Amid the escalating US-China trade conflict, many are eyeing India as a new global economic powerhouse. But can India repeat its success in other sectors outside of the IT industry?
The US-China conflict and India’s opportunities As the conflict between the US and China intensifies, global companies are aggressively pursuing a “China Plus One” strategy – a move to diversify their supply chains away from a sole reliance on China. In this process, India is emerging as a new alternative.
India’s advantages are clear. A huge population of 1.4 billion, an abundant English-speaking labor force, and a strategic alliance with the U.S. India is already globally competitive, especially in IT services. Indian IT companies like Infosys and TCS are globally competitive, and the country’s abundant English-speaking workforce and excellent engineering education system have made it a global center for IT outsourcing.
Success factors for the Indian IT industry
The success of India’s IT industry is no accident, with several key factors at play.
- English-speaking workforce: As a legacy of British colonial rule, India has a large English-speaking workforce. This has become a huge competitive advantage in the global IT outsourcing market.
- Excellent engineering education: Top universities, including the Indian Institutes of Technology (IITs), churn out a large number of talented engineers every year.
- Time zone advantage: The time difference between India and the US is about 12 hours. This has enabled the “Follow the Sun” model of working around the clock.
- Government support: The Indian government has implemented a number of policies to foster the IT industry, including the creation of software technology parks and tax incentives. These factors combined to make India a global center for IT services, especially after the Y2K problem was solved and the country became a major offshore destination for US companies, the Indian IT industry exploded.
Challenges in the manufacturing sector
However, the IT industry’s success equation doesn’t seem to translate to manufacturing. This is because manufacturing requires a completely different ecosystem than IT services.
- Lack of infrastructure A robust infrastructure, including reliable power supply, efficient logistics systems, and modernized port facilities, is essential for manufacturing success. The reality in India is far from this. According to the World Bank’s 2018 Logistics Performance Index (LPI), India ranks 44th out of 160 countries surveyed, compared to China’s 26th place in the same year. The country’s unreliability of power supply is particularly acute. Manufacturers face frequent power outages that disrupt production, which leads to lower productivity.
- Complex labor regulations India’s labor laws are among the most complex and stringent in the world. For example, companies with more than 100 employees need government permission to fire employees, which makes it difficult for companies to have a flexible workforce. There is also a strong labor union presence, which means there is constant pressure to raise wages. This is gradually eroding India’s low-wage advantage.
- Declining share of manufacturing Surprisingly, the share of manufacturing in India’s GDP is actually declining. It is expected to be around 13% by 2022, down from 17% 20 years ago. This contrasts with China, where it has remained around 30% over the same period. This reflects the fact that India’s economy has become increasingly service-driven. The success of IT services has paradoxically hindered the development of manufacturing.
- Skilled labor shortage While India has an abundance of high-end IT talent, it lacks the mid-level skilled labor needed for manufacturing. This is because India’s education system is heavily skewed toward IT and engineering. For example, according to the National Skill Development Corporation of India (NSDC), there is a shortage of about 10 million skilled workers in manufacturing by 2022, which is a major obstacle to attracting large-scale manufacturing.
Government efforts and challenges
The Indian government has recognized these challenges. Prime Minister Narendra Modi announced the ‘Make in India’ policy in 2014 to promote manufacturing. The goal of the policy is to increase the contribution of manufacturing to GDP to 25% by 2025.
Key policy highlights include
- deregulation of foreign direct investment (FDI)
- establishment of manufacturing special economic zones
- introduce a production-linked incentive (PLI) system
- support technology transfer and R&D investment
Despite these efforts, the country has yet to see tangible results. This is because many challenges remain.
- Regulatory reform: The complex bureaucracy and regulations need to be simplified to create a business-friendly environment. The World Bank’s Doing Business ranked India 63rd out of 190 countries in 2020.
- Infrastructure investment: There is an urgent need to improve basic infrastructure such as power, roads, and ports. The Indian government announced its National Infrastructure Pipeline plan in 2019, pledging $1.4 trillion in infrastructure investment by 2025, but funding will be key.
- Improve the education system: There is a need for practical skills training for many industries outside of IT. The vocational education and training (VET) system needs to be strengthened.
- Labor law reform: Labor laws need to be revised to increase employment flexibility and reduce burdens on businesses. The Labor Law Reform Bill was passed in 2020, but its effectiveness remains to be seen.
Economic analysis: The future of manufacturing in India
Let’s apply some economic concepts to predict the future of Indian manufacturing.
- Comparative Advantage Theory – According to David Ricardo’s theory of comparative advantage, each country should specialize in the products that it can produce most efficiently in relative terms. For India, there is a clear comparative advantage in IT services right now. But in the long run, it also has the potential to gain comparative advantage in labor-intensive manufacturing. This is due to the abundance of labor and relatively low wages, but the aforementioned infrastructure and institutional challenges need to be addressed.
- Industry Cluster Theory – Michael Porter’s industrial cluster theory explains that the success of a particular industry fuels the development of related industries. In India, the success of the IT industry has not translated into the development of manufacturing, which can be attributed to the lack of linkages between the two industries. Therefore, the Indian government should consider policies that can link IT and manufacturing, for example, by investing in areas such as smart manufacturing and industrial IoT.
- Endogenous growth theory – Robert Lucas and Paul Romer’s endogenous growth theory emphasizes the importance of human capital and technological innovation. India already has good human capital, but it needs to develop it in a form that is suitable for manufacturing. This will require increased government investment in R&D, stronger industry-academia collaboration, and an improved vocational education system, especially in developing high-tech manufacturing talent for the ‘Industry 4.0’ era.
- Institutional Economics – Douglas North’s institutional economics emphasizes the importance of institutions in economic development. In the case of India, complex regulations, bureaucracy, and unclear property rights have been pointed out as factors that hinder economic development.
While India is poised to benefit from the U.S.-China conflict in the IT sector, the manufacturing sector will take some time to reap the rewards due to key challenges such as strengthening the rule of law, fighting corruption, and institutional improvements such as deregulation.
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