More than three years after Prime Minister Narendra Modi launched his "Make in India" policy to encourage investment in manufacturing, there is little sign of momentum.
The share of manufacturing in India's economic output has actually contracted in the wake of the government's shock cancellation of large denomination bills in late 2016 and the chaotic launch of a goods and services tax (GST) eight months later. Manufacturing is forecast to have dropped to 16.3% of gross domestic product in the fiscal year ended March 31. This would be its lowest level since the beginning of the current series of data six years ago and leave the government far short of its goal of bringing manufacturing's share up to 25% by 2025.
The Modi administration has taken successful action in some areas, notably in cutting red tape. India jumped 30 places last year in the World Bank's "Ease of Doing Business" rankings to just break into the top 100 nations.
But there have been major missteps. The GST introduction was marked by poor design and an inept rollout without adequate administrative oversight or technical preparation. The lack of clarity and uncertainty involved hit the manufacturing sector hard. The country's informal sector, which represents 85% of the Indian workforce, suffered particularly badly.
Manufacturing's low share of GDP in India compares with around 40% for China and similar figures for many developing and middle-income countries. The nation's manufacturing landscape is dominated by a multitude of small companies, which account for more than three-quarters of industrial employment, but often have low rates of investment and productivity. To boost manufacturing, the government needs to make reforms to give companies more flexibility on hiring and firing staff and facilitate the acquisition of sites for factories. More fundamentally, India needs to invest more money and effort into basic education and health care, social pillars that helped transform the economies of East Asia.
Despite pledges of reform, the Modi government has made no real improvements on the labor front. Companies with more than 100 employees, for example, are still required to obtain official approval before they can fire anyone.
More flexible labor rules are key. The government needs to try to find a middle path between giving companies the ability to retrench in line with business cycles and protecting workers. Bureaucratic control should be replaced with transparent laws that do not discriminate against companies due to their size.
On the land front, the landmark 2013 Land Acquisition Act has in fact led to little land acquisition. The bill, passed under the previous Congress party-led government, was intended to defuse land buying controversies by assuring protection of community interests. It requires establishing a local consensus for factory site purchases, a social impact assessment, rehousing of those displaced and compensation of up to four times market value for landowners.
But many Indian states have been ignoring the requirements for community consent and social impact assessments. This has led to rising conflicts between landowners and would-be acquirers as it has opened up the possibility of forcible acquisitions and inadequate compensation.
This is unfortunate, as the 2013 act on its surface does provide a workable framework for facilitating industrial land acquisition. As with labor rules, the key to progress is an approach that balances the interests of factory builders and landholders. In spirit, the land law does this. A sincere embrace of the law at the local level and a removal of political considerations would help to defuse land sales as a contentious issue and support more industrial development.
Floundering investment is another major stumbling block for Indian manufacturing. After a surge in leveraged investment between 2004 and 2008, bank and corporation balance sheets are stretched. Not surprisingly, private capital expenditure has slowed dramatically. As measured in terms of manufacturing capital formation, government data shows the compound nominal annual growth rate was just 4% for the four fiscal years to March 2016 as compared with 12% for the nine previous years. Many companies find it easier to invest in existing facilities rather than greenfield ventures.
Foreign direct investment in manufacturing has remained elusive. The services sector continues to attract the majority of FDI inflows.
In its effort to boost manufacturing, India has seemingly turned protectionist. It recently imposed a series of import duties on electronic goods to protect and build domestic industry. In the national budget announced on Feb. 1, the customs duty on imported mobile phones was raised to 20% from 15%, for example. Hectic lobbying is in progress to extend new duties to solar energy equipment, another area in which India is not competitive with China.
While there is an argument for protecting manufacturing industries to give them time to grow, such an outcome is not guaranteed while national policies on land and labor continue to impose undue costs. India has been here before -- in the 1960s, '70s and '80s, it unsuccessfully tried the same strategy of import substitution but low-cost, competitive industries failed to develop.
Meanwhile, India has not invested enough in human capital. The country's poor record in training its workforce reflects a lack of focus on basic education. India's literacy rate of nearly 75% compares with China's 95%. Education is still seen merely as a desirable social goal and not something crucial for the economy. The government has shown more willingness to spend on infrastructure and heavy industry.
This mindset is in sharp contrast to the "miracle" economies of East Asia, where high-quality education for the masses was considered essential to create the army of skilled industrial workers needed to compete globally.
According to the National Institute of Public Finance and Policy, only about 2% of Indian workers have qualified for certificates documenting their mastery of professional skills compared with about 70% of workers in Europe and 80%-90% in East Asian countries like Japan and South Korea. The prime minister's flagship Skill Enhancement Scheme has failed to make any meaningful dent in this gap.
Sick workers also do not make productive employees. For example, according to World Health Organization data, the death rate in diarrhea cases in India in 2014 was 59 per 100,000 people, compared to seven in Vietnam and one in China.
To improve human capital, India's poor record on health and education needs to be set right. While the pace and outlook for politically sensitive land and labor reforms is uncertain, the government can surely muster the will to achieve better outcomes in health and education.
Kunal Kumar Kundu is India economist for Societe Generale.