India’s Prime Minister Narendra Modi has rightly picked “Make in India” as the most important plank in his drive to help accelerate the country’s rise towards becoming an economic superpower.
His target is to grow the manufacturing sector’s contribution from 17 percent of India’s gross domestic product (GDP) in 2013 to 25 percent within the next decade. A rapidly growing manufacturing sector is the only way India can create highly productive jobs for the 10 million-plus youngsters who join the country’s labor force each year and the much larger number of farmers who need to move from working the soil to the working on the factory floor.
China’s former leader, Deng Xiao Ping, launched a similar initiative in 1992. At the start of the 1990s, China’s share of global manufacturing was 2.6 percent , down on the 2.9 percent share in 1980. After 1992, however, the country’s manufacturing share grew rapidly – to 7.1 percent in 2000 to 24.9 percent in 2013.
How did China do it? What lessons does China’s experience hold for India? We discuss four policies which helped China’s emergence as the world’s factory and their relevance for India.
Building Infrastructure “Ahead of Time”
Over the last 35 years, China has been the world’s most aggressive investor in domestic infrastructure — roads, rail, waterways, power, ports, airports and telecom. According to McKinsey Global Institute, during 1992-2011, China spent 8.5 percent of GDP on infrastructure, much more than any other large economy. During this period, India spent 4.7 percent of GDP on infrastructure while Latin America spent a meager 2.3 percent.
Investing in infrastructure ahead of time eliminates supply-side constraints, boosting the availability of most factors of production while reducing their cost. India’s physical infrastructure today is not very different from that of China in the early 1990s. Since India is also playing catch-up, it needs to start spending on infrastructure at 9-10 percent of GDP as quickly as possible. Capital availability is unlikely to be a constraint.
Letting Selected Industries and Regions Take the Lead
Rather than aiming for a resurgence of manufacturing across the entire economy, China’s policy makers let selected industries and geographic regions take the lead in ramping up manufacturing. The lead sectors were export-oriented consumer goods (such as textiles, shoes and toys) and infrastructure and real estate- related industries (such as steel, cement, glass, construction equipment, and ship-building). And it was the east coast that took the lead – especially from Shanghai to Guangdong. As documented in academic studies, historically, this region has been home to some of the most entrepreneurial people in China. It also enjoys geographic proximity to Hong Kong and Taiwan, two economies that have abundant capital and are highly integrated into the global economy.
Letting some sectors and regions serve as pioneers enables the country’s leaders to start ramping up manufacturing in those segments of the economy with already enjoy some comparative advantage. These early movers also become showcase examples from which other industries and regions could learn from. In the case of India, pioneering industries that can start boosting manufacturing’s contribution to GDP include infrastructure-related industries, alternative energy (especially solar), automotive, consumer electronics and defense. Among large economies, India today is the world’s fastest growing market for solar panels, cars as well as smartphones and the world’s largest importer of defense equipment. The Modi government’s push to boost domestic production in these sectors holds considerable promise. Geographically, the early movers are likely to be some of the states along India’s large coastline such as Gujarat, Maharashtra, and Tamil Nadu.
Sharp Reduction in Barriers to Inbound FDI
Starting in the early 1990s, China started dismantling barriers to inbound foreign direct investment (FDI). The reforms included lowering of policy-driven barriers and the creation of several special economic zones which provided rapid access to needed licenses and permits, easy availability of ancillary services, as well as many tax incentives. From 0.8 percent of GDP in 1990, inbound FDI flows grew rapidly to 3.4 percent of GDP by 2000.
For emerging economies such as China or India, the importance of inbound FDI goes well beyond mere financial capital. Multinational enterprises bring valuable knowhow as well as links to global supply chains and markets. Longer-term, the economic impact of these “non-financial resources” can be much larger than that of financial capital. The lessons for India are clear. In 2013, India’s inbound FDI flows were 1.5 percent of GDP, lower than in 2010 (1.6 percent), and lower than the 2013 figures for the ASEAN region (5.2 percent) whose GDP size is only slightly larger than India’s. FDI inflows into India need to be much higher: at least 3 percent of GDP. The Modi government has made a promising start by increasing the permitted level of foreign ownership in the defense and insurance sectors to 49 percent and in the rail sector to 100 percent. The government also aims to improve India’s ranking in the World Bank’s Ease of Doing Business index from a lowly 142 to above 50 in the next two to three years.
Investment in Skill Development
Until the recent emergence of labor shortages, China’s manufacturing sector has benefited from a growing pool of young workers trained for production jobs in government-run vocational schools. At the start of the reforms in 1980, only 19 percent of senior high school graduates came out of vocational schools. By 2001, however, driven by a policy to emulate Germany’s dual-track training system, the proportion of senior high school students graduating from vocational schools was much larger: 45 percent or about 6-7 million vocationally trained graduates each year. This policy ensured that 90-100 percent of the young workers joining China’s factories would be well-trained.
In contrast, the state of vocational training in India has been much weaker. Various surveys suggest that, as of 2009-2010, only 2-7 percent of India’s youth were receiving vocational training. It is difficult to imagine Mr. Modi’s “Make in India” initiative achieving its targeted goals without redressing the gap in vocational skills. The World Bank estimates that India’s economy is currently growing at a faster pace than China’s and forecasts it is likely to remain the world’s fastest growing large economy for the foreseeable future. For these projections to materialize, it is critical that Mr. Modi succeed in realizing his goals for the “Make in India” initiative. The dragon to the north has already demonstrated that this can be done. India would do well to learn the lessons from its neighbor’s success.