Industrial Policy Challenges for India

Global Value Chains and Free Trade Agreements

Smitha Francis

• Editorial: Routledge India
• Año: 2019
• ISBN:
  9780429534416
• Edición: 1
• Categoría: Business
• Categoría: Business generale

This book looks at the debates on global value chains (GVCs) and free trade agreements (FTAs) as springboards for industrial development in developing countries, especially India. It connects the outcomes in GVC-led industrial restructuring and upgrading to industrial policy choices in trade and FDI liberalisation, in particular those through FTAs.

With the share of manufacturing in GDP stagnant at around 15–16% since the 1980s, India's policymakers have pinned their hopes on greater integration into GVCs to revitalise the manufacturing sector. The multiple FTAs the country has signed over the last few years, specifically the ones with the Association of Southeast Asian Nations (ASEAN), South Korea, Malaysia and Japan have been sought to be rationalised using the same argument. The book argues that failing to factor in the industrial policy causalities involved in sustainable indigenous technology development, structural barriers to the entry into GVCs, the assessments of the available evidence on the adverse impact of trade and FDI liberalisation as well as existing FTAs on firm-level incentives for undertaking domestic production, and the industrial policy constraints imposed by FTAs can prove costly for the trajectories of developing country economies, including India.

Rich in data, this book will be useful to scholars and researchers of development economics, economics in general, development studies and public policy as well as government bodies, industry experts and policymakers.

Chapter 1

Introduction

India has seen much discourse on manufacturing sector revival strategies in academic and policymaking circles in recent years. This has followed widespread recognition that the stagnant manufacturing sector, and its growing import dependence and lacklustre export performance after more than 25 years of liberal reforms, reflects the limited extent of structural diversification that should have accompanied economic development.¹ With the manufacturing sector’s share in India’s GDP stagnating at about 15–16 per cent since the mid-1990s despite extensive and intensive trade and financial liberalisation, India’s policymakers have pinned their hopes on greater integration into global value chains (GVCs) to help revitalise the manufacturing sector. The multiple free trade agreements (FTAs) the country has signed over the last few years, particularly the ones with ASEAN, South Korea, Malaysia and Japan, have also been sought to be rationalised using the same argument. India is currently involved in more FTA negotiations, including one with the EU, as well as a mega regional FTA, the Regional Comprehensive Economic Partnership (RCEP).

Meanwhile, in a silent admission of growing concerns about Indian industrial performance, and in a reflection of the fact that the popular opprobrium attached to industrial policy has ‘waned’ after the resurgence in industrial policy discussions globally, the Department of Industrial Policy and Promotion (DIPP) under the Ministry of Commerce and Industry came out with a Discussion Paper on a new Industrial Policy in August 2017. With an explicit focus on increasing “global strategic linkages”, the stated objective of the new policy is to provide “an overarching umbrella policy framework” (Government of India 2017: 7, 8). However, the document considers foreign direct investment (FDI), exports, domestic value generation, technological development, employment, etc. in a piecemeal manner, raising the question as to whether there will be any fundamental break from the past in the expected new industrial policy in terms of the underlying analytical model.

Indeed, most of the ongoing academic and policy discussions surrounding India’s manufacturing sector revival strategies take place without acknowledging the following: that the analytical framework underlying the changed national policy framework since 1991² has imposed serious constraints on successive governments in dealing with the structural diversification challenges facing a lower middle-income economy like India under globalisation and rapid technological changes. This has been a framework that – after realising the ‘limits’ of the state-led import-substitution strategy – has perceived liberalisation of trade and FDI flows as policy objectives rather than as policy tools in achieving industrial development. This fundamentally owes to the fact that the theory underlying this framework equated ‘inefficiency’ of the import substitution industrialisation (ISI) strategy with industrial policy itself. The consequence has been that trade strategies, foreign investment policies, science and technology policies, labour policies, SME development policies, financial sector policies, fiscal policy, etc. have been considered in silos, divorced from a coherent industrial development framework.

It will be incorrect to say that this has been a singularly Indian problem. The export-led growth strategy that has been the preferred development model for successive Indian governments since the drastic and comprehensive policy shift in 1991, the accompanying progressive liberalisation of FDI and the tendency to shun industrial policy (by encapsulating it within the state-versus-market debate) have all been part of a global trend.

Global industrial policy debates: the underlying currents

From the beginning, trade policy has been one of the principal issues surrounding development strategy, and as such, it has been an integral part of industrial policy. Intense debates related to trade strategies associated with the development of then late industrialisers, the United States, Germany, France, etc. in comparison with the trade strategies that enabled Britain to develop its industry and progress have gone on since the 18th century. These debates continued after the US became the dominant economic and political power in the early 20th century and afterwards, as a number of former colonies became independent. Subsequently, it was widely recognised that the financing of developing country growth through primary product exports would come up against constraints to development in the form of undiversified production structure and net financial outflows leading to financial fragility. This was based on critical observations by early development theorists contrasting the way Britain, the US and other countries had developed their underdeveloped economies by promoting manufactured goods, while Latin America (dependent on its primary exports) had continued to be underdeveloped. Consequently, active policies for the targeting, promotion and protection of domestic production in increasing return activities, in particular, manufacturing, were designed by developing countries too. These were aimed at promoting diversification, away from activities based on natural (or static) comparative advantage and existing endowments of labour and capital, towards new sectors offering higher productivity potential for the whole economy (see Dutt 2005; Kattel et al. 2009; Reinert and Kattel 2010).

This development framework, which integrates state policies with the need for strategic protection and promotion of national increasing return activities through their import substitution and export-led market expansion phases, squarely places trade policy as a tool within the larger industrial policy framework – with the goal of advancing specific sectors that bring economy-wide productivity gains required to sustain a dynamic development process (detailed discussion follows in Chapter 2).

The post-World War II policies relating to foreign capital were also integrally linked to these industrial policy goals. It was recognised that, to harness foreign capital’s role in the development process, it must be channelled mostly to savings and investment rather than to an increase in import-dependent consumption. The latter could lead to displacement of whatever little domestic industrial production exists in a developing country and prevent further industrial development, as well as lead to adverse balance of payments situations. Once again, this in turn requires that these strategies to utilise FDI must be used in tandem with the targeting of increasing returns activities (see Chapter 2).

Subsequently though, as several scholars have shown, debates on development strategies became dichotomised in terms of state-led versus market-led growth models. While industrial growth had accelerated throughout much of the developing world at varying rates after World War II, a number of internal and external factors got manifested in different medium-term outcomes in Africa, Latin America and Asia. The particularly contrasting industrial growth experiences of a selective few Latin American and East Asian economies were interpreted by neoclassical development economics as proof that, while developing country governments that intervened strongly in markets suffered from gross inefficiencies (like in Latin America and India), those relying on competitive markets operating broadly on neoclassical principles could foster high levels of economic efficiency and rapid self-sustained growth (as in East Asia) (see Ghosh 2009; Reinert and Kattel 2010). ‘Misguided’ state activism and development planning which had been pushing industrialisation for the domestic market in defiance of static comparative advantage were attacked by the neoclassical economists (Storm 2015). Gradually this interpretation came under increasing attack, especially in terms of the crucial role of government intervention in the market-oriented economies in East Asia (in particular, the first-tier newly industrialised countries or NICs of South Korea, Taiwan and Singapore) in building their productive capacities (“the developmental state”) (see Amsden 1989, 2001; Wade 1990; Sridharan 1996; the literature cited in Fine and Jomo 2006; etc.).

However, one critical element that mainstream economists have continued to highlight is the apparent openness of these economies in terms of trade and FDI that facilitated their rapid economic restructuring. Particularly in Asia, this emerged in the form of the ‘flying geese’ paradigm, as a type of catching-up industrial development strategy to be led by FDI (see Francis 2003). This is despite the fact that several scholars showed empirically through case studies (indeed the only way in which debates about the role of FDI in technology transfer and industrial catching-up can be settled) that the dominant forms of interaction with transnational firms by late industrialisers (starting with Japan, followed by South Korea, Taiwan and Singapore) involved ‘unpackaged’ forms for technology transfer – such as licensing arrangements, franchising, management contracts, turnkey contracts, production-sharing contracts, international subcontracting, etc. (see Helleiner 1989; Sridharan 1996; Lall 1992, 1996; see also the extensive literature cited in Francis 2003).

While there were definite domestic and external factors behind India’s 1991 balance of payments crisis,³ the dramatic shift in Indian economic policy framework from the early 1990s was a part of this global shift with the ideological ascendance of neoliberalism. The tragedy in Indian economic policymaking, as elsewhere, has been that arguments against state intervention – such as the danger of corruption and rent-seeking, inefficiency and misguided economic incentives leading to distorted resource allocation – became equated with industrial policy itself. Arguably, this has been a major factor preventing the development of intelligent economic policymaking in India, unlike, say, in China. Rather than tweaking policy interventions for overcoming the observed causes of state failure under the varied ISI experiences in Latin America and Asia, the industrial policy baby was thrown out with the bath water of import-substituting industrialisation.

Thus industrial policy – of the selective or ‘active’ kind, as understood in the early development literature – was shunned in international policy discussions with the advent of structural adjustment programmes from the mid-1980s onwards. Ex post, it is evident that it was always a part of the Washington Consensus and post-Washington Consensus of the late 1990s (and into the 2000s), albeit in a different form. Accordingly, the policy prescriptions by international financial institutions like the International Monetary Fund (IMF) and the World Bank shifted to ‘passive’ or horizontal industrial policies (Francis 2017), supposedly of the non-price-distortive kind of state intervention.

As described in UNCTAD (2016: XIV, 185–188), a horizontal industrial policy framework (also called a functional industrial policy; see Lall 1996: 126) essentially accepts existing factor endowment-based static comparative advantages and mainly aims to reduce the costs of doing business, while carrying out hands-off trade and financial liberalisation to allow greater play of market forces.⁴ The reduction in the costs of doing business (‘ease of doing business’) is achieved through policy measures aimed at removing inefficiencies and ‘dead-weight losses’ by improving infrastructure, business entry and exit regulations, taxation, customs and other administrative procedures, investment promotion and facilitation, labour market ‘flexibility’, trade facilitation, etc. (Low and Tijaja 2013: 4; see also Lall 1996).

Quite evidently, lagging infrastructure development (including energy supply) is an important supply-side factor impacting firm-level competitiveness, just as it impacts the overall development of a country (Francis 2015a). Cumbersome administration of tax and customs is also efficiency reducing. However, other horizontal policies that are advocated such as economy-wide labour market ‘flexibility’ (meant to address the so-called ‘rigidities’ in the labour market) and reduction in corporate tax rates have critical development implications, quite apart from the fact that the rationale underlying these have been seriously contested. Their development implications include adverse impacts in terms of inadequate demand, loss of government revenues and the generation of significant inequalities, all of which lead to unsustainable growth trajectories.⁵ In fact, all talk about ‘inclusive development’ (a misnomer in itself) becomes vacuous in the backdrop of implementing such policies.

‘Active’ or vertical or selective industrial policies that were practised by the first-tier newly industrialised countries in East Asia (South Korea, Taiwan and Singapore) during their 20th century catching-up decades and continue to be practised by them and some of the other late industrialisers such as China, Brazil, etc. are quite in contrast to ‘passive’ industrial policies (UNCTAD 2016: XIV; Lall 1996; Gallagher and Shafaeddin 2009; Yu et al. 2015; Kasahara and Botelho 2016; etc.). Vertical industrial policies seek to influence the pattern of national industrial development by policy interventions that guide and promote investment domestically towards new activities and sectors with higher productivity, better-paid jobs and greater technological potential (UNCTAD 2016: XIV) – i.e., increasing returns activities. Indeed, policies adopted by most developed countries – including the US, Japan and the EU as well as others like Israel, Ireland and Taiwan – have also continued to make important departures from the rhetoric on ‘non-price-distortive’ industrial policy, as, for example, documented in the several papers cited in UNCTAD’s Trade and Development Report (2014, 2016, 2017); Breznitz (2006); Wade (2012, 2016, 2018); Mathews (2010); and Brandt and Whitford (2017).

From the mid-1990s onwards, along with the spread of an export-led economic growth paradigm, the developing world saw a much wider shift towards passive industrial policies. This was driven primarily by their commitments on tariff liberalisation, along with the restrictions on national policies deemed as trade-related investment measures (TRIMs) and trade-related intellectual property rights (TRIPs) under the World Trade Organization (WTO) from 1995 onwards.

However, by the mid- to late-2000s, after nearly two decades of trade and financial liberalisation, there was recognition that the Washington Consensus policies had not led to the desired effect in developing countries (Rodrik 2008). Soon, research began to emerge discussing industrial stagnation, deindustrialisation and middle-income traps in developing countries (Wade 2006, 2012; Felipe et al. 2012).⁶ Meanwhile, renewed interest in industry’s role as a dynamic instrument of growth in the developed economies after the global financial crisis has coincided with a renewed concern for industrialisation and structural change in the mainstream of development economics (Storm 2015). Ironically, around the same time, the policy discourse on developing countries saw a broad shift from trade liberalisation as the panacea for underdevelopment to participation in global production networks (GPNs) and global value chains.

Globally, the post-global financial crisis resurgence of industrial policy discussions has been followed recently by increased focus on the state’s role amidst rapid advances in advanced manufacturing technologies and digital disruptions (and increased public attention around Germany’s ‘Industrie 4.0’). Thus the developed world has been debating the evolving role of the state as observed in practice and ‘in effect’ (Mathews 2010; Wade 2012, 2018; Fine et al. 2013; Low and Tijaja 2013; Nawrot 2014; etc.),⁷ which have included discussions around ‘the networking state’, ‘the entrepreneurial state’ and re-visiting the role of the public sector (Kattel and Lember 2010; Mazzuccato 2013, 2017; Lember, Kattel and Kalvet 2013; Brandt and Whitford 2017; Kattel 2018). On the contrary, the global development literature and mainstream economists in developing countries have been advocating that simply easing investment and business regulatory policies for participation in global value chains (GVCs) and entering into free trade agreements (FTAs) will offer springboards for industrial development for developing countries, through greater access to export markets and increased foreign investments (see UNESCAP 2011; OECD 2013; WTO et al. 2013; etc.).⁸

Industrial policy evolution in India: an overview

It is widely known that import liberalisation was initialised in India in the 1980s in response to the realisation that the planned form of state-led import-substituting industrialisation (ISI) development strategy – with extensive controls on production, prices, investment, trade and foreign collaboration – subscribed to in the post-independence decades had in effect led to stifling competition and the eventual establishment of an inefficient industrial sector (Mani 2000a; Nagaraj 2003).⁹ Despite having a broad-based industrial base, inadequate indigenous technological development meant that import liberalisation raised the import intensity of domestic production (see Ghosh 2013; Sridharan 1996; Nayyar 1994; Chandrasekhar 1994a; etc.). The increase in current account deficits following increased imports was financed by an increase in foreign borrowing from the IMF, the international commercial banking system and non-resident Indians (Ghosh 2013: 177).

One of the major objectives of the liberalisation process was to raise the growth performance of the industrial sector by removing various constraints (on entry and expansion of firms) and especially the req...