Thursday, May 6, 2010

China Club instead of Bombay Club?

Emulate China's coordinated policies for strategic sectors, and we'll rely less on commodity exports

Shyam Ponappa / New Delhi May 6, 2010

With the momentum of the past few years, India’s potential for growth is enormous, despite the chaotic loose linkages. In sectors like power and telecommunications, this translates to demand far outstripping capacity. Some contend that domestic inability to build capacity — i.e., being able to actually pull it off, as against the perpetual potential — will conscribe not only these sectors, but also limit overall growth. So the argument goes, e.g., let China build India’s power plants, because we need the power and don’t have capacity/they do it cheaper.

Comparative advantage notwithstanding, this reasoning is fallacious given the realities of national interests and self-interest. To understand why, consider the naïveté of the underlying assumptions — about “rational man”, that capitalism is fair, capital is immobile, surplus value accrues to countries and not to companies, or that the pursuit of self-interest maximises societal benefits.*

Our quandary is aggravated by our inability so far to orchestrate supportive policies for even a level playing field. Ironically, one need only consider India’s approach to IT and IT-enabled services (ITeS) in the initial growth years to realise this. India’s policies in IT and ITeS, while far from perfect — in fact, sneaked through by stealth, as in the preferential 64 kbps communications lifeline, and the tax breaks for software service exporters — provided the foundations for transforming IT and then ITeS/BPO/KPO (Business Process and Knowledge Process Outsourcing).

These sectors also benefited from a controlled exchange rate, as the Reserve Bank of India (RBI) managed a steady depreciation during those years. But they did not have another vital ingredient of coordinated policies as did the Asian tigers: low borrowing rates (see diagram below for real interest rates in China, USA and India, 2002-2004).

This is one reason why, for instance, India’s machine tool manufacturers or shipbuilders have not matched the growth of knowledge-based services. The former need inexpensive, long-term capital for production and marketing, as well as for continuous innovation, upgrade and scale.**

Why labour arbitrage and not products

This is also one reason why we lack product orientation, because product design, development and marketing require the support of easy access to cheap capital for a long period. Labour arbitrage needs little capital. Therefore, we have been better mercenaries than producers of products, compared with the chaebols (Samsung, Hyundai) or keiretsu (Mitsubishi, Dai-Ichi/Mizuho). There are, of course, many additional reasons: their education, training, work practices, our policies against large corporations, etc.

With growth in domestic markets across a broad range — telecom equipment, engineering goods, power — there are domestic manufacturing initiatives, such as L&T and Bharat Forge in power generation joining Bhel, or Tejas Networks in optical switching. But for the transformational changes we have witnessed in IT, we need coordinated industrial policies that support domestic manufacturing, because that’s the competition. Unthinking acceptance of “open markets” without heed to how others — including developed economies — cosseted and built their manufacturing capacity will ensure that India stays a raw materials and commodities exporter, while importing trains, aircraft, machine tools, and equipment for power generation, telecommunications and defence.

Integrated policies work

Ideally, supportive policies comprise a coordinated range, such as state and central taxes, favoured locations with good infrastructure — energy, transport and communications, subsidised land, favourable exchange and interest rates, preferred access to domestic markets, and barriers to unfair competition, like import tariffs not below the WTO floor, and safeguard duties. Without this orchestration, the victors are companies and countries that have understood these principles, and have these systems in place. (This applies equally to farm products.)

Many are apprehensive that what works elsewhere will not work in India because of malpractices, as seen in recurring scams. There is every need for systems with integrity, and for enforcement with penalties. But just as corruption in government or civil society does not do away with the need for either, misuse does not negate the need for incentives. It would be self-damaging to lose the opportunity to try and get our act together simply because of apprehensions of corruption and/or incompetence. That would be like not subsidising food for the poor; it’s a different matter that we need better methods to prevent gross misappropriation.

The consequence of heedless, ad hoc muddling through instead of orchestrated strategies is that manufactured imports will dominate our markets, while domestic manufacturing is fragmented, hamstrung or absent. Having said that, consider India’s needs in electricity or communications — telecom, Internet and broadcasting — and it is apparent that crafting policies is not simple. So many conflicting images, some based on facts, others, mere impressions, which are often more important than facts. What should policy-makers do for our needs on such a massive scale with growing shortfalls?

Emulate China

The short answer: learn from China. In the power sector, Chinese suppliers have the following advantages:

  • Low-cost access to capital.
  • An exchange rate advantage (10-30 per cent).
  • No sales tax and octroi, aggregating to about 11 per cent.
  • Zero customs duty on equipment for large plants (China imposes a 30 per cent import duty).

Corrective action discussed for years has not resulted in concrete steps. The power ministry, citing supposed user benefits, opposes the planning commission’s recommendation of a safeguard duty. This is as shortsighted as “free electricity” that undercuts investments in power.

In telecommunications, consider Huawei, with revenues of over $20 billion, nurtured for 20 years with the People’s Liberation Army (PLA) as an R&D partner and guaranteed customer, vis-à-vis, say, Tejas Networks from Bangalore, with no government support.

Our policies need to focus on our long-term interests with strategic intent and execution, as in other countries, balancing costs with the benefits of domestic capabilities. These sectors need government procurement support, not criteria that disqualify Indian companies in strategic sectors like power and communications. They also need interim methods for Chinese companies to contribute while upgrading our skills and processes. Our aim needs to be a level playing field.

* For why “individual ambition serves the common good” doesn’t quite work, see “Prisoner’s Dilemma” at:

** “An Analysis on the Determinants of Indian Machine Tool Exports”, Rijesh Raju, 2007:

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