Renu Kohli: From treadmill to fast track

Last Updated: Fri, Jul 15, 2011 20:00 hrs

Expanding the share of manufacturing in the country’s economic base is likely to prove very difficult

The Indian manufacturing sector has had to run very fast in order to stand still in this millennium. Despite an exceptional performance in the first decade, its share in the overall gross domestic product (GDP) has remained between 15 and 16 per cent. A new policy on manufacturing now aims to raise this stake to a quarter per cent by 2025. For this to happen, the sector needs to step off the treadmill, get onto the tracks and sprint very fast. Its run, however, is likely to face resistance from shrinking markets abroad and higher inflation rates in the coming times.

Assuming that real GDP grows at an average annual rate of eight per cent over the next 14 years, the new manufacturing policy’s objective translates into a five-fold increase in the size of the sector in real terms; from the current Rs 7,730 billion to Rs 35,818 billion in 2025. This, in turn, implies a real growth rate of about 12 per cent each year, entailing a steep jump relative to historical trend; by way of comparison, decade average growth rates for manufacturing are eight per cent in 2000-2010 and 5.7 per cent in 1991-99.

In the five years to 2007-08, the manufacturing segment grew at an annual average rate of 10 per cent in real terms, outpacing India’s strongest ever GDP growth of 8.9 per cent in the period. It also contributed to more than half of the increase in private investment in this period: real private investment growth averaged 17 per cent annually but business spending on machinery and equipment grew much faster at 31 per cent. The sector increased its share in aggregate investment to about 42 per cent, equalling that of the services segment, while the economy-wide investment rate rose from 27.4 per cent to 39 per cent.

Despite these spectacular dynamics, its portion of the GDP pie increased just one percentage point!

External demand was critical in accelerating the growth momentum in manufacturing during 2003-07. Global output growth averaged an unprecedented five per cent in this period, outstripping the previous record mean of four per cent in 1984-89. This fuelled the robust export growth of these years — an annual average of 22 per cent. Indeed, growth in manufacturing is closely correlated with subsequent export growth in this period (correlation of 0.70). Globalisation has strengthened the manufacturing-export linkages substantially in the 2000s: the two correlate strongly at 0.60 over 2000-10 compared to a non-existent association in the preceding decade. And, although exports directly account for approximately 15 per cent of aggregate manufacturing output, machinery and equipment investment and export growth are as strongly correlated.

Despite the stellar export statistics of this period, overall manufacturing appears to have steadily lost competitiveness since 2000. This is observed from plotted values of revealed comparative advantage (or RCA, an index with values below one indicating relative disadvantage of a country in that segment) in the Reserve Bank of India Annual Report (August 2010: pg 67). Reproduced here (see chart), the RCA in overall manufactures is observed falling below one by 2008. Competitiveness losses are more marked in textiles that exports two-fifths of its output, contributes 14 per cent of industrial production and employs about eight per cent of the labour force: the RCA shows a steep fall from 5.5 in 2000 to less than 3.5 by 2008. By one estimate (Deutsche Bank Research, May 13, 2011), terms-of-trade losses have been as much as 15 per cent over 2000-2010.

Strong growth has also induced structural changes like in diversification of exports from low-skill to higher-skill products; import-substitution in segments like steel, metals, etc where domestic capacities exist; and channelling of foreign direct investments flows into non-traded segments like housing and construction, indicating the relative unattractiveness of the tradable sector to foreign investors. Some of these could portend a weakening ecosystem for manufacturing that is hard to regain on permanent destruction.

The strategy of the new policy to arrest the treadmill performance and falling external competitiveness of Indian manufacturing is to create national investment and manufacturing zones (NIMZs) à la China. The zones, however, are just one part of the Chinese story. The other – central – part has been its exchange rate policy of undervaluation to keep exports consistently competitive abroad. Further, studies show that critical differences between Chinese and Indian manufacturing companies lie mainly in size (the median Chinese firm employs 400 vis-à-vis 88 in India), labour skills (Chinese labour has higher computer and IT skills) and labour flexibility other than infrastructure; the NIMZs would address mainly the infrastructure problem.

Then again, the macro-economic environment – external and domestic – which is a significant determinant of manufacturing growth is no longer what China faced in its years of double-digit growth. The period of Great Moderation that kept prices benign for a long time was a boon for countries like China because it kept input costs, including real wages, low. This is now all but over and global inflation rates are poised considerably higher due to high levels of public debt, and charging fuel and commodity prices. Though the global scenario affects all countries equally, India is especially impacted due to its high import-dependency for oil and other commodities. On the domestic front, too, persistent inflation threatens to erode the low-cost advantage of India’s manufactures as other input costs like raw materials, wages, interest rates and other prices escalate.

Looking ahead, can we expect an external environment of the preceding decade? The global economy has little means to deliver the high growth rates of 2003-07: the developed economies have to shrink as they address their large levels of private and public debt, distressed financial systems, unemployment and loss of competitiveness. The rest of the world cannot deliver such growth rates alone, especially as food, fuel and commodity prices pose a serious risk to inflation and limit growth.

Expanding the share of manufacturing in the country’s economic base by an additional 10 per cent is thus likely to prove very difficult in the post-crisis world.

The author is Consultant Professor, G20 Project, at ICRIER and is former staff member of IMF and RBI.  

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