Stagnant Manufacturing

This month marks the 25th anniversary of India’s “big bang” economic reforms. This newspaper and many others have recounted the turbulent times preceding July 1991. The backdrop was a succession of unstable governments with a rapidly deteriorating macro-economy and the commencement of the first Gulf war leading to a spurt in oil prices. There was great drama too, with secret airlifting of India’s sovereign gold to pledge as collateral for an emergency foreign loan.

Even though 1991 is the marker, it is fair to say that reformist thinking was evident even in the mid-1980s. For instance, there were trade reforms (easing of capital goods imports), financial sector reforms (abolition of control of capital issues) and several other smaller reform measures in the administration and running of the public sector. This prior incremental journey has been forgotten because it was overtaken by the tumultuous events of 1990 and 1991.

It is also clear by now that support for the reforms process was sprinkled across different ministries. Some well-known bureaucrats (now acclaimed as the architects of India’s reforms) occupied key positions in the economic ministries and the Prime Minister’s Office and saw eye-to-eye on what was needed to be done. Their synergy and collective intellect provided the force for the reforms roll-out. The political cover ultimately came from prime minister Narasimha Rao, whose leadership was crucial for the success of the reforms. Rao managed to obtain key cabinet decisions and consensus without the advantage of a mechanism like the group of ministers, used extensively by his successors.

By far the biggest reform of 1991 was industrial delicensing. In one swoop the licence-permit raj was dismantled, eliminating the need for permission to set up a new factory, or indeed even to add capacity to an existing factory. It is true that cement decontrol had commenced earlier in 1989, but an order affecting India’s entire industrial sector was 1991’s big move. Interestingly, this particular reform was announced by the then industries minister in the forenoon of 24 July 1991—the same day that finance minister Manmohan Singh gave his historic budget speech. The next day’s jubilant headlines missed out that crucial detail, that the licence raj had been demolished by the industries minister, who was none other than the prime minister himself.

The dismantling of the suffocating licensing regime was supposed to unleash the industrial sector in a big way. Just like our East Asian peers, we should have seen a jump in the share of manufacturing in national gross domestic product (GDP). Unfortunately this promise was never fulfilled. The share of manufacturing was 16.41% in 1989-90 and is 16.2% in 2015-16 (new GDP series). If anything, it has fallen just a bit. This is a big puzzle. Additionally, even employment in the organized manufacturing sector, especially the public sector, has remained stagnant.

It is true that in real terms GDP has quadrupled, which means industrial production too is four times bigger (since its share has remained constant). But it should have galloped and increased its share.

The National Manufacturing Policy (NMP) aims to increase the share from the current level to 25% in the next seven years. This seems almost impossible in light of the experience of the past 25 years. The reasons for the stagnation could be many: excessive tax burden, inadequate infrastructure and connectivity, unreliable electricity, non-availability of credit or appropriately skilled labour, lack of research, development or technology adoption and so on.

One of the members of the 1991 reforms team and former Reserve Bank of India deputy governor Rakesh Mohan also pointed out another troubling feature. This is manifest in India’s trade balance. If you take out the 6-7% earnings from remittances and software exports, and add 1-2% as “healthy” current account deficit for a growing economy like India, then our merchandise trade balance is a negative 8-9% of GDP. This is largely the shortage of industrial goods in the country. This gap reflects our inability to service our domestic market in a variety of industrial sectors, from electronics and cellphones to capital goods and machinery. Foreign imports, superior in quality and cheaper (thanks to an overvalued exchange rate), manage to swamp our markets and harness our purchasing power. E-commerce companies are probably sourcing the bulk of their merchandise through imports anyway. According to a FICCI study, the logistics cost component can be as high as 17% of the domestic cost of industrial production. (This includes the ad hoc entry taxes arbitrarily slapped on interstate movement of goods).

The NMP document of 2013 already has the blueprint of what needs to be done. Initiatives like Make in India and Mudra Bank loans to small and medium entrepreneurs, the nationwide roll-out of the goods and services tax, easing of power shortages—all will cumulatively give a fillip to industrial production. But as we deal with and solve the problems of yesterday, the challenges of tomorrow are already at our doorstep. This means dealing with the rise of robotics, 3-D printing, vastly diffused and distributed value chains across countries and falling trade barriers thanks to free trade agreements. Raising the share of manufacturing in GDP: this is a hard nut to crack, but crack it we must.