The state of Indian industry
THE industrial sector in India has had a very mixed record of performance during the last five years. Growth accelerated during the boom years of the mid-1990s, but ever since the slowdown of 1997-98, this sector has been in the doldrums despite a mild recovery in the economy during 1999-2000. What is true of the aggregate is also true of virtually all the segments in the sector.
In Figure 1, we display the annual growth rates over the past few years of the Index of Industrial Performance (IIP) and its sub-sectors – manufacturing, which accounts for the bulk of the index, mining and electricity. The overall index clearly tracks the behaviour of the manufacturing index. From a high point of 14% growth during 1995-96, the indices have shown a steady decline in growth.
For the latest year in the period, 2000-01, the growth of the industrial sector is below the overall rate of GDP growth, which is now being entirely propelled by services. From being a leading sector – an engine of growth – for a brief period during the mid-1990s, the industrial sector, largely manufacturing, has turned into a laggard, a burden on the growth prospects of the economy.
This performance can be viewed from another perspective. The IIP is conventionally divided into the so-called use-based categories of goods. The four main categories are capital goods, basic goods, intermediate goods and consumer goods. The last is further sub-divided into durable and non-durable goods. In Figure 2a, we display the growth performance of the first three categories. In Figure 2b, we show the performance of the consumer goods sector, along with its two components.
Capital goods have never had a particularly robust spell, fluctuating year to year. However, in the year 1998-99, when all the other segments were sluggish, this segment accelerated. Detailed analysis of the components revealed that this was the result of an explosion in investment in the telecom sector, rather than a broad-based recovery in investment. Intermediate goods showed a sharp spurt during the boom years, but have since languished, as have basic goods towards the end of the period.
Consumer goods showed a great sensitivity to the agriculture-induced slowdown in during 1997-99. The subsequent recovery in agricultural production saw acceleration in the segment as a whole. However, the driving force in this segment was the performance of the durables category, which accelerated sharply in the early phases of the recovery, before levelling off in 2000-01, with a still healthy growth rate of around 15%. However, early indications from the current fiscal year are that this segment is experiencing a dramatic slowdown, while none of the others show any signs of recovery.
The message from this record of performance is clear. The Indian industrial sector is rapidly losing its competitiveness. The expectations from this sector in the new economic environment, considering the range and depth of the reforms aimed at it, have sadly gone unrealized. There is no question that India has a potential comparative advantage in many manufacturing activities. First, there is the substantial natural resource endowment. In an investment regime driven by cost and efficiency considerations, this would have been the foundation of a competitive mineral based industrial sector.
Second, there is the agricultural sector as a source of raw materials, both food and non-food commodities. Downstream processing of these commodities provides a substantial foundation for competitive manufacturing activity, given the right environment. Third, there is the oft-repeated abundance of relatively low-cost labour, much of which is endowed with craft skills emerging from the tradition of occupational castes. Manufacturing is really the only activity that can translate this resource into relatively high-productivity employment, thus setting the stage for a virtuous circle between growth, employment and poverty alleviation.
In short, sustainable and equitable growth of India’s economy is inextricably tied to the manufacturing sector. The performance of this sector over the last decade has, therefore, been a huge setback for the well-intentioned efforts at policy reform. It has provided opponents of reform legitimate arguments that the reforms have not delivered on the implicit promise of sustained and equitable growth. However, having arrived at this premise, the argument can be taken in two directions, with diametrically opposite implications.
The first is that the basic principles underlying the reform strategy have been faulty. If this is true, one needs to go back to the drawing board and re-examine the forces driving the Indian economy and the appropriate policy regime within which they can be productively harnessed. The second is that the underlying principles are sound; the failure has been in the implementation, in not being able to put the complete blueprint into action. There are, as a result, substantial frictions, even constraints, that have emerged in the system, which have contributed to the rather disappointing state of affairs in the manufacturing sector.
What follows is based on an acceptance of the greater validity of the second position. If one has the blueprint of reforms firmly in one’s mind, the sources of these frictions and constraints are not at all far to seek. This analysis is based on a simple conceptualization of the sources of manufacturing competitiveness. Essentially, it is based on the ability of producers to procure as many inputs as they can at as low a price as they can. We can categorize inputs into two groups: tradable and non-tradable. Tradable inputs can be sourced from anywhere in the world, the only consideration being their landed price.
Clearly, the industrial and trade policy reforms initiated during the early 1990s directly addressed this source of competitiveness. Producers were free to import low-cost inputs, putting enormous competitive pressure on domestic suppliers, which was reinforced by the freedom of entry of new producers as a result of delicensing. The combination of the two forces would have substantially lowered the input costs of the typical Indian producer. In doing so, the reforms were serving to put him on an even footing with his competitors from other countries, who generally had access to the world’s cheapest inputs.
Non-tradable inputs, on the other hand, cannot be procured from just anywhere. These are an integral part of the existing system and the producer has to pay the price that the system imposes on him. The higher the proportion of these inputs in the total cost of production, the more vulnerable the producer is to a system that delivers these inputs with great inefficiency and high cost. It is precisely with respect to these inputs that the promise of Indian manufacturing has been betrayed. The reforms, by and large, have so far failed to address the critical issue of improving the supply and lowering the costs of these inputs. This failure has contributed significantly to the inability of Indian manufacturing to sustain, let alone enhance, its competitiveness over the past decade.
We can categorize non-tradable inputs into three broad categories on the basis of the impact they have on competitiveness or lack of it. The first is the category of infrastructure services. There is a virtual consensus on the fact that the power situation all over the country is far worse at the end of the decade than it was at the beginning. The reasons for this are well known and need not be repeated here. It would be no exaggeration to say that Indian industries pay inordinately high prices (when they do) for inordinately low quality power (when they receive it). This immediately imposes a severe constraint on production and would inevitably affect the investment decisions of new entrepreneurs. It also leads to an enormous wastage of capital as producers have to seek private solutions by way of captive power plants and generators to keep their processes going.
Transport, by any mode, is relatively expensive and because of infrastructural constraints, hugely unpredictable in terms of transit time. Intense competition in the road transport sector may have driven tariffs down, but for many producers this is hardly compensation for the time that their shipments spend in traffic gridlock or waiting for entry and exit from cities because of movement restrictions.
The second category of non-tradable inputs, in the presence, of course, of significant restrictions on the legal movement of people across borders, is labour. A producer has to employ his workers from those who are available. As was pointed out above, the Indian tradition of occupational castes has provided the modern industrial establishment with a readymade pool of skills which need to be integrated into the modern technological and organizational context. This essentially requires that the labour market functions with a reasonable degree of efficiency.
Subject to the constraint that all employees have certain rights that must be protected, market efficiency implies that workers will be hired or retrenched as the demand for their particular skills expands or contracts. Wages of those who remain employed will also adjust to changing market conditions. In the organized sector of the Indian economy, the second condition is generally satisfied, as most employers build in a substantial variable component in their wage agreements with unions, which is a model replicable in non-union establishments as well.
However, the first condition is not satisfied, because an employer has to seek permission to lay off workers from the state government, which in practice is never given. For practical purposes, once a worker is hired, his costs have to be borne by the employer whether he is contributing to revenues or not. In a risky business environment, and there is no question that the policy changes have all contributed to enhancing business risk, this imposes a cost of hiring on the employer which goes beyond the cost of wages.
This has to impact adversely on an already precarious competitive position. It is small wonder then that during a decade in which we have seen the highest average annual growth rate of GDP since Independence, we have seen an abysmal growth rate of about 0.5% per year in the organized sector. The government has drastically reduced its intake of people, and the private sector just doesn’t seem inclined to take up the slack for the reasons advanced above.
Whether we have seen an increase in employment in the unorganized sector is as yet difficult to discern. However, if this is the consolation that is being sought for the sluggishness of the organized sector, then it is rather small. As important as the unorganized sector may be to the development process of a labour-abundant, low-income economy, it cannot be viewed as anything more than a transitional phase. The fact is that employees in this sector do not get anything more than the subsistence wages that market forces dictate.
The sheer pressure of excess supply means that they cannot claim any of the rights that, as a society, we have deemed to be their right. Given the financial and technological conditions in which this sector operates, there is little opportunity for productivity growth and as a consequence income increases in the typical enterprise in this sector are low. In short, it is a necessary source of subsistence for a large number of people, but hardly a mechanism for the kind of improvement in earnings potential and working conditions that is concomitant to growth and development.
The third category of non tradable inputs can be broadly labelled as governance. The difficulties that entrepreneurs have in dealing with the multifarious agencies of government – and in the Indian scenario, these include purveyors of supposedly tradable inputs like banks and insurance companies – are well known. These involve direct pecuniary costs as well as a dissipation of entrepreneurial and managerial energies.
Failure of governance is not just confined to transactions with the state; it also applies to the problems that the system creates for the enforcement of commercial contracts. Doing business in India is fraught with risks over and above the normal uncertainties associated with a competitive marketplace. And, in such an environment, staying afloat has as much to do with the ability to manipulate the system – ‘manage the environment’ as it is sometimes put – as with the ability to produce high-quality goods at low cost.
The issue of governance also encompasses the patently bad policies that still remain, a holdover from the regime that was sought to be dismantled by the reforms. The foremost example of this in relation to the industrial sector is the policy of reservation of commodities – numbering about 800 – for production by the small scale sector. It supports and sustains weak and inefficient producers, hinders the assimilation of technology, and perpetuates sub-optimal scales of production; in short it does everything to make the producers who derive benefits from it uncompetitive.
This is not to say that reservation has been a tightly binding constraint on Indian industry. Exemptions based on export obligations (currently 50% of production, but the S.P. Gupta Committee on Small Scale Industry has recommended lowering this to 30%), which are, by all accounts, hardly monitored, are one way in which back door entry by large producers into the manufacture of reserved products takes place. However, it would be fair to say that a back door that is ajar is far less effective as an inducement for competitive entry than a front door that is fully open.
The Union Budget for 2001-02 contained some significant initiatives for improving the situation faced by Indian producers with respect to non-tradable inputs.
Infrastructure: in the power sector, the precarious financial situation of the State Electricity Boards (SEBs) was emphasized in the budget speech and a series of remedial steps have been indicated, all of which will be built into Memoranda of Understanding (MoUs) between the Centre and the states. The key elements of this reform include:
* 100% metering by the end of this year.
* Comprehensive energy audits.
* Programmes for the eventual elimination of power theft.
* Tariff determination by State Electricity Regulatory Commissions and full compliance with these tariffs.
* Commercialization of distribution.
* Restructuring of SEBs.
These measures were discussed at a state power minister’s conference last year and there appeared to be a broad consensus on them. MOUs had already been signed with five states. The interesting element contained in the budget is the linking of funds disbursed by the Centre to the states under the Accelerated Power Development Programme (APDP) to the achievement of the milestones specified by the MoU. This is a good example of fiscal leverage being used by the Centre to ensure compliance with a reform agenda on which there is a broad consensus, but often becomes captive to powerful political interests.
The positive bias towards states moving ahead with reforms will be seen in terms of additional allocation of power to their SEBs from the central power suppliers, investments by these organizations in those states and preferential access to foreign assistance. In all, the plan outlay for the power sector was increased by 9% over last year, not a very large increase in real terms. However, the APDP component of the plan, about 11% of the total last year, was increased by 50% in this budget.
Transport: The National Highway Development Programme, announced two years ago, envisages complete two-laning of national highways linking the four metros, as well as the expansion of the north-south and east-west arteries. This is to be partially funded out of a cess on petrol and diesel. A significant fraction of the cess so collected is aimed at improving the other components of the road network, from rural roads to state highways. There has been a 93% enhancement in the plan allocation for this year over last year. The major initiative on ports is the beginning of the corporatisation process. This will enable ports to raise funds directly from the markets.
Labour: A fundamental initiative announced in the budget speech was the amendment of the Industrial Disputes Act to allow establishments employing less than 1000 people to lay off workers without government permission. This limit has been raised from the current ceiling of 100. It clearly brings a very large number of both establishments and workers into a far more flexible environment, which is certainly to the good of the employers.
It may not be to the good of this specific set of workers, but the main argument in favour of this amendment is that it now makes it more attractive for many more employers to take on more workers, because they are not bound to retain them when the business fails. So, it is for the greater good of all those looking for jobs but not finding them in the current, restrictive environment. For those who are now vulnerable to retrenchment, the budget also proposes a limited unemployment insurance scheme to be run by the public sector General Insurance Corporation on a no-profit basis.
Along with the amendment to the Industrial Disputes Act, the Contract Labour Act is also proposed to be amended. The basic constraint imposed by the current version of this act was that contract labour could claim permanence beyond a certain tenure of employment. The flexibility offered by contracts was severely limited by this right. As per the amendment, contract labour now comes without any restrictions, barring those, which involve the basic rights of safety, health and insurance. The combination of these two amendments will make a major contribution to increasing the flexibility of the Indian labour market and thereby correcting the disadvantage that Indian producers face on this front.
Industrial Restructuring: Apart from the major contribution from the proposed amendments on labour, the budget speech also addressed the broader issue of constraints on industrial restructuring. It proposed the elimination of the Board for Industrial and Financial Reconstruction (BIFR), which for the last 15 years, has been shown to be totally ineffective in dealing with the problem of industrial sickness and exit. The reasons for its ineffectiveness have been analyzed before and do not merit repetition here. The important aspect of the budget proposal is that it has recognized the basic weakness of the BIFR approach, which was its quest for consensus between the various stake-holders in a sick establishment. It has addressed this by setting up a tribunal, which can be effective if it functions as a binding arbitrator. This should both speed up the process of restructuring and allow the outcome to be driven by objective commercial considerations.
Unfortunately, most of the major initiatives announced in the budget have not yet seen the light of implementation. Many could well be presumed dead, particularly the crucial labour reforms. The recent flurry of activity on economic reforms, during which the government was exhorted to get moving on all the undelivered commitments is yet to translate itself into any kind of action plan. In the face of persistent inactivity on the policy front, the inescapable conclusion is that time is rapidly running out for Indian industry.