With an unstable relationship between the US and China looking like a long-term geopolitical reality, pressure to relocate manufacturing away from China is growing. Could neighbouring India, which has a similar population size and rate of economic growth, be positioned to benefit from the shift?
I believe this is not a realistic expectation. Understanding why requires a quick recap of India’s industrial history.
Constructing — and dismantling — the socialist edifice
In the decades after India gained independence in 1947, while East Asia was opening up to the rest of the world, Indian manufacturing stagnated under a series of protectionist trade policies and a socialist industrial model that stifled competition, discouraged innovation and encouraged downsizing rather than expansion. Labour was protected to the point of dysfunction, while education and skills languished in the hands of a corrupt and inefficient bureaucracy. India’s location did not help — in a historically poor region far from key sea routes, with poor connections with the West and East Asia.
Reform came in the early 1990s when a spike in oil prices sparked by the Gulf War coincided with a trough in remittances from Indians in the Gulf. With FX reserves for imports and debt servicing running dangerously low, a desperate Indian government secured an emergency loan from the International Monetary Fund in 1991. In exchange, the government implemented sweeping reforms to open up the economy.
By the 1980s, India’s growth was accelerating fast. But it was arguably too little too late for Indian manufacturing. East Asia had captured a large chunk of the export market and had established the global supply chains and networks necessary to trade.
Instead, since the 1980s, services have dominated India’s economy, contributing two thirds of GDP growth. Within services, the fastest-growing sectors have been finance, communications and information technology — the modern parts of the economy. The finance sector has grown by over 11% annually on average since 1983. Communications grew by nearly 20% annually between 1993 and 2013. Not only have services generated growth, they have had much higher productivity than other sectors, and have created jobs.
The key to these sectors’ phenomenal growth has been a technological surge, driven by the computer, mobile phones and the internet. This has been enhanced by a domestic readiness to accelerate in the services sector, which was spared the ills of India’s stifling trade, industrial and labour policies.
I believe services will remain the principal driver of economic growth as agriculture shrinks and manufacturing, at best, maintains its share of GDP. With 400 million smartphone users and with data costs essentially falling to zero, the digital economy is growing much faster than the traditional economy. In the digital economy, you don’t need to invest in plants and machinery, but in brands, marketing and human capital.
Most of India’s start-ups are not in manufacturing; they are in services, such as online retail, digital health and education services, online media, transportation & logistics and fintech. The digital economy has scale and can increase productivity. It also plays to India’s strengths of bottom-up, unregulated growth. The common theme in these success stories is that software is trumping hardware.
Changing consumer trends
As India’s per-capita income increases, demand is gradually shifting from food, apparel and other manufactured items to services such as media & entertainment, financial services, health care and education. Therefore, spending on services as a proportion of total income is likely to rise, and spending on food and apparel is likely to fall. These demand trends are another reason for the services economy to grow faster than the manufacturing economy. My next piece will look in greater detail at these changes in demand.
Sectors of the future
While finance and IT are likely to remain at the forefront of growth, the expansion in services is becoming increasingly broad-based. Technological change is impacting traditional service sectors — retail, transportation, travel and hospitality, health, education, media & entertainment and government services.
A manufacturing comeback is unlikely
India’s manufacturing is still constrained by several factors, including high land acquisition costs, high taxation, outdated labour laws and still-weak infrastructure, and there are few new entrants. Car manufacturing has not seen a new entrant in years, while Uber, Ola and a host of two- and three-wheeler fleet and taxi services are on the rise.
With increasing protectionism in the goods trade and the Trump administration’s attempts at on-shoring manufacturing output, I believe that for India to follow an export-led manufacturing strategy would be unlikely to produce the same rewards as it did historically for many East Asian countries.