Subir Gokarn: Charting competitiveness - I

The National Manufacturing Competitiveness Council (NMCC) recently released its draft National Strategy for Manufacturing. The several recommendations for action made by the Council raise several issues for debate.

In this and my next article (October 24), I shall explore the merits and implications of several of the recommendations. It is convenient to divide the discussion into three sets of issues""the philosophy and principles underlying the recommendations; the specific components of the strategy; and, the evaluation mechanism, or how to tell whether things are going according to plan.

The basic premise of the strategy document is quite straightforward""the fact that manufacturing accounts for only about 17 per cent of GDP. Between 1991 and 2003, this sector grew at slightly over 6 per cent a year, barely above the rate of growth of GDP as a whole.

This performance is in sharp contrast to the role that manufacturing played in the growth of East Asian countries, where it grew at an appreciably faster rate than overall GDP and achieved up to 35 per cent of GDP in some countries.

Accepting this performance as a benchmark, the report aspires for a 12 per cent rate of growth in manufacturing, which, over a 10-year period is expected to take its share of GDP to 23 per cent (of course, assuming rates of growth for the other sectors). Coming in the way of this achievement are several factors, which are then addressed later in the report in the form of several specific recommendations.

Before we get to those, we should look at the measure of competitiveness embedded in this premise. An increasing share of GDP is unquestionably convenient. It is relatively easy to observe and is also consistent with firm-level measures of competitiveness like increasing market share. However, is it the right one from a macroeconomic point of view and, if right, is it adequate?

At the company level, competitiveness typically has a profit dimension to it. A reasonable way to characterise a competitive firm would be in terms of its ability to increase market share without sacrificing profitability (or alternatively, to increase profitability without sacrificing market share).

Of course, "profitability" as a concept is difficult to translate into the macro level, but we cannot sidestep the idea that "competitiveness" needs to be measured across at least two dimensions.

At the country level, a true measure of competitiveness is the ability to increase global market share without any recourse to policy distortions. These could be at the macro level (an undervalued currency, suppressed interest rates) as well as the micro level (tax exemptions, subsidies).

The point is that an increasing share of manufacturing in GDP does not reflect increasing competitiveness if it is achieved with a significant use of such distortions.

A similar problem affects another common measure of competitiveness, the country's share in world trade. It could be boosted by distortions, just as it could be suppressed by other countries' distortions. Either way, it does not truly measure competitiveness.

Moving on to another critical building block, the report quite clearly adopts what might be called a "technocratic" line on the contentious issue of labour market reforms.

Following the reports of the task forces on employment opportunities (2001) and foreign direct investment (2002), it reinforces the proposition that the achievement of competitiveness in manufacturing and, more importantly, the translation of this into significant increases in employment, will not happen without a major streamlining of labour regulations.

Although I will get to the specifics of this later, the point that needs to be made here is that there is an accumulating weight of opinion amongst government-appointed expert bodies that labour market reforms are key to generating momentum in output and employment growth.

Unfortunately, the political establishment refuses to accept this. The irresistible force collides with the immovable object. What is the likely resolution on this? Should expert groups simply give up making reference to labour regulations and find the best way possible around them?

Or, will the political class accept the inevitability of change and begin a process of consultation with their trade unions and amongst themselves to find a feasible way out?

Coming to the second category of issues""specific components""the report lists six broad sets of constraints to achieving greater competitiveness. The burden of indirect taxes, sub-optimal scales of production, low process efficiency and high transactions costs combine with labour market constraints and weak infrastructure to hobble Indian manufacturing.

Of course, most of these factors inflict unnecessary damage on other sectors of the economy as well, but that is another story.

On the fiscal front, two realities need to be confronted. One, the indirect tax burden is heavily skewed towards manufacturing, relative to agriculture (which is better-known for receiving subsidies than paying taxes) and services (which are just beginning to contribute to the kitty).

Two, within the manufacturing sector itself, the burden of taxes is skewed towards the registered/organised component, which is estimated to generate about half the total value added in the sector.

Neutralising the adverse impact of the tax structure on manufacturing competitiveness will require dealing with both these imbalances simultaneously. Reduced subsidies to agriculture, better coverage and enforcement of the service tax and greater levels of registration of informal manufacturing establishments are all equally important.

There are some positive developments, notably on service taxes and the implementation of VAT by states, which will inevitably induce producers to register themselves in the sales tax net.

This can then be leveraged by other government agencies. The government can afford to reduce the burden on currently tax-paying manufacturers only if it is able to collect its fair share from everybody else.

Sub-optimal scales are again a well-known impediment to competitiveness. The reservation policy was based on the mistaken notion that small establishments were more employment-intensive. Of course, they have to be viable first, not always a given.

In any case, experience tells us that employment intensity varies more across sectors than across establishments of different sizes. China has managed to create large numbers of jobs in very large establishments, producing inherently labour-intensive goods.

Given the report's recognition of this problem, its advocacy of an active promotion regime for small enterprises is something of a contradiction. This point and the remaining issues mentioned in the beginning of this article will be addressed in the continuation piece.

The author is chief economist, Crisil. The views here are personal.