If the Indian economy has an Achilles’ heel, it is the country’s manufacturing sector. Despite rapid economic growth since pro-market reforms began in 1991, the share of manufacturing in India’s gross domestic product has remained stubbornly low, at about 15 percent. (In China, it has been about 30 percent in recent years.) Indian growth has been driven by services, most famously in information technology.
The lack of a large, competitive manufacturing sector has consequences. One statistic more than any other captures the consequence of an underdeveloped manufacturing sector: Just over 40 percent of India’s total workforce is still employed in agriculture and allied activities that account for only 18 percent of GDP. Unlike advanced economies, India does not have an unemployment problem; instead, it struggles with underemployment. In the absence of significant social security, people cannot afford to go without jobs, so they are forced to content themselves with low-productivity, low-wage jobs in farming. Services have not been able to absorb this excess low-skill workforce. In fact, they have not done so in any country that has become rich.
Now that three decades of rapid growth have raised the expectations of the population, there are increasing calls for high-quality jobs. Ironically, China might lend a helping hand. Beijing’s strict “zero covid” policy is severely disrupting global supply chains. The recent shortage in iPhone supplies is just the most prominent example. China now poses a bigger risk to supply chains than at any point during its rise as the factory of the world over the past three decades. Xi Jinping’s consolidation of unchallenged control at last month’s Chinese Communist Party congress marks a firm break with the moderate era initiated by Deng Xiaoping. The deepening authoritarianism in Beijing translates into great unpredictability in the actions of the world’s second-largest economy. The world looks on with growing concern.
The problems don’t end there. Many critical supply chains outside China, for example, are in the neighboring East Asian region, where China has outsize influence. Over 80 percent of leading-edge technology semiconductors are manufactured in just two locations: Taiwan and South Korea, both of which face permanent threats in the form of China and North Korea.
The United States seems to have recognized the risks. Last month, the Biden administration announced what is in effect a “tech war” on China by banning the export of semiconductor chips as well as the technology and equipment used to manufacture them. U.S. allies that have access to similar knowhow might follow suit. Given that the Trump administration also cracked down on trade with China, it is fair to assume there is now a bipartisan consensus in the United States on the need to contain Beijing and diversify critical supply chains.
India is notorious for missing geopolitical opportunities — but this time might be different. In contrast to his predecessors, who mostly hailed from the agricultural heartland of North India, Prime Minister Narendra Modi comes from the western coastal state of Gujarat, which has long given priority to manufacturing. In Gujarat, manufacturing contributes 30 percent to the state’s GDP, a level comparable to China’s.
Having served as chief minister of the state for nearly 13 years before he became prime minister, Modi is acutely aware of what manufacturing needs to thrive. Since he became prime minister in 2014, Modi has tried to make life easier for businesses by cutting regulations and incentivizing bureaucrats to speed up approval processes. Now, in his second term in office, he is going further by embracing industrial policy.
India’s long history of failed state intervention has made politicians wary of industrial policy. Yet in recent years, as manufacturing continues to lag, Modi has opted to intervene. His production-linked incentives program is designed to reward domestic and foreign-owned firms across 13 chosen sectors, from automobiles to pharma to advanced batteries. The aim is to ensure global competitiveness by achieving greater scale in production. The program is set to distribute about $25 billion to industry over four years.
The second is his program for manufacturing semiconductor and display factories, which offers up to $10 billion in the form of capital subsidy to potential investors. (Disclosure: My company, Vedanta, has applied for subsidies from this program as part of its investment in a semiconductor and display manufacturing joint venture with Taiwan’s Foxconn.) Interestingly, the subsidy program was announced before the Biden administration passed its Chips and Science Act this year.
Modi’s embrace of industrial policy is a gamble — but it might be India’s best hope. Subsidies on their own won’t be enough. Success depends on whether the Indian manufacturing sector can prove its ability to compete in global markets. That will likely require a whole host of other structural reforms — a huge challenge in India’s noisy democracy, where a multitude of vested interests complicates the withdrawal of protections and unproductive subsidies. This will require all of Modi’s considerable political skills (and perhaps a third term in office starting in 2024).
But the country’s manufacturers have no time to waste. Right now, firms exiting China are looking for other options. India needs to do everything to ensure it is the first choice.
Dhiraj Nayyar is the director for economics and policy at Vedanta Resources.