Hollowing Out India

Should India develop and sustain certain capacities, or allow them to be eroded?

Shyam Ponappa   |   April 5, 2018

A society’s functional capacity can “hollow out” in many ways. The following examples illustrate how self-imposed policies, regulations or practices subvert our capacity. To avoid this, our governments and polity need to adopt “rules of the game” based on constructive perspectives that maximise benefits. Our present approach is often restrictive and rationing, i.e., scarcity oriented.

A path-breaking article in the Economic and Political Weekly four years ago highlighted the fall of India’s share of manufacturing in total manufactured goods.¹ Although manufacturing exports were rising, imports grew faster than exports resulting in a hollowing out, with disproportionate gains to foreign suppliers. Manufacturing contribution to gross domestic product (GDP) remained at 14-16 per cent since the 1980s, compared with China’s growth of 34 per cent, Thailand’s 40 per cent, or Malaysia’s 24 per cent. Employment in manufacturing remained at 12 per cent from 2000 to 2009, while contribution to labour productivity growth was only 6 per cent, compared with China’s 32 per cent and Malaysia’s 68 per cent.

The World Economic Forum and A.T. Kearney's "Readiness for the Future of Production Report 2018" is more positive, although with a warning regarding the future. Countries are classified along two dimensions, “Drivers of production”, and “Complexity and scale of production structure”.

Source: http://www3.weforum.org/docs/FOP_Readiness_Report_2018.pdf
Note: Average performance of the top 75 countries (weighted average driver score, weighted average structure score) is at the intersection of the four quadrants to create the archetype borders.

On the drivers (vertical axis), India is a little below middling, while in scale and complexity (horizontal axis), India is somewhat better than middling.

India is in the “Legacy” quadrant (strong base, but at risk for the future) including Hungary, Mexico, the Philippines, Russia, Thailand, and Turkey among others, and is ranked ahead of Russia, Brazil, and South Africa.

Chart 2: Future of Productivity Readiness Some legacy Countries & Brazil - Rank Structure of Complexity Production  & Scale Hungary 17 42 India 30 44 Mexico 22 46 Philippines 28 66 Russian Federation 35 43 Thailand 12 35 Turkey 32 57 Nascent Countries Brazil 41 47

The commerce ministry is reportedly taking remedial action, applying recommendations by the same author who wrote about the hollowing out of manufacturing, Dr Banga, in her subsequent capacity as head of trade competitiveness at the Commonwealth Secretariat. Her recommendations are to link into specific Global Value Chains (GVCs).² India could benefit significantly if these initiatives are followed through, as with the  Automotive Mission Plan 2006-2016, now in its second 10-year cycle. Automobile assembly jobs grew from 10 million in FY06 to 32 million in FY16. This collaborative effort between the Ministry of Heavy Industries and Public Enterprises and the Society of Indian Automobile Manufacturers is a road map for sectors that need urgent attention, such as solar energy and wireless broadband. This is why politicians need to focus on working with government, industry and citizens on shared objectives, instead of destroying possibilities of working together through perpetual confrontation.

Hollowing Out Happens In Other Ways

One way is through equipment imports. Take solar equipment imports: The issue for India, with so much insolation together with other requisites such as technical skills and production capabilities, is how to formulate policies and regulations to support innovation in solar energy use, with incentives for R&D and manufacturing/marketing for such products and practices. The entire value chain has to be designed and set up comprehensively, instead of our typical piecemeal and/or episodic, or half-baked approach. Without this, such imports ensure that India, among the top five countries in terms of demand, remains a captive market for foreign producers. Similarly, domestic manufacturers of conventional energy equipment face foreign competition that has access to subsidised material and inputs, export incentives, low-cost funds, and better infrastructure. Imported equipment for solar or conventional fuels lasts for 25 years, blocking the best markets for developing local production capacity. This hamstrings local suppliers, who already lack comparable policy support, including government procurement and country-backed funding. In this situation, local production can rarely develop, if at all, to supply large but inaccessible local markets. We have to recognise all this, devise remedial ways, and follow through with implementation.

Competitive bids and auctions result in a race to the bottom focusing on the short run and hopes of cashing out, creating a mirage that prevents building sustainable capacity. A number of energy companies have done this, although several have stalled before they could sell out. Low bids below spot electricity prices obstruct genuine capacity building. For renewable energy, feed-in tariffs are unreasonably low, subverting their viability. One example is a Chinese-Japanese consortium bid in the United Arab Emirates at $0.0242/kWh (about Rs 1.61). Such bottom-fishing ensures that no projects succeed, whether for conventional or solar/renewable energy.

A variant is through controlling materials that go into batteries and electric vehicles, such as lithium, cobalt, nickel or manganese, or copper for charging equipment. For example, Chinese companies produce 77 per cent of refined cobalt.³ Therefore, decisions such as the promotion of electric vehicles over conventional vehicles need a life-cycle analysis, including the sourcing of raw materials.

Yet another example is how India’s policies hamper the design and production of wireless equipment for telecommunications and broadband. India has the chip-designing and production capability for Software-Defined Radios (SDRs) for wireless communications except for the fabrication of chips and chipsets (similar to Qualcomm), and is a huge market for such equipment. Yet, as evidenced by entrepreneurs designing SDRs and TV White Space devices, it is difficult even to get access to the spectrum required for testing devices. Innovators cannot begin to design commercial solutions and win without radical changes to our policies and practices, extending through funding at the intermediate stage, and access to domestic markets. Who will buy from unproven undertakings in an oligopolistic market dominated by a few international giants?

Many more areas — agriculture, finance, the Internet — have similarly obstructive rules and practices. As felicitous policies and regulations boost capacity, we need to adopt tariffs and local sourcing aligned with World Trade Organization norms, with the emphasis on permissible incentives, such as waiving excise for fuel and customs for exports, interest subvention, end-to-end financing, value chains, and access to markets. We need barriers and umbrellas, with heavy emphasis on the latter.

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Shyam (no space) Ponappa at gmail dot com

1. Rashmi Banga, “Trade Facilitation and ‘Hollowing Out’ of Indian Manufacturing, Economic & Political Weekly 49, no. 40 (2014). www.epw.in/journal/2014/40   |   http://www.epw.in/journal/2014/40/notes/trade-facilitation-and-hollowing-out-indian-manufacturing.html

2. Banga, “India’s Global Value Chains-Linking LDCs”, Commonwealth Secretariat (2016)

http://icsa.net.in/uploads/study/1493533092BoostingIndiaExports1.pdf

3. For details on control over sources, see Arunabha Ghosh, “A Wild West for minerals?”, Business Standard (March 26, 2018)

http://www.business-standard.com/article/opinion/a-wild-west-for-minerals-firms-are-rushing-to-buy-mines-overseas-118032601192_1.html

Seeing the Whole Elephant

Shyam Ponappa / New Delhi November 23, 2008

While the world scrambles to prevent chaos, we seem to be moving in a dream...


The accompanying graphic has six opinions on how to assure growth, from economists and industry association heads at the India Economic Summit 2008, sponsored by the World Economic Forum and the CII.

These views give some idea of how much dissonance there is on what should be done for growth. Five of the six agree on investment in infrastructure (the top row). Thereafter, only two-at-a-time agree, on (a) regulations without stifling markets, (b) stimulating consumption: one through tax cuts, another through rate cuts, and (c) incentives to banks to lend.

Is infrastructure spending a good solution? Consider the evidence: our problem from even before the economic crisis was not funding for infrastructure, but inability to get projects implemented. For instance, there are the highway projects that started off well enough, then slowed over the last couple of years. In the last few months, many have been given up by our top constructors. A report in this newspaper attributes this to unrealistic project estimates and/or high interest costs.* Other instances are the steel and aluminium projects stalled because of land acquisition policies and practices. Therefore, efforts to spend on such projects are likely to have little immediate effect until the structural problems in their award and execution are resolved. What it will do is help anchor better expectations — one peg to raising confidence — because it will signal better developments for the future. But we have to survive the present in good enough shape to be able to enjoy the future…

In such circumstances, one would expect a certain alignment between the opinions of the industry chambers and of bankers, but this coherence is missing. Is this getting lost in the cacophony of a typical Indian dialogue-of-the-deaf, where everyone talks while no one listens, so there is no discernable common thread, let alone harmony and symphony?

However, three of the six opinions do address the immediate crisis of profits, revenues, and of continuing investment and consumer spending, the necessary ingredients to keep growth on track. This is what needs attention: the logic and urgency of time lines — what needs doing now, to keep from falling over the cliff.

From the perspective of a time line, let us distinguish between what can be done quickly for immediate effect in this crisis, as against what can be done for the medium- and longer term. First on our list, most likely, would be rate cuts, because of the impact and ease of execution. These would be in the SLR and CRR to provide a massive psychological cushion of liquidity, and in the repo and reverse-repo rates to bring down the tide of interest costs. Combined with the announcement of a redefined ‘priority sector lending’ which would include rollovers of loans except where there is demonstrated bad-faith, and a system (to be developed and introduced in the near-to-medium term) of online monitoring for compliance, with incentives and penalties. This would lead to credit availability for projects and businesses, now made profitable by the repricing of funds and projects. Real estate and property development, however, will need rescheduling with major asset re-pricing.

In terms of urgency, these would be the first steps to alleviate the situation immediately. Followed by steps to rationalise taxes, e.g., on petroleum products (Kelkar Committee recommendations). The objective: to reduce input costs and multiplier effects on the overall cost structure. Keep our steel mills, automotive companies and airlines running, our airports building… What this would achieve is continuing domestic-demand-driven growth, encouraging reasonable levels of consumption, and retaining employment. As for government revenues, the logic of profit-sharing, so clearly understood for petroleum exploration and some aspects of telecommunications after NTP ’99, would ensure that government makes much more from fat geese that lay many golden eggs, than from strangulating the few that are presently scratching about to eke out a living.

If this is not done, in all likelihood we will have escalating bankruptcies of capital-intensive enterprises, which, because of increasing repossessions and collapsing prices, may lead to a risk we have been spared so far: bank failures. If these events occur, the likely consequence is a severe recession in India as well — not for six months, but for many years — because both investment and spending will dry up, as will growth. And the great benefit of having become an attractive investment destination will, instead, become a frightful return to the uncertainties of pre-2003.

Those inclined to see a glass always half-full would say (next year and the next): But growth is 4-6 per cent in catastrophic global times. The rest of us will see it as running at half-speed, with all the attendant consequences for a talented people, once again held down by our collective inability to work things out for the common good.

shyam ponappa at gmail dot com

* ‘Few takers for highway projects’, BS November 17, 2008:
http://www.business-standard.com/article/economy-policy/few-takers-for-highway-projects-108111701067_1.html