Notes on Indian manufacturing, growth, and industrial policies · Notes on Indian manufacturing,...

Notes on Indian manufacturing, growth, and industrial policies

Dani Rodrik

August 2011

Roadmap

• Productivity gaps – both symptom of underdevelopment and growth potential

– ‘internal convergence’

• Structural change– Where does India stand with respect to pace and direction of

structural change?

• Policies to foster requisite structural change– Conventional policies

– Relative price of tradables: real exchange rate

– “industrial policies”

Growth requires both new activities and

ongoing structural change

05

01

00

15

0

7 8 9 10 11ln_sumlprod

In %, = (agr_lprod_kppp00/non_agr_lprod_kppp00)*100 Fitted values

1960

1961

19621963

1964

1965

1966

1967196819691970

1971

19721973

19741975

197619771978

197919801981

198219831984198519861987

1988198919901991199219931994

1995199619971998

19992000200120022003

20042005

1950 19541955

195619571958

19591960

1961

19621963196419651966

19671968

196919701971

197219731974197519761977

1978

197919801981

1982

1983

1984

19851986

19871988

1989

1990

1991

19921993

1994

1995

199619971998

199920002001

2002

2003

2004

2005

19601961196219631964196519661967196819691970197119721973197419751976197719781979

19801981

198219831984198519861987

1988

1989199019911992

199319941995199619971998

1999200020012002200320042005

02

04

06

08

0

In %

, =

(a

gr_

lpro

d_

kp

pp

00

/no

n_

ag

r_lp

rod

_kp

pp

00

)*1

00

7 8 9 10 11ln_sumlprod

IND FRA

PER

Relationship between economy-wide labor productivity (horizontal axis) and the ratio of

agricultural productivity to non-agricultural productivity (percent, vertical axis)

India

India is at the stage of development where the potential for growth-enhancing structural change is nearing its maximum.

Productivity gaps within economy are large, but diminish over the course of development

MWI

ETH

ZMB

GHA

KEN

SEN

NGA

BOL

IND

CHN

PHL

IDNBRA

PER

THA

COL

CRI

VEN

MEXTURCHLARG

MYSKOR

MUS

ZAF

DNKTWN

ESP

UKM

JPN

SWEITA

NLD

FRA

SGP

HKG

USA

-.35

-.3

-.25

-.2

-.15

Com

pon

en

t plu

s r

esid

ual

7 8 9 10 11lnlabprod05

Relationship between inter-sectoral productivity gaps and income levels

dis

per

sio

n in

lab

or

pro

du

ctiv

ity

acro

ss b

road

sec

tors

Economy-wide labor productivity

Productive heterogeneity in the economy

Indian labor productivity as percent of U.S., 2005

Manufacturing has the greatest potential to create jobs, yet is among the least productive activities outside of agrculture

63% of employment

63% of employment63% of employment11% of employment

2% of employment

Heterogeneity within organized manufacturing

Indian labor productivity as percent of China, 2005

2.7 % of formal manuf. empl.

20% of formal manuf. empl.

1.4 % of formal manuf. empl.

Productivity dispersion within manufacturing

0.2

.4.6

.81

kd

en

sity lnla

bor_

pro

du

ctivity

7 8 9 10 11 12x

India China

Log labor productivity across 4-digit manufacturing industries

Growth-enhancing structural transformation is not automatic

-0.02 -0.01 0 0.01 0.02 0.03 0.04 0.05

HI

ASIA

AFRICA

LAC

within

structural

Decomposition of productivity growth by country group, 1990-2005

Productivity growth

within sectors

Productivity growth due

to structural change

Perverse structural change in Latin America: Argentina

agrcon

cspsgsfire

man

min

pu

tsc

wrt

-.5

0.5

11.5

2

Lo

g o

f S

ecto

ral P

rod

uctivity/T

ota

l P

rodu

ctiv

ity

-.06 -.04 -.02 0 .02 .04

Change in Employment Share(Emp. Share)

Fitted values

*Note: Size of circle represents employ ment share in 1990**Note: denotes coef f . of independent v ariable in regression equation: ln(p/P) = + Emp. Share

Source: Author's calculations with data f rom Timmer and de Vries (2009)

= -7.0981; t-stat = -1.21

Correlation Between Sectoral Productivity andChange in Employment Shares in Argentina (1990-2005)

Perverse structural change in Latin America: Brazil

agr

con

cspsgs

fire

man

min

pu

tsc

wrt

-10

12

Lo

g o

f S

ecto

ral P

rod

uctivity/T

ota

l P

rodu

ctiv

ity

-.1 -.05 0 .05


Fitted values



= -2.2102; t-stat = -0.17

Correlation Between Sectoral Productivity andChange in Employment Shares in Brazil (1990-2005)

Perverse structural change in Latin America: Chile

agr

con

cspsgs

fire

man

minpu

tsc

wrt-.5

0.5

11.5

2

Lo

g o

f S

ecto

ral P

rod

uctivity/T

ota

l P

rodu

ctiv

ity

-.1 -.05 0 .05 .1


Fitted values



= -2.3674; t-stat = -0.43

Correlation Between Sectoral Productivity andChange in Employment Shares in Chile (1990-2005)

Patterns of structural change: India

agr

concspsgs

fire

man

min

pu

tsc

wrt

-10

12

Lo

g o

f S

ecto

ral P

rod

uctivity/T

ota

l P

rodu

ctiv

ity

-.04 -.02 0 .02


Fitted values



= 35.2372; t-stat = 2.97

Correlation Between Sectoral Productivity andChange in Employment Shares in India (1990-2005)

Patterns of structural change: Thailand

agr

con

cspsgsfire

man

min

pu

tsc

wrt

-10

12

3

Lo

g o

f S

ecto

ral P

rod

uctivity/T

ota

l P

rodu

ctiv

ity

-.2 -.1 0 .1


Fitted values



= 5.1686; t-stat = 1.27

Correlation Between Sectoral Productivity andChange in Employment Shares in Thailand (1990-2005)

India versus Thailand

agr

concspsgs

fire

man

min

pu

tsc

wrt

-10

12

3

Lo

g o

f S

ecto

ral P

rodu

ctiv

ity/

To

tal P

rod

uctiv

ity

-.2 -.1 0 .1

Change in Employment Share( Emp. Share)

= 35.2372; t-stat = 2.97

India

agr

con

cspsgsfire

man

min

pu

tsc

wrt

-10

12

3

Lo

g o

f S

ecto

ral P

rodu

ctiv

ity/

To

tal P

rod

uctiv

ity

-.2 -.1 0 .1

Change in Employment Share( Emp. Share)

= 5.1686; t-stat = 1.27

Thailand

*Note: Size of circle represents employment share in 1990**Note: denotes coeff. of independent variable in regression equation: ln(p/P) = + Emp. Share

Source: Authors' calculations with data from Timmer and de Vries (2009)

Correlation Between Sectoral Productivity andChange in Employment Shares in India and Thailand(1990-2005)

Fitted values

Sources of economy-wide productivity growth

Respective contributions of labor productivity within broad sectors and of structural change to economy-wide growth during 1990-2005

Are resources moving in the right direction within manufacturing?

151

153

154

155

171172

191

202

210

221

222

241

242

251

269

273

281

289

291

292331

351

359

369

above average productivity

below average productivity

textiles, spinning, weaving

basic chemicals

transport equip. nec

gen. purpose mach.

other chemicals

grain mill products, etc

-1-.

50

.51

1.5

-.04 -.02 0 .02change in employment share, 1998-2005

Structural change within manufacturing has reduced labor productivity growth of the sector by 0.9% p.a. during 1998-2005.

Structural change as engine of productive development

• Low productivity in manufacturing, plus slow (or perverse) structural change are both a drag on the economy

• It would be a mistake to focus only at the high-end, most competitive industries

– Skill- and capital-intensive, and unlikely to generate the levels of employment needed

– Shift of labor to mid-range industries would still generate growth, as well as more employment

What constrains the structural change process?

• Labor laws?

• Infrastructure?

• Red tape/corruption?

• Self-discovery/coordination externalities?

• …

The (real) exchange rate as a short-cut

Relationship between undervaluation and growth(developing country sample, FE)

MNG75

ROM65MNG80

YEM90

MNG85

NGA80

GHA80

ZAR75

SYR85

BRA55

NGA75

SYR65

MOZ65

CHN60

SYR80

SYR90

MOZ70

CHN65

COG100

CHN55SUR90

TUR55ROM70

UGA75

BTN75

IRN85TZA80GHA75

GNQ65NGA95

CHN70

SYR75

GNB70

GNB80

SCG95

SYR70SDN85

ZAR80NGA70

SYR95

GNB65

SYR100TZA75

UGA80

BRA65

YEM100JAM100

LBR95

BRA70

UGA85

SCG100

GNB75

TZA70

BRA60

LBN100

SDN75

YEM95

TON75

LBR90

MAR55

SOM80

CHN75

SDN80

SDN90

NGA85

ZMB80

CAF90SUR85GNQ70COG65TZA85

MWI60

LBR100

TZA65

ETH85

MOZ75COG75SUR80

ZAR100

MWI65ZMB100

SUR75ZMB75COG70

TUR75

MRT80

AFG90

ZMB95

GHA65

LBN95

MWI55

PAN55

EGY85GRD95GRD90GMB75

MNG90

TON90TUR65

TGO100

COG90SEN90NGA100FSM100

PAN60ETH55

KIR95

TUR90

LKA55TWN55

JAM95

KIR90MRT90BTN80

ETH65COG85TUR60

BTN85MWI70COG95

ETH60MRT85

TON80

HND100TGO90PAK65

GHA60

BEN90

KIR80

LKA60

BEN75

GNB85CMR75ZMB90ETH70CAF85

GNB90STP85TON95

VUT75MLI90

TUR100GMB90

MRT75

MDG100

HND85

KIR100

BEN60

TZA95

PAK60

BWA90

BWA80GNQ90

ISR55PAN65

TZA90

PER95

CMR90

STP80DOM55

CIV75

STP75

ZMB70

UGA70PER100

TGO65

WSM90

TCD75IND60

SDN100

GHA70

FSM95TUR95TGO95

CMR85

CHN80GMB80

NGA65

CIV90

PER90

IND55MOZ80

BTN100FJI80WSM95COL55CIV65

URY65TUR70

SLV100

LKA65

FSM90

CAF95GMB85

ZAR95

WSM100

KEN75GNB95

BFA90

TZA100

SOM100JAM65

COG80

IRN90

BEN80

MYS60SOM95BIH100

NGA90CAF100SEN85

JOR100

NER75

CAF75

VUT100TGO85

SUR95NER90

BEN65

CMR80

BWA75BFA75BFA65

WSM75

MDG80PAK55KOR55

KIR75

BFA60

MDV95

JAM70HND65TCD65KEN80VUT90GTM100

DZA85

BIH95

VUT95TGO75KIR85ZAR90PAN70MWI90

BDI80

MDG95

ETH75FSM80

MDG90TCD70IND65

ZAR85

JAM75

FJI75SEN75MDV100

GNQ95

MYS65

MAR60

KEN70

JAM60

TON100

MWI75

TCD80

FSM75BEN100GMB100

KEN100TWN60

IRN95

GHA85

LBR85

DOM60BEN95

ERI100

HND80CUB100

BTN90

ZMB65

HND70GHA90

FJI85

COL60GRD85IRL60STP90

THA55

BFA70

PHL55ETH90

MDG75

DOM65

RWA85

JOR80BLZ90SLE80

FJI95CIV80

AFG100

KEN85

SEN70ETH80

CPV75

FJI90

NER85SEN65

JAM55

HND60SEN95

GNB100

BFA85

NAM90BEN85

IRN80

MLI85CHL55

BOL80

MDV90BEN70

SLE100CMR70

SLB100

NPL65LSO90

MLI95

JAM80

LKA70CIV85

CIV95

MLI100

SDN95

TUR80

UGA95

HND55ECU100

GMB95JOR75ZMB85PAN75DOM75

DOM70MYS70

KHM85THA60TWN65

TGO80

DOM80

MEX70BLZ95MWI80

NER80

NAM95

DJI90

HND95MEX65

TGO70

MOZ85NER70

CRI55CUB75BWA85

SLB95

IRL55

JOR95

JOR90

CPV70

SLV95

BTN95FSM85CIV70JOR85GTM95BFA80TCD90KOR80

MDG85FJI100

CPV90TUR85

CAF80IND70

KHM80

VUT85VUT80

UGA90

DZA90

SLE75DOM95

GMB70

MNG100

CHL60

THA65SOM85

TWN70NGA60

MKD95

BOL95

GRC55GRC60NGA55

TWN75

SEN100ZMB60

GMB65

MEX60

CUB95

MLI80ECU95MWI85CMR65

HND75COL65

GNQ85

BDI65

LBR80

KHM100

SEN80GHA95

BDI85MYS75MRT95MYS80PNG90

LBR75SLB90

MAR65

MAR70PAK70DZA75

RWA75CHL65

TON85

BOL90

ZWE100CIV100

COM90

KOR75

GTM55BOL100WSM80CRI60

NER65

BLZ85

NAM75

JAM90DZA80

RWA95

CUB80

MDG65

MLI75COL80

VCT90TCD85

MNG95RWA90

NER100KEN95ROM100

MKD100

CMR95

NAM100MAR75HND90SGP65

COM100

GTM60SOM75DOM90

KHM95

KEN60BDI75KEN65

ZWE65

PRY80

IDN75

KHM75

MDG70

BFA95HKG65NPL70

ALB100RWA80

MDV85

MYS85

BOL85

ESP55GTM80

JAM85

JPN60

CPV95

WSM85

VCT85DJI95

LCA85

BDI70

CRI70

TCD100

LSO95

EGY55

KEN55SLV90

LSO65

BDI90

ZWE60

THA90

CPV65NAM80BOL55

PHL60

CRI65POL80MAR95

KHM90

DJI85

NER95

SLB80

MWI95ROM75

ERI95

LCA80

KOR60

UGA100MAR90

THA70SLB85

DZA70GTM90TTO55TCD95GTM65

LSO70

KOR70

PAK75STP100MAR100KEN90

IDN80COL70

BFA100

EGY60PHL95TUN75

PRT65

JPN55

CMR100

MDV75GTM85

DZA100PRT60

IND75

SLB75BOL75LSO80

ATG75PRT55

TUN90

SLV85MEX55

GRD80

EGY80

EGY75STP95

DJI100

DZA95

PNG75

GTM75IND80

ZWE55

BDI95

HTI100COL90IDN70CHN85

PHL65

CUB90

EGY95

MRT100MDV80PRY95PAK80

SLE95

DMA85

IDN65

COL75

CPV100

LCA75COM95

TUN70BOL60THA75DZA65

CHL75

MLI70ROM95

ZAF60LSO75

CPV85

CPV80COL85EGY65

THA80

SLE90

PRY90HTI95

PER85

PHL90GTM70

ZWE70

RWA70ZAF55

ZWE85

ECU80BOL65

KOR65

UGA65

MWI100

LSO100

RWA100

MLI65

IND85ECU90

ALB95ZWE75

EGY100

GIN70

EGY90

PNG80EGY70

MAR80

MOZ95

THA85

JOR70

PRY75PAK90JOR55VCT80

GRD75

NAM85DJI80PNG85GHA100

ZWE80

UGA60UGA55

COM85

PRY85ESP60

PRY65

PHL100

TUN65

NIC100PRY55

IDN90

NIC90

BLZ80

BOL70

ROM90

LSO85TUN80

PRY60

MAR85BLZ75PRY70

PER65ETH95

VCT75

CHN90

CHN100

MOZ90

ECU85

PER70

NPL75

TUN85BGD95GIN90

ECU65

SLV80

PAK95

JOR60

PAK85

GIN65NIC85

CHN95

BGD90

AFG95

PAK100IDN85

NIC95

GNQ75

RWA65

ZWE90DMA80

NPL80LKA75BGD75

BGD100

ECU75

ECU70

KNA75

GIN75

PRY100

JOR65

BGD85

MOZ100IND90SLV60

SLV55

HTI85HTI90

KNA80COM75

BDI100

NPL85

GIN60

PER60PNG95

BGD80PHL80

GIN85DOM85PHL85

ECU60

AZE100

LKA90

ETH100

SLE85PHL75VNM100

GNQ80

NPL90

LKA95

PER80ZWE95

COM80SLV65GIN95

GIN80NIC80PHL70

SOM90LKA100VNM95IND95

IDN100PER75

AZE95

ECU55

IND100

NPL100IDN95NPL95

DMA75

IRN60LKA80

GEO95

PER55LKA85IRN65

UZB95SLV70

SWZ75

SLV75SWZ80

MDA100HTI80

MUS60ARM100

AFG85

PNG100

MUS55MUS65

GEO100HTI75

NIC55

MDA95

UKR95

NIC60

MUS70GIN100

AFG75

COM65

UKR100

COM70

AFG80

VNM90

TJK95

TJK100

KGZ95

UZB100KGZ100

-.2

-.1

0.1

Com

pon

en

t plu

s r

esid

ual

-2 -1 0 1 2underval

Undervaluation, industrial employment and growth

Industrial employment and growth

-.05

0

.05

.1

gro

wth

(ort

hogonal part

to o

ther

regre

ssors

)

0 .1 .2 .3 .4 .5industrial employment share

-.15

-.1

-.05

0

.05

.1

industr

ial em

poym

ent share

(ort

hogonal part

)

-2 -1 0 1 2undervaluation index

Undervaluation and industrial employment

Each observation is a country over a 5-year period. Initial income and fixed effects for countries and time periods included.

Role of the real exchange rate

The undervaluation index is the price level of Indian goods relative to other countries, corrected for the Balassa-Samuelson-effect.

What about industrial policy

In addition to overcoming other failures that prevent new industries from getting off the ground, there exist a wide range of theoretical arguments for IP, based on the existence of market failures specific to such activities:

• Learning spillovers from the introduction of new products or new technologies (e.g., garments in Bangladesh, HYVs in India…)

• Upstream spillovers from FDI (e.g., auto plants)• Dynamic scale economies and LBD (e.g., Japanese steel)• Coordination and agglomeration externalities (e.g., tourism and

electronics clusters…)• Credit market imperfections (e.g., wide variation in interest rates across

borrowers in South Asia and elsewhere; absence of long-term credit markets)

The ambiguous case for IP (in practice)

Insurmountable obstacles to the practice of IP?

• Lack of information– can governments identify the relevant firms, sectors, markets subject to those

market imperfections?

• Political capture– can governments withstand lobbying and rent-seeking to prevent IP from

becoming an instrument of rent transfer to incumbents?

The debate on IP revolves not around its theoretical merits, but around sharply conflicting views regarding the relative importance and pervasiveness of these obstacles

• “Look at how difficult it all is…”• “But look at countries in East Asia who have done it …”

Does empirical work help? (1)

• Case studies

– plenty of “successes”• POSCO, Embraer, Chilean salmon, Singapore’s high-tech clusters…

– as well as “failures”• African white elephants, Proton, …

– but rarely subjected to explicit cost-benefit analysis• with a clear counterfactual

• some exceptions that come close

– Banerjee-Duflo (2004) on directed credit in India

– Irwin (2000) on U.S. tinplate industry in 1890s

– and not clear what we would learn even if they were• in view of selection biases

Does empirical work help? (2)

• Cross-industry econometrics

– did protected/subsidized industries do better?

– fair number of studies• Krueger and Tuncer (1982), Harrison (1994), World Bank (1993),

Lee (1996), Beason and Weinstein (1996), Lawrence and Weinstein (2001), …

– has the usual econometric complications of specification, omitted variable bias, measurement, etc.

– but the problems run much deeper

• Even when IP is appropriately targeted at industries with positive spillovers, observed correlation between measures of support and performance can be negative!

Where does this leave us?

• strong theoretical justifications for policy intervention• inconclusive empirical evidence on whether policy works “on average”• just like …

– education policy (human capital externalities)

– health policy (moral hazard, adverse selection)

– social insurance and safety nets (incomplete risk markets, behavioral factors)

– Infrastructure policy (natural monopoly)

– stabilization policy (Keynesian “rigidities”)

– …

• in all these areas, it is recognized that the market-failure arguments for intervention can be exploited by powerful insiders and overwhelmed by informational asymmetries

• but policy discussions typically focus not on whether the governmentshould do it, but on how– debate on what works and under what conditions

• making progress with IP requires a similar shift

Institutional design for IP must recognize that:

1. The requisite knowledge about the existence and location of the spillovers, market failures, and constraints that block structural change are diffused widely within society

– Especially in such a large economy as India

2. Businesses have strong incentives to “game” the government

3. The intended beneficiary of IP is neither bureaucrats nor business, but society at large

Design features for IP institutions (1):Embeddedness

• Economists tend to think of policy design in top-down, principal-agent terms– Takes informational incompleteness and asymmetries as given, while

keeping the private-sector at arms’ length

• This model has the advantage that it gives bureaucrats autonomy and protection from private sector rent-seeking…

• But it has the disadvantage that it severely restricts the flow of information from below– Businesses cannot communicate information about the

constraints they face other than through their actions

• “Capture” model also obviously wrong, since it leaves bureaucrats in the pockets of business.

Design features for IP institutions (1):Embeddedness

• Right model lies in between the two extremes:• strategic collaboration and coordination between the private

sector and the government with the aim of uncovering where the most significant bottlenecks are • deliberation councils, supplier development forums, “search networks,”

investment advisory councils, sectoral round-tables, private-public venture funds…

• IP as a process of discovery rather than as a list of policy instruments• focusing on learning where the binding constraints lie, rather than on

whether you should use tax breaks, R&D subsidies, credit incentives, and so on

• eliciting information on private sector’s willingness to invest subject to the removal of obstacles (or provision of incentives)

• combination of autonomy and embeddedness

Design features for IP institutions (2):Carrots and sticks

• Without rents for entrepreneurs, there is too little investment in cost discovery and other activities that promote structural change

– Schumpeter’s insight: entrepreneurship requires rents

– rents as second-best mechanisms to alleviate market failures discussed previously

• patents are the obvious rich-country example

• But open-ended rents bottle up resources in unproductive activities


• Hence a two-pronged strategy:• encourage investments in non-traditional areas (carrot);• weed out projects/investments that fail (stick)

• conditional subsidies• sunset clauses• monitoring and evaluation

• Empirical background:• East Asia 1960-90: both incentives and discipline

• Lots of new activities, closely monitored for performance

• Latin America under ISI (1950-1980): lots of incentives, but too little discipline • Lots of new activities, some world-class performers, but many duds

• Latin America in the 1990s: lots of discipline, but too little incentives • Too few new activities


• Success in IP is determined not by “picking winners” but by “letting losers go”

– given uncertainty, optimal policy outcomes will necessarily lead to mistakes

– trick is not to avoid mistakes altogether, but to ensure that

• mistakes are recognized as such

• and entail phasing out of support

– a much weaker requirement than “omniscience”

– governments may not be able to pick winners, but they can recognize losers

Design features for IP institutions (3):Accountability

• If bureaucrats monitor businesses, who monitors the bureaucrats?

• Need for mechanisms of transparency and accountability• A high-level political principal and “champion” for IP activities

• someone associated with IP activities and who can be held politically responsible

• as with education policy or monetary policy

• Mechanisms of transparency• publication of requests from business• publication of activities• accounting of expenditures• processes that are open to new entrants as well as incumbents • Periodic accounting of what was done and why (cf. inflation

targeting)

Concluding words

• Macro policy/RER critical to new tradable activities

– Cannot be separated from discussion on manufactures policy

• We need to “normalize” IP

– pragmatic rather than ideological approach

• Not “whether” but “how”?

• IP is a craft

– The importance of local learning-by-doing, and institutional innovation

• IP is a process and a frame of mind; not a set of policy tools and sectoral priorities

– The quality of government-business dialog is critical

Notes on Indian manufacturing, growth, and industrial policies · Notes on Indian manufacturing,...

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