Make in India Success Stories: Lessons Learnt POLICY PAPER 2016
Satish Y. Deodhar
This policy paper was written based on the talks delivered in the‘Make in India – Success Stories: Lessons Learnt’ Lecture Series, organised by the Pune International Centre (PIC).
Comments and ideas on the earlier draft by Professors Abhay Pethe, Chandrahas Deshpande, Pradeep Apte and Raghunath Mashelkar are acknowledged.
Special thanks to Dr. Vijay Kelkar for his valuable feedback and for conceptualizing this policy paper under the auspices of Pune International Centre (PIC) and Mahratta Chamber of Commerce Industries and Agriculture (MCCIA).
Data inputs from Vishal Gaikwad are appreciated.
About the Author
Satish Y. Deodhar teaches Economics at the Indian Institute of Management Ahmedabad (IIMA).
He has been honoured with the Distinguished Young Professor Award for Excellence in Research by IIMA (2008) and the Dewang Mehta National Education Award for Best Professor of Economics (2012 & 2015) by the Business School Affaire.
Prof. Deodhar has worked on imperfectly competitive market structures, World Trade Organization (WTO), agricultural trade, food quality, and CSR issues. He has conducted research projects for India’s Ministry of Food Processing Industries, Ministry of Agriculture, Indian Bank, and Economic Research Service of the US Department of Agriculture and was selected as the Hewlett Fellow of the International Agricultural Trade Research Consortium during 2006–2008.
An author of quite a few monographs and books, one of his books, Day to Day Economics, has gone on to become a national bestseller in the non- fiction category with close to 50,000 copies sold till date.
Currently, he is the Chair of the Post-Graduate Programme in Management (PGP) at IIM Ahmedabad.
MAKE IN INDIA:
Lessons from Successful Manufacturing Enterprises
he Make in India theme is not new to India. It was highlighted by economists and entrepreneurs alike as early as in the last decade of 19th century. Justice M.G. Ranade, a forerunner of the modern Indian economists, had emphasized in 1892 that science and its application were the ultimate basis for industrial society (Ranade, 1898). He had warned then that while India needed pragmatic education and skilled labour, issues of political dominance (by the British) were attracting far more attention than the formidable though unfelt domination of capital and skill (Adams, 1971). Paying heed to the warning, Laxmanrao Kirloskar had begun manufacturing India’s first iron plough and fodder-cutter at around the same time (Kirloskar, 2003). And later, Jamshetji Tata’s efforts culminated in the establishment of an Indian steel mill.
However, as India attained independence in 1947, the East India Company phobia had become the zeitgeist of the times. The then socialistically thinking government not only cordoned-off India from the rest of the world, but it also cordoned-off private sector in favour of the all- pervasive public sector. Critical intermediate goods sectors such as power, steel, transportation, and telecom were forced into public sector which lacked competition. Further, over time, more than 800 industrial items including leather and textiles got reserved for small scale industries (SSI). The consequent results of first three-and-a-half decades were for everyone to see – Absence of incentives for public sector to stay efficient, private sector facing unfair competition from public sector, thwarted incentives for private sector to invest and grow out of SSI mould, and a resultant poor GDP growth rate. However, reforms began to be introduced quietly by 1980s, which are now referred to as reforms by stealth (Panagaria, 2004). For example, partial decontrol in import licencing and domestic pricing began without much fanfare in the mid-eighties. Government also tried with the idea of establishing export processing zones (EPZs) though with no much success. Then happened the economic liberalization in 1991, triggered by India’s precarious condition in her balance of payments (BOP). The trigger turned out to be a watershed event in changing the direction of economic policy. While the new direction stayed on course, it got slowed down over the next two decades as the governments got mired down by financial scams, environmental activism, lack of sufficient political support in parliament, and administrative inertia. In 2005, EPZs were brought back in their new form called Special Economic Zones (SEZs). However, SEZs also did not deliver goods. And now, the Make in India theme has breathed a new life. It found an emphatic mention by Prime Minister of India, Mr. Narendra Modi, in his Independence Day speech from the ramparts of the Red Fort on 15 August 2014. The popular slogan seems to suggest a newly-found activist role for the government. However, conventional trade theories do not champion any active role to governments. In a free trade environment, it is the comparative advantage that decides what a country will produce and export (Ricardo, 1821). In this context, one may wonder if the Make in India theme is at odds with the principle of free market comparative advantage. The answer would be an emphatic no, if Make in India theme encourages improvement in India’s comparative advantage over time. Many East Asian economies did exactly that in the second half of the twentieth century. Improving dynamic comparative advantage is no crime and it certainly cannot be viewed as a protectionist or autarkic economic policy. Essentially, then, the question boils down to this – How does one improve and operationalize India’s comparative advantage?
“A Country is not a Company,” wrote Nobel laureate Paul Krugman (1996). Taking a generic course in economics may not help a budding entrepreneur run a company and a cavalier business venture may not help her formulate country’s economic policies either! Importantly, however; successful & sanguine, and, experienced & ethical business executives can certainly offer a prescriptive direction to economic policies; if they are offered a conducive ideas-forum to share their views. One can effectively leverage their problem-solving efforts from within the companies to shape economic policy. In this context, Pune International Centre (PIC) and Mahratta Chamber of Commerce, Industries, and Agriculture (MCCIA) offered that conducive ideas-forum to leading industrialists who are members of PIC and MCCIA. Four talks were organized at MCCIA, Pune, during July 2015 and August 2016, on the topic, “Make in India – Success Stories: Lessons Learnt.” The speakers included CXOs of four successful manufacturing companies – Dr. Kamal Sharma, Vice Chairman of Lupin Limited; Dr. B.N. Kalyani, Chairman of Bharat Forge Limited; Mr. Pramod Chaudhari, Chairman of Praj Industries Limited; and, Dr. Naushad Forbes, Co-Chairman of Forbes Marshall Private Limited and President of Confederation of Indian Industries (CII, 2016-17)1.
The speakers represented diverse manufacturing industries; namely, health and pharmaceutical; auto-component and heavy engineering; biofuel and effluent management; and control instrumentation, steam engineering, and process efficiency sectors; respectively. They are also diverse in terms of company structure – Going by the customary stock market segmentation, one is a Large Cap company, another a Mid Cap company, and yet another a small and medium enterprise (SME) that had turned into a Small Cap public limited company. If three of them are public limited companies, the fourth is an unlisted private limited company. While there is so much diversity among these four companies, there are quite a few important commonalities among them – They all are, of course, Indian companies, represent technology driven manufacturing enterprises, are export driven enterprises, have their manufacturing bases in foreign countries, and, are exemplary role models of Indian multinationals that thrived in the post-1991 economic liberalization era. Therefore, the objective of arranging the talks was twofold – Distil the experiences, learnings and strategies emanating from the success stories of these companies; and, galvanize them by economic theory to make policy prescriptions for India’s long road ahead.
To this end, the paper is organized as follows. Section 2 summarizes the phenomenon of structural changes in the sectoral contribution to GDP and the reasons for India skipping the predominant share of industry in her GDP. It also points out ways and incentives to promote manufacturing by focusing attention away from public sector and towards private sector. While acquiring a significant share of GDP by manufacturing may be a necessary condition for innovations and improving comparative advantage, it is not a sufficient condition. To highlight the importance of Research and Development (R&D), Section 3 provides the stark difference in R&D spending in advanced industrial nations, East Asian countries and India. Further, a link is established between competition and R&D which lead to innovations. A point is also made that technology is apolitical in nature and need not result in jobless growth. In Section 4, we show how the R&D synergy among companies, academia, and government contributes to innovations, where significant R&D spending should come from private sector, universities, and government autonomous institutions, in that order. While Section 5 concentrates on facilitating role of infrastructure, ease of land acquisition, access to power, flexibility in labour laws, skill upgradation, speedy and improved implementation of GST, and ease of doing business; Section 6 focuses on provision of macroeconomic stability to businesses in terms of inflation, exchange rate, and fiscal deficits. Finally, Section 7 summarizes and provides important policy takeaways for improving India’s dynamic comparative advantage.
02. Sectoral Contributions and Focus on Manufacturing
It is a well-established phenomenon that a country’s sectoral contribution to GDP undergoes a structural change through its stages of economic growth. In the first stage, share of agriculture dominates. In the second, as economic development progresses, share of secondary sector becomes the largest. And, finally, in the third stage, it is the share of service sector that predominates over the other two. However, India has been an outlier in that it skipped the second stage! Till 1974, share of agricultural in India’s GDP was highest at 40 per cent. From thereon, it did decline to 14 per cent by 2014; however, the secondary sector remained stagnant at 25 per cent. In fact, within the secondary sector, manufacturing sector accounted only for about 14 per cent of GDP (GOI, 2014).
This was the result of a few misplaced policies. First, Licence Raj, a euphemism for strict controls on issuance of manufacturing licences, had reduced competition and production in the manufacturing sector. Moreover, preference for public sector undertakings (PSUs) and reservation of hundreds of industrial products for SSIs had dis-incentivised industrialists to invest and grow. Further, high customs duties and quotas on imported goods had thwarted competition from the rest of the world. Second, due to large informal sector, government’s tax revenue through direct taxes was very low and it had resorted to collecting as much as 80 per cent or more of its revenue from indirect taxes. Services were never taxed until as late as mid 1990s and fiscal burden of indirect taxes fell mostly on manufactured products. Moreover, unlike the recently enacted Goods and Services Tax (GST), indirect taxes such as excise duty were not destination based. As a result, Indian manufacturing companies had lost their competitive edge in the world market. Third, propensity to take risk among entrepreneurs was curtailed, for the stringent labour laws and factory act had made it very difficult for companies to leave the industry in the event of companies becoming unprofitable for various reasons. Fourth, with a single- minded focus on soviet style command and control economy, attention to development of infrastructure and vocational skills was undermined leading to underperformance of labour and high transactions costs in logistics and supply chains. As a result, while share of manufacturing in GDP remained at about 14 per cent by 2014, more than 60 per cent of GDP share was accounted for by the service sector. This dominant share, however, was attributable mainly to a large, unorganized, low-skill, low-wage service sector coupled with a very small high-skill service sector (software, communication etc.).
If India does not succeed in catapulting manufacturing this time around, she will be facing massive imports from as diverse product categories as electronic gadgets, railway equipment, power-plant equipment, semiconductors, navigational radars, optical mediums, medical equipment, aerospace and many other capital goods. In the recent past, India has imported about Rs. 5 trillion worth of manufactured goods per year, and, ceteris paribus, this number may rise to about Rs. 11.5 trillion by 2020. Importantly, experience in most of the industrialized countries has shown that a threshold dominance of manufacturing sector provides scope of innovations. And, innovations in turn, improve the comparative advantage of the respective countries. The early industrialization in United Kingdom (UK) and Europe provided ample scope for innovations in the 19th century. Later, industrialization moved to the United States (US) in the early 20th century. And, as US developed, the industrialization phenomena moved to Japan in the period following 2nd World War (WW II). Finally, the last three countries to follow Japan were the South Korea, China, and Taiwan. Experience gained in production of diverse goods, adoption of various scales of production, and maturing of competitive environment had resulted in innovative technologies and products in these countries, improving their comparative advantage. Time seems to be ripe for India to broad-base and scale-up manufacturing sector, which will nourish benign conditions for innovative technologies and products. Of course, the term manufacturing has to be redefined in the modern world, which would include sectors as diverse as food processing and electronics to service-embedded manufacturing of physical infrastructure and virtual networks infrastructure.
Focus Away from PSUs
In the immediate post-independence era, PSUs had made strategic investments in many sectors of the economy including but not limited to defence production. For example, all ordinance factories were PSU owned. India had borrowed the production and procurement apparatus of these sectors prevalent in UK in the 1950s and 1960s. While these PSUs served an important purpose then, today, they cannot be expected to produce defence equipment meant for 21st century using archaic technology and administrative systems. As an example, it took about Rs. 20,000 crore and 20 years to perfect Kaveri jet engine by the government’s defence production establishment. Had it been given to private sector, the development would have been done much sooner and perhaps at about 1/10th of the cost. One must understand that the nature of government functioning is such that transactions cost in PSUs are bound to be too high. Ironically, UK gave up on production of defence equipment by the public sector long ago during Prime Minister Margaret Thatcher’s regime. Of course, while a few strategic production operations may have to be necessarily reserved for public sector; it is equally true that India’s private sector did not receive sufficient opportunities to prove itself.
One of the doyens of the modern Indian industry, late Mr. Shantanurao Kirloskar would say, “Jump in the water and you will know how to swim.” However, government procurement regulations are such that it first wants private enterprises to prove that they can swim! As a result, contracts go to foreign companies due to unrealistic procurement norms. It is worth noting that ceteris paribus, by the year 2025, India may end up importing defence hardware worth Rs. 2.5 trillion. It is time to realize that private sector has come of age – Private sector has proved its maturity and capabilities on a number of occasions. For example, India’s private sector has proved that it can produce world class defence hardware. During the Kargil war, when the defence forces were running short on Bofors guns, Bharat Forge had produced and supplied guns at a very short notice. It is noteworthy that Indian Space Research Organization (ISRO) did not get itself bogged down by the archaic procurement architecture of the 1950s and 1960s. It depends upon the private sector to supply critical components for its space programme. No wonder, ISRO continues to successfully manage its Mars orbiter mission (MOM) since its launch more than 2 years ago. Thus, a heightened amount of understanding of the capabilities and maturity of India’s private sector to produce defence hardware would be desirable. Of course, private companies cannot sustain if they cannot cover their cost and earn at least normal profits. This is contingent upon companies getting assured long-duration contracts, especially in heavy industry sectors such as defence manufacturing. If government can partake risk-sharing in production by way of sustained, threshold levels of sales orders, private sector can accomplish the task at much lower cost than the cost incurred by PSUs or foreign companies for that matter. Further, governments may want to give up traditional assumption that companies are bound to break laws. Self-certification can be encouraged and instead of creating a messy laundry-list of what activities private sector can do, it is easier to reduce the transactions cost by identifying only the negative list of a few areas which private sector need not occupy.
What has been pointed out by speakers about the sectors such as defence, it equally applies to a few civilian sectors. Economic principles tell us that for efficient allocation of resources, if markets must allow free entry to companies, they must also allow free exit to them. While Indigo Airlines makes a good business and provides efficient service to passengers, loss-making private companies such as Air Sahara had to leave the industry, saving the nation from inefficient allocation of resources. However, the same rule must apply to government owned Air India. If Air India makes cumulative losses of more than Rs. 360 billion (ET, 2015a) and mounting, it must leave the market. There has been no (free) exit for Air India ever since its nationalization decades ago! In the process, tax payers money is being wasted, which can be used for more productive activities elsewhere. In fact, with no budget constraints and competition commission completely ignoring markets occupied by PSUs, private sector faces unfair and distorted competition. Competition Policy must monitor PSUs as well. The argument that Air India operates on some of the unprofitable sectors where private airlines will not operate does not hold water, for private airlines can also operate if a subsidy is given to them for those limited sectors. What is true for Indigo Air and Air India, the same is true for say the private company Finolex Cables and the PSU Hindustan Cables. As we write, it appears that Hindustan Cables may go under hammer for privatization.
Nurturing Private Sector
Within the private sector itself, there are at least five critically important industries that are simply missing their presence in India. Four of them are aerospace technology, healthcare equipment manufacturing, technology hardware equipment manufacturing and electronic and electrical equipment manufacturing. The fifth one is defence, where we have some presence; however, in comparison to the modern defence manufacturing capabilities elsewhere, India’s production is very small. There is sufficient entrepreneurial talent in the private sector to run both – PSUs that can undergo disinvestment and initiate manufacturing in the four altogether new private sector areas where India has no presence. One will have to attract quality leadership from private sector which will take a strategic perspective on investments in different sectors of the economy. If India has a goal of raising share of manufacturing from 14 per cent to 25 per cent, her GDP will have to grow at least by 7 per cent for the next 10 years. And, to accomplish this objective, role of private sector will be very important. This calls for a few policy initiatives on the part of the government. The policy issues which will incentivise entrepreneurs to take a strategic view towards industrial investments and production would be the following:
First, in the short to medium run, foreign direct investment (FDI) may be encouraged. FDI not only helps the domestic partners in raising capital, it also facilitates access to technologies hitherto unavailable domestically. For starters, India could allow companies such as Foxconn Technologies of Taiwan to partner with Indian companies to invest in manufacturing plants for electronics goods and some others to invest in many other industries such as garments, as has been done in China. Foxconn, for example, employs 1.5 million workers in China with some of its multi-story factories employing as many as 400,000 workers. Second, while the current corporate income tax-rate of about 34.61 per cent is a far cry from what it used to be in the late seventies (about 97 per cent!), the current world average of the corporate tax-rate is only about 24 per cent. Therefore, there is a significant scope to reduce corporate tax-rate further, to say 25 per cent, which will incentivize industrialists to think in terms of long-term investments in different sectors.
Third, speedy implementation of GST and changes in labour laws in all states of India will be very helpful, an issue which we discuss in detail in a subsequent section. Fourth, domestic savings will also have to be ratcheted up to finance growing investments needed for high GDP growth. Just to give a comparison, while gross domestic savings rate in China is about 50 per cent, it is only about 32 per cent in India. Therefore, the process of financial inclusion of every section of the society will have to be hastened. The savings rate could be improved in the medium run through speedy and successful implementation of various policies ranging from the latest Gold Monetization Scheme (GMS) for the rich, popularizing systematic investment plan (SIP) in mutual funds for the middle-class, to the Jan Dhan Yojana for the masses. As referred to in the previous section, higher level of manufacturing provides scope for innovations, and, consequently, it improves the dynamic comparative advantage of a country. We turn to this issue now.
03R&D, Innovative Technologies, and Employment
Share of R&D
While threshold level of manufacturing may be necessary for innovative technologies, it is not a sufficient condition. South Korea’s innovation transformation took place during the period 1970 to 1990.
During this period, her GDP growth rate was phenomenal with an annual average rate being more than 10 per cent. In this period, the share of manufacturing in GDP increased from about 18 per cent to 27 per cent. Further, during this period, share of R&D increased from 0.4 per cent of GDP to
1.9 per cent of GDP. This is a high ratio, given that the other two newly industrialized countries of that time, Singapore and China, took another 15 years from 1990 to reach to that ratio. In fact, South Korea’s 2014 ratio of 4.3 per cent is the highest among all the newly industrialized countries of the East and other developing countries such as India and Mexico. To top it all, during the same period her share of industrial R&D in the total R&D increased from 13 per cent to 81 per cent. Therefore, what South Korea witnessed was a substantial rise in proportion of GDP accounted by manufacturing sector, the sector which achieved substantial share of total R&D, the R&D which exhibited a rising share in GDP, and, the GDP which was also rising at more than 10 per cent a year! This force multiplier has resulted in an absolute growth of R&D in manufacturing by a factor of 100 between 1970 and 1990. China’s innovation transformation happened between 1975 and 1995 with very similar growth numbers. As a result, these countries were able to offer innovative manufacturing products to the world, while improving their dynamic comparative advantage.
In contrast, while India’s GDP growth rate has been averaging at about 7 per cent since 1991, her share of manufacturing in GDP has been just about 14 per cent. Importantly, the share of R&D in GDP too has been very low. It was about 0.7 per cent in 1991 and has marginally inched to 0.9 per cent in 2014. There is a lesson for India – As Indian economy hopes to grow rapidly, it must get ready to embrace increasing share of manufacturing in GDP, and, entrepreneurs must complement this process by focusing on increased investments in R&D. Fortunately, this forward looking business sense has been demonstrated by quite a few entrepreneurs in India. Lupin, Praj, and Bharat Forge have demonstrated that they have been at the forefront of R&D investments. Even during the years following the advent of recession in 2008 and leading up to the present, these companies have been engaging in substantive R&D. If Lupin’s R&D to net income ratio was about 46 per cent in 2015, Praj’s R&D to net income ratio was 36 per cent in 2009 and 27 per cent in 2015. Bharat Forge too has increased its R&D from Rs. 36 million to Rs. 435 million between 2009 and 2015, an increase of more than 1000 per cent over 7 years. No wonder, today Lupin is one of the largest producers of anti-Tuberculosis and other life-saving drugs in the world; Praj is a global leader in first-generation ethnol technology; and, Bharat Forge is the largest manufacturer of auto and engineering components in the world.
Competition, R&D, and Innovations
What makes companies invest in R&D? There is considerable literature that shows empirical relation between competitive markets and technological innovation, and that monopoly is inimical to innovation. Clement (2008) has summarized this literature for US industries, where, after shipping industry received competition from railroad and trucking industry, cement industry received competition from foreign producers, and regulated electric power monopolies became more competitive; their productivity levels went up. Similarly, anti-cartel laws in UK had had positive impact on labour productivity. What has been so far known empirically has now been proved theoretically as well – Holmes, Levine, Schmitz (2012) argue that technological innovations are subject to switchover disruptions. Such disruptions occur when innovative processes are employed and there are uncertainties about delays in prospective sales and the sales lost in the interim period. Monopolists will be very conservative in innovating, for they already make huge profits and the opportunity cost of expected disruptions are very high for them. Such opportunity costs do not exist for companies in a competitive market.
It should not come as a surprise that behavior of Lupin, Bharat Forge, and Praj was very much disciplined by the worldwide competitive forces since they are export oriented companies. In fact, this feature was common to all rapidly growing newly industrialized countries of East Asia. Competitive export markets forced Lupin, Praj, and Bharat Forge to innovate through indigenous R&D. The lesson seems to be that government must encourage competition. One way to do this is, of course, continuing with the Competition Commission’s mandate. The decision of imposing penalty of more than Rs. 6000 crore on top ten cement companies for collusive behaviour a few years ago is a case in point. And, of course, competition policy must be equally applicable to PSUs, for they enjoy the luxury of operating without any budget constraint, creating an unfair and distorting competition for private sector. Moreover, government can provide competitive environment by removing impediments to foreign trade. It is well known that with no competition in its segment, the vintage Ambassador car had remained what it was throughout many decades since independence. Another illustration would be of India’s current customs duties of 125 per cent and 50 per cent on import of chicken products and apples, respectively. With such prohibitive tariffs, domestic players face less competition from abroad. To that extent, they may not be keen to innovate their supply chain processes and improve quality attributes as compared to what they have been doing for so many decades. Similarly, in the retail and wholesale segment, fragmented liberalization in terms of limiting FDI to 50 per cent in some cases and 100 per cent in some other, limiting it for single brand in some cases and multi-brand in other, and, forcing 30 per cent domestic content requirement may dampen the competitive spirit with which government is trying to open up markets to foreign players.
While India liberalizes trade unilaterally, it is also important that she pursues an aggressive policy on engagement with other countries on free trade agreements. Trading opportunities and exposure to competition through multilateral agreements will help Indian companies and the economy grow rapidly, as has happened with East Asian countries in the past. While India must continue its efforts for the success of multilateral agreements under the auspices of World Trade Organization (WTO), it must also simultaneously engage in other mega-regional and plurilateral agreements that matter. For instance, China is already a full member of Regional Comprehensive Economic Partnership (RCEP) of ASEAN countries where India is only at a negotiating stage. Similarly, China is already seeking membership in Trans Pacific Partnership (TTP), Free Trade Area of the Asia-Pacific (FTAAP), and the plurilateral agreement on Trade in Services Agreement (TISA) that is open only to WTO member countries. India has been the original member of WTO since 1995. In fact, China joined about 6 years later. For RCEP, TTP, and FTAAP, and TISA, India seems be late. But better late than never, for otherwise she risks less-than-fair treatment from member countries of these trade groupings. Indian companies must receive access to foreign markets through such institutional arrangements.
Of course, at a micro level, competition alone cannot create innovation transformation in organizations. Factors internal to an organization are equally important. Businesses have to nurture leadership qualities that are supportive to their employee decisions and develop culture of learning from mistakes. For example, since its inception, ISRO leadership got nurtured from one leader to another. If Dr. Vikram Sarabhai was a founding visionary to guide Dr. Satish Dhavan, Dr. Dhavan was a role model to Dr. Abdul Kalam. When the launch of the Rohini satellite failed in 1979, as Chairman of ISRO, Dr. Dhavan took the responsibility for the failure at the press conference. However, when Rohini was successfully re-launched in less than a year, he requested Dr. Kalam to hold the press conference in his capacity as the team leader for Rohini project. In private sector too, as traditional family owned businesses become professionalized, their management and human resource practices must evolve in similar ways, where leadership and risk- taking abilities are developed in the organization. While entrepreneurial qualities will come naturally to some, they can also be acquired or enhanced by some others through management education. Moreover, as has been initiated at a few management institutes and by National Innovation Foundation (NIF), offering incubation environment for innovative and entrepreneurial ideas will give an added push for innovation transformation in businesses.
Walk on Two Legs
Experience over the last several decades shows that in a developing country like India, adoption of modern technology gets viewed with suspicion, especially if it is initiated by private sector. Typically, modern technology has been viewed as anti-labour. Today, the same fears are being expressed about China as it embraces automation and robotization of its manufacturing sector (Knight, 2016). The fears of such jobless growth expressed today had been echoed for centuries together. Keynes (1931) wrote an essay titled Economic Possibilities for our Grandchildren. He alludes to the fact that despite rapid technological changes starting 16th century up until the end of 19th century and despite rapid growth in population, average standard of life had grown fourfold. Further, in the context of 20th century, he states that there may be growing-pains of over rapid changes but that is a temporary phase of maladjustment. To quote Keynes:
“We are being afflicted with a new disease, namely, technological unemployment. This means unemployment due to our discovery of means of economising the use of labour outrunning the pace at which we can find new uses for labour. But this is only a temporary phase of maladjustment.”
Technology is apolitical in nature and gets harnessed to benefit society at large. Use of technology increases productivity and reduces cost and prices. In turn, it increases demand for goods and services. It also increases demand for capital goods that are required to sustain the technology. The multiplier effect of this, both in capital goods sector and consumer goods sector creates more jobs. Moreover, as GDP grows, it also creates more demand and jobs in service sectors such as education, healthcare, entertainment, and travel, to name a few. Furthermore, in today’s interconnected world, one produces not just for the domestic market but for the world at large. This is possible only with newer technology and higher scale of production. Scaling-up, diversifying supplies between domestic and export markets, and diversifying among various export markets, helps a country insure against varying degrees of recessionary tendencies in domestic and export markets.
And, it is not as if SMEs have no place in the above scheme of things. Lupin, Bharat Forge, Praj, and Forbes Marshall, began with small scale operations before they became Indian multinationals. In fact, ten critical components of India’s recently launched Mangalayan were procured by ISRO from SME tool rooms. In countries such as Germany there is a strong presence of SMEs or what are known as Mittelstand. They account for 52 per cent of earnings of all companies and about 54 per cent of them keep bringing new innovative products in the market. For effective contribution by SMEs in the Make in India story, one needs start-up support in manufacturing. So far, India’s start-up support system is mainly focused on service sector. Through the ASPIRE programme, Government of India’s Ministry for Micro, Small, and Medium Enterprises is trying to promote small manufacturing units. What it could also do is to support budding entrepreneurs at various stages of their business – It may provide seed funding, first in the ideation-to-prototype stage, and then for prototype-to-pilot-production stage. Later, the entrepreneurs could be introduced to venture capitalists, angel investors, and private equity fund managers. Moreover, as will be discussed later, labour laws could be made more flexible and requirements for approvals and permissions to start or expand business could be simplified.
With such a congenial environment, SMEs themselves can bring a positive change in their perception about their activities. Moving up in the value chain, an ancillary unit must view itself as an outsourcing partner, reverse engineering must be viewed as re-engineering, a low cost producer must view itself as a high quality producer, building as per print must be viewed as customized engineering, and a domestic operator must have aspirations to grow as an international player. East Asian companies, many of them SMEs, have integrated themselves into international production networks or what is also termed as global value chains (GVCs). Indian SMEs too can specialize in their niche production activities and get integrated into GVCs. In fact, some of the GVCs are very much labour intensive as shown by Chinese employment in Foxconn and other labour intensive sectors such as textile and garments. Still others can create job growth in skilled labour by moving up the value chain. Thus, small companies or large, labour intensive ones or skill intensive, purely manufacturing or service-embedded-manufacturing, either type has a scope to grow. To quote Joshi (2016), “It will be misleading to portray India’s developmental challenge as a choice between two mutually exclusive strategies of industrialization – one labour intensive and the other capital and skill intensive. India could and should walk on two legs!”
04. Role of R&D and Synergy among Companies, Academia and Government
It will not be surprising to know that absolute amounts of R&D are much higher in developed countries. For example R&D expenditures in US, Germany, and UK are about $480 billion, $110 billion, and $54 billion per year, respectively. What is striking, however, is that China and South Korea’s R&D expenditure are also quite high at about $200 billion and $50 billion per year, respectively. More importantly, on an average, the share of corporate sector and universities in the total R&D expenditure among these 5 countries is about 72 per cent and 16 per cent, respectively. The rest is accounted for by government autonomous institutions. Large absolute amounts, residual share of government autonomous institutions, dominant share of corporate R&D, and the complementary yet significant role of universities contrasts in bold relief to that of India’ R&D effort. India’s R&D expenditure is just about $17 billion per year and the share of government autonomous institutions is at a high of about 61 per cent. Another 35 per cent is accounted for by the corporate sector, and a miniscule residual share of 4 per cent is contributed by universities.
Vladimir Lenin coined the term “commanding heights” in 1922 to denote critical sectors of the economy that were to be controlled by government (Kling and Schulz, 2011). After independence, India’s first prime minister, Jawaharlal Nehru borrowed the term and the philosophy of commanding heights. In pursuance of that philosophy many autonomous research institutions were set up in the public sector. Today close to 300 such government autonomous institutions exist in India. Most of these stand-alone institutions were expected to do research with little teaching. Universities, on the other hand, due to lack of funds and industry interface, ended up focusing their attention mostly on teaching. However, government autonomous institutions suffered from lack of synergy between masters and Ph.D. level students and the research faculty. Lack of commercial orientation and the consequent patenting culture also contributed to their lower research efforts. Further, there was very little potential for inter-disciplinary approach to research as would have been possible in a university setup. Because of these limitations, while substantive R&D spending was incurred in government autonomous institutions, high quality research experience and output was severely constrained. Indian companies too, therefore, were reluctant to absorb employees from government autonomous institutions or hire students from universities for their own R&D efforts. In fact, R&D efforts in the private sector create spillover effects and positive innovation externalities for other companies in the economy. The cost-benefit ratio for R&D in the private sector is very low compared to that in the public sector. For these reasons, governments of developed free-market economies provide fiscal support to private R&D efforts. India too could offer tax incentives for the private R&D efforts. In the absence of such incentives and the various reasons mentioned above, innovation propensity has been low in India.
To give contrasting examples, the Silicon Valley in California, famously known for technology driven companies and start-ups, emerged out of Stanford University’s efforts to encourage STEM (science, technology, engineering, and mathematics) research and provision of venture capital to its graduates. In addition to Stanford, Department of Defence and National Aeronautics and Space Administration (NASA) also collaborated with private companies to further cutting-edge research on products such as transistors, semiconductors, silicon chips, and internet. It is well known that start-ups from the region have gone on to become famous companies such as Apple, Microsoft, Facebook, and many more. To the East, by the end of the WW II, Japan created Ministry of International Trade and Industry (MITI), which was to promote manufacturing R&D for almost three decades. While MITI may be criticised for some of its protectionist policies, its facilitating role in R&D resulted in top five Japanese companies conducting collaborative research. In fact, so much importance was given to this facilitating role, that till 1980s, prime ministers of Japan were expected to serve a tenure as minister of MITI. Of course, MITI is not in existence for more than a decade now; however, it served its purpose of raising Japanese industry from the ashes of WW II. So much so, that in 1980s MITI had to implement voluntary export restraints (VERs) on exports of Japanese cars and other gadgets to the US (Schaede, 1997).
The kind of synergy that occurred in Silicon Valley or in Japan can be replicated in India too. The announcement in the recent budget about the proposed establishment of 10 public and 10 private world-class universities should be a landmark move. Integration of higher education and research in universities; competitive bidding for government research funds by universities, as happens in US through National Science Foundation (NSF) and National Bureau of Economic Research (NBER); and, collaborative R&D between corporates and academia, will be helpful for India’s innovation transformation. In fact, as universities start producing quality researchers, companies will also hire them and up their R&D efforts. If not at a systemic level, in their own way, some stakeholders have moved in that direction. For example, Lupin had worked with Council for Science and Industrial Research (CSIR) to develop anti-Tuberculosis (TB) molecule a few years ago. Similarly, Bharat Forge sends their engineers to earn a master’s degree at Indian Institute of Technology (IIT), Pawai and train them for R&D activities. While the concept of venture capital is rather new in India, it was attempted successfully by an Indian company in the 1980s. No surprises again – It was Praj, an SME then, which secured venture capital support from ICICI and Tata Sons during 1983-85 and developed indigenous technology to process biomass and generate biogas and sustainable waste management practices. Today, many service sector entrepreneurs receive venture capital support but very few are in manufacturing. Many start-ups today are developing interface between technology and services – ‘Apps’ for retail sales, transportation service aggregation (Ola, Uber), and a few others. It is commendable that Praj had successfully utilized venture capital for manufacturing more than three decades ago.
05. Infrastructure, Labour Laws, Skilling,GST, and Ease of Doing Business
A key factor in the growth of manufacturing and employment is the access to job opportunities facilitated through infrastructure networks. If the connectivity and physical infrastructure among villages, towns, and cities is not well developed, labour mobility is hampered.
In a memorandum stating his objections to Mahalanobis model, Friedman (1955) had argued that one of the basic requisites for India’s economic policy was improved facilities for transportation and communication, to promote mobility not only of goods but also of people and labour. When companies want to establish plants in rural areas, it is difficult to attract semi-skilled or skilled labour from towns and cities due to lack of access to physical infrastructure like roads, railways, schools, and hospitals among other. Today, per capita, annual consumption of cement in China is about 1.6 tonnes and the corresponding figure for India is barely 200 kilograms. This concrete gap only goes to show that there is tremendous scope for government in the medium term to commit to development of physical infrastructure. One important pre-requisite for developing physical infrastructure is availability of land.
David Ricardo (1821) described rent as a reward for the ‘original and indestructible powers of the soil’. However, if the supply of land is ill-managed, these rewards (rents) can skyrocket choking industrial development. Countries with very low population density in the Americas and Africa, and countries such as Australia, New Zealand, and Russia may have fewer land acquisition issues, for land is abundantly available. Similarly, totalitarian regimes like China may also have fewer issues in acquiring land, for considerations of sanctity of individual rights and freedom may not necessarily take precedence over dictates of the state. On the other hand, land acquisition for industrial growth is a challenging issue for a country like India which is both – a vibrant democracy and a densely populated country. In 1950s, when large dams such as Hirakud and Bhakra Nangal were constructed, Jawaharlal Nehru would inaugurate them, but reports of sufferings of villagers evicted from their land and being made destitute would also surface alongside (Guha, 2007). This was the result of the coercive power government had enjoyed for over a century through the colonial Land Acquision Act of 1894. As a reaction, though much later, a new act was passed in 2013 with a rather lengthy name – Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act (LARR). However, the hastily passed act had some lacuna.
LARR had left out over 13 central laws that could have prevented higher compensation to landowners, giving scope for lengthy disputes. Moreover, LARR made it mandatory to return lands that were acquired but not used for 5 years. This was inconsistent with implementation of large infrastructure projects which generally have long gestation periods. Similarly, no more than 5 per cent of fertile land could have been acquired in any district as per LARR. This too prevented many mega-projects to get implemented. Amartya Sen (2007) had clearly opined that industry always competes with agriculture for land, and historically, for trade and logistic reasons, production of industrial goods has taken place along large rivers like Hooghly and Ganga which obviously have fertile lands. This happens, for industry generates output many times more than what a fertile land can. Moreover, projects such as affordable housing, rural infrastructure & hospitals, national security, industrial corridors along highways may not need to have consent and lengthy social impact assessments. The social benefits of such projects are starkly obvious and far outweigh in comparison to private costs. The latest ordinance promulgated at the end of 2014 has made appropriate changes to LARR on the above issues (The Hindu, 2015). If central government cannot get this bill going, the states should, on their own, for the uncertainty over the land acquisition issue has hindered development of physical infrastructure.
The unamended LARR and the uncertainty associated with it, has also contributed to forestalled industrial expansion in private sector. For example, in Maharashtra, vast expanses of land amounting to about 66,000 acres have been identified for SEZs, however, uncertainty over LARR seems to have made it difficult to acquire 90 per cent of the land. A 3000 acre SEZ jointly promoted by Reliance and City and Industrial Development Corporation of Maharashtra (CIDCO) has not moved ahead for years together (TOI, 2015). Further, about 4000 units of plots allotted in Mumbai MIDC (Maharashtra Industrial Development Corporation) area have not been used for industrial activity for various reasons including delays in getting a mammoth of 78 permissions, delays in loan approvals, and perhaps due to a general apprehension about LARR (ET, 2015b). Furthermore, the Urban Land Ceiling Ac (ULCA, 1978) that was enacted to avoid concentration of urban land in the hands of a few rich individuals has had its adverse impact too. This law led to shortage of usable land in urban areas, for lands were either not declared out of fear or kept vacant with convenient exemptions sought by the owners for their non-profit trusts and foundations. Though the central government gave the lead by repealing the act in 1999, quite a few states including West Bengal have yet to do so (TOI, 2014a). And, those states which have repealed the act have not pro-actively made use of the vacant lands. Using large tracts of urban vacant lands for housing of urban poor will provide impetus for realty sector, put a halt to skyrocketing realty prices, and, importantly, solve the problem of affordable housing for the industrial workers – an important pre-requisite for growth of manufacturing sector.
Yet another infrastructural bottleneck is availability of power. In India, during peak loads, demand exceeds supply by about 15 per cent. And, even otherwise, power supply is erratic. As a result big corporates produce their own captive power which is very expensive, and, growth and expansion of SMEs is thwarted for lack of power supply and an uninterrupted one at that. As per the Electricity Act of 2003 state governments were to unbundle the state electricity boards (SEBs) into generation, transmission, and distribution companies (discoms). While private players have been allowed in power generation, distribution companies are still with state governments. Paradoxically, excess capacity has resulted in power generation due to inefficiencies in SEB discoms in power distribution and their inability to buy power due to bankruptcies. The solution seems to be that SEBs must charge cost-plus pricing and/or they be sold off to private players. The identified destitute can be subsidized through other means such as direct cash transfers.
Furthermore, reforms in labour laws may have to be undertaken. For example, a manufacturing unit comes under the purview of Factories Act 1948, the moment it employs 10 or more workers with power or 20 or more workers without power. As a result, companies have a disincentive to expand operations, for the moment they hire beyond 10 (or 20) workers, they are restricted to only 50 hours of overtime work per worker per quarter, and women are excluded from working in night shifts (ILO, 2014). The minimum worker limit on companies to come under the purview of Factories Act could at least be raised to 20 (40) workers, respectively. In fact, the overtime restriction could be raised to 100 hours and with certain safety provisions women too be allowed to work in night shifts. Currently, all factories in a particular area are allowed to have weekly-off only on a specific day. They be allowed to have staggered weekly-offs on different days so that the problem of power load-shedding will be managed much more effectively preventing valuable production loss. At present, the rules of Factories Act are expected to be amended by state governments. They should be allowed to be amended by central government so that the rules get changed quickly across states and remain consistent throughout the country.
Similarly, Industrial Disputes Act 1947 requires that a company must take approval from the government for laying-off workers or shutting the company down if it employees 100 or more workers. As a result, companies are unable to adjust to changing market conditions by altering its labour requirement. Moreover, under extreme conditions, exit of loss-making companies becomes very difficult. Amendment to this act should be made so that companies are required to take government approval only if they employ 300 or more workers. This flexibility will provide confidence to the industry to invest in manufacturing. Also, while workers have the legitimate right to form unions, too many unions in a factory create problems in terms of inter-union rivalries among workers, and companies find it difficult to deal with many unions simultaneously. As a result, the transaction cost of negotiations with workers is too high. The norm on minimum number of workers required to form a union should be raised to at least 30 per cent. Government of Rajasthan has brought about some such changes in the industrial laws (TOI, 2014b). Gujarat and Maharashtra are following suit. Other states may have to actively pursue this objective to promote manufacturing. It is worth remembering that one of the reasons for EPZs and SEZs not succeeding in India in comparison to China was that they failed to address the above mentioned inflexibilities.
Skill upgradation is an important pre-requisite to innovations, for latent ideas and creativity can blossom with training. Labour skilling is a merit good and the role of government in its provision cannot be overemphasized. Social benefits of this merit good are much larger than the benefits accruing to the skilled individuals alone. To this end, for several decades, governments have run institutions such as industrial training institutes (ITIs) and polytechniques. However, for a rapidly growing and modern manufacturing sector, requirements of well-trained workforce and the polytechniques will change and grow by leaps and bounds. To accommodate this need, governments could bolster and add to their existing programmes by tapping the vast and experienced pool of retired technical personnel from two behemoths – Armed Forces and Indian Railways! This retired pool of technical personnel, ranging from seasoned masons to mechanics, electricians to engineers, clerks to chartered accountants, and paramedics to paediatricians, can be productively employed in teaching and training at various levels of vocational programmes for skilling the workforce. Private sector can also play its role in these efforts. For example, companies like Lupin fund high school and ITI education of children in remote villages and in turn create a pool of semi-skilled and skilled workforce right where the greenfield investment projects are going to come up. Similarly, Bharat Forge and Praj too have been at the forefront of similar CSR activities. In fact, as per the new Companies Act, from the fiscal year 2015, Indian government has mandated that companies with certain threshold levels of turnover, profits and/or net worth must spend 2 per cent of their profits on CSR activities. Other corporates may consider this requirement as an opportunity to upgrade skills of their potential workforce through CSR activities.
GST: One Nation, One Tax, One Rate
While the speedy implementation of the recently passed GST bill would avoid cascading of taxes and improve competitiveness of Indian goods in world market, it will also ease the movement of goods across the country. Currently, central excise duty, variable tax rates among states, and long delays in vehicular movement across state and city borders for payment of taxes increase supply chain costs. About 60 per cent of the total travel time on road for commercial purposes is wasted in waiting at various border check-posts to pay taxes (Joshi, 2016). This substantive inefficiency will hopefully go away very soon. It was expected, however, that there will be only one GST rate. That has not happened. Ranging from 6 per cent to 26 per cent, there are 4 tax rates within GST with further separate cess on luxury and demerit goods. An economy produces millions of final and intermediate goods and services. Therefore, existence of so many rates will enormously increase the transaction cost of GST collection. There will also be lobbying by multitudes of industry groups in every budget to formally get them into lower GST slab. Moreover, multiple tax rates create conditions for potential obfuscation to categorise goods in lower tax slabs. This will only promote directly unproductive activities (DUP) and corruption, undermining the potential of a uniform single GST rate. Furthermore, central government has assured 100 per cent compensation for any revenue loss by the states for 5 years. This may have to be revisited, for this will create moral hazard problem for state governments. Currently state administrations will be dis-incentivised to fully exert themselves and be efficient in revenue generation. In fact, there will also be demand to extend the 100 per cent compensation well beyond 5 years.
In terms of economic principles as well, multiple GST rates bring-in inefficiencies. Differential GST rates alter relative prices of goods and services, creating market distortions in production and consumption decisions. Some argue that lower rates on food are required to control food inflation. However, food inflation in India is a production and supply chain issue and that needs to be addressed urgently rather than introducing low-GST induced market distortion. Some argue that lower GST on food and essentials is required because poor cannot afford them. However, under the new welfare paradigm, central government has proposed and begun to implement direct cash transfers to the destitute. Therefore, price determination can be left to markets alone with a uniform GST rate. Some others argue that GST is regressive in nature and hence lower GST rate is required for food, essentials, and other items of importance consumed by the poor. However, one needs to understand that even if GST was regressive, it is no more regressive than the indirect taxes it is going to replace. Moreover, India’s overall fiscal structure is still progressive with progressive direct taxes and substantive exemptions to lower income households. Furthermore, while GST may seem a regressive tax in terms of its proportion to income, it will turn out to be a tax proportional to lifetime consumption; for savings and investments are tax-deferred and they will be subjected to GST when converted to consumption in future. Perhaps these are the compelling administrative and economic reasons for which Vijay Kelkar (2016) recently opined that India will eventually move to ‘one nation, one tax, one registration, and one rate.’
Ease of Doing Business
As per the World Bank ratings, out of 190 countries, India ranks as low as 155th and 130th in terms of ease of starting a business and the overall ease of doing business, respectively (World Bank, 2016). While these ranks have improved marginally in the last couple of years, the corresponding ranks for South Korea are 11 and 5! This gap is starkly wider when we compare the issue of ‘enforcement of contracts’ parameter. Out of 190 countries, while India ranks way behind at 172, South Korea’s rank is 1! This has relevance to how Indian companies are able to attract foreign partners and access FDI. Central government, on its part, seems to have recognized this issue, and aims at bringing, among other things, a few of the following changes:
- Process of applying for industrial license and industrial entrepreneur memorandum to be made online on 24×7 basis through eBiz portal,
- Validity of industrial licenses to be extended to three years,
- Services of all central government departments and ministries to be integrated with the eBiz – a single window IT platform for services,
- A check-list of required compliances to be placed on ministry/department web portals,
- All returns to be filed on-line through a unified form, and,
- Process of obtaining environmental clearances to be made
In addition, however, confidence has to be instilled among companies on contract enforcement issues. This, in part, can be done by government giving up its propensity to exhume retrospective tax collection and by setting up judicial mechanisms for a quicker redressal of commercial disputes. Such initiatives, of course, should not remain only on paper, should not be onetime events, and must improve over time.
Importantly, ease of doing business can very much be enhanced by the local and state governments. In fact, they can do a yeomen service to their own residents if they attract investments by ensuring quality of infrastructure in terms of speedy connection and access to water, power, land records, and construction permits from tehsildar offices. Moreover, such services may be streamlined through online forms, payment, and document verifications. Such facilities reduce transaction costs significantly and increase competitiveness of different states and towns in bringing business in their area.
06. Stable Macroeconomic Environment for Companies
Defence, dams, and deep-sea lighthouses are one of the most popular examples of pure public goods cited in economics textbooks. However, they miss out on a very important but less obvious pure public good – macroeconomic stability. From the point of view of businesses, in simple terms, this comprises of price stability, exchange rate stability, and fiscal balance. While wider price and exchange rate fluctuations cause uncertainty in business planning and negotiations, inflation and currency appreciation certainly compromises competitiveness of exportables and import-substitutes. A chronic problem of this kind can cause large current account deficit leading to a repeat of 1991 economic crisis. Profligacy in fiscal deficits by the government, on the other hand, causes interest rates to rise leading to crowding out of private investments and dampening the manufacturing activity. In fact, continued long-term fiscal deficits can cause alarmingly large accumulated debt, which at some point makes it impossible for a government to borrow further. The result is either debt repudiation or hyperinflation by way of printing money. Both result in social and political unrest – a nightmare for business enterprises and consumers alike. Therefore, if businesses are the engine of growth for the economy, macroeconomic stability is the engine oil – a lubricant that minimizes friction in the engine of growth. And, it is the government and/or Reserve Bank of India (RBI) which must provide this macroeconomic stability.
Two obvious supply shock scenarios spark-off inflation in India. One is the act of Almighty causing draughts and/or a succession of draughts, and, the second is the act of Arabs causing petroleum cartel to raise price of oil. A combination of these two cost-push factors, coupled with domestic demand pull policies and market interventions by government had caused average annual inflation to reach double digits during 2008 to 2013. For example, during 2006 to 2013, government procurement prices on wheat and rice had gone up by 113 per cent, a majority of which occurred in the pre-election years. This policy-induced upward price shock gets transmitted to general price level. In fact, as a result of sustained price support, production of wheat has increased by 850 per cent since 1960s. And, this has come at the cost of orphaning production of non-cereal staple crops such as pulses which have grown only by 50 per cent since 1960s. It is no wonder that prices of pulses, an important source of protein for an average Indian, have crossed Rs. 200 per kilogram in recent times. Rural wages also went up significantly by about 16 per cent per year during 2008 and 2013 partly due to employment guarantee scheme (EGS) and partly due to revised salaries by the pay commission. Despite the above conditions, RBI had a soft approach to raising interest rates in response. Thus, both cost push and demand pull factors caused substantial inflation till 2013. In the last few years, oil prices have come down dramatically going down even below $50 per barrel and the monsoon has been good in 2016. These supply side factors have reduced inflation significantly. Current CPI inflation as of August 2016 has come down to about 5.3 per cent.
Given these conditions, ceteris paribus, the recently established Monetary Policy Committee of RBI may be adopting a flexible inflation targeting within a band of 4 to 6 per cent. Currently, the RBI repo rate is 6.75 per cent (October 2016). At the current low level of inflation, it just may want to lower interest rates further to boost investments. If investments, employment, aggregate demand, and therefore GDP are to rise, and that too without inflation, a few caveats are important. The transmission mechanism of RBI’s lowering of interest rate is weak at this time. This is so, for lowering of repo rate by RBI say by about 50 basis points results in reduction in commercial bank lending rates only by about 25 basis points. Full transmission does not happen, for the government regulated interest rates on small savings remain fixed for a year, which form a benchmark for fixed deposits of commercial banks. These in turn, form the basis for lending rates of commercial banks. Hence, small savings rate may have to be made to move along with other policy rates. Similarly, statutory liquidity ratio (SLR) may have to be lowered below the existing 21 per cent to allow banks to lend more to private sector. Another feature that has hampered commercial bank lending is the steep rise in stressed assets. Stressed assets of public sector banks (PSBs) were about 14 per cent in September 2015. Recapitalization of banks, buying of stressed assets by a newly established quasi- governmental organization which would focus on recovering the bad loans and changing the ownership pattern of banks over time, are some of the changes that would increase efficacy of monetary policy.
Finally, as referred to in the earlier section, ease of doing business has to improve if more investments have to happen in response to lowering of interest rates. In fact, as reported by Joshi (2016), a ‘commercial courts bill’ is being given a consideration to decide on judicial mechanisms for a quicker redressal of commercial disputes. This should be a good development. Moreover, to subside inflationary pressure from agricultural sector, attention may be focussed on promoting production of non-cereal crops such as pulses, promoting FDI investments in modern agri- commodity supply chains, and reviving futures markets (Deodhar, 2016). Similarly, labour compensation in EGC could be made based on piece rate rather than daily wage to avoid moral hazard problem, and, EGC must be employed strictly in non-sowing and non-harvest seasons. This could ensure that both the agricultural production and the rural assets such as roads, wells, bunds, check-dams get constructed alongside the scheme expenditures and agricultural wages do not spiral up during sowing and harvesting seasons. Overall, prices will be stable if increased aggregate demand is met with increased aggregate supply.
Competitive Exchange Rate
One can think of addressing external balance in quite a few ways. One is to keep exchange rate fixed and allow full capital account convertibility (CAC). This leaves domestic companies to fend for themselves in maintaining their competitiveness, especially in inflationary periods, and, deprives a country of exercising its independent monetary policy. Therefore this is not a good regime to choose. Another would be to have flexible exchange rate and full CAC. Under this regime, a country would lose complete control on exchange rate and capital flow. Heavy rush of capital inflow due to irrational market sentiment may lead to excessive appreciation of exchange rate and current account deficit. Similarly, reverse irrational market sentiment can do just the opposite, as had happened in 1997 in the East Asian Economies. Therefore, a compromise option of neither fixed or flexible exchange rate nor full CAC seems to be the way out. This is referred to as a ‘managed float’.
India has followed this policy of managed float effectively. While RBI allows market to decide exchange rate on most occasions, it intervenes in the market at times to maintain trade competitiveness of Indian products.Maintaining trade competitiveness also limits current account deficit. At the same time, partial CAC allows inflow of FDI which is more stable than short-term inflows and inflows into banking system which are highly volatile. In fact, when there is a persistent surge in inflow of capital, RBI buys the foreign exchange and does not allow exchange rate to appreciate. This helps RBI build its foreign exchange reserves as well. A build-up of reserves to the tune of $300 billion by 2007 had helped India cover payment deficit during the sub-prime crisis of 2008. Sometimes a mere presence of such reserve boosts confidence in the market and averts capital flight. However, whenever RBI has moved away from this regime, there have been problems. In fact, since 2013 RBI let the real exchange rate appreciate by about 10 per cent. This played a part in the decline of exports in 2014 and 2015 with the continuing expectation of the trend in early 2016 (Joshi, 2016). Another development that may be of concern is the liberalization of inflow of funds into government securities and borrowing by banks and companies. Such inflow is, as mentioned above, volatile as compared to FDI. Hence, a very conservative approach to limited CAC may have to be considered.
Avoiding Crowding Out
In the recent past, southern European countries; namely Portugal, Ireland, Italy, Greece, and Spain (PIIGS) have experienced debt crisis. Greece’s debt to GDP ratio was as high as 143 per cent in 2010 and it was unable to repay debt and the interest on debt resulting in major turmoil in the country. India’s debt to GDP ratio of about 70 per cent is not in a comfortable zone. It certainly puts upward pressure on interest rates, which companies view it as a high cost of capital, crowding out their private investment projects. Reducing this ratio implies disciplining the fiscal and revenue deficits and its quality. Fourteenth Finance Commission (FFC) has targeted the debt to GDP ratio to come down to 61 per cent by 2019-2020. To achieve this, by that same year, the central government’s fiscal deficit will have to come down to 3 per cent of GDP and that of the state governments will have to come down to 2.7 per cent, totalling a combined deficit limit of about 5.7 per cent. Within that, it is expected that revenue deficit for central government should come down to 1 per cent and that of the state government should reach a surplus of 2 per cent, totalling a combined revenue surplus of 1 per cent.
In this context, the central government seems to have done well in bringing the fiscal deficit down to 3.9 per cent of GDP and revenue deficit down to 2.5 per cent in the year 2015-16. Though, the 2019-2020 goal looks difficult, for the FFC had assumed that the debt/GDP ratio in 2015-16 would only be 65 per cent. Moreover, meanwhile, the 7th pay commission recommendations will be getting implemented and there may be a proposal for recapitalization of banking system. This will put pressure on government exchequer and may reverse the trend. The fixed target for the central government fiscal deficit of 3 per cent was codified through the Fiscal Responsibility and Budget Management Act (FRBM) of 2003. However, it has been rescheduled through amendments several times. A fixed target is difficult to achieve especially during times of recession. If one were to stick to the fixed limit during recession, the deficits turn out to be pro-cyclical. Hence, a new FRBM norm may be devised which sets a band for fiscal deficit. In any event, if lowering fiscal deficit towards 3 (5.7) per cent is to be pursued, fiscal consolidation through additional tax revenues and cutting expenditures is in order.
The immediate goal on taxation side, would be to hasten implementation of GST. In the short-run, it may not perhaps deliver higher revenues; however, as more and more hitherto informal sectors come under GST, tax revenue will increase. However, the government can do more on GST. Instead of having a single GST rate, government has announced 4 rates ranging from 6 per cent to 26 per cent with additional cess on luxury goods and demerit goods. As detailed in Section 5, among other things, this is going to increase the transaction cost of tax collection. More importantly, central government has agreed to fully compensate state governments for their loss of revenue under the new regime for 5 years. This creates a moral hazard issue, for state governments will not exert themselves as much and will not be as efficient now in collecting taxes since they will always be compensated by the central government.
Government may also not want to increase income tax exemption brackets in every budget and certainly not faster than the growth rate in per capita GDP. Agriculture has been the holy grail of taxation. Time has come that central and state governments agree to tax agriculture. In the process, this will also eliminate the propensity to evade taxes by showing non-agricultural income as arising from agricultural activities. Yet another way to generate one time revenues and using them to retire debt and reduce interest payments would be to sell loss-making PSUs, many of which ought not to have been in the public sector on the basis of economic principles. As mentioned in Section 5, state owned discoms can be privatized. Apart from the state government undertakings, it is estimated that the value of central government PSUs amounts to about 40-45 per cent of GDP (Kelkar, 2010). Quite a few of these PSUs can be privatized. As referred to in Section 2, one such company that was in the news recently for privatization was Hindustan Cables. On expenditure side, the process of removal of subsidies on 3fs – food, fuel, and fertilizer must be hastened. Since 2013, subsidy on diesel has been gradually removed thanks to substantive drop in petroleum prices. Even then, today the explicit subsidies on fertilizers, food, power, water cess, and others amount to 1.7 per cent of GDP or more than about Rs. 2.2 trillion. The savings on these items would be more than sufficient to give direct cash transfers to the destitute, as has been envisioned through Adhaar. All the measures mentioned above would reassure businesses that fiscal debt and deficits will not go out of control and private investments will not get crowded out due to high interest rates.
07. Summing Up and Takeaways
The modern idea of Make in India is more than a century old. Economists and entrepreneurs of yesteryears like Ranade and Kirloskar had understood the importance of skill building, capital, and domestic production. The colonial government though, was not on their side.
Today, economists and entrepreneurs seem to be ably supported by the will of the central and state governments, and that too with a changed paradigm of economic development. One caveat needs to be remembered though. In the past, only three countries have demonstrated a sustained GDP growth rate of more than 10 per cent for at least 2 decades at a stretch. They are South Korea, China, and Taiwan. And, none of them was a democracy during their long respective stretches! India has been and will remain a democracy. To quote Dr. C.D. Deshmukh (1956) from his consecutive 6th union budget speech inaugurating the 2nd five-year plan:
“The sanction behind the [2nd five-year] Plan is not the will of Government ( ‘kkLku’kfDr ) but the will of the people ( tu’kfDr ). Democracy is for us a means as well as an end. It defines our objective, and it indicates the approaches and techniques to be adopted for the fulfilment of the objective.”
The Make in India theme popularized by the current government must be viewed in that light. The argumentative democratic approaches and techniques will decide how long it takes for India to accomplish the economic goal. Yes, a country is not a company; however, learning from experiences of entrepreneurs who have succeeded within the stifling democratic milieu of a developing country can give a fillip to actualization of the Make in India theme. Through this policy paper, we have elicited most of the stated and quite a few intended economic prescriptions that emanated from the talks given by the four speakers at the forum offered by PIC and MCCIA. Galvanization of their prescriptions by economic theory renders us the policy takeaways as listed below. Quite a few of them are aimed at increasing manufacturing activity by removing inefficiencies arising out of the past and existing policies; and, other are aimed at improving dynamic comparative advantage through innovation transformation:
- Over the decades India’s private sector has matured. Government must nurture and allow space to private sector which has hitherto been cornered by PSUs, albeit inefficiently. For example, Bharat Forge has demonstrated that Indians companies can deliver in heavy engineering and defence sector provided they get the assured threshold level of sales orders and that procurement regulations are not archaic, which many times favour foreign companies or the And, it is not just about private companies being vendors to the government. PSUs have to be privatized in a phased manner.
- Private sector will get a fillip in manufacturing sector the sooner all indirect taxes get replaced with one GST regime. GST is a destination based tax and hence Indian companies will become competitive in the world market as excise duty will be done away with. Recently, however, government has announced 4 different rates for GST with additional cess on luxury and demerit It is suggested, as explained in the paper earlier, that there be just one GST rate. Moreover, central government may want to rethink on the 100 per cent compensation that it has agreed to states for any loss of revenue under the new regime. This will avoid the moral hazard problem for states, for currently they are dis-incentivised to exert themselves and be efficient in revenue generation.
- Similarly, in the case of direct taxes, it turns out that world average for corporate tax rate is only 24 per cent. India may want to lower the corporate tax rate from its existing rate of 34.61 per cent and bring it down to 25 per This will be a big boost to incentivise entrepreneurial class.
- While China’s gross savings rate is 50 per cent of GDP, India’s is about 32 per cent. To enhance domestic investments through domestic savings, fuller financial inclusion through Jan Dhan and Adhaar, promotion of SIPs in mutual funds, and promotion of gold monetization scheme may be speeded up. In the meantime, FDI be encouraged, especially in diverse product categories such as electronic gadgets, power-plant equipment, semiconductors, navigational radars, optical mediums, medical equipment, aerospace, defence, and technology hardware equipment, where India does not even have a minimal In wholesale and retail FDI, we may do away with too many administrative buckets such as allowing 50 or 100 per cent FDI, single or multi brand FDI, and ease domestic procurement norms.
- Central and state governments may amend, as has been done by states such as Rajasthan, Industrial Disputes Act of 1947 to exempt companies employing 300 workers or less from government approval for worker retrenchment. Similarly, Factories Act 1948 could be modified to allow 100 hours of overtime in a
- Requirement for union formation be raised to at least 30 per cent of the Weekly-offs for workers may be staggered over different days in groups of companies in an industrial belt so that power-outages are avoided and production does not halt. Moreover, for many other labour laws, state governments may want to initiate self-certification by companies with random checks of once in 5 years. Such moves will reduce transaction cost of companies significantly.
- For speedy progress in infrastructural projects and industrial expansion, land acquisition becomes an important pre-requisite. Either central governments and/or the state governments may introduce amendments to LARR act for acquisition of land for socially beneficial large infrastructure projects such as affordable housing, roads/rail network, rural schools/hospitals and national security. Similarly, local and state governments can streamline and significantly reduce the number of permissions required for using the lands allotted to companies for industrial production in SIDC (state industrial development corporations) areas. The amendments to ULCA be used by state governments to allow either private parties or governments to construct urban affordable housing, hospitals, or schools in urban areas.
- An important bottleneck in manufacturing is the availability of power and that too uninterrupted While power generation plants are being privatized, SEB discoms could also be privatized. This will avoid excess capacity in power generation on the one hand and inefficient power usage by discoms on the other. Power subsidies to agriculture and households can be done away with except for a small first block to cater to destitute population.
- Ease of doing business can be enhanced by local and state governments by allowing requests for permits, registrations, and water & power connections through single window online Similar approach by the central government for granting licences and environmental clearances for foreign partner companies has to be adopted.Similarly, lack of contract enforcement is an important criterion on which companies are averse to do business in India. Establishment of commercial courts for quicker resolution of disputes and government refraining from exhuming retrospective taxation issues would be important steps on this issue.
- Skill upgradation for manual and vocational labour force could be promoted in addition to existing ITIs through short-term They could be run through accredited private or public polytechnique institutes. Getting qualified instructors for such institutes is always a challenge. Experience of retired personnel from railways and armed forces can be harnessed for this purpose. There is also a scope for CSR activities initiated by companies themselves, keeping in mind their future workforce needs.
- Government and RBI must also provide stable macroeconomic environment to Indian Essentially, RBI could maintain competitiveness of Indian manufacturers through ‘managed float’ of the Indian rupee as it has been doing in the past. This entails market intervention by RBI when there is a severe risk of real appreciation of Indian rupee. Related issue is to contain inflation within a range of 4 to 6 per cent. Any higher inflation severely reduces competitiveness of Indian companies in the world market. Finally, as per FFC, by 2019-2020 combined fiscal deficits should be contained within 5.7 per cent of GDP (3 per cent for central government) and a combined surplus of 1 per cent on revenue account. This should address the issue of crowding out of private investment due to high interest rates associated with high fiscal deficits.Assuming that the above reforms are undertaken, India will have to grow at more than 7 per cent per year for at least next 10 years to take manufacturing to a threshold level of 25 per cent of GDP.As the sector begins to approach the threshold, it would catalyse experienced entrepreneurs to innovate, contributing further to the dynamic comparative advantage. Here are the pertinent issues in this context:
- Threshold levels of manufacturing may be a necessary condition for innovations and improving dynamic comparative advantage, however, that is not R&D is an essential ingredient for innovations. R&D to GDP ratio for South Korea is about 4.7 per cent and that for India is barely about 0.9 per cent. Perhaps India must at least double the number in next 5 years to 1.8 per cent. Moreover, a substantive proportion of R&D has to happen in the manufacturing sector as has been demonstrated by companies in developed world and the East Asian countries. R&D efforts in the private sector create spillover effects and positive innovation externalities for other companies. The cost-benefit ratio for R&D in the private sector is very low compared to that in the public sector. Therefore, governments of developed free-market economies provide fiscal support to private R&D efforts. India too could offer tax incentives for the private R&D efforts.
- Theory and empirical research shows that companies operating in competitive markets invest more in R&D rather than those in monopolistic markets. This has been demonstrated by Lupin, Praj, and Bharat Forge; where stiff competition in foreign markets disciplined them to spend on R&D. Government will have to promote competition through unilateral trade liberalization, furthering WTO led trade liberalization, engaging in free trade agreements such as RCEP, TTP, and FTAAP, and plurilateral agreements such as TISA. If India does not pro-actively become part of these trade agreements, Indian companies may have to forego the benefits of market access in rest of the world. In the domestic markets, Competition Commission must be alert to any collusive behaviour as was exemplified a few years ago in the case of cement industry. Importantly, competition policy must be applicable to PSUs as well, for PSUs operating without budget constraints distort and create unfair competition to private
- Rather than running stand-alone autonomous research institutions, government may promote R&D through competitive grants to universities, where interdisciplinary research culture gets imbibed through graduate students working should-to-shoulder with faculty members. The recent decision by central government to establish 10 world class universities both in private sector and public sector is most welcome and the process should be speeded up. In fact, the more serious research happens within universities, the more companies are likely to demand scientists coming out of the universities. They are the ones who will further the private R&D initiatives of companies. And, as mentioned in point number 12 above, fiscal incentives for private sector R&D will have to be thought
- Finally, propensity to do R&D and innovate is also a function of the internal culture of the company as exemplified by its management, HR practices, and the quality of leadership. While these aspects have to be inculcated and need not necessarily be taught, they can be cultivated
- through education. There are a few management institutions which facilitate executive education in entrepreneurial and leadership roles and provide incubation environment for innovative ideas. And then, there are non-governmental foundations like NIF which do similar work. For a country of India’s size, perhaps there is need for more such institutions.
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