The shape of manufacturing 3.0 for Modi 3.0

The United States has a stake in ensuring India’s success in having a robust manufacturing base

Updated - July 10, 2024 02:10 pm IST

Published - July 10, 2024 12:08 am IST

‘India’s ability to achieve greater success in manufacturing will require far more moving parts than what the central government in Delhi controls’

‘India’s ability to achieve greater success in manufacturing will require far more moving parts than what the central government in Delhi controls’ | Photo Credit: Getty Images/iStockphoto

Prime Minister Narendra Modi has formed the government, albeit now as head of a coalition in his third term. The new government must redouble its efforts on economic reforms, particularly related to manufacturing. India’s continued urbanisation will see hundreds of millions of agriculture workers relocate to cities to find formal employment in the coming decades. A failure to generate low-skilled employment could push staggering stress on India’s governance structures. Success in manufacturing will not only help India’s domestic trade and employment goals but also expand resources for national security — which is good for American interests, too.

Manufacturing base must improve

When the Modi government first took office in 2014, the government committed to increase manufacturing as a percent of gross domestic product (GDP) from 15% up to 25% by 2025. The writer can point to some significant economic reforms that should have helped this target become a reality, most notably the approval of the Goods and Services Tax (GST) in 2017, which largely unified India’s State-level tax codes.

However, as World Bank data indicates, manufacturing is in relative decline, making up only 13% of the GDP in 2022. This compares unfavourably to markets such as Vietnam (25%), Bangladesh (22%), Malaysia (23%), Indonesia (18%), Mexico (21%), and, of course, China (28%).

India has powerful domestic compulsions to improve its manufacturing base. First, India has a massive employment-creation requirement. About half of Indian labour remains mired in low-productivity agriculture. If India’s attempts to enact major farming reforms are successful, there could be a fast, massive transition of employment out of agriculture. These workers are ill-suited for India’s highly successful skilled services sector.

A second reason behind India’s desire to boost manufacturing is the nation’s goods trade deficit. Despite a perception that India is “anti-trade”, India had a little over $1 trillion in goods trade in the last 12 months — and a $250 billion deficit during that period. While hydrocarbon imports account for over one-quarter of India’s imports, manufactured goods such as electronics are a substantial import component. When looking at trade more broadly, India enjoys a large surplus in services trade — about $160 billion surplus in the last 12 months on $518 billion in total services trade. But, again, even though the services sector creates substantial economic output, it employs relatively few workers.

The United States has a stake in India’s success in building a robust manufacturing base for two reasons. First, improvements to India’s industrial base will have direct and indirect effects on India’s ability to underwrite its emerging role in regional security which is increasingly important given China’s rising aggression. Second, some amount of manufacturing will not come back onshore. Having this manufacturing based in friendly countries improves the viability of U.S. supply chains. India’s ability to achieve greater success in manufacturing will require far more moving parts than what the central government in Delhi controls. Most factors of production such as electric power, water, sanitation, labour regulations, land acquisition rules, and environment regulations are primarily controlled by India’s State governments. This is where the new Indian government needs to provide a much higher degree of policy attention.

States and their business environments

The Modi government’s early attempts to stoke States into competition with each other have fallen by the wayside. The rankings of States’ business environments called the “Business Reforms Action Plan (BRAP)”, has not been updated since the COVID-19 pandemic, and was anyway considered weak as it focused on States’ self-reporting on their local business practices which was often at odds with actual investor experiences. The central government’s plan to help craft model industry laws for States to consider has been underwhelming.

The Bharatiya Janata Party (BJP) controls almost half of India’s States. Most of the remaining States are controlled by India’s numerous regional parties, with varying levels of cooperation and friction with the central government. Getting more States to focus on thoughtful, transparent industrial policies is a difficult task and will require an improved toolkit of sticks and carrots. The government should also consider putting stronger emphasis on job-creating manufacturing sectors such as textiles, paper mills, and furniture, instead of pushing almost exclusively for investments in capital-intensive sectors such as semiconductors and robotics.

Go beyond Delhi-Mumbai-Bengaluru circuit

The U.S. can play a modest but meaningful role in improving the business attractiveness of Indian States. This may include expanding engagement with Indian States to provide direct guidance on effective economic governance, and to improve pathways for potential investors to engage with State governments. Senior U.S. officials visiting India must commit to going beyond Delhi-Mumbai-Bengaluru and engaging a wider set of large States on the importance and opportunity from the current evolution of global supply chains.

India’s national election provided an opportunity to assess and redirect policy. But India’s core needs behind the current manufacturing push — jobs, trade, and security — will not change. The size of the market and current growth rates are quite attractive to investors. But more work needs to be done, especially at the State level in India, for “Make in India” to further accelerate.

Richard Rossow holds the Chair in United States-India Policy Studies at the Center for Strategic and International Studies (CSIS). He has worked on India’s commercial reforms for over 25 years in a variety of private sector capacities

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