Finally, working on an industrial policy

The Industrial Policy Discussion Paper could have taken a more holistic view on FDI, technology development and trade

Indian policymakers have finally acknowledged the global revival of discussions on industrial policy, centred around the need to go back to such an approach. Grossly misunderstood and maligned, industrial policy has been anathema to market-led growth strategies. This has shown signs of changing after it became known that neo-liberal champions, including the US, have adopted active industrial policies to support their domestic manufacturing sectors directly or indirectly, especially since the 2008 global financial crisis.

But despite the initial excitement it elicits, the Industrial Policy Discussion Paper (DP) recently put out by the department of industrial policy and promotion for comments disappoints. Given that the Indian economy is at an inflection point as it rightly identifies, it should have proposed a comprehensive framework that addresses the inter-related issues impacting industrial performance. This should have necessarily involved an objective stocktaking of ongoing government schemes and benchmarking them against earlier policy recommendations, including those in the 2011 National Manufacturing

Policy.

Piecemeal approach

While the stated objective of the new policy is to provide “an overarching umbrella policy framework”, the document considers FDI, exports, domestic value addition, technology development, employment, etc, in a piecemeal manner. A crucial part of the diagnosis of the current state of Indian industry would be an explicit recognition that trade and investment policies are integrally linked with industrial policy. While the focus in the DP is on increasing “global strategic linkages” and there is a noteworthy call for undertaking an FDI policy review, there is no mention of the ongoing industrial slowdown and growing import dependence of Indian industry after 25 years of liberalisation of trade and FDI policies.

Arguably, the huge increase in import dependence and the low level of FDI into the manufacturing sector can both be linked to the market failures associated with non-strategic trade and investment liberalisation, which have negated both domestic and foreign producers’ incentives to undertake production locally. Apart from liberalising FDI entry non-strategically into almost all sectors, Indian policymakers have also liberalised other FDI-related regulations (technology collaboration, performance requirements, etc.) over and above what is required under the WTO’s Trade Related Investment Measures agreement. The failure to reframe policies ingeniously to ensure that FDI inflows served to improve the manufacturing and technological capabilities of the country needs to be urgently corrected.

Another central problem has been that trade liberalisation in most sectors has also not been aligned with development needs. This has been exacerbated by signing free trade agreements (FTAs) on the basis of an argument that participation in FTAs will enable Indian firms to become part of global value chains (GVCs) and improve their export capabilities. This has been especially reflected in the kind of tariff liberalisation that India undertook in its FTAs with Asean, Japan and South Korea, whereby the country has reduced or eliminated tariffs across the board. In the absence of active industrial policies to upgrade the domestic manufacturing and technological base, such tariff liberalisation has led to these partners achieving greater market penetration in India than what India could achieve in their markets. In light of such evidence, the DP should have recommen- ded that more FTAs should not be signed before evaluating the existing agreements.

Critical interface

The interface between the extent of trade liberalisation carried out by India and her ability to obtain developmental benefits from FDI is critical. Neither technology transfer nor domestic value addition by a foreign investor occurs voluntarily unless there is some advantage in it. Once tariffs are already very low, a country loses a major trump card — access to the large domestic market — which has been used by China effectively in some strategic sectors, including electronics and telecommunications. In such a scenario, it is not labour market conditions but technological strength and its continuous upgradation that will help domestic firms attract/utilise FDI sustainably and gainfully. Moreover, there is mounting evidence globally that the very entry and level at which developing country firms integrate into any GVC (which, in turn, determines their scope for moving up the chain) are conditional upon their existing technological capabilities.

All these clearly underline the need to recalibrate not just FDI policy, but equally crucially, trade policy. Simultaneously, the country requires active interventions to build and upgrade domestic entrepreneurial and technological capabilities. It needs to be stressed that following dilution in the role of tariffs as industrial policy, several countries have been using non-tariff measures such as sanitary and phytosanitary measures, technical barriers to trade, environmental/resource protection, etc. The DP has no discussion of these, all of which impact upon industrialisation efforts, particularly in the context of developing green technologies.

It would also have been pertinent for the DP to note that successive governments failed to pursue two major roles that were assigned to the public sector in the 1991 Industrial Policy, namely: (a) technology development and building of management capabilities in areas crucial for long-term development of the economy where private sector investment is inadequate; and (b) manufacture of products where strategic considerations predominate. These remain critical and should be re-emphasised in any new vision for industrial development.

Moreover, despite the evidence that the credit needs of MSMEs are unmet by private commercial banking and financial entities, the DP has recommended other market-based financing instruments such as peer-to-peer lending and crowd sourcing. Experiences from other countries including Brazil and China show that long-term financing needs of SMEs can be effectively supported publicly. Purely market-based mechanisms suggested by the DP may play only complementary roles.

It would be timely for a new industrial policy document to dissociate both state support for industrial development and public sector firms from the legacy of the excesses that were part of import-substitution industrialisation and grant them their rightful place in financing long-term investment and technological change. To ensure this, financing mechanisms must be designed in ways that preclude political leverage to avoid rent-seeking behaviour and inefficiency. Moreover, any government support must be time-bound and periodically modified based on performance monitoring. This was one of the factors that distinguished the successful industrial policy regimes of South Korea and Taiwan.

Trade, investment, fiscal and financial sector policies and policies for skill and technology development have to be coordinated within a strategic framework to achieve sustainable industrial development. This requires that along with policies geared towards upgrading firm-level, industry-level and economy-wide productivity, trade and FDI policies do not negate incentives for domestic production. These challenges need to be addressed.

The writer is a Delhi-based economist