July 08, 2019
By Nitin Desai
The Economic Survey and the budget speech have both focused attention on the need to boost the growth rate beyond its current 6-7% band. The goal of becoming a $5 trillion economy in five years is clearly the driving force of economic policy now. But the growth rate of 10-11% required for this target is not possible without a substantial increase in the production of manufactured goods and tradeable services, quite apart from the radical improvements in infrastructure, capital markets and labour mobility that would be needed.
At the macro level, the share of manufacturing in GDP has stayed around the 17 percent mark for about four decades. The share of tradeable services in areas like information technology and tourism has gone up. Moreover, within the aggregate number the share of downstream industries has increased relative to the basic materials.
Growth in manufacturing industries can accelerate if demand growth accelerates. Domestic consumption demand cannot be the driver as it is more likely to be a consequence rather than a cause of accelerated growth. The old policy of import substitution, re-endorsed by the tariff changes in this year’s budget, has limited potential and dilute the drive for global competitiveness, though, given the scale of our requirements, public procurement of sophisticated equipment for defence or infrastructure projects like Metro rail or for public service digital networks can stimulate growth in a few sophisticated engineering industries if those responsible for the procurement have a long-term vision. However, the economy wide impact of this would be modest and a broad based exogenous demand boost will have to come from an acceleration in the growth of exports of manufactures and tradeable services.
The Economic Survey dwells at length with the Chinese record of accelerated growth in which export led growth in manufacturing was the key driver. The Chinese approach and that of other East Asian countries to growth strategy is best described as Export-led Backward Integration. Starting with the manufacture of some high growth exportable product based on imported technology, components and materials, domestic companies, often actively promoted by the parent company, acquired the capacity to manufacture these inputs. The indigenisation of technology development was driven mainly by the pioneering parent companies.
This has not happened in India. For instance we have a pharmaceutical industry whose exports have grown quite rapidly.But it still depends largely on imports for the active ingredients and speciality chemicals that it uses and much of this comes from China. A more recent example is the smartphone industry which is simply an assembly operation in India. Another successful export sector is software services.But here too there has been little backward integration into software development and even less so in frontier areas like artificial intelligence and machine learning.
India could have followed the East Asian example and actually did so in the automobile sector, driven however not by exports but by burgeoning domestic demand. When Maruti was launched in the early eighties it promoted component manufacture in a systematic way with assured purchase, finance and technological hand-holding. Today we have a globally competitive automobile and auto component industries which has emerged as a significant global player.
What can we do to multiply this example? An export-led strategy that also includes incentives for backward integration is substantially different from an infant industry strategy because it has an inbuilt pressure for efficiency and cost reduction.
Export led strategies depend crucially on four things-adequacy and efficiency in the supply of non-tradeable inputs, particularly infrastructure services, the availability of labour with the required skills, an exchange rate that moves in line with purchasing power parity and productivity changes relative to competitors and, above all technological dynamism.
The availability of basic infrastructure like power and transport and communication is becoming less and less of a problem for manufacturing investment. The real problem is in trade facilitation and the administrative infrastructure of trade policy making, clearances, border controls and tax administration. Witness for instance the problems in GST refunds for exporters.
The availability of labour with the required skills is important but is not a precondition for exploiting export opportunities. When opportunities open up job seekers go and acquire the relevant skills, often at their own cost, as we have seen when export prospects opened up for call centres and software coding for Y2K. In addition relatively low cost on job training can ensure that skill availability is not the binding constraint on export growth. A base level of education and training is of course necessary and has been built up, though the education and training system does require significant quality improvement all the way from primary schools to higher education.
Exchange rate management is important. Between 2002-03 and 2011-12 India's non-oil exports rose five-fold from $50 billion to $250 billion. Since then the growth in the dollar value of non-oil exports has slowed to a crawl. The export weighted real exchange rate was more or less static at the 2004-05 level during the high growth phase. But since then the real exchange rate has risen making exports less competitive which must be at least partly responsible for the slow growth.
All these three factors are important in the medium term. But in the long term what matters most for exports of manufactures and business services is technological capacity at the corporate and country level.
Technological dynamism is more than improvements in factor productivity or energy and material productivity. It has to include the Schumpeterian dimension of the rate at which innovations in the form of new products, processes, business practices are introduced and the rate at which new markets are developed.
An outward-oriented development strategy generates pressures for technological dynamism in both senses—improvements in resource efficiency because of the need to be price competitive and technological dynamism for innovative development of new products and new processes to remain relevant in evolving global markets. An undervalued exchange rate can help and an over valued exchange rate can hurt price competitiveness. But both the prospects for entry into a global market and the staying power will depend on meeting the minimal quality norms and keeping up with changes in these brought about by innovations.
The greatest barrier to an export-led backward integration strategy that focuses on these four areas is the way policy is being formulated now with the focus being on grand sounding goals rather than on redesigned instruments. Effective growth policies focus more on means than on ends.