A re-look at production-linked incentives

The best way to support the manufacturing sector is to free it from the umpteen regulations that have stalled investment for decades

September 27, 2022 12:22 pm | Updated 02:12 pm IST

Under the PLI scheme, the government has offered subsidies as high as 50% to companies producing goods, ranging from semiconductor chips to drones. File photo.

Under the PLI scheme, the government has offered subsidies as high as 50% to companies producing goods, ranging from semiconductor chips to drones. File photo. | Photo Credit: Bijoy Ghosh

Many Indians on a daily basis use sophisticated goods that are either fully imported or just simply assembled in India. This is because India lacks a well-developed manufacturing supply chain that could help produce things from scratch. To tackle this, in 2020, the Central government came up with the Production Linked Incentive (PLI) scheme that proposed to promote the domestic manufacturing sector, create more jobs, and cut down on imports. Under the PLI scheme, the government has offered subsidies as high as 50% to companies producing goods, ranging from semiconductor chips to drones. Naturally, several companies have competed for these subsidies. According to the government, hundreds of companies across 14 sectors have been shortlisted to receive subsidies.

Comparing sectors

Over the years, many experts have strongly argued that India’s manufacturing sector, which contributes to about 15% of the country’s gross domestic product (GDP), is too tiny to absorb excess labour from the agricultural sector. Their contention may be true. But the only way to know the right size of manufacturing or any other sector in any economy is by letting market forces play out. At the end of the day, whether a piece of land is best  used to raise a crop, or build a semiconductor chip manufacturing unit, or set up an information technology park depends on  consumer demand for their final output. It is not the job of economic policymakers to promote the allocation of resources towards particular sectors; it is a job best left to entrepreneurs.

It may be true that many developed economies transitioned from agriculture to manufacturing before they started building their services sector. But there is no hard and fast rule that all economies need to follow the same path of economic development. If India’s advantage lies in its services sector, there’s no reason why its manufacturing sector should contribute to a quarter or half (pick any arbitrary number) of its GDP just to copy the economic trajectory of developed countries. It should be up to entrepreneurs, guided by the preferences of consumers, to decide which sectors to develop and which ones to desert.

Are subsidies the answer?

Next, even if manufacturing in India is truly underdeveloped when compared to its real potential — as may well be the case — the way to promote its growth is not through subsidies. The best way to go about it is to free the sector from umpteen regulations that have stalled investment for decades. This will ensure that entrepreneurs can satisfy consumer desires without the burden of unnecessary regulations. The granting of subsidies can also misdirect the allocation of resources. It should be remembered that the primary purpose of a market-driven economy is to allocate resources in the most efficient manner, which means in accordance with the preferences of consumers. Subsidies such as the ones offered under the government’s PLI scheme disrupt the plans of consumers and replace them with the diktats of government officials. Furthermore, these subsidies can turn out to be a huge drag on the economy as they are funded by taxes which negatively affect the incentive that people possess to work or create economic value.

Lastly, a major issue with the PLI scheme is the potential risk of favouritism. When government officials get to decide who gets subsidies and who does not, there is always the risk of corruption. Supporters of the scheme believe that the risk is mitigated through objective rules that define the eligibility for subsidies. But even when there are clear rules, in schemes like the PLI there is still an element of discretion involved in the interpretation and implementation of the rules.

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