Get industrial policy right to take on China – What govt can learn from Japan

Trade is advantageous to all when the trading countries have equal wares to share and that there is a shared vision of mutual welfare. (Representative image)

By Sarthi Acharya & Santosh Mehrotra

India’s approach to development in the last 2-3 decades has been service sector-led and has undermined manufacturing; at the same time, China has made rapid strides in manufacturing. This has resulted in an uneven balance between the two in their development stages.

China has developed capacities across a wide spectrum in applied engineering and chemical processes and has attempted to capture global markets. India on the other hand is stuck with various low-end services, many of which are of “body-shopping”, the scope for which is rapidly declining. It has begun to lose abilities in manufacturing, even in fields where it still has some presence, e.g., pharmaceuticals (68% dependence on China, for active ingredients) and auto-industry (15-20% dependence on China for electricals, electronics and fuel injection), to name two. The list of items on which India depends on Chinese imports include solar panels, metal-ware, cloth-ware, industrial machinery, a range of consumer electronics like mobile phones and TVs, and even low-end products like furniture, kitchenware, toys, kites or incense.

The annual trade-deficit between the two countries, of over $50 billion, is unsustainable for more than one reason. First, most Indian exports are raw materials or in that genre (low-tech and low employment, like ores, rare earths, chemicals), while the imports are in manufacturing (high-tech). Such a trade pattern inevitably results in unequal terms of trade in time (“I can do without your products but you can’t without mine – case, Chinese manufactures vs Australian barley and beef”). Next, as stated earlier, even in areas where India has some competence, critical inputs are imported from China. Third, a sustained current account deficit has led India to multilaterals for loans even for undertaking earthworks, and then use the foreign exchange to balance the current account. Since most multilaterals require global tendering for awarding contracts, Chinese companies creep-in through (at times) questionable routes to dig tunnels or make railroads in India, making Indian industries functionally further unfit. India is thus progressively exporting meaningful jobs to China, draining precious foreign exchange, and losing prowess in modern technologies and manufacturing.

Trade is advantageous to all when the trading countries have equal wares to share and that there is a shared vision of mutual welfare. The present dynamic, however, suggests that China quotes low prices to obliterate industries in unsuspecting countries, manipulates currency, follows few labour standards to cut costs, undermines IPRs, and inundates other countries with large loans, eventually landing them in a debt trap (Sri Lankas’ ceding of Habantota Port, with more to follow through BRI). They practice hostile takeover of companies and countries through any means including gunboat diplomacy—a 18th/19th century approach of European colonisers (China-India or China-Vietnam border threats).

India’s approach to development—following an Indian version of the Washington Consensus since the last three decades—has to change in favour of manufacturing if a total surrender is to be forestalled. There would be short-term financial losses to consumers, traders and domestic manufacturers for up to 2-3 years by not being able to import inexpensive auto- and machine/electrical parts or active ingredients in pharma from China, but this will gradually reduce. Lower imports from China would also imply better overall terms of trade and therefore, stabilisation of the rupee, resulting in lower rupee value of petroleum products. Thus, even if the price of a motorbike, car, or bus goes up, the cost of imported transport fuel correspondingly falls, evening out the said price increase in the former. Next, a near ban on imports of low-end products and consumer goods will create more jobs, and further stabilise trade deficits/rupee.

Business analysis at Bloomberg believes that up to 3,000 imported (Chinese) items (toys, watches, plastic products) could be substituted by local supplies. This is not reversion to the import-substitution model of yesteryears: there is a clear difference between strengthening local companies to become globally competitive (proposed) and companies producing under license for captive markets (earlier). Also, there is more than economics here: Earlier, local industries could not grow in size due to controls, now they can; and earlier, they were psychologically not prepared to face international markets, now they are. Also, the approach proposed here is not to fully substitute imports but to reduce unnecessary imports for saving foreign exchange and jobs, along with weaving the Indian industry into the international division of labour. This would necessarily imply a great deal of imports, but which would also boost exports, local competence and jobs.

The present government, while making the right statements through the ‘Make in India’ campaign, has no manufacturing strategy. The share of manufacturing in GDP and employment has stagnated since economic reforms began in 1991 and manufacturing employment actually fell after 2014.

India needs a strong industrial policy for development, employment and facing a belligerent China. There are at least five components of a proposed policy:

• • Government and industry need to work closely and create mutual trust for promoting industries through tariffs, subsidies, land and labour law easing, infrastructure, etc. Like the MITI of yesteryears in Japan or South Korea more recently, the government must help national companies to grow and become internationally competitive. That is what China did.
  • Approaches to gain economies of scale need to be put in place to overcome India’s shortcoming of having 66 million MSMEs. A “one-state/district-one product approach” can bring together SMEs to form a single giant unit. Again, the state needs to initiate this process by means of planning.
  • Need to invest heavily in targeted R&D, for which private-public sector partnership is essential. Indian government and defence labs along with R&D Departments of private and public sectors require joining hands for this. Expenditure on R&D should rise 3-4 times from 0.7% of GDP at present.
  • Investment in education, training, and human capital formation should rise from the current 3% to 6% of GDP, with greater industry-based training, focus on quality, and emphasis on STEM.
  • Contain brain-drain out of India (from top engineering and medical colleges) to foreign shores. Partnerships with the best universities in the West is one approach to provide quality education here.

Acharya is Delhi Chair professor at Institute of Human Development, and Mehrotra is professor of economics, Jawaharlal Nehru University