INDUSTRIAL PERFORMANCE: AFTERMATH THE ECONOMIC REFORMS

Introduction

The Industrial sector has always been the backbone of India. In 1990–1, Industry contributed 26 percent of India’s GDP, employing 15 per cent of the workforce and using 39 percent of the economy’s capital stock. In the 1980s, industry was the economy’s ‘leading’ sector, growing annually at over 6 per cent, while the domestic output grew annually at around 5.5 per cent and exports, of which two-third were from manufacturing, at 8.5 per cent. The decade witnessed modernisation of the production structure with a step up in infrastructure, delicensing of investment and output controls, and a shift in trade policy from quotas to tariff. However, in 1991, the economy faced a liquidity crisis on account of the Gulf war, (b) collapse of the Soviet Union, and (c) the domestic political uncertainty, paralysing policymaking. 

Encouraged by the industrial and export boom of the 1980s, the orthodox economic reforms initiated in 1991 sought to (i) make a bonfire of the remaining output and investment controls that are said to have throttled private initiative; (ii) cut back public investment as it is believed to have ‘crowded out’ private investment; (iii) undermine the protective and promotional measures for small-scale industries that are claimed to have bred inefficiency and failed to expand labour-intensive manufactures; and (iv) Carry out disinvestments to reduce government’s fiscal deficit. Thus, Policymakers perceived an opportunity in the crisis to quickly undo India’s state-led, inward-oriented industrialization strategy, as it is claimed to have delivered neither adequate growth nor measurable equity

Over the time, there has been discomfort with the regulatory mechanism in India. Soon there was compelling official evidence against the dysfunctional and discretionary policies critiquing India’s industrialization strategy.

Market forces at large have diverse implications for unequal agrarian economy. Liberal trade and investment regime could be a recipe for a flood of imports, decimating domestic enterprise and retrenching workers; domination of foreign capital resulting in deindustrialization, compelling the nation to revert to exporting primary products that face cyclical fluctuations and adverse terms of trade in the long run. Serious apprehensions were also expressed that the reforms could undermine the domestic market–driven independent path of industrialization, denting the long-term growth prospects—as had happened in much of Latin America and Africa after the debt crisis in the 1980s. In other words, while the market-oriented reforms were adopted on the promise of faster and labour-intensive (hence equitable) growth, critics feared debt, deflation, and de-industrialization. With this  view, we start with our analysis of Industrial performance.

INDUSTRIAL PERFORMANCE AFTER 1991–2

The annual growth rates in industrial output as measured by (i) the index of industrial production (IIP) and (ii) GDP in industry and since 1990–1; both the indices show the same trend. After an expected dip in 1991–2 on account of the crisis and adjustment, output boomed for four years, peaking in 1995–6 at 13 per cent—following the predicted ‘J’ curve, vindicating the reform stance. However, the boom petered out quickly, followed by a steep deceleration for seven years until 2002–3. The next boom lasted for five years, from 2003–4 to 2007–8. 

So, the average of annual growth rate over the 17-year period since 1991–2 was 6.6 percent. During this period, consumer durables grew the fastest at 8.1 per cent per year, capital goods at 7.4 percent per year. By two-digit industry groups, beverages recorded the fastest growth at 12 percent per year. However, capital goods due to the reduction in tariffs stagnated during the first boom but bloomed in the next one, growing annually at nearly 15 per cent during 2003–8, led by transport equipment.

Moving forward, we see that in spite dismantling of the much criticized ‘permit licence raj’, the industrial growth rate has not accelerated, nor has the growth rate of labour-intensive consumer goods went up; but there has been no deindustrialization either. Like in the 1980’s debt crisis in Latin America and Africa the shares of industrial employment and output in the total have not declined. The structural transformation of the workforce has continued at the same pace after the reforms, though the workforce has gone into the services, not manufacturing Within the industry, the incremental workforce has gone into construction. When measured by investment, the reforms were not a setback for industrialization, as the manufacturing sector’s share in total fixed investment has gone up from around 27 percent in the 1980s to about 40 percent in the current decade.

As expected the share of capital goods in output and investment fell, due to the state-led import substitution industrialization. But its growth rate went up modestly after the reforms.

Moreover, India’s export basket has got diversified after the reforms, mainly into services. It is outcome of India’s  earlier sustained investments in capital goods and high-technology industries, along with the nurturing of scientific and technical education. However, within merchandise exports, the share of manufactures has fallen from 80 percent in the 1990s to 64 percent in 2007–8 as primary exports such as iron ore) boomed in the current decade.

However, there are some causes of concern. While there is no deindustrialization, industry or manufacturing sector’s share in domestic output has practically stagnated and its export share has declined; by implication, primary sector’s shares in merchandise exports has risen. Arguably, the rising share of primary exports is almost entirely due to iron ore exports to China (Beijing Olympics–related construction), as India rode the commodity boom, perhaps out of the necessity to finance increasing petroleum imports. This was perhaps avoidable, if the much-anticipated expansion of labour-intensive manufacturing was realized. 

Moreover, Coming to employment  we see that manufacturing sector’s share in total employment stagnated despite a respectable trend growth of over 6.5 percent per year. Prima facie, it represents the failure of the reforms to promote labour-intensive manufacturing in spite of doing away with the import substitution bias in the industrial policy. Partly, growing capital intensity of production in general perhaps explains the employment stagnation, as it has become much easier to import the latest labour-saving equipment in an open trade regime with modest tariffs. However, there are some deeper structural reasons as well, with increased outsourcing of manufacture of parts and auxiliary services to the unorganized sector, and forging of close supply-chain networks. Such an organization of production is quite the opposite of the vertically integrated production structures that were common in the early years of industrialization. After the reforms, with increased competitive pressure, under the liberalized rules of resource use, and with lax enforcement of labour laws, firms have apparently restructured their production processes by shedding labour. Conceivably, some of the employment lost in the organized sector would have reappeared in the unorganized sector, though no direct evidence for it is available. Therefore, while the stagnation of the industrial employment share is a cause for concern, it perhaps represents an outcome of the changing market conditions, organization of production, and technology in an open labour-surplus economy. 

Thus, what emerges from the foregoing statistical account is a subtle picture of industrial change. While India has managed to avert deindustrialization, its output growth rate has not accelerated. Manufacturing sector’s share in GDP has stagnated; its share in merchandise exports has declined in favour of primary products—perhaps suggesting signs of weaknesses of the domestic capability. Yet, the sustained growth in output and exports, and a rising share in the economy’s fixed investment are reassuring that the reforms have not damaged, in any essential sense, India’s industrialization prospects. 

Other Aspects of Industrial Change 

The reforms have increased the effective competition in the domestic market with easier imports and entry of new firms. Perhaps, for the first time, there is a buyers’ market in industrial goods, with improved quality, and variety  which is evident from the decline in the relative price of capital goods, making fixed investment more productive. This raised import intensity of production from 12.9% to16.8 % between 1993-4 and 1998–9 thereby reversing the declining trend up the 1980s. Arguably, increased import competition, especially in capital goods, would have enhanced productivity. Yet, the evidence of its impact on total factor productivity growth is not conclusive, though labour productivity has climbed steadily. With the reduction in the entry barriers for foreign-owned firms, their share in manufacturing GDP has gone up from 5 percent in 1991 to about 8 percent in 2007. With the decline in public investment, the share of public sector enterprises in total manufacturing GDP has halved to 8 per cent between 1991 and 2008 

In the 1990s, the manufacturing sector underwent painful restructuring—plant closures, sell-offs of productive assets and relocations, and unprecedented lay-offs and retrenchments In the end, however, it has apparently improved production efficiency to face the increased competition, especially from China. Although research and development (R&D) investments have contracted as a proportion of the domestic output, the restructuring and competitive pressure seem to have spurred innovation and product development. The growing strength and stature of Indian industry and enterprise are also evident from their ability to acquire and manage factories and firms in developed economies in relatively advanced manufacturing industries 

WHY DID THE REFORMS FAIL TO DELIVER THE EXPECTED RESULTS? 

The reforms after 1991 did not yield faster output, employment, and labour-intensive growth. Many argue hat the reforms have remained incomplete, with the persistence of the labour market rigidities, lack of entrepreneurial freedom to hire and fire workers at will, infrastructure bottlenecks, and incomplete financial integration, including full convertibility of the currency.

Based on cross-country analysis, Kocchar et al. argued that India has followed idiosyncratic policies in promoting skill-intensive industries, discouraging labour-intensive manufactures—a pattern that has not changed after the reforms because of the labour market rigidities. They also contend that on average Indian firms tend to be small because workers cannot be fired, preventing them from reaping the advantages of economies of scale in production. But, since skilled workers and professionals are outside the purview of trade unions, India has specialized in skill-intensive industries.

 Following I.M.D. Little, Anne Krueger they have argued that industrial productivity is low in India because of the dominance of large-sized factories in manufacturing industries, representing inward-looking state-dominated industrialization. Krueger believes that Indian factories are either too large or too small, both of which are said to be inefficient while the middle-sized factories (100–500) are the most efficient. She has also identified poor agricultural productivity growth, inadequate infrastructure, and labour market rigidities as the other reasons for poor industrial growth. 

However, the average factory size in registered manufacturing in 2004–5 was 35 workers per factory declining from 140. Thus, Krueger’s observation was correct for the 1950s but not anymore, with the growth of factories in the intermediate-sized classes. The relationship between size and efficiency too can be ambiguous in principle and practice as it could depend on a number of other factors like financial structure and aspects of the  industrial organization. Thus, without further probing, the argument that the size structure of factories in India is per se inimical to efficiency is perhaps difficult to sustain. However, the labour market rigidity hypothesis still remains.

Labour Market Rigidity Hypothesis 

The reformists argue that India’s labour laws are the most protective of the organized labour, which makes firing of workers almost impossible, rendering labour a quasi-fixed capital, leading to substitution of capital for labour, yielding little employment growth. The exemptions and loopholes in the labour laws are sufficient to defy these arguments. Perhaps it is suffice present that  between 1997 and 2004, 1.3 million workers in registered manufacturing alone, lost their jobs without a murmur of protest or industrial unrest Moreover, Since 2008 3.7 lakh workers lost their jobs, mostly in export-oriented textiles and gems and jewellery industries—an ample testimony to the fallacy of the labour market rigidity hypothesis, at least in the aggregate.

Infrastructure Bottlenecks 

That infrastructure bottlenecks are throttling industrial progress is undisputed. Until 1991, public sector provided much of the infrastructure, as in most industrializing economies. But its poor supply was often blamed on lack of resources, enormous cost and time overruns in project completion, and poor public management in general. 

Attributing these problems to public ownership, the reforms have encouraged entry of private and foreign capital in these industries. Infrastructure services, have a long gestation period and are capital intensive, with low rates of return spread over a long period. They are often network industries, where efficiency of an individual plant or a firm depends on the performance of the entire network, and financial returns depend on output pricing, which were public policy decisions. In such industries, foreign investment is fraught with risk.

Thus, we see that infrastructure bottlenecks are the proximate cause for the low-level effect of 91 reforms.

WHAT SHOULD BE DONE NOW? 

The reforms implicitly assume that the policy-induced restrictions on supply are holding back output growth. Surely, there is some truth in this, as industrial regulation had degenerated into an inefficient and dysfunctional system. But  these were not the binding constraints on long-term growth, as the reformists claim. The reforms, in our view, failed to deliver because they ignored the demand factors. Now we know, the long-term industrial growth in India is constrained by supply as well as demand factors, which, it seems, runs on the twin engines of public investment and agriculture productivity. Moreover, in a large agrarian economy, public investment removes constraints on productivity growth in agriculture, creating demand for industrial goods. Surely, the creative function of competitive industrial structure is to spur efficiency, but it need not necessarily translate into faster and labour-intensive growth, as argued in the mainstream economic literature. As the experience of the 1980s has demonstrated, gradual deregulation of industrial markets, along with stepping up of public infrastructure investment and rising agriculture productivity perhaps provided the right demand and supply conditions for industrial turnaround. 

Arthur Lewis famously said that if a nation wants to industrialize, it should enrich its farmers. But farmers have got impoverished after the reforms as the growth rate of crop production has decelerated. This seems to get reflected in the widespread phenomenon of farmers committing suicide (under debt burden), which is not just a crisis of production but also a serious humanitarian. problem. The agrarian distress has also manifested itself in a political crisis, fuelling rural violence.

Proponents of the reforms would probably contend that agriculture has lost the capacity to absorb labour and, in any case, India is saddled with excess food stocks. Both are probably half-truths, India’s land productivity in all major crops is a modest fraction of the world average, so the argument that agriculture has little scope for absorbing labour to increase productivity is simply incorrect. Also the  overflowing food stocks are not a measure of food self-sufficiency when a large proportion of the poor cannot demand food for lack of purchasing power. So, the argument that agriculture cannot absorb labour is patently false. If we believe that the pace of workforce transformation depends on agriculture productivity to sustain non-agricultural employment, then poor agricultural growth is surely retarding industrial progress. 

The other extreme view that agriculture alone can cure all the ills of unemployment and underemployment is perhaps equally false, as the ‘excess’ growth of agriculture can choke industrialization via rising wages in the industrial sector and lack of industrial inputs in agriculture.10 Therefore, what is needed is balanced growth.11 Surely, rising demand from rural economy can boost industrial output, but unless industry modernizes to augment exports, economy may face external imbalance. 

Therefore, what is also required after reaching a certain level of economic development is growing exports of manufactures to meet finance import requirements. As India has more or less completed import substitution phase, what it now needs to vigorously pursue is export of labour-intensive goods to finance its burgeoning import requirements (especially of oil) to lubricate the engine of domestic market-led growth. This requires modern infrastructure and long-term credit at reasonable interest rates. 

But even after steady improvement in the financial performance of public sec- tor enterprises (PSEs) over the last two decades, rising tax–GDP ratio, and a steep increase in domestic saving rate, policymakers continue to favour private sector over public sector in infrastructure development due to fiscal orthodoxy. It is true that in the period after the mid-1960s to 1980, excessive and discretionary regulation stifled private initiative. However, it is equally true that leaving infrastructure to private initiative after the reforms did not lead to faster investment and output growth. 

CONCLUSIONS 

Thus ending the strategic role of the state-led import-substituting industrialization, the two decades of industry and trade policy reforms have dismantled the output and investments controls. Many lines of manufacture have become more competitive.The quality and variety of goods produced have improved; the relative price of capital goods has declined. The unintended boom in the export of information technology and related services can be clearly seen as a consequence of investments early on in the heavy industry and scientific and technical education. A growing number of Indian firms have gained technical expertise to run factories and firms across the globe acquiring technology to enhance their domestic capabilities. 

Mainstream economists claim rigidities in the labour market, inadequate infrastructure, and the incomplete financial sector reforms. Labour market rigidities hypothesis does not hold, with over a million manufacturing jobs lost during last decade without a murmur of protest. 

There is, however, a great unanimity on the need for stepping up infrastructure investment, but not on how to achieve it. With the rising tax revenue and domestic saving as proportions of the domestic output, and with a steady improvement in public sector’s physical and financial performance, lack of resources and organization are no longer the binding constraints on augmenting infrastructure. The real stumbling block, therefore, appears to be the policymakers’ commitment to (i) fiscal orthodoxy and (ii) encourage private and foreign investment in infrastructure provision. 

The principle drawback of the reforms is its exclusive focus on removing supply constraints at the neglect of demand. There is a growing consensus on the need to raise agriculture productivity to find markets for industrial goods, but the view has no serious takers as (i) there are enough buffer stocks to ward off any emergency and to maintain price stability, and (ii) there is a growing belief that agriculture has lost the capacity to absorb labour. Both the arguments are fallacious since the nation’s food needs are far from fulfilled (though enough to meet demand) and the agriculture productivity in most crops is only a modest fraction of the world average. 

Yet, these achievements have not translated into faster and labour-intensive industrial growth or growth in industrial exports, as compared to the 1980s. As a result, the services sector has replaced manufacturing as the economy’s leading sector. Though India did not witness de-industrialization, rather industry’s share of domestic output and employment has stagnated; its share in merchandise export has declined, with rising exports of primary exports.