Approach:
- Introduce your answer by elaborating on how the manufacturing sector has remained stagnant.
- In the body, mention reasons behind falling manufacturing sector productivity and measures that can be taken to correct the same.
- Conclude your answer appropriately.
Model Answer:
Indian economy can be divided into three sectors: agriculture, manufacturing and services. Agriculture contributes only about 20% of India’s Gross Value Added but still employs close to 55% of India’s workforce. This required pulling people out of agriculture and soaking up the excess labour in the manufacturing sector. However, this did not happen in India. The share of manufacturing, both in India’s GDP and overall employment, has largely stayed stagnant at 15 to 17% from 2017 to 2022. Most of India’s GDP now comes from the service sector.
The reasons behind the falling manufacturing sector productivity in India are:
- Small-scale manufacturing sector: The most dominant characteristic of India’s manufacturing sector is the extraordinarily small scale of establishments relative to any major emerging country. Given this, India is reaping far smaller gains from scale economies than many other countries. Larger establishments often use newer technologies and thus achieve higher productivity, while smaller establishments are much less productive.
- High capital intensity: While firms in India have remained small, a large share of India’s manufacturing has been in sectors that usually require a larger scale of production. Moreover, production has tended to be particularly capital-intensive. The relatively high capital intensity of manufacturing appears out of line with relative prices, given that the cost of capital has been very high relative to labour costs throughout most of the economy.
- Wide differences in manufacturing productivity across states: Western and Central Indian states tend to have the highest average productivity in manufacturing, while the Southern and Eastern states have the lowest. This is in contrast to the GDP per capita ranking of states, in which Southern states tend to have higher incomes than their Western and Central counterparts.
- Less investment in workers: Studies show that productivity is strongly correlated with firms’ investments in their workers. This investment could either be through higher salaries and/or better benefits, e.g., medical facilities, recreation, festival bonuses, etc. However, in India, due to the scenario of mass unemployment, investment by firms in their workers has been low.
- Labour has moved from agriculture to the informal sector: Most labour has moved from agriculture to the informal non-agricultural sector and this has boosted productivity. However, at the same time, labour has moved out of the high-productivity sector, i.e., the formal sector. As a result, the overall impact of changes in employment shares has been to reduce the growth of labour productivity.
Measures that can be taken includes:
- Improvement in the manufacturing process: Compared with India, manufacturing productivity in Indonesia is twice as high. In China and South Korea, productivity is four times higher. Improvements to key manufacturing processes could increase labour productivity as well as capital productivity at the same time.
- Policy reforms: There is a need for policy reforms that help create better infrastructure and logistics, and also help Indian manufacturing become more productive.
- Securing technology: India’s established manufacturing value chains possess the technology and know-how however they need to compete with their overseas peers. One approach could be to create a stable framework of time-bound and conditional localization incentives to entice global companies to set up operations in India, either independently or with a local partner.
- Access to capital: This is one of the single biggest obstacles to increasing India’s manufacturing GDP. Financial reforms would help stable, cash-generating manufacturers attract low-cost domestic capital from long-term savings pools, such as pension funds and insurance.
- Improving business environment: A number of national and international business surveys suggest that weaknesses in India’s business environment have inhibited or distorted investment, thus reducing growth and employment creation. Hence, improving the business environment could boost the manufacturing sector in India.
- Upskilling workforce: A skilled workforce is a productive one. Employees who are knowledgeable make fewer mistakes and deliver to a higher standard. A commitment to training and development also helps retain employees.
Therefore, the importance of the manufacturing sector in reviving the fortunes of the economy is well established. The government has already taken various measures such as Make in India, Production Linked Incentive (PLI) schemes, Ease of doing business, etc. The finance ministers of the past have also emphasized that the manufacturing sector needs to grow from the current levels of 16-17% of GDP to a healthier 25% which will enable the economy to grow at 8% per annum.
