Make in India: Myth vs Reality

PM Modi should be lauded for the efforts that he is putting in to make India an industrial hub and generate jobs for the rising young population. But the efforts beg a question — whether Make in India will work as a policy and achieve its desired objectives i.e. increase the share of manufacturing and generate jobs. Given the current regulatory environment, the answer seems no. Let’s explore why.

Before understanding whether Make in India will work, look at the historical composition of the Indian economy:

India is an outlier when it comes to structural change of the economy. At India’s level of per capita GDP, most countries would have a higher share of manufacturing rather than services. India is different because it directly jumped from a high share of agriculture to the services sector, bypassing the growth in manufacturing that is seen as an intermediate step in most developing economies. Thus India missed on pulling out its masses from the agricultural sector. Although services contribute more than 50% to Indian GDP, the sector employs a much smaller proportion of the population. On the other hand, manufacturing share has remained almost constant in terms of GDP.

Make in India should be seen in this context — to correct the historical bias in India’s growth story and revive manufacturing to generate jobs on a mass scale as happened in China. Indian regulations have been blamed for this lopsided non-growth in manufacturing. To understand whether Make in India can give a boost, we need to look at the three basic factor market inputs for any sector: capital, land and labour.

1) Capital

Capital markets have been relatively free and open in India — there is a well-developed stock market as well as banking services to infuse capital into new firms. But the banking sector which forms the core of this factor market has been brought to its knees due to unscrupulous lending to crony capitalists. The public sector banks are in dire need of massive capital infusion without which they cannot kick-start the lending cycle. Bad plus restructured loans form 17% of total assets of public sector banks. One can forget about firms investing in new projects given that banks are not in a position to take risk and lend money. Modi’s initiative to court foreign investors can ameliorate this problem to some extent but FDI and FII are not going to reignite investment in the whole economy.

2) Land

Land is another crucial factor, but unlike capital it is highly regulated in India. Given problems in land acquisition, serious businessmen who do not have deep pockets to bribe the establishment cannot set up any industry. The Land Acquisition Bill passed by the last UPA government delivered the final nail in the coffin — making acquiring land a gargantuan task, almost impossible for any small investor. Since the Modi government could not pass modifications to the current land bill, the land market is completely strangulated at the current moment.

3) Labour

Labour is the third main factor market and is again highly regulated. A massive number of regulations kick in once a firm crosses employment thresholds. This along with firing costs makes it almost impossible for any firm to shut down loss-making operations, thus putting a brake on the process of creative destruction.

Since many labour regulations kick in at 10 employees, the sharp decrease in the number of enterprises at that threshold is not a surprise. Another important drawback of these labour regulations is that they have forced the manufacturing sector to automate, making this sector highly capital intensive — which again means there would not be enough employment generation even if firms figure out how to invest and acquire land.

What clearly stands out is that at India’s level of per capita GDP, the share of labour-intensive sectors is too low. China at four times India’s per capita income uses the same labour mix as India. Sadly, beyond the slogans the Modi government has not passed any game-changing laws for labour deregulation either. Unless trade unions and other vested interests are taken head-on, it is highly unlikely that India can generate enough jobs for its youth.

Given these deep problems with factor markets, it will only be a miracle if Modi can deliver ten million new jobs every year through his Make in India initiative. The fundamentals are wrong and it will be plain stupidity to expect otherwise. While big conferences are a good PR exercise, they cannot replace serious policy changes. Hopefully the Modi government will learn the art of the possible before it is too late.