Why India’s manufacturing sector needs a big push

New Delhi | September 06, 2018 3:34 AM

The Indian industry certainly needs to upgrade to compete globally, but without an effective and targeted policy support, the manufacturing sector will stagnate and not be able to compete with its emerging market peers. Effective collaboration between the government and the private sector is the need of the hour.

manufacturing sector, manufacturing industryIllustration: Rohnit Phore

The commerce and industry minister Suresh Prabhu recently mentioned that the soon-to-be-unveiled industrial policy will enable a modern, globally-competitive and innovation-driven Indian industry ecosystem. He also acknowledged China’s “unparalleled” economic growth, attributing it to the huge investment by the Chinese government. Industrial revolutions don’t happen overnight. They require careful planning, policy interventions, regular upgrades, and innovations and investments at every stage of development. In 1990, India’s GDP per capita ($385) was higher than that of China’s ($318) and total GDP almost equal to that of China. Since then, China has outgrown India in terms of economic size, with its GDP almost five times that of India’s.

China’s enviable growth has been primarily driven by the manufacturing sector, which contributes more than a quarter to the global manufacturing GDP. China’s careful planning, huge investment in infrastructure, incentives and subsidies, progressive decentralisation, and market-oriented reforms contributed to its manufacturing revolution. Not to forget its massive infrastructure upgrades. Between 2001 and 2006, China spent more money on infrastructure like roads, railway tracks, airports and critical fixed assets than had been spent in the previous 50 years put together. Now, through the Made in China 2025 strategic plan, the government is incentivising Chinese companies to leapfrog on the technology forefront by encouraging manufacturers to upgrade their factories in terms of quality, productivity and digitisation.

On the other hand, South Korea has transitioned into a high-tech manufacturing country by focusing heavily on purchase of technology, and subsidies on R&D investments made by the public and private sectors. Tax incentives for R&D in South Korea are provided at every stage. Therefore, South Korea’s comparative advantage lies in technology and design.

One cannot deny India has missed the bus for a full-fledged manufacturing revolution, unlike China, South Korea and other emerging markets. In terms of growth, India’s manufacturing sector has underperformed compared to the overall GDP growth in the past decades. As a result, the share of manufacturing in India’s GDP has stagnated at 16-17%. To put this in perspective, manufacturing accounts for 29% of GDP in China and South Korea, and 27% in Thailand. Manufacturing is the backbone of an economy contributing to sustainable economic growth. According to estimates, every job created in manufacturing has a multiplier effect of 2-3x additional jobs in other sectors. In this regard, the government’s new industrial policy is a ray of hope for the manufacturing sector, as the government promises to reduce the cost of doing business in India in order to make Indian industry competitive.

India’s industrial competitiveness is impacted by a variety of factors. The first is the cost and quality of power. Setting up of captive power supply for stable, concurrent and uninterrupted power is a huge cost burden for all energy-intensive manufacturing units. Cross-subsidisation has increased industrial power tariffs over the years. Additional tax burdens for heavy manufacturing industries like coal cess, RPO and PAT increase the overall energy cost. According to a NITI Aayog report, for energy-intensive manufacturing units, coal cess, RPO and PAT put together amount to a carbon tax of $9.7 per tonne of carbon dioxide emissions. As per the report, from a developing country perspective with low per capita consumption of electricity, this carbon tax seems to be excessive. Also, in terms of quality of power, India ranks 80 out of 137 countries as per World Economic Forum. According to the World Bank, access to electricity is the second-most important obstacle for manufacturing firms and is holding back corporate investment in the sector. India also faces the highest transmission and distribution losses in electric power in Emerging Asia due to low technological investment in innovations.

Second, Indian logistics costs are estimated to be of around 14-15% of GDP, almost double of the 7-8% of GDP in developed countries. In India, nearly 60% of the cargo travels by road. This is because of over-saturated railway networks, high rail freights, long transit times, inadequate port depths, high turnaround time at ports, and poor warehousing facility. As per anecdotal evidence, the distance from Guangzhou in China to Mumbai is five times greater than that between Delhi to Mumbai, but the cargo cost is almost comparable.

Third, India’s demographic and low labour cost advantage is eroded by growing skill mismatch and low productivity of labour. Today, 62% of India’s population is in the working age group and more than 54% of the total population is below 25 years of age. However, it is estimated that only 4.7% of India’s workforce is formally skilled, as against 52% in the US, 68% in the UK, 75% in Germany, 80% in Japan, 96% in South Korea and 24% in China. As per official estimates, India needs to train 126 million people across 34 sectors. Aspiring Minds, an Indian employability assessment firm, estimates that more than 80% of engineers in India are “unemployable”. This has an impact on productivity. As per OECD estimates, manufacturing productivity in value added per hour worked terms for China and Brazil is 1.6 times and 2.9 times higher, respectively, than in India.

Fourth, if India is to realise its goal of increasing the manufacturing share in its GDP to 25%, expenditure on R&D is critical. According to the Economic Survey, India’s spending on R&D as a share of GDP has been stagnant at 0.6-0.7% for the last two decades. This is much lower than the US (2.8%), China (2.1%), South Korea (4.2%) and Israel (4.3%). The survey recommends doubling R&D expenditure. There is a not only a need for greater state and central government spending, but also industrial application oriented R&D and greater collaboration with the private sector. Cross-movement of researchers between public research organisations and industry is critical for facilitating transfer of knowledge and understanding each other’s needs. This is one common factor that has differentiated highly industrialised economies like South Korea and Taiwan from the not-so-industrialised.

Last but not the least, for India’s manufacturing sector to grow, it is pertinent that we push the frontier for MSMEs—they contribute nearly 32% of the GDP. There is an urgent need to bring down the cost of capital for these firms so that they stay competitive and innovative. The Economic Survey of FY18 points out that a meagre 17% of credit disbursed to industry goes to MSMEs, while the rest is garnered by the large enterprises. The average loan packet granted to these units under the Pradhan Mantri Mudra Yojana has been low (average loan size of `50,000), despite low levels of NPAs for this sector. If we want our MSMEs to innovate, export and prosper, we must create suitable conditions for them in terms of cost and provision of capital.

While the Indian industry needs to upgrade to compete globally, without an effective and targeted policy support, the manufacturing sector will stagnate and not be able to compete with its emerging market peers. Effective collaboration between the government and the private sector is the need of the hour.

By Prachi Priya & Aniruddha Ghosh. Priya is a Mumbai-based economist, Ghosh is an LSE alumnus and a US-based economist

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