The Difficulties of Retooling the Indian Economy

7 MINS READJul 20, 2016 | 09:15 GMT
The Difficulties of Retooling the Indian Economy
The growth of manufacturing, including textile production, in India has remained relatively static, and Prime Minister Narendra Modi's efforts to expand the sector have bogged down over stalled land and labor law reforms.
Forecast Highlights

  • India will likely fail to achieve its goal of expanding manufacturing's share of gross domestic product to 25 percent by 2022.
  • Prime Minister Narendra Modi will be unable to pass land and labor reforms this year.
  • The opposition Indian National Congress party will selectively thwart land and labor legislation, capitalizing on anti-government sentiment among Indian farmers.

Even though India's economy, which grew at a 7.6 percent rate in 2015, is the fastest-growing in the world, job creation in the country has fallen to its lowest point since 2009. Speeding the pace of the Indian economy's shift from agriculture toward manufacturing has been one of Prime Minister Narendra Modi's chief objectives since he took office in 2014. In launching his "Make in India" campaign in 2014, Modi outlined a plan to increase the manufacturing sector's share of India's gross domestic product to 25 percent by 2022 and to add 100 million more manufacturing jobs (currently, manufacturing constitutes 16 percent of GDP and employs some 50 million people). Modi's goal for manufacturing growth is nothing new; the previous administration, led by the center-left Indian National Congress, mapped its own blueprint for bolstering manufacturing in 2011. But entrenched opposition to labor and land acquisition reforms are throwing off the prime minister's timetable for reaching his ambitious goals for the sector.

Despite their ideological antipathy, the Indian National Congress and Modi's Bharatiya Janata Party recognize the need to fortify manufacturing. But as the Bharatiya Janata Party gains seats in the upper house and the Indian National Congress continues its long, slow decline, the latter — along with other leftist opposition parties — will likely try to thwart Modi's plans. As a result, Modi will probably struggle to pass the land acquisition and labor reform measures that are vital to attracting foreign direct investment (FDI) to India's manufacturing sector. Without the reforms, the Make in India campaign's goals are liable to go unfulfilled.

A Peculiar Path

According to one classical arc of economic development, as agrarian societies meet the basic needs of their people, economies transition to manufacturing before developing services sectors. The development of India's economy, however, followed a different trajectory. In 1950, three years after India achieved independence, agriculture accounted for 73 percent of its economy. As the country emerged from British colonial rule, its first prime minister, Jawaharlal Nehru, tried to implement Soviet-style industrialization to reduce the country's dependence on foreign manufactured goods. But to propel itself to modernity, India's agrarian society needed agricultural, land and education reform. In failing to make the necessary reforms, Nehru undermined his industrialization project. Since farmers were not making money, their demand for manufactured goods was low. Then, during the 1960s, the Indian government cut its investment into industry, while the dominating presence of state-owned firms stifled competition. Together, these factors impeded the country's progress toward industrialization. Today, agriculture remains the biggest source of jobs in India, employing nearly 50 percent of the labor force, though it contributes just 16 percent of GDP.

The legacy of Nehru's policies — overbearing state regulation and a byzantine regulatory system known as the "License Raj" — endured. But after a balance of payments crisis forced India to seek an emergency loan from the International Monetary Fund in 1991, things began to change. As a condition for the loan, the IMF demanded austerity measures, and then-Finance Minister Manmohan Singh began to dismantle the License Raj, the first step toward freeing the economy from overregulation. In the wake of those reforms, the country's economic growth rate effectively doubled to 6 percent. From 1980 to 2012, manufacturing — which forms three-quarters of India's industrial sector — saw its share of the economy hover around 16 percent. During the same period, the services sector's portion grew from 40 percent to 57 percent, turning the classic economic development model on its head. Now the shortcomings of that approach are catching up with India's economy.

Laboring Under the Law

Since services jobs require higher levels of education, the influx of semiskilled workers from the waning agricultural sector poses a major challenge for Indian policymakers. The logical place for displaced agricultural laborers to find work is in manufacturing. But manufacturing jobs are not being added in great numbers, in part because of restrictive labor laws that make it difficult for firms to fire employees. Rather than risk hiring employees whom they cannot dismiss, Indian companies favor capital-intensive expansion, leading to more automation. Until the government introduces more flexible labor policies, factories will probably continue to shy from hiring.

Reforming the country's labor laws has been a priority for Modi, who has pushed to whittle the country's 44 national labor laws down to just five. But he has faced strong resistance. In September 2015, Indian National Congress-affiliated labor unions representing 150 million workers launched a nationwide strike with a clear message: Do not threaten our job security. In a country where about 30 percent of the population (about 360 million people) lives below the poverty line, workers' anxieties offer a stark reminder of the challenges Modi faces in revamping labor regulations. Other legislative priorities are stealing Modi's focus in the current parliamentary session, and the prime minister will likely refrain from pushing labor law reform this quarter, leaving unfulfilled a core prerequisite for boosting manufacturing, at least for this year.

The Road to Prosperity

Though labor reform is important, large-scale manufacturing and economic growth also depends on a robust infrastructure network. The previous administration estimated that from 2012 to 2017, India would need to invest $1 trillion — half its economy — to rework the country's dilapidated roads, bridges, railways and ports. Since this amounts to a $200 billion annual expense (India's 2016 national budget was $289 billion), the government has depended in part on private capital to fund the endeavor and is employing public-private partnerships to work on the projects.

Still, this is not enough. To raise the money it needs, India must rely on FDI. In 2015, India attracted nearly $29 billion in investments for greenfield manufacturing, or building new factories, making up two-thirds of its overall FDI inflows for the year. About 45 percent of the investments went to electronics manufacturing projects, and though that industry has grown twelvefold as a result, it is not a labor-intensive sector. India's failure to attract more foreign investment — China, for instance, attracted $136 billion in 2015 — is due in part to its stifling regulatory environment, hence Modi's emphasis on reform.

In 2013, the Indian National Congress passed a bill requiring the government to obtain approval from at least 70 percent of people living near a potential development site before the land could be sold. Modi's attempts to override parts of the legislation to make it easier for businesses to buy land have failed. Because nearly 70 percent of Indians live in villages, Modi faced an uphill fight to institute reforms in land use and acquisition laws that could harm the interests of India's majority rural population.

To reach the Make in India campaign's goals, Indian manufacturing would have to grow at a 14 percent rate through 2022. The pace of the growth has lagged, and until Modi has the political means to pass the highly contentious reforms on land and labor that he will need to meet those goals, manufacturing will continue to grow only incrementally, leaving India's overall economic potential unrealized. 

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