The two most important challenges facing the Indian economy are – an increasing trade deficit and the need to generate employment for millions of youth joining the workforce soon. While India is a recognized for its services sector and services contribute 60% to its GDP but it does not account for as many jobs (contributes only 15% to the numbers of jobs.) India’s focus should continue on developing Services and Agriculture (food security) sectors but at the same time we need to find solutions that can help meet with both the challenge of jobs and trade deficit.
Solution to the challenge – Manufacturing
Growth in manufacturing is the long term solution to meet both of these challenges facing the Indian economy- an increasing trade deficit and the need to generate employment for millions of youth joining the workforce soon. At present, India is unable to meet most of its own requirements for manufactured products and the manufacturing sector has been growing at its slowest pace in a decade with the IPP numbers actually falling by 1.6 % in May, 2013. The result is that a significant portion of the domestic demand is imported. These imports range from sophisticated technologies to basic toys and products for regular usage. If India is able to grow its manufacturing sector, it will in turn lead to increased employment and further growth- in other words; manufacturing sector growth is likely be the ‘tipping point’ for increasing the GDP growth in India.
In this blog, I will discuss some other steps to improve India’s footprint in manufacturing.
In this blog, I discuss the following seven simple steps to improve India’s manufacturing competitiveness.
- Using Services to grow Manufacturing
- Improve the supply chain
- Grow the MSME and encourage entrepreneurship
- Improve the IP environment
- Modify tax structures
- Improve human capital
- Adopt global standards
Using Services to grow Manufacturing: In contrast, in spite of strong global economic challenges, the services sector has kept growing over the last decade. The question I am pondering with is, how we can use India’s leadership in software and complement it with our objective to grow manufacturing ? How can software and services sector can become the backbone of the manufacturing ?
Software and hardware are no longer two different sectors independent of each other- in fact they complement each other. For example, Intel pushes the boundaries of technology to build better ‘systems on a chip’ so that hardware and software work seamlessly and provide enhanced customer experiences. Worldwide, hardware companies are partnering with companies providing security services so that security can be incorporated in the hardware. And this is by no means an ICT industry phenomenon. From cars to refrigerators to electric grids, everything else around us is getting ‘smart’ and they are becoming smart because cutting edge software modules are integrated into hardware form factors and networks connect them using telecommunications technology. Even the so called ‘heavy industries’ like petroleum and mining are using cutting age software and computerized equipment to detect and extract mineral deposits from deep inside the earth’s crust. In fact, some of the so called ‘hardware’ companies now employ the largest number of software engineers.
India has a unique opportunity to leapfrog and move into manufacturing of next generation goods by utilizing its strength in services. Some of the world’s largest manufacturing companies already have design and development centers in India. Government should incentivize these companies to move development for the next generation of manufacturing to India. This effort can start with incentivizing production of prototypes or ‘development models’ here in India by relaxing restrictions on importation and exportation of these devices and providing a sound and clear tax policy designed to move more manufacturing related research into development centers. Once the prototypes start to develop in India and companies are not concerned about tax implications of doing end to end research and development, they will start to increase manufacturing footprint in India. The government also must encourage Indian software companies to invest in research and development in hardware systems development. Some of these software companies are already providing critical services to the hardware companies- this is potentially the next big thing for the Indian software sector as it matures from a low end outsourcing model and hence move up the value chain of the work we do in the country.
Improving the Supply Chain: After Independence, the stress was on creating integrated industrial towns, such as the steel plants in Bokaro and the rail factory in Chittaranjan. Nehru called these the ‘temples of modern India’, and they still serve the country. However, modern manufacturing relies on movement of goods across borders- at a very fast rate. Companies rarely invest in integrated plants. They look for ways to reduce inventories and manufacturing is typically done ‘just in time’. The brand owners of the finished product typically do not own the entire supply chain; instead they rely on many suppliers spread across the globe. A cell phone’s chip may be manufactured in Taiwan, memory and other parts in Malaysia, and the product might be assembled in China. People often only see the name of the country where the assembling takes place and wrongly conclude the product is ‘made’ there when assembling is often the lowest value addition in the chain.
To grow its manufacturing, India must integrate itself in the global supply chain and specialize in niches most relevant to its strengths. It is very difficult, if not impossible, for any country to have the entire, or even a specific value of the supply chain of a product inside its borders. What is critical is to enable the integration into the global supply chain and then moving up the value chain to ensure the most valuable parts are manufactured in the country.
While there has been significant improvement in the infrastructure of the country, much more work is required. No doubt significant investments are needed to put in place new infrastructure. However, a lot of the improvement can be done without investing money, but by simply easing the regulatory filings required to import into and use goods within the country. Particularly, the documentation process involved in ‘clearing’ goods from the ports can be very cumbersome, time consuming and is often a source of corruption. Movement of goods inside India is again subject to several regulations and these regulations also provide wide discretionary powers to the officials.
To address these concerns, the Government has started the process to develop manufacturing ‘clusters’. This process is a welcome step and movement of goods between the clusters should be relatively easy. Simplified shipment of goods will help companies in a given cluster develop a mini supply chain among them and may also create integrated supply chains with the companies outside the cluster. But considering the global nature of supply chains, the companies inside the cluster would still depend on goods imported from other countries and goods from other states. It is therefore imperative that the Central Government and State governments work together to reduce the documentation and processes required to move goods. While some airports have greatly improved thanks to adoption of the PPP model, there is considerable room for improvement in the manner in which sea ports operate. The adoption of GST will also be very beneficial in this regard.
Growth of MSME and encouraging Entrepreneurship: The Micro, Small and Medium Enterprises sector (MSME) is the backbone of any economy. Even in advanced economies such as the USA and Germany, MSMEs contribute the largest share- both in terms of employment and contribution to GDP. And, let’s not forget that Google, Apple, Microsoft and Dell all started from garages. Today’s MSMEs are tomorrow’s blue chip giants.
In India we have not seen much interest among the entrepreneurship community to venture into manufacturing sector. We need to encourage the budding entrepreneurs to invest into manufacturing related sectors. Specific training programs must be started by Government, in consultation with the private sector, which allows engineering graduates to have the skills that will enable them to establish successful small and medium manufacturing bases in India. We already have a budding entrepreneurship community in the software and services sector- we need to show budding entrepreneurs in the manufacturing sector can also be profitable.
Unfortunately, the cost of funds is very high in India on account of high interest rates. Bank interest rates are determined by macro-economic considerations and it is difficult to decrease them for specific companies. Instead, India should facilitate availability of funds for entrepreneurs independent of the normal banking system. Many international finance companies have pioneered innovative funding structures for MSMEs. The regulatory environment regarding financing should be relaxed so that financing companies can market these innovative products to MSMEs in India (of course RBI will have to ensure that high risk toxic products are not dumped on the MSMEs). Private equity investment in the MSME sector should be encouraged- private equity funds not only bring funds but also encourage adoption of good corporate governance practices and advice the promoters in taking management decisions.
Improving the IP environment: Often a strong IP regime is wrongly seen as a ‘barrier of entry’ for other players. However, this argument is not by substantiated by much empirical evidence. In practice, especially in the ICT sector, the market is very dynamic and few companies have been able to hold on to their market share. Every few years new companies emerge and disrupt the market even though the existing players have hundreds of thousands of patents. A strong IP regime actually helps enterpenership as existing players are more comfortable sharing their knowledge, by way of trade secret disclosures and patent filings, which can be used by entrepreneurs to build more innovative products. In fact, numerous studies show that a strong IP regime leads to increased foreign direct investment (FDI), more voluntary technology transfer that is of higher value, and greater domestic innovation.
The Indian IP regime has improved considerably in recent years. However, even here the stress should be on improving timelines for approval and reduction in regulatory costs. For example, under Indian law all patent holders are required to file ‘working statements’ every year – these add on to the cost to maintain a patent. The government should train MSMEs on IP issues, especially with regard to how to manage intellectual property and innovation. Industry has a role to play here and major companies like Intel should help MSMEs understand how to manage innovation and IP.
Finally, Government must step up its efforts to prevent pirated goods entering the market. Piracy is not only bad for the economy in terms of loss to tax revenue; it also effectively makes legitimate business unprofitable.
Currently India faces a peculiar problem of ‘grey goods’. These goods are imported by non-authorized dealers from neighboring countries who take advantage of exchange rate arbitrages. The goods are often not suited for the Indian market and are not supported by warranties. The consumers suffer because of these imports, and they damage the viability of Indian manufacturing. These imports also effectively increase the current account deficit. Any steps the Government takes to control these goods will benefit all stakeholders.
Modifying the Tax Structures: Indian Industry faces a problem of ‘inverted duty structure’ under which it is much cheaper to import finished products than to import the raw materials and manufacture them in India. We understand the Ministry of Information Technology & Communications is working with stakeholders to address these concerns. Hopefully, the Ministry of Information Technology & Communications and Ministry of Finance will be able to correct the distorting tax structure. Also, as noted above, introduction of a GST will greatly benefit industry. The central government should also get more active in international negotiations aimed at reducing taxes on imports.
Improving Human Capital: The time when manufacturing meant ‘unskilled’ workers working on big machines is over. Modern manufacturing is highly technical and there is significant amount of computing involved. Stakeholders should work together to train the next generation workforce. Government should ramp up the ITI system to include modules on modern manufacturing methods. Industry of course has its own role to play and cannot rely only on the Government for support in this regard. As Mckinsey rightly notes “India’s manufacturers could learn a lot from the IT sector’s experience in promoting the large-scale development of skills.” 
Adoption of Global Standards: India should get more active in the global standards setting forums and adopt these standards. Adoption of global standards will enable Indian companies to access the global export market. As the software industry has shown, growth of an industry often first comes from the export market. Also, the export market is generally more profitable and growth in exports will reduce the trade deficit. India should desist from mandating country specific standards as these discourage innovation, often increase the price of products compliant with such standards, and restrict the market for goods manufactured in India.
There is an abundance of human resources and technical competence in the country. The central Government and many state Governments have rolled out several policies and regulations to encourage manufacturing in India. Of course there are no silver bullets and one policy cannot change the dynamics of the sector and make India the most desirable place to manufacture for any particular sector. Where we probably need to work the most is in creating a regulatory environment that enables enterprises to flourish. As the Manufacturing Plan released by the Planning Commission notes, “Poor implementation” of polices and lack of coordination between ministers and state and central government are the “root cause for India’s poor performance in Manufacturing”.
With increasing costs in China, companies are considering whether to shift parts of their supply chain to other jurisdictions. This emerging trend, combined with India’s divided demographic, provides a ‘once in a generation’ opportunity to restart the manufacturing sector in India. The devaluation of the rupee might also become a blessing a disguise. We need to urgently create a cohesive legal and regulatory framework which encourages companies, small and big, domestic and international, to invest in the Indian manufacturing sector in the long run. The decisions are ours to make, if we have the courage to make them. The rest will follow.
 See e.g., “The Economic Value of Intellectual Property,” Robert J. Shapiro & Kevin A. Hasselt, pp. 2-3 (Oct. 2005); available: http://www.sonecon.com/docs/studies/IntellectualPropertyReport-October2005.pdf (summarizes significant research on conditions affecting technology transfer); “The Global Innovation Policy Index” (Information Technology and Innovation Foundation 2012) (reviews a wealth of academic research that documents the relationship between the strength of a country’s intellectual property protections and the extent of trade and technology-intensive FDI).