India’s Manufacturing Moment

On 12 May 2020 amid COVID-19 stress, the Modi-led government sounded a clarion call for Atmanirbhar Bharat and Vocal for Local. The call came amid heightened emphasis on diversification of global supply chains in the backdrop of supply shocks from China. The government of India realized this was an opportune time to attract new investments to bolster share of the manufacturing sector to 25% of GDP from the current stagnation at 14-15%. We believe if executed well, Atmanirbhar has potential to create a competitive manufacturing ecosystem in India and push its contribution to 18-20% of GDP.

Previous attempts to do so under the aegis of Make in India have seen limited success as there was no specific focus to address shortcomings India faces, such as high logistics cost, relatively poor infrastructure, restrictive labour laws, inverted duty structure to name a few. Even though, India’s manufacturing wages in assembly are only 43% of that of China and just slightly below that of Vietnam, India ranks lower in overall logistics & infrastructure index and has much higher land cost. After deducting subsidies, tax breaks and gains due to ease of doing business, effective cost of manufacturing mobile handset in China is 79.55% compared to 89.05% for Vietnam and 92.51% for India.

Despite Make in India, India’s manufacturing value add in various sectors lags those of EMs. India’s domestic manufacturing as well as exports has anti-labour bias. Even today, the share of unskilled labour-intensive merchandise exports in China is higher at 20.2% vs India’s 14.5% despite China moving into high value-add exports. In the absence of any concerted export policy, India has been losing its comparative advantage in labour-intensive sectors and has now begun to compete with China in some high value-added, capital-intensive and skilled labour-intensive exports.

The Atmanirbhar Bharat program addresses some of the shortcomings of the Make in India program and tries to incentivize investment through fiscal incentives and uses import restrictions as a means to develop the manufacturing ecosystem for new-age sectors. While the strategy of import substitution suffers from several downsides because such a strategy relies only on protections instead of rewarding production, we believe if complemented well with reforms in factor markets, taxation and ease of doing business, it can boost manufacturing ecosystem in India. We believe recent labour reforms are the step in the right direction. In fact, a cross country comparison of India, Vietnam and China on labor laws shows that except for provisions related to retrenchment and layoffs, India does not fare as badly compared to its Asian peers.

While analyzing the rationale behind Atmanirbhar Bharat , we take a specific example of mobile phone manufacturing and highlight the steps taken by the government to build manufacturing capabilities over the past three years and estimate value add generated through mobile phone manufacturing under the Production Linked Incentive (PLI) scheme at 1.7% of FY20 GDP. We estimate India would be able to garner export revenue of ~ USD 57 bn per annum in five years from now through handset exports.

While the value add potential for mobile phone manufacturing in India is unlikely to be more than 30-35%, we argue in favour of the same by showcasing gains China’s economy has made. We believe this can pave way for India to make a sizeable contribution to global value chains which in turn can lead to gains for India’s per capita income, labour productivity, exports, employment and domestic value add. Studies by C. Veermani and Anwesha Dhir (2020) on India data show a10% increase in foreign value added share of gross exports leads to a 17.9% increase in dollar value of gross exports, which, in turn, causes domestic value added (from exports) to increase by 7.7%, Finally, a 7.7% increase in domestic value added increases employment by 13.2%.

Any discussion about mobile manufacturing would be incomplete unless we discuss Vietnam’s mobile manufacturing sector and highlight why it should not be India’s role model. In a related section, we highlight why Vietnam has failed to rise up the value chain and lessons for India. In this context, we find merit in India’s concerted approach to attract investment into higher value-added products of mobile manufacturing.

We conclude by suggesting criteria that should be used for determining sectors that should qualify for interventions under the Atmanirbhar Bharat program. We set three conditions, namely, the sector should lead to high value addition, it should have relatively low capital intensity and consequently higher asset turnover, and India’s import dependency within the sector should be high and concentration risk should be elevated. Accordingly, we recommend the following sectors that can become suitable candidates for support: fabricated metal products, electronics & electrical equipment, knitted apparel, furniture, bedding, leather products, footware, optical & photographic instruments, musical instruments, food processing, toys, games and sport goods.