What India must do to modernise
Daily Times Monitor
Historically, successful development has involved exporting labour-intensive manufactures. Despite opening up to the world economy in many respects, Indias policies continue to retard the expansion of labour-intensive sectors. Here is a discussion of how India could speed its transition to a modern economy.
A key advantage claimed for the outward-oriented development strategy is that it allows poor, labour-abundant countries to specialise in labour-intensive products and, thus make efficient use of limited capital stocks. To quote Anne O. Kruger (1985), An export-oriented strategy permits countries to use the international market to exchange their own, relatively labour-intensive commodities for capital-intensive goods.
They are thus able to take advantage of the division of labour and specialisation. This ability contrasts sharply with import-substitution policies under which labour-abundant developing countries produce the entire spectrum of manufacturing goods and experience high and rising capital/labour ratios.
The experiences of South Korea, Taiwan, Brazil and most recently China offer broad support to this claim. Increasing shares of industry in GDP in general and of labour-intensive manufactures in particular accompanied the adoption of outward-oriented strategies in these countries. Exports of unskilled-labour-intensive products such as apparel, footwear, toys and numerous light manufactures expanded rapidly.
Indias recent engagement with the world economy has produced a contrasting pattern, however.
Contrary to the impression in many circles, Indias industrial and services sectors are almost as open as those of China. The simple average of industrial tariffs is 12% compared with 9% in China. The highest industrial tariff rate (with tariff peaks in several sectors) has been brought down to 10%. In fiscal year 2005-06, custom duty as a proportion of merchandise imports was just 4.9%. With some negative-list exceptionsmost notably multi-product retailthe goods and services sectors are quite open to foreign investment. Only in exceptional cases such as insurance and media the sectoral cap on foreign investment caps are below 51% and in most cases go up to 100%. While this opening-up has been accompanied by acceleration in growth to 6.3% during the last two decades and to almost 9% in the last four years, Indias experience differs from that of China in at least three important respects. First, while India has seen the share of agriculture in the GDP decline, it has not experienced perceptible rise in the share of manufactures.
Second, exports out of and direct foreign investment (***) into India have not seen the same rapid expansion as that seen in the case of China. Finally, fast-growing exports from India have been either capital-intensive or skilled-labour intensive. The shift in favour of unskilled-labour-intensive products traditionally observed in response to the adoption of outward-oriented polices has not happened in India.
Indian exceptions: The share of manufacturing in the GDP in India has been stagnant at 17% since the early 1990s. In China, this share stood at a hefty 41% in 2006. Indias leading and fast-growing exports, such as engineering goods, petroleum products, gems and jewelry, and software, are either capital-intensive or skilled-labour intensive. The share of textiles and textile products in total merchandise exports has declined to 15% in 2005-06 from 20% in 2003-04. Within this category, unskilled-labour-intensive ready-made garments account for only half of the exports. In contrast, the export pattern of China quickly adjusted to its factor endowments after it began opening up its economy in the late 1970s and early 1980s.
First, exports of textiles, apparel, toys, sports goods and footwear surged. Then in the 2000s, with rising skill endowments, it moved into more sophisticated assembly operations such as office machinery, telecommunications and electrical machinery.
The most dramatic difference between India and China lies in the magnitude of international economic engagement. One measure of this difference is that the annual expansion in Chinas trade has been larger than Indias total annual trade during last several years. For instance, Chinas merchandise exports expanded by $169 billion to $762 billion in 2005 in comparison to Indias total merchandise exports of $103 billion in 2005-06. Equally dramatic are Figures 1 and 2 with the former showing the evolution of China and Indias two largest merchandise exports and the latter depicting *** inflows. What holds back India?: How do we explain these differences in the response to trade openness of two economies with very similar factor endowments? The key to answering this question is the poor response of large-scale labour-intensive manufacturing including assembly and processing activities in India. As per the conventional wisdom, these activities have served as the magnet for *** and a conduit for rapid expansion of exports in China. But this has not happened in India. Large-scale labour-intensive manufacturing activities have been virtually absent from India. Apparel factories employing thousands of workers under a single roof found in China are non-existent in India.
While high growth has helped India bring its poverty ratio (the proportion of the poor below the official poverty line) down from 36% in 1993-94 to 27% in 2004-05, its transition to a modern economy remains problematic: it must still move the vast majority of its workforce out of farming into non-farming activities. With the services leg doing all of the walking, the economy can only limp along towards this transition. For a more rapid transformation, India must walk on two legs. That means more rapid growth of the labour-intensive manufacturing.
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