Why an industrial policy is crucial
Mains Paper 3: Economy
Prelims level: Industrial policy
Mains level: Significance of the industrial policy
- The contribution of manufacturing to GDP in 2017 was only about 16%, a
stagnation since the economic reforms began in 1991.
- The contrast with the major Asian economies is significant. For example,
Malaysia roughly tripled its share of manufacturing in GDP to 24%, while
Thailand’s share increased from 13% to 33% (1960-2014).
- In India manufacturing has never been the leading sector in the economy
other than during the Second and Third Plan periods.
Core to growth
- No major country managed to reduce poverty or sustain growth without
manufacturing driving economic growth.
- This is because productivity levels in industry (and manufacturing) are
much higher than in either agriculture or services.
- Manufacturing is an engine of economic growth because it offers
economies of scale, embodies technological progress and generates forward
and backward linkages that create positive spillover effects in the economy.
- In the U.S. and Europe, after the 2008 crisis, the erstwhile proponents
of neo-liberal policies started strategic government efforts to revive their
industrial sectors, defying in principle their own prescriptions for free
markets and trade.
- The European Union has identified sector-specific initiatives to promote
motor vehicles, transport equipment industries, energy supply industries,
chemicals and agro-food industries.
- The United Nations Conference on Trade and Development or UNCTAD finds
that over 100 countries have, within the last decade, articulated industrial
- However, India still has no manufacturing policy.
- Focussing (as “Make in India” does) on increasing foreign direct
investment and ease of doing business, important though they may be, does
not constitute an industrial policy.
Key reasons for a policy
Need to coordinate
- First, there is the need to coordinate complementary investments when
there are significant economies of scale and capital market imperfections
(for example, as envisaged in a Visakhapatnam-Chennai Industrial Corridor).
Needed to address learning externalities
- Second, industrial policies are needed to address learning externalities
such as subsidies for industrial training (on which we have done poorly).
- In fact, industrial policy was reinforced by state investments in human
capital, particularly general academic as well as vocational
education/training aligned with the industrial policy, in most East Asian
- However, a lack of human capital has been a major constraint upon India
historically being able to attract foreign investment (which Southeast Asian
economies succeeded in attracting).
Role of organiser of domestic firms
- Third, the state can play the role of organiser of domestic firms into
cartels in their negotiations with foreign firms or governments a role
particularly relevant in the 21st century after the big business revolution
of the 1990s (with mega-mergers and acquisitions among transnational
- In fact, one objective of China’s industrial policies since the 1990s
has been to support the growth of such firms (examples being Lenovo
computers, Haier home appliances, and mega-firms making mobile phones).
- Fourth, the role of industrial policy is not only to prevent
coordination failures (i.e. ensure complementary investments) but also avoid
competing investments in a capital-scarce environment.
- Excess capacity leads to price wars, adversely affecting profits of
firms either leading to bankruptcy of firms or slowing down investment, both
happening often in India (witness the aviation sector).
- Even worse, price wars in the telecom sector in India have slowed
profits (even caused losses), which hampers investment in mobile/Internet
coverage of rural India where access to mobile phones and broadband
Internet, needs rapid expansion. The East Asian state managed this role of
industrial policy successfully.
Industrial capacity installed
- Fifth, an industrial policy can ensure that the industrial capacity
installed is as close to the minimum efficient scale as possible. Choosing
too small a scale of capacity can mean a 30-50% reduction in production
- The missing middle among Indian enterprises is nothing short of a
failure of industrial strategy. Contributing to the missing middle
phenomenon was the reservation of products exclusively for production in the
small-scale and cottage industries (SSI) sector (with large firms excluded)
from India’s 1956 Industrial Policy Resolution onwards. By the end of the
1980s, 836 product groups were in the “reserved” category produced only by
SSIs (which encouraged informal enterprises).
- In 2005, there were still 500 products in this category, 15 years after
the economic reforms were launched.
- Thereafter the reservation of products of small firms was cut sharply to
- By then, small scale and informality had gotten entrenched in Indian
manufacturing. Incentivisation to remain small in scale cost India dearly.
Need for structural change
- Sixth, when structural change is needed, industrial policy can
facilitate that process. In a fast-changing market, losing firms will block
structural changes that are socially beneficial but make their own assets
- East Asian governments prevented such firms from undermining structural
change, with moves such as orderly capacity-scrapping between competing
firms and retraining programmes to limit such resistance.
- Finally, manufacturing will create jobs; its share in total employment
fell from 12.8% to 11.5% over 2012 to 2016.
The Asian story
- The East Asian miracle was very much founded upon export-oriented
manufacturing, employ surplus labour released by agriculture, thus raising
wages and reducing poverty rapidly.
- This outcome came from a conscious, deliberately planned strategy (with
Five Year Plans).
- The growing participation of East Asian countries in global value chains
(GVCs), graduating beyond simple, manufactured consumer goods to more
technology and skill-intensive manufactures for export, was a natural
corollary to the industrial policy.
- India has been practically left out of GVCs.
- Increasing export of manufactures will need to be another rationale for
an industrial policy, even though India has to focus more on “make for
- From 2014 to 2018 there has been an absolute fall in dollar terms in
- In this quest for increased exports, economies of scale are critical.
- Such economies were not possible with the policy-induced growth of
micro-enterprises and informal units (the unorganised sector accounts for
45% of India’s exports).
Lessons from IT taking root
- If evidence is still needed that the state’s role will be critical to
manufacturing growth in India, the state’s role in the success story of
India’s IT industry must be put on record.
- The government invested in creating high-speed Internet connectivity for
IT software parks enabling integration of the Indian IT industry into the
- The government allowed the IT industry to import duty-free both hardware
and software. (In retrospect, this should never have continued after a few
years since it undermined the
growth of the electronics hardware manufacturing in India.)
- The IT industry was able to function under the Shops and Establishment
Act; hence not subject to the 45 laws relating to labour and the onerous
regulatory burden these impose.
- Finally, the IT sector has the benefit of low-cost, high-value human
capital created by public investments earlier in technical education.
- Without these, the IT success story would not have occurred.
- These offer insights to the potential for industrial policy when a new
government takes over soon.
Q.1) With reference to the development of railways in British India,
consider the following statements:
1. In order to create confidence among English capitalists, the Government
of India offered a guaranteed interest of
atleast 5% on their investment.
2. The railways followed a system of preferential freight charges.
3. The increased requirement of coal as a fuel in railways led to the
development of coal mining in India.
Which of the statements given above are correct?
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3
Q.1) How would you describe India’s industrial policy? How they can be improved?