Beijing lessons for Delhi?

Expert view on Indian manufacturing vis-à-vis China

As Prime Minister Narendra Modi’s “Make in India” project to boost domestic manufacturing capacity gains momentum both in terms of policy focus and the public discourse, this week The Hindu turned to academic experts to ask what substantive macro-changes are required to make the campaign a reality and not merely a catchy slogan.

Critical questions were posed to them pertaining to the comparison of India’s strengths in manufacturing vis-à-vis China, and whether there is something India can learn from Beijing’s approach towards domestic manufacturing.

China’s multi-year lead

After all, as K. Sudhir, James L. Frank Professor of Private Enterprise and Management and Director of the China-India Insights Programme at Yale School of Management, pointed out, India has lagged 10 years behind China in economic reforms — 1991 versus 1980.

Similarly, in terms of the Gross Domestic Product, China became a $1-trillion economy in 1997-98, a $2-trillion economy in 2004-05, and is today an $8-trillion economy, whereas India hit the one-trillion mark only in 2007, and though close, has not yet become a $2-trillion economy.

While few economists may project that kind of “geometric growth,” Professor Sudhir argues, equally few economists predicted 10 years ago that China would be an $8-trillion economy by 2014. “There is hope that if Mr. Modi [Prime Minister Narendra Modi] sets the right regulatory tone for India, we may be able to unleash the kind of growth China has had in the past 10 years,” he says, a target that is by no means certain, but by no means impossible.

Private sector matters too

But it is important to get the context right. Policy shifts may be a key element of spurring such growth but some part of this process boils down to the private sector.

Specifically, Economics Professors Nicholas Bloom and Megha Patnaik of Stanford University argue that a focus on increasing the competitiveness of Indian firms through higher Foreign Direct Investment and on improving ease of business through better rule of law is required, in addition to managerial training on current best global practices.

The evidence that they have compiled on Indian firms’ operations is compelling, pointing to the fact that “Indian firms show low awareness of lean management practices and claim they are as good as other firms, without a need to improve.”

Further, the Stanford experts underscore weaknesses in the performance of firms with family ownership, which tend to be “worse managed and less productive and less profitable.”

They explain that while family managers may not necessarily be the best choice for the job, given the poor rule of law in India, firm owners may be reluctant to hire outside managers, thus reducing the competitiveness of their firm because of the weak business environment.

Optimal environment

This brings us back to the legal and legislative frameworks that underpin the environment in which firms of all sizes operate, and to that extent “ease of doing business” is also driven by labour costs and the rules for labour market flexibility.

Why does labour market flexibility matter?

Professors Bloom and Patnaik explain that more flexible labour laws help firms align the incentives of workers, by allowing pay to be based on performance rather than tenure, and to allow hiring and firing based on performance. They found in the case of a range of U.S. states they studied that firms in states with more flexible labour laws had management practices linked “with higher profitability, higher innovation and higher growth.”

Economic control, Beijing-style

At this point, it is worth returning to the comparison with China.

Contrary to common assumption, Professor Sudhir argues, in reality China is a highly decentralised economy, with city and provincial officials held to a very high level of accountability for economic growth and other metrics, and where there are enough price signals in the market that drive production.

“The mayors and provincial officials of the Communist Party perform well because their careers and promotions depends on GDP growth of the areas under their control. While this has occasionally led to ‘growth for growth sake’ problems, by and large this has proved beneficial,” he says.

But there is a “dark side” too: on balance, Chinese officials only act on metrics they are measured on, but not on social metrics such as education, health and pollution, Professor Sudhir says, and this is entirely unsurprising as they do not get the feedback from the local people about the “balance” in their social and economic needs, and hence focus much more on economic growth.

Eschewing the command economy

He explains that in India, it is not democracy that is a problem, but the lack of accountability for bureaucrats or politicians on the economy, which also goes hand-in-hand with a greater focus on short-term subsidies to buy votes rather than long-term policies to boost investment. It also fuels a system of regulations that help enrich politicians and bureaucrats to ensure the need for bribes.

Professors Bloom and Patnaik appear to concur on the unsuitability of a command-type economic system for India. “A command economy is neither viable nor valuable in India,” they argue adding that the government should focus on encouraging the many entrepreneurial private firms in India through improving business environments with better rule of law, better access to finance and more flexible labour regulations.

Hope is not lost for emerging democracies like India, Professor Sudhir says, and “If a stable government can convince the people that investment can lead to better outcomes for them relative to subsidies, and can discipline themselves to have a longer term perspective around investment, India will be able to create the infrastructure environment necessary to stimulate long-term growth.”

While China may enjoy an extensive head start across manufacturing sectors, India could potentially outperform its neighbour in a different regard — balancing labour protections versus the need for efficiency.

Mass persuasion is key

This balance should not be viewed as an “either-or,” argues Professor Sudhir, and to a great extent this may depend on the ability of the Modi government to persuade the masses that there will be more jobs and more pay for labour.

“We need to move the dialogue with labour to a win-win mind-set where we expand the pie, rather than grab a larger share of a small pie. Perhaps, Mr. Modi can use his gift of persuasion and oratory to persuade the electorate that what we want to do is earn more rather than have a large share of a small pie.”

At this potential inflection point in growth though, the Indian economy faces a situation where “in our urge to make firing and laying off so difficult, we have tilted the pendulum so far back as to make people afraid to invest. We should make it costly to fire people, but it should not be so costly to deter investments. There is ample space for a middle ground,” Professor Sudhir argues.

In part it may be a problem of messaging and shaping the public discourse. Professor Sudhir notes that think tanks and the media have a critical role to play here, especially if they are able to shed ideologies about “us versus them” notions of “class warfare.”

Competition, competition, competition

Once a general “buy-in” has been obtained for desired reforms at the national level, the Central government could create an environment of competition between the State governments which have meaningful control of resources and thus possibly “mimic” some of the success in manufacturing that China has had, argues Professor Sudhir.

A system of “score cards” on various metrics, which incentivise bureaucrats and state ministers to aspire towards higher rankings during their terms and win reputations for effectiveness may be a good thing, he adds noting that this competition could also be extended to FDI.