Market friendly, joint Centre-state approach key for new industrial policy

The global economy is in the midst of a proliferation of activist industrial policies whose beneficial effects, beyond enriching company owners, are doubtful. For instance, the current widespread subsidy-oriented government support for chip manufacturing, driven by geopolitical concerns, is likely to lead to global overcapacity, lower international prices, and reactive protectionist measures, ultimately resulting in higher costs for chip-using manufacturing activities in the states that are doing this. In fact, over the past few years, there has been a dramatic increase in distortive industrial policies globally, rising from a few hundreds in 2017 to more than 2,000 in 2023, with about 100 in India.

 

An activist industrial policy, however, is an established tradition in India. Ten years ago, in 2014, one such version — the Make in India initiative — was launched. Since then, a variety of sector-oriented measures have been implemented. The primary form of subsidy support to corporations is revenue forgone, which amounted to Rs 1.09 trillion in 2022-23, accounting for 13 per cent of the corporation tax collected. Recently, more direct subsidies have been introduced for chip manufacturing and for a variety of other industries under the production-linked incentive (PLI) scheme. But the record of manufacturing growth during the Make in India programme period (2014-15 to 2023-24) shows a fall in the share of manufacturing in total gross value added (GVA) from 16-17 per cent in the first five years to 14-15 per cent in the last five years. An activist industrial policy that is focused on specific sectors and companies has not led to an acceleration of industrial growth.

 

I believe the government’s industrial policy should be market–friendly, not business-friendly, as the latter often leads to crony capitalism. The growth boom in manufacturing that India experienced following the shift of focus from public sector to the private sector was driven more by market-friendly than business-friendly interventions. The most visible change after 1991 was the removal of industrial licensing and a more gradual transformation of the international trade system with the removal of quantitative trade controls, exchange rate reform, and tariff reductions.  Both of these are important in the effect they had on private investment and India’s presence in the global trade and finance economy.  However, in my view, the most substantial change was in the institutional arrangements in the financial market that transformed the savings-investment flow into something that was more competitive and acted as a booster for private investment.

 

A set of substantive changes were made that has transformed the financial market. The most impactful change was the opening of the banking and mutual funds sectors to private enterprises that has led to a substantial improvement in the quality of banking and investment services available to savers and investors. The simplification of share trading through dematerialisation greatly facilitated the widening of savers’ interest in shares. The shift of regulatory authority from the Controller of Capital Issues in the finance ministry to the Securities and Exchange Board of India (Sebi) is another important change. These, along with other changes in the government’s financial policies, have been major factors behind the average 6 per cent growth India has experienced over the past four decades.

 

Private corporate growth was boosted by the liberalisation of the financial market, leading to a significant increase in new capital issues by private companies and a rise in the volume of assets in mutual funds. This opening of the finance market has continued with the emergence of non-banking finance companies that are more effective at reaching out to smaller borrowers, and lately, the emergence of fintech companies. The rapid expansion of digital infrastructure has also been critical to the broader liberalisation of the financial system.

 

All this has led to a radical increase in private corporate investment relative to public sector investment, with the ratio between the two rising more than four-fold from 0.37 in 1990-91 to 1.63 in 2022-23.  As for investment in manufacturing, in 2022-23, the private sector accounted for 71 per cent, small enterprises within the household sector for 22 per cent, and the public sector for only 7 per cent. One measure of the transformation because of the reform of the financial system is the sharp rise in the market valuation of shares as a percentage of gross domestic product (GDP), from an average of 37 per cent between 1991-92 and 2004-05 to an average of 85 per cent between 2005-06 and 2023-24.

 

The decision about sector and technology should be left to investing corporations, including the small ones, rather than be influenced by the government through sector-oriented industrial policy.  The government must make it more necessary for enterprises to be adventurous in the choice of sectors and technologies by making the manufacturing sector more open to the global economy and avoid using protectionist policies. India has higher tariffs compared to other emerging market developing economies (EMDE) and we should aim to return at least to the average EMDE tariff level.

 

There are certain things beyond supporting competitive markets that the government needs to do, particularly to ensure the efficient impact of market prospects on private sector decision-making. Perhaps the most important of these is land acquisition, which remains a major constraint for many.

 

Given the complexity of ownership and land acquisition laws and processes in many parts of India, it is difficult to get land for industry directly.  However, if the government acquires land and then makes it available to investors as a package, the process becomes much simpler. In the long term, government support for industrial development must focus on areas such as technology research and development, as well as education and skill development. This is especially crucial to facilitate investments in emerging sectors.

 

A successful industrial policy requires constructive cooperation between the Union and state governments. Two crucial areas, land availability for industry and education and skill development depend on the efficiency of the state governments in these areas.  One example of a successful industry-promoting state is Tamil Nadu, which is supportive of land acquisition, labour availability, and other immediate considerations that shape the location decisions, particularly of foreign-controlled corporations.

 

The New Industrial Policy should be a joint product of the Union and state governments. The Union must concentrate on the required infrastructure development, promoting competitive market mechanism, ensuring a mechanism for oversight of the financial system that ensures prudence, probity and prolificity, global trade openness for manufacturing products and support for long-term technology development.  The states should focus on simplifying land acquisition by new investors, ensuring the availability of skilled local and migrant labour, and creating a smooth interface for enforcing environmental and other standards. Cooperation between states should be organised to facilitate the establishment of national manufacturing value chains. If this is done, a New Industrial Policy will stimulate employment and output growth in manufacturing.

 

desaind@icloud.com