The visible hand

Government intervention is not a suitable way of shaping investment and technology choices

This month marks the tricentenary of the birth of Adam Smith, perhaps the most influential economic theorist of the capitalist market economy. His concept of the “invisible hand” has shaped the belief of many people about the positive social benefits of a market economy driven by private profit incentives, as long as it is guided by free competition rather than ownership-based coercion.

The famous phrase “invisible hand” occurs just once in Adam Smith’s classic book, An Inquiry into the Nature and Causes of the Wealth of Nations. The single use of this famous phrase is in a passage in a chapter titled “Of Restraints upon the Importation from Foreign Countries of such Goods as can be Produced at Home”. The relevant sentence says: “By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.”

The truth is that the history of capitalist market economies has been shaped more by the visible hand of the government determining the economic environment within which supposedly free individuals seek personal advancement. This has often involved the government shaping technological choices and investment, sometimes through publicly-owned enterprises and sometimes by the visible hand choosing private sector winners.

Perhaps the most common use of the visible hand is the protection of the domestic economy from foreign competition or promoting the capacity of the domestic economy to compete in foreign markets. The tool for this could be import tariffs designed for protection and export subsidies designed to discriminate in favour of exports against supplying domestic markets. A more aggressive use of the visible hand is the government promoting specific companies as potential winners in this area. This happened as part of the East Asian export and growth boom and is now being attempted in India through the production-linked incentive (PLI) programme and measures like the large subsidies for new chip manufacturing plants.

The visible hand of the government in the PLI programme aims mainly at imposing an entrepreneurial vision of politicians and bureaucrats on sectoral and technological development. The government’s press release, in April 2021, projected these as part of the drive for Atmanirbhar Bharat or self-reliant India. It states that the objective is to make domestic manufacturing globally competitive and to create global champions in manufacturing. The basic mechanism is to offer companies incentives on incremental sales from products manufactured in India, over the base year.

The government announced an outlay of Rs. 1.97 trillion for PLI schemes in the 2021-22 Budget. Of the 14 PLI schemes, the first three were announced in March 2020 and the remaining ones a little later. As of June 2023, the total amount disbursed is Rs. 2,900 crore  in the first two years of the programme, or about 1.5 per cent of the total outlay.

A substantial part of the amount paid out as the PLI subsidy has gone to mobile phone assemblers and the sharp increase in the net exports of mobile phones is being shown as an indicator of the success of the PLI programme.  A careful study by former Reserve Bank of India governor Raghuram Rajan and two collaborators suggests that when imports of parts for assembly of mobile phones are taken into account, the net exports of mobile phones plus parts for the phones is negative and the net value added may be less than the PLI subsidy given for mobile phone “manufacture”.

The PLI programme is a determined attempt by the government to pick sectors as the key to growth and companies as winners within these sectors. Giving a subsidy for production above a baseline is a direct subsidy for growth when the policy should be to create favourable conditions for demand growth, cost reduction and product and prices development that will benefit all companies, not just the ones chosen as winners by the government. One must also note that picking winners may be shaped by the visible hand getting into collusion with influential capitalists, influenced sometimes by two-way benefits, to put it politely!

An even more aggressive assertion of the government’s attempt at shaping corporate decisions is the commitment of a 50 per cent subsidy for chip and display fabrication units and some other related facilities with a provision of $10 billion (Rs. 82,000 crore at the present exchange rate). So far, no international unit with technological knowledge about chip fabrication has applied and the one application that was under consideration seems to be foundering for lack of technology access. If the primary purpose of this is long-term technological competence, then the government should explain why the amount that it will give to a single chip fabricating company is more than six times as large as the total budgetary provision (averaged over FY 22 and FY 23), for the three departments under the Ministry of Science & Technology.

Even if India succeeds in attracting a chip fabricator, the design of chips (measured in nanometers) that is being proposed is 10-15 years old and will not meet the requirement of appliances designed to use more modern chips. Hence, this desire to promote self-reliance could well lead to setbacks for the chip-using appliance manufacturers and perhaps also tariff increases to protect the government-sponsored private manufacturer. That is the problem with a piecemeal approach to self-reliance.

A country like India cannot afford to develop every area of technology that its production process requires.  Moreover, with the increased integration with the global economy, the competitive dimension becomes the determining factor. Corporations and entrepreneurs are better judges of what should be done than bureaucrats and politicians with little business experience. One example of this foresight of corporations is the successful development of the auto component industry in India promoted by assemblers of vehicles like Maruti-Suzuki who did it to keep their costs under better control. So perhaps the promoters of self-reliance may like to rely more on the invisible hand of capitalism that Adam Smith spoke about than on interventions by a visible hand!

The visible hand of the government should focus on promoting competition among capitalists. Its substantive and more detailed interventions must deal with what profit-oriented entrepreneurs will not provide at the level required.  This includes measures to protect the environment, providing monopolistic infrastructure services, supporting long-term science and technology research and ensuring education and health facilities at the level and quality required. The visible hand of the government must also address a major limitation of a market economy and ensure fairness in the distribution of income between those who own resources and those who work with the resources to produce products of value. That is the centuries old lesson that must be better understood by the government.

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desaind@icloud.com