Although India’s GDP growth rate since Independence has consistently increased, industry accounts for only 25% of GDP (in 1950, it was 8%). Manufacturing contributed in 2017 only about 16% to GDP, stagnating since the economic reforms began in 1991. By contrast, in east Asia, the industry’s share has exceeded 30-40% while that of manufacturing is 20-30%. Malaysia roughly tripled its share of manufacturing value-added in GDP from 1960 to 2014 to about 24%, while Thailand’s share increased from 13% to 33% over the same period; Vietnam, too, has seen a sharp recent increase. In India, manufacturing has never been the leading sector other than during the second and third Plan periods, and certainly not since 1991.
No major country managed to reduce poverty or sustain growth over long periods of time without the manufacturing sector driving economic growth. This is because productivity levels in industry (and manufacturing) are much higher than in either agriculture or services, and it is the source of productivity gains across primary and tertiary sectors, through the spread effects of technological change.
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The 1991 reforms reduced barriers to entry for private industry (ending industrial licensing), reduced the sectors reserved for the ‘public sector’ from 17 to eight (apart from the beginning of disinvestment in public enterprises), and significantly reduced import duties. It was the thrust of policies over two decades.
By the late noughties—the decade from 2000 to 2009—the need for a real industrial policy was being felt. Hence, in 2011, the National Manufacturing Policy was announced. However, by this time, the rapid reduction in tariffs had led to Chinese and other imports flooding India with capital goods, intermediates as well as consumer goods.
While the most severe effects of open-economy policies on India’s manufacturing were felt from the early 2000s onwards, those effects had begun in the 1990s. In manufacturing, the simple average tariff fell from 126% in 1990-91 to 36% in 1997-98, and then to 12.1% in 2014-15. Tariffs were reduced to well below the upper-bound of rates permissible under WTO rules.
Meanwhile, GDP growth in India was led by the services sector, led by communications, software and air transportation since the early 2000s. Services growth was accompanied by a sharp rise in import demand for manufactures—computer hardware, telecom equipment, and aircraft. So, economic liberalisation, while contributing to growth in the services part of the GDP, had the reverse effect on manufacturing.
This situation from 2001 onwards was not helped by the spate of free trade agreements (FTAs) signed by India, which led to an inverted import duty structure (IDS)—it means higher duty on intermediate goods compared to final/finished goods, with the latter often enjoying concessional customs duty under some schemes. Due to such a duty structure, domestic manufacturing units end up importing finished goods from China, Europe and East Asian countries. As a result, the trade deficit in manufacturing on account of import competition was 44% of manufacturing GDP during 2008-09 to 2010-11.
One sector that did not face IDS and prospered is automobiles. In this sector, most final goods are under the negative list of imports; components are not. MFN tariff rates have been also quite high for importing vehicles in completely built-up form. However, duties are quite low for the completely knocked down version of the vehicle, which is expected to promote local vehicle assembly. Hence, prima facie, the duty structure is in line with promoting domestic production in automobiles. Not surprisingly, India has become, in the last 15 years, one of the world’s largest manufacturers of two-wheelers, three-wheelers, cars and trucks.
Second, since 1991, the import-intensity of manufacturing production has dramatically increased. For India, an upward trend in import intensity since 2003 explains capital intensity, to some extent. The implication is that manufacturing would be characterised by ‘jobless growth’, while numbers of youth joining the labour force was rising.
According to economist Dani Rodrik, it will not be possible for next-generation industrialising countries to move 25% or more of their workforce into manufacturing, unlike the East Asians. However, this shouldn’t mean that India cannot increase manufacturing share in GDP, or the share of employment above the current 12%, relying both on domestic and export markets.
We are making the case for an integrated trade-and-industrial policy, which means that the ministry of commerce and industry, the Department of Industrial Policy & Promotion, and the ministry of finance (which takes a final view on taxes) will need to work together on such an integrated trade-and-industrial policy. However, there is no constituency for manufacturing in any ministry, especially ministry of finance.
IDS constitutes negative protection of India’s merchandise industries. If the effective rate of protection (ERP) is positive in the presence of IDS, then the latter may not affect domestic industries. A 2017 study of ERP in Indian manufacturing, with a view to examining the effect of IDS, shows that inverted duty structure exists in paper and paper products, chemical and chemical products, pharmaceuticals, computer, electronics and optical products, machinery and equipment, other transport equipment for the majority of the years under consideration. Another study by Hoda and Rai (2014) had also reported IDS in electronic products such as refrigerators, air conditioners, washing machines, microwave ovens, etc. Tariff Commission studies have demonstrated the same.
Action too little, too late
In the Budget for 2014-15, the government had, with a view to boost domestic manufacturing and also to address IDS, reduced the basic customs duty (BCD) on various inputs (for example, for the chemicals and petrochemicals sector). This initiative was carried forward in the Budget 2015-16 (for example, BCD was reduced on 22 key inputs/components).
However, the existing FTAs contain long-term contractual obligations, which cannot simply be modified. Although the government can consider invoking the WTO’s ‘safeguard clause’ (embedded in most FTAs to sanction the adoption of countermeasures to guard a domestic industry facing ‘threat of serious injury’ from imports), maintaining a symmetry between applying safeguard measures and the objective of trade liberalisation is always a challenge.
The goods and services tax (GST) does deal with IDS in a specific clause. The law provides for refund of unutilised input tax credit (ITC) where credit accumulation is on account of IDS, subject to certain riders. However, this action is insufficient to counteract IDS. All that the GST has managed to do is neutralise the negative protection, and possibly level the playing field—but levelling the playing field for the potential domestic manufacturer cannot lead to a manufacturing sector investment boom. A new government will need to take rapid action with a new Industrial Policy aligned to Trade Policy.
The author is Professor of Economics, JNU, and the author of ‘Realising the Demographic Dividend: Policies to Achieve Inclusive Growth in India’