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How crucial is an Industrial policy for robust manufacturing sectors

  • Category
    Economy
  • Published
    25th May, 2019
  • The contribution of manufacturing to GDP in 2017 was only about 16%, a stagnation since the economic reforms began in 1991.
  • The contrast with the major Asian economies is significant. For example, Malaysia roughly tripled its share of manufacturing in GDP to 24%, while Thailand’s share increased from 13% to 33% (1960-2014).

Issue

Context

  • The contribution of manufacturing to GDP in 2017 was only about 16%, a stagnation since the economic reforms began in 1991.
  • The contrast with the major Asian economies is significant. For example, Malaysia roughly tripled its share of manufacturing in GDP to 24%, while Thailand’s share increased from 13% to 33% (1960-2014).

About:

  • The Draft Industrial Policy floated in August 2017 by the Department of Industrial Policy & Promotion aims to create jobs over the next two decades, promote foreign technology transfer and attract $100 billion FDI annually.
  • This will be the third industrial policy drafted in independent India. The first was announced in 1956, and the second, in 1991.

Main objectives of the Industrial Policy:

(i)  to maintain a sustained growth in productivity;

(ii) to enhance gainful employment;

(iii) to achieve optimal utilization of human resources;

(iv) to attain international competitiveness;

 (v) to transform India into a major partner and player in the global arena.

To achieve these objectives, the Policy focus is on deregulating Indian industry; allowing freedom and flexibility to the industry in responding to market forces; and providing a policy regime that facilitates and fosters growth.

Economic reforms initiated since 1991 envisages a significantly bigger role for private initiatives. The policy has been progressively liberalized over years to at present.

Analysis

No major country managed to reduce poverty or sustain growth without manufacturing driven economic growth. This is because productivity levels in industry (and manufacturing) are much higher than in either agriculture or services.

However, a lack of human capital has been a major constraint upon India historically being able to attract foreign investment (which Southeast Asian economies succeeded in attracting).

Manufacturing is an engine of economic growth because it:

  • Offers economies of scale
  • Embodies technological progress
  • Generates forward and backward linkages that create positive spillover effects in the economy

Even neo-classical economists accept government intervention in the case of market failures.

Mainstream economists point to specific instances of market failure that require a government-driven industrial policy:

  • Deficiencies in capital markets
  • Lack of adequate investments inhibiting exploitation of scale economies.
  • Imperfect information with respect to firm-level investments in learning and training
  • Lack of information and coordination between technologically interdependent investments

Why should India have an effective and up-to-date industrial policy?

  • To coordinate complementary investments when there are significant economies of scale and capital market imperfections (for example, as envisaged in a Visakhapatnam-Chennai Industrial Corridor).
  • Industrial policies are needed to address learning externalities such as subsidies for industrial training.
  • Industrial policy was reinforced by state investments in human capital, particularly general academic as well as vocational education/training aligned with the industrial policy, in most East Asian countries.
  • The state can play the role of organizer of domestic firms into cartels in their negotiations with foreign firms or governments — a role particularly relevant in the 21st century after the big business revolution of the 1990s (with mega-mergers and acquisitions among transnational corporations).
  • Role of industrial policy is not only to prevent coordination failures (i.e. ensure complementary investments) but also avoid competing investments in a capital-scarce environment.
  • An industrial policy can ensure that the industrial capacity installed is as close to the minimum efficient scale as possible. Choosing too small a scale of capacity can mean a 30-50% reduction in production capacity.
  • When structural change is needed, industrial policy can facilitate that process. In a fast-changing market, losing firms will block structural changes that are socially beneficial but make their own assets worthless.

State’s role in the success story of India’s IT industry

  • The government invested in creating high-speed Internet connectivity for IT software parks enabling integration of the Indian IT industry into the U.S. market.
  • It allowed the IT industry to import duty-free both hardware and software. (In retrospect, this should never have continued after a few years since it undermined the growth of the electronics hardware manufacturing in India.).
  • IT industry was able to function under the Shops and Establishment Act; hence not subject to the 45 laws relating to labour and the onerous regulatory burden these impose.
  • Finally, the IT sector has the benefit of low-cost, high-value human capital created by public investments earlier in technical education. Without these, the IT success story would not have occurred.

The LPG and 1991 era

Industrial Policy since 1991 has been more for facilitating the industrial development rather than anchoring it through permits and controls.

Industrial licensing has, therefore, been abolished for most of the industries and there are only 4 industries at present related to security, strategic and environmental concerns, where an industrial license is currently required:

  • Electronic aerospace and defence equipment: all types.
  • Industrial explosives including detonating fuses, safety fuses, gunpowder, nitrocellulose and matches.
  • Specified Hazardous chemicals i.e. (i) Hydrocyanic acid and its derivatives; (ii) Phosgene and its derivatives and (iii) Isocyanates & Disocyanates of hydrocarbon, not elsewhere specified (example Methyl Isocyanate).
  • Cigars and cigarettes of tobacco and manufactured tobacco substitutes.

Chronicles of industrial policy chronicle

  • When India’s industrial policy chronicle is reviewed, it is found that the country has mainly followed three regimes after independence.
  • These are the planned or controlled period till the end of the 1970s, the limited liberalization period of the 1980s and the post-reform period beginning in early 1990s.
  • It is seen that the performance of the industrial sector as a whole coupled with the manufacturing sector has witnessed substantial growth in terms of output after the 1980s, which further stabilized in the 1990s.
  • However, mining and quarrying as well as electricity, gas and water supply sectors of industry have decelerated in the post-reform period.

Summary note:

  • The idea behind Industrial Policy is to strengthen ease of doing business and reduce compliance costs for the industry. This, in turn, will boost private investments and entrepreneurship, thereby creating more employment opportunities.
  • The new industrial policy is expected to embed provisions that will give weightage to the quality of foreign direct investment (FDI), with a preference to investments that are expected to create local value additions and, thus, jobs.
  • To promote the use of new technology such as robotics and artificial intelligence, the policy is expected to emphasize promoting R&D and set up an institutional mechanism to encourage commercial utilization of research done using government funds.
  • The policy will focus on ‘Make in India’, improving ease of doing business, aligning trade and manufacturing, improving access to credit for MSMEs, industrial infrastructure creation, skill development and promotion of technology.
  • The policy will also act as a catalyst to help the Start-up India initiative to drive India’s economic growth.

Learning Aid

Practice Question:

Critically analyse new Industrial Policy of India in the backdrop of Make In India and De-Globalization trends.

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