The return of industrial policy is welcome but it needs far more

In East and Southeast Asian countries, success at industrialization was driven by industrial policy implemented by governments, recognizing that economic openness, while necessary, was not sufficient. In India, the government abandoned industrial policy without creating the conditions or the ecosystem that could have enabled manufacturing to become competitive in world markets.

Strangely enough, it was not recognized that industrial policy was responsible for the three success stories of industrialization in India: pharmaceuticals (the Patents Act of 1970 eliminated product patents in medicines), automobiles (stipulation that Suzuki would produce a car with 70% domestic content within five years) and information technology (income tax exemption/concession for two decades). The dismantling of India’s industrial policy, starting in the early 1990s, juxtaposed with increasing economic openness, had its consequences. The share of the manufacturing sector in GDP dropped from 17.5% in 1995-96 to 13.5% in 2019-20, suggesting a premature de-industrialization.

Reviving industrialization is an imperative for India. It is the only path to employment creation, as the jobs potential in agriculture is negligible, while the informal services sector is an employer of last resort with its low-income and poor-quality jobs. It is a potential source of economic growth, for it can provide employment at higher productivity levels than elsewhere, absorbing unemployed people, our most abundant yet underutilized resource. And manufacturing is the only means of creating capabilities in the Indian economy to organize and transform its productive activities, so essential for development. Thus, it is time to rethink and revive industrial policy.

In 2021, the government announced its production-linked incentive (PLI) scheme with a total outlay of ₹197,000 crore (roughly $25 billion) over five years, with specified allocations for 13 selected sectors. The largest shares are for automobiles and components (29%), mobile phones and components (20%), pharmaceuticals and ingredients (11%), advanced cell batteries (9%), telecom (6%). The remaining 25% of the outlay is divided between food products, textiles, specialty steel, white goods, electronic products, solar PV modules, and medical devices. The disbursements will be based on performance as a percentage of incremental sales (over base year): 4% in first year, 3% in second year, 2% in third year, and 1% in fourth year.

Such support related to production and sales, rather than exports, is admissible under World Trade Organization rules. It is provided to eligible firms in selected sectors, not selected firms, so that it is non-discretionary. The selection of automobiles, pharmaceuticals and textiles is possibly based on a revealed comparative advantage in exports, while the choice of mobile phones, food products and specialty steel could be based on an assessment of potential comparative advantage that may stimulate exports, but the choice of batteries, telecom, white goods, electronic products and medical devices probably seeks to replace imports.

This is a first step in reviving industrial policy, which is an important beginning. Even so, it must be recognized that industrial policy succeeds where there are effective governments, with the ability to coordinate economic policies across sectors over time in pursuit of national development objectives, using carrot-and-stick means to implement their agenda. It is simple enough to dangle carrots. It is more difficult to enforce compliance so that incentives are contingent on performance, or to impose penalties whenever stipulated objectives are not met. It is just as important to ensure that the support is time-bound. Therefore, exports that can ultimately compete in world markets, in price and quality, are the real litmus test of success.

The PLI scheme has some obvious limitations. The selected sectors are largely capital, technology or skill intensive in production, so they are unlikely to create mass employment. Only some among the selected sectors will be subject to the price and quality discipline of export markets. Despite the sunset clause implicit in the scheme, there might be pressures to continue support beyond five years.

Beyond the PLI scheme, the wider context is far more important. The revival of industrialization in India requires, inter alia, calibration of trade policy, correctives in exchange rate policy, recognizing the critical role of interest rates and a rebirth of industrial finance. Strategic coordination of these policies in a long-term perspective, often described as industrial policy, which was at the foundations of success in Asia’s industrialization, is essential.

For latecomers, catching up in industrialization is not simply about imitating, following and learning from leaders, because that is a moving target which becomes more elusive with technical progress. It is just as important to think ahead of the curve, anticipating technological changes on the horizon, and leapfrog though innovation to become a leader in some sectors, as South Korea did.

Going forward, effective industrial policy will require an ecosystem of human capital, institutional quality and innovative capabilities. It will also need imaginative and creative thinking—for example, about evolving synergies between manufacturing and services.

Deepak Nayyar is emeritus professor of economics, Jawaharlal Nehru University.