Despite
the rapid expansion of services in the economies of
developed and developing countries, it still remains
true that a nation's economic strength is in the final
analysis based on the strength of its commodity producing
sectors. Also, given the more rapid pace of productivity
expansion in manufacturing, the creation of a substantial
and dynamic manufacturing sector has historically
been the centre-piece of development strategies.
Seen
from that perspective, there is much that is disconcerting
about the development process resulting from the adoption
of a neo-liberal reform agenda in the 1990s. To start
with, despite claims to the contrary by the government,
manufacturing growth performance during the 1990s
and more recently has been worse than in the 1980s.
Not only has the trend rate of growth tended to be
at best similar to that observed in the 1980s, but
the pace of manufacturing growth has tended to be
extremely volatile with creditable growth rates being
concentrated in one or two year periods separated
by slow growth and recessionary conditions. Second,
there are some signs of the ''hollowing of the
middle'' in Indian industry, with growth occurring
in the very large scale sector, while the medium and
small scale industry has witnessed slow growth and
high rates of mortality because of competition from
imports or import intensive ''domestic'' products,
a recessionary environment, waning state support and
inadequate credit access at times of distress. The
small scale sector that tends to persist is that which
caters to the ancillarization needs of large firms,
to niche markets and to low margin markets that persist
because of low per capita income and high poverty.
Third, there are clear signs of consolidation within
the large industrial sector, in which foreign firms
encouraged by liberalization of rules governing foreign
direct investment, play a major part. Since these
firms invest and expand in India to cater to domestic
and not export markets and since they are characterized
by large outflows on account of intermediate imports,
royalty payments and profit repatriation, their growing
presence not only limits the maneuverability of the
government when it comes to industrial policy, but
also has adverse balance of payments implications
in the form of a rising trade deficit that encourages
dependence on purely financial flows to help finance
that deficit. Finally, the most disconcerting feature
of industrial development during the 1990s is the
lack of any contribution of output growth in the organized
sector to employment growth. In fact, there appears
to be a negative relation between output and employment
growth. While it is known that the manufacturing sector
tends to be far less labour-absorbing than agriculture
or services, this feature of growth in organized industry
is extremely disturbing and needs correction.
There
is reason to believe that most of these features of
manufacturing growth during the neo-liberal era were
a direct result of policy, defined as consciously
designed acts of commission and omission. These have
had implications for both the pace of growth and its
volatility, as well as for the pattern of growth with
several attendant consequences as noted above. Consider,
for example, the fact that a feature of the 1990s
was the extreme volatility of growth rates in the
manufacturing sector, which in the past had been more
characteristic of areas like finance. This instability
also suggests that even the moderately positive performance
of the industrial sector may not be sustainable.
There
are two factors that seem to explain instability.
On the one hand, the evidence indicates that public
expenditure has been far more unstable in the 1990s.
The latter has been partly because of variations in
the government's degree of adherence to its irrational
fiscal deficit targets initially imposed by the IMF,
partly because of a sudden burgeoning of public expenditure
towards the end of the 1990s because of the implementation
of the Fifth Pay Commission's recommendations, and
partly because of the influence of the political business
cycle that results in a ramping up of public expenditures
of certain kinds in the run up to an election. It
needs to be noted that it was not the agricultural
cycle that influenced the government's inter-temporal
expenditure patterns (as used to be the case when
the agrarian constraint was binding in the sixties
and seventies); not was it the threat of a balance
of payments crisis that constrained government expenditure
(despite the experience of 1990-91, India has recently
foreign capital flows in excess of that needed to
finance its current account deficit). But for the
moment what matters is that the instability in government
expenditure that contributed in part to the instability
in industrial growth has been the result of autonomous
actions of the government rather than the result of
externally imposed constraints.
The
second factor explaining the instability in manufacturing
growth is the fact that in the initial post-liberalization
years, the sudden increase in access to domestically
assembled or produced import-intensive manufactured
goods resulted in the release of the pent-up demand
for such goods among sections who had had the ability
and the desire to consume such goods, but whose consumption
of such commodities was limited by import regulation
of both final products and intermediates and components.
Inasmuch as such pent-up demand is soon satiated,
the spur to growth provided by this specific factor
evaporated, resulting in a slowing of the growth rate
pending an expansion of the market for such manufactures
among a larger section of the population.
Finally,
instability in the pace of manufacturing growth has
been the result of the specific way in which that
market for manufactures has been expanded, especially
in urban India, during the years of neo-liberal reform:
through a boom in housing and consumer credit. One
consequence of financial liberalization and the excess
liquidity in the system created by the inflow of foreign
capital, has been the growing importance of credit
provided to individuals for specific purposes such
as purchases of property, consumer durables and automobiles
of various kinds. This implies a degree of dissaving
on the part of individuals and households. It also
implies that financial institutions, which are willing
to provide such credit without any collateral, are
betting on the inter-temporal income profile of these
individuals, since they are seen as being in a position
to meet their interest payment and amortization commitments
based on speculative projections of their earnings
profile. These projections are speculative because
of the fact that with banks and other financial institutions
competing with each other in the housing and consumer
finance markets, individuals can easily take on excess
debt from multiple sources, without revealing to any
individual creditor their possible over-exposure to
debt.
There
are two implications of the expansion of the market
for manufactures through these means. The occurrence
and the extent of such an expansion depend crucially
on the ''confidence'' of both lenders and
borrowers. Lenders need to be confident of the future
ability of their clients to meet interest and repayment
commitments. Borrowers (excluding those consciously
involved in fraud) need to be confident of their ability
to meet in the future the commitments that they are
taking on in the present. This crucial role of the
''state of confidence'' in triggering this
form of demand is what is captured in the oft-used
phrase: ''the feel good factor''. Since there
is a strong speculative element involved in lenders
providing credit and borrowers increasing their indebtedness,
the state of confidence of both parties matters. When
such confidence is ''good'', we can experience
growth or even a mini-boom. When such confidence is
low in the case of either borrowers or lenders, we
can experience recessionary conditions. To the extent
that financial liberalization provides the basis for
an expansion of the world of debt - mediated either
through bank accounts or plastic cards - a degree
of volatility in manufactures demand is inevitable.
The
second implication of debt-financed manufacturing
demand is that it is inevitably concentrated in the
first instance in a narrow range of commodities that
are the targets of personal finance. Commodities vary
from construction materials to automobiles and consumer
durables. To the extent that these commodities are
of a kind that are capital- and import-intensive in
nature, the domestic employment and linkage effects
of this expansion would be limited. Not only would
employment growth be limited, as has been the case,
but sustaining the growth process would require generating
more of the same kind of demand. Manufacturing growth
would become increasingly of a speculative character.
It
hardly bears stating that a large share of the commodities
for which demand is triggered by credit are both capital-
and import-intensive in character. There are a number
of other reasons why manufacturing outputs sucked
out by a credit boom tend to have these characteristics.
First, the liberalization of policy with regard to
foreign direct investment has meant that much of the
credit-financed ''new'' market for manufactures
is catered to by these transnationals, endowing these
products with a greater degree of import- and capital-intensity.
This tendency has been helped along by the fact that
those favoured with credit fall in the middle classes,
which too is characterized by a pent-up demand for
''foreign'' goods that could not be satiated
earlier, not just because of protection but also because
they lacked the means (including credit) to acquire
these commodities rapidly. A second reason why domestic
linkage and employment effects would tend to be low
is that a combination of import competition, the induction
of larger firms into the small-scale sector through
the redefinition of ''small'' and ''dereservation''
of areas of production has undermined the ability
of smaller firms to service certain markets. Finally,
with end of the era of development banking in general
and directed credit in particular, the possibility
of such firms obtaining the finance to emerge and
survive has declined.
The
net effect of all these has been the set of disconcerting
trends we spoke of earlier. Identifying the proximate
causes for those trends also helps us specify certain
measures that must be part of any industrial policy
agenda. In the long run, a conducive industrial environment
requires significant structural change such as the
breakdown of land monopoly in rural India, in order
to expand the mass market for manufactures. While
the realization of that goal must wait, the decision
of the new government, as embodied in the CMP, to
launch on a pro-poor development path, provides the
basis for the correction of the errors in policy during
the 1990s that have generated the scenario that we
just described. That scenario was one characterized
by speculative debt-financed consumption and dissaving,
growing import intensity of domestic production and
a sharp rise in capital intensity that implied ''job-displacing
growth''.
There
are four elements that in our view should enter into
any interim industrial policy. First, the role of
public expenditure, especially public investment as
an important stimulus to industrial expansion, through
direct demand expansion and income generation and
by relaxing infrastructural bottlenecks, needs to
be restored. This requires reversing the decline in
the tax-GDP ratio, increasing revenue collection through
more appropriate rates and a wider tax net and focusing
on generating additional non-tax revenues by reorganizing
the public sector rather than resorting to quick privatization
of profit-making public enterprises. It also requires
encouraging demand based on income growth rather than
debt expansion. Second, the role of finance as a stimulus
to manufacturing dominantly through debt-financed
consumption spending must be replaced by one in which
financial institutions dominantly support investment
through lending and investment. This requires reversing
the tendency to undermine the development finance
institutions by converting them into universal banks.
Further, the earlier tendency of the financial institutions
to lend to a few big firms in a few areas, which led
up to the UTI-debacle for example, must be corrected.
More widespread lending, including to small and medium
sized firms is crucial if the phenomenon of job-displacing
growth in manufacturing is to be reversed.
There
is one possibility that needs to be considered seriously
in this context. The commercialization of development
banking has seen the increasing presence of the financial
institutions as active traders in domestic stock markets
in search of high returns. This speculative presence
in the market, which increases the ratio of their
assets held for speculative as opposed to productive
purposes, needs to be curtailed. However, over the
years these institutions have not merely accumulated
non-performing assets in the form of credit to some
of the leading corporate groups in India, but they
have also acquired a large volume of debt and equity
in well-performing large firms. Having supported the
growth of these firms and business houses, it is perhaps
time for the financial institutions to gradually withdraw
from these locations by selling out their assets and
using the funds so acquired to finance new ventures
of a kind characteristic of a dynamic economy.
This
implies that new legislation that helps financial
institutions pursue firms in which they hold non-performing
assets should be implemented. Innovative practices
like securitization of debt to withdraw from debt
provided to more successful business groups should
be adopted. And financial institutions should resort
to a careful process of sell out of equity acquired
(either directly or through the exercise of the convertibility
option) in successful firms in the past. All this
would help release resources that could go into financing
new and needy projects. This would partially reduce
the pressure on the government to increase the investment
ratio in the economy by investing its own budgetary
resources.
The
third area in which the government should make changes
is with regard to foreign direct investment. Such
investment is indeed required and can play an important
role if of an appropriate kind. But foreign investment,
which acquires large chunks of equity in firms catering
to the domestic market, uses these firms to market
import-intensive branded products and then takes out
large amounts of foreign exchange in the form of technology
payments and dividends, needs to be regulated. The
obvious adverse balance of payments implications of
the operations of these firms, implies that to earn
their profits they are draining the national pool
of foreign exchange resources which is then refurbished
with capital in the form of hot money that not merely
drains out further foreign exchange but increases
the vulnerability of the system to financial crises.
It is perfectly rational as well as reasonable that
foreign firms with equity holding above a certain
limit and extracting large technology payments should
at the minimum earn the foreign exchange that they
propose to take out. Further, in terms of emphasis,
the effort should be to encourage foreign investment
that uses India as the outsourcing base for world
market production, with positive net employment and
balance of payments effects. If outsourcing in software
and IT-enabled services is seen as such a major source
of strength for India, there is no reason why outsourcing
in manufacturing should not be seen as positive, and
provided more privileges than foreign investment catering
primarily to the domestic market and regulated for
balance of payments reasons.
Finally,
industrial policy should encourage small scale production
with both employment and linkage effects in mind.
Protecting small scale production with the employment
objective in mind in a labour-surplus economy is not
a form of charitable intervention but rational economic
policy. This was recognized by Mahalanobis in his
four-sector model which explicitly provided for small
and cottage production as a means of neutralizing
the adverse employment implications of investment
in capital-intensive sectors. Such protection would
involve a rethink of excessive import liberalization
in sectors where small-scale production is viable,
a restitution of measures of protection like reservation
of production and differential tariffs, and a conscious
direction of credit from the appropriate financial
institutions to meet investment and working capital
needs.
These
are some of the principal measures that the government
can adopt immediately to redress the distortions which
indiscriminate liberalization parading as ''reform''
has resulted in.
