India fails as a manufacturer-exporter

When economic reforms began in 1991, optimists hoped India would soon become the next Asian tiger. The original tigers were Singapore, Hong Kong, Korea and Taiwan. Then came the tiger cubs, Thailand, Malaysia and Indonesia. And finally came the spectacular performance of Deng’s China. While they followed differing strategies, they had one thing in common: they created conditions favourable for export-oriented manufacturing.

This resulted in a new international division of la-bour, with low-tech factories shifting from higher-wage to lowerwage countries. This increased employment, incomes and prosperity.

Now, creating conditions favourable for export-oriented manufacturing is not easy. Low wages alone are irrelevant: global industries do not shift to Sub-Saharan Africa or Nepal where wages are the lowest. What matters ultimately is productivity. If a poor country has one-tenth Japan’s wages but one-fifth of Japan’s productivity, then Japanese factories will have an incentive to migrate. But if a poor country has one-tenth the wages but one-twentieth the labour productivity of Japan, obviously no Japanese industries will shift.

Labour productivity is determined by several factors. High educational standards and skills help. Top-quality infrastructure cuts the cost of production and movement, facilitates rapid and reliable delivery, and so increases labour productivity. Strong financial markets lower the cost of capital and transactions, and so increase productivity.

Flexible and well-enforced laws covering labour, land, and capital (including bankruptcy) aid the rapid redeployment of these factors of production whenever needed, and so increase productivity. Substantial deregulation helps harness entrepreneurial energy. Rapid and fair procedures where regulations are still needed, judicial mechanisms to resolve disputes fairly and quickly, an alert and responsive bureaucracy and polity, a strong civil society with democratic rights, low levels of corruption, all are aids to productivity. No developing country can claim to have all these attributes. But having a majority of them is enough to create economic miracles, as one Asian country after another has proved.

India, alas, dos not have a majority of these attributes. Literacy is barely 60 per cent. Infrastructure is in a terrible mess. Corruption and bureaucratic sloth are widespread. The financial sector has serious weaknesses. A legal system exists and in some respects works well (as Enron will testify), but legal enforcement is poor because of incompetent police and enormous legal delays. Markets for land, labour and capital remain rigid and largely unreformed. One reason is India’s unique political economy where every political party is also a labour party (every major one has an affiliated trade union).

The Urban Land Ceiling and Regulation Act was amended by ordinance, yet not a single state took advantage of it to liberalise its rules. The climate for mergers and acquisitions has improved, but banks are still unable to effectively seize assets of defaulters, and the liquidation of companies takes decades. So there can be no speedy redeployment of land, labour and capital to meet changing conditions.

In sum, economic reform remains half-baked. Politicians have neither the guts nor inclination to take on powerful sectional interests like trade unions and farmers. This is not surprising given the political economy of liberalisation, which has been driven by the bankruptcy of central and state governments, not ideological conviction.

This explains why, after eight years of reform, few multinational companies see much promise in shifting factories from other countries to India. India can indeed occupy a few small labour-intensive niches. Sundaram Fasteners, for instance, has become a successful exporter of radiator caps for the global operations of General Motors. But this is a tiny operation. In general, multinationals do not regard India as a cost-effective production centre for the global market, and are interested mainly in its domestic, protected market. Hewlett Packard considered using India as an export base but ultimately decided that the infrastructure was neither rapid nor reliable enough.

India’s merchandise exports have indeed grown in the last 15 years. From a low of 4.5 per cent of GDP in the mid-1980s, they now amount to roughly 10 per cent of GDP. However, the composition of merchandise exports has changed surprisingly little. The Economic Survey 1998-99 shows that between 1980-81 and 1997-98, the share of agricultural exports moved from 18.7 per cent to 18.8 per cent, of textiles and garments from 23.7 per cent to 20.7 per cent, of gems and jewellery from 15.1 per cent to 15.1 per cent (no change).

Exports of electronic goods are new items that have taken some market share from chemicals and machinery. The remarkably limited compositional change suggests that much of the increase in exports since 1980 has come more from a realistic exchange rate than tiger-like improvements in manufacturing productivity.

Half-baked reform has released entrepreneurial energy and helped improve productivity and growth. But manufacturing remains plagued by a series of problems, which politicians are reluctant to correct since this would antagonise strong sectional interests. India’s polity is now so fragmented that coalition governments seem likely for most if not all of the foreseeable future. Such fragile coalitions are not well suited to take on strong sectional interests. This is why reform proceeds so slowly, and why India’s manufacturing productivity is not rising fast enough.

Yet there remains cause for hope. India’s economy, as well as the world’s economy, is shifting steadily from industry to services. Half-baked liberalisation does not hamper the growth of services, which include many new areas not clogged by vested interests. India appears to have a much greater comparative advantage in services than in manufacturing. That improves its prospects greatly in the coming century. In my next column, I shall discuss why India, which looks very unlikely to become a manufacturing tiger, may yet become a services tiger.

What do you think?