there is a need to change the regime for the special economic zones. Allow enterprises from these zones to sell into the domestic area with import duties at the lowest applicable rate with any trading partner and the same value-addition norms. Tax exemption on profits could be dispensed with while continuing to provide a duty-free import regime. This would create a level-playing field for production vis-à-vis competitive locations overseas. Large zones would have to be developed by the state. The private sector can be partners in the process, but achievement of scale is only possible by the state. Production for the domestic as well as the global market would become easier.
Further, domestic value-addition can be incentivised by reducing duties to zero for all primary raw materials and inputs, and then have progressively higher rates for intermediates with the highest rate for the finished product. In short, have just the opposite of the inverted duty structure we have had for computers. The incentives so created could change investment and production decisions if other costs of production in India have been made competitive. We have succeeded in the auto sector with import duties on cars being high so that auto majors have been choosing to make in India. This could be attempted in a few high-priority areas such as electronics and toys.
In some industries, commitment of procurement of full production for a few years would suffice to get investment. Bids could be invited for solar panels, or for battery storage for the grid, for annual supply for, say, five years with the condition that full value-addition has to be done in India. Commitment to buy for five years from the year production commenced from a new plant in India would provide for amortisation of the capital investment and make it a risk-free investment. If the bid size is large enough, the best global firms would come and invest. If the bids are repeated, prices would come down and a competitive industry structure would be created.
Public investment in firms should not be ruled out altogether on the principle that the government has no business being in business. In some cases, it may be the best way to create competitive capacity. Maruti Suzuki is a good example in India. Volkswagen was set up by a state government in Germany, which is still a substantial shareholder. This is a policy instrument that can be used to create competitive advantage. There should also be willingness to create a fund that looks at modest returns, but aims at creating national and global champions through start-ups.
The Israelis have achieved wonders with this approach. An Intel or a Samsung could be persuaded to set up a chip manufacturing plant with our public investment and a mutually-acceptable risk-allocation arrangement. The foundation of China’s incredible success was laid by Deng Xiaoping with the maxim on economic policy that one should not bother about the colour of the cat as long as it caught mice. India’s policies have tended to be doctrinaire. We need a heavy dose of pragmatism to achieve our full potential.