Summary: In previous episodes, we have analyzed the domestic challenges to India's economic growth, in this episode, we analyze the challenges to India's economic growth from a global perspective. The challenges to development posed by global trends, while not necessarily unique to India, have a direct impact on India's economic goals. Global trends including de-industrialization, peak growth led by IT and services, decline in export growth, stagnation in world economic growth, etc., have greatly exacerbated India's problems.
Historically, manufacturing has provided a platform for structural transformation of countries from predominantly agrarian economies. Whether it is East Asian economies or developed Western economies, their development trajectory has involved manufacturing-based industrialization.
All of these countries once focused their development on manufacturing, starting with the production of simple products and gradually upgrading their technology to produce more advanced products. The higher the labor productivity, the higher the labor income, and this industry-income relationship pushed economies to absorb large numbers of lower-skilled workers, and as their labor skills improved, the industry upgraded along with them. The trajectory of all developed economies shows that the share of manufacturing in output and employment tends to rise, peaks when countries reach middle-income levels, and then falls.
But in recent years, this trend has weakened markedly, as countries become service-dominated service economies before going through the full cycle of industrialization. Development economist Rodrik describes this aborted industrialization trajectory as "premature deindustrialization". Manufacturing has been undergoing some structural changes for many years, driven by a wave of trade liberalization and the globalization of production chains, and the validity of the traditional path of rapid manufacturing-led economic growth has been questioned.
Currently, the de-industrialization of emerging economies, including China, appears to be much earlier; India has not been immune to these long-term global trends. This trend has exacerbated the decline of India's manufacturing sector as a share of the national economy, and is a natural consequence of domestic policies such as the protection of some of the country's outdated industries dominated by small firms, extensive industrial licensing, and labor regulations limiting the number of workers, as well as the decline in the manufacturing sector, which has been fueled by a shortage of infrastructure and skilled workers.
In India, manufacturing's share of GDP has long been stagnant at around 16%. After the global recession of 2008-2009, this fell to less than 13% in 2014, a rapid decline. India's manufacturing share of GDP has now regressed to the levels of the 1960s.
However, the share of employment generated by manufacturing peaked at 13% in 2002, and the decline has been even greater than the fall in the share of output. Worse, India began de-industrialization with a per capita GDP of only $2,000, compared to income levels of $9,000 to $11,000 when manufacturing began to decline in Western economies that year.
A working paper published by the Asian Development Bank shows that when employment peaks, GDP per capita declines much faster than manufacturing's share of GDP declines after it peaks. The study suggests that not only does the manufacturing share of employment peak earlier at any stage of their development, but countries are also investing less in industry. This could dampen the prospects of rapid manufacturing-led growth and job creation in countries like India and Africa.
One of the key drivers of this trend of declining employment driven by manufacturing is repetitive automated production through mechanization, including the use of robots. The declining price of mechanized equipment and the difficulty in recruiting and retaining skilled labor has led to a growing trend of replacing labor with automation, a trend that is now being carried over to India as well. It is estimated that major Indian automobile manufacturers have automated nearly 30% of their production activities.
The trend toward replacing labor with automation has highlighted the need for policy to shift attention away from India's traditional industrial policies, which have largely revolved around fiscal and other capital incentives, often at the expense of ignoring labor costs. In this regard, trade unions announced a budget item in the 2016-17 budget to subsidize the 8.33% employer contribution to employee pension schemes, which would clearly go a long way towards addressing the huge employment pressures in India.
In this scenario, the construction sector, which is now likely to be the second largest employer in India after agriculture, is set to play an even more important role. The share of the labor force it employs rose from 5.6% in 2004-2005 to 11.3% in 2009-2010, while manufacturing's share declined from 12.2% to 11.4% over the same period. Moreover, while the elasticity of employment for the economy as a whole declined from 0.44 to 0.01, the coefficient of elasticity of employment for the construction sector, which is the change in employment corresponding to a unit change in the value of economic output, grew from 0.78 to 1.54.
However, this growth has been underpinned by heavy investment in infrastructure development. Unlike manufacturing, the construction industry, and the construction labor market in particular, operates in a largely informal manner through a large network of informal subcontractors. This helps employers to circumvent their obligations under many laws and regulations, and this semi-underground state of operation, in addition to tax evasion, frees them from bondage and improves the competitiveness of construction firms.
Because of India's chronic infrastructure shortage, Indian scholars believe that the construction industry is likely to continue to grow in the future, making it an important source of job creation in the future. However, what can a prematurely de-industrialized and underdeveloped manufacturing India do to support the huge investment in infrastructure? One can't help but ask a big question mark about this.