India Squanders its Comparative Advantage
India is squandering its comparative advantage in labour-intensive manufactures, writes John West
East Asia’s successful economies, like Japan, Korea and China, enjoyed export-driven growth during their high-growth periods which exploited their comparative advantage, based on their abundance of lower-skilled labour. Thus East Asia’s rapid economic development was initially driven by exports of labour-intensive manufactures.
Over time, the sophistication of these economies advanced through investments in human capital, growing technological capacity, and much learning by doing, meaning that their comparative advantage also evolved. So today, Japan, Korea and to a lesser extent China are now major exporters of high-technology products and have become advanced, prosperous economies and societies.
India, one of Asia’s later developers, has much in common with these successful East Asian economies in that it has an abundance of lower-skilled labour. But it is fundamentally different in that its solid development following the reduction in trade barriers since the early 1990s has been substantially facilitated by the export of information, communication and technology (ICT) services, rather than labour-intensive manufactures.
Services now account for more than one-third of total exports, a larger share than in most OECD countries and emerging economies. Indeed, India’s share of world services trades more than quadrupled from 0.5% in 1995 to 3.5% in 2018.
How is it that India, one of Asia’s poorest countries in terms of GDP per capita, could be so successful in sophisticated areas like ICT services?
According to Indian economist Santosh Mehrotra, there would be a number of factors, viz, government investment in high-speed Internet connectivity for software parks; duty-free import of hardware and software; the ICT industry is not subject to the 45 labour laws which apply to industry, and the ICT sector benefits from public investment in technical education.
The English language bequeathed to India by its colonial masters obviously also helps. And India’s diaspora population, the world’s largest, also helps develop new export markets and facilitate the transfer of technology and know-how.
In the area of merchandise goods, India performs well in the export of pharmaceuticals, medical devices and petroleum products. India is also the largest manufacturer of cut and polished diamonds. Even in the smartphone market, India has transformed itself from being a net importer to a net exporter.
But the weak point of India’s development has been the inability to exploit its comparative advantage in labour-intensive manufactures. Overall, manufacturing exports have fallen as a share of total exports and their composition has shifted from labour-intensive to high-skill and technology-intensive items. Indeed, for textile, garment and footwear, India has seen its share of world trade decline in recent years, while Bangladesh has almost caught up to India, and Vietnam has well overtaken it.
Weakness in labour-intensive exports is very costly for India. Today, India has 11 million young people entering the labour market every year. They could offer India a demographic dividend, something that Japan, Korea and China enjoyed during their high growth periods. But today’s reality is that the Indian economy is not creating enough jobs, and a declining share of the working-age population is actually working. Less than half of India’s working-age population has a job, while in China some 65% are working.
In other words, the inability of India to exploit its comparative advantage in labour-intensive exports is undermining the country’s economic development and destabilising India’s society.
The government is alive to the desirability of improving its manufacturing base, notably under the Make in India flagship programme, launched in 2014. Further, today, India has the opportunity to capture some parts of China’s global value chains (GVCs) in light of China’s rising labour costs, Donald Trump’s trade war, and the Coronavirus which highlights the risks of the concentration of GVCs in China. And the evidence suggests that India has indeed seized some of the market shares lost by China, although some Southeast Asian economies have done better.
But much greater efforts are required if India is to fully exploit its potential in labour-intensive manufactures. What are the main factors holding it back its export of labour-intensive manufactures?
While India’s policy environment and business climate have improved in recent years, there is much need for improvement before India can be a major player in Asia GVCs.
Attracting foreign direct investment is often a starting point for participating in GVCs. And while India has been attracting growing amounts of FDI, its restrictions on FDI remain higher than most OECD countries, based on the OECD’s Foreign Direct Investment Regulatory Restrictiveness Index.
In a similar vein, India still retains many restrictions on international trade, despite the impressive trade liberalisation from the early 1990s. Indeed, its withdrawal from the Regional Comprehensive Economic Partnership, a trade agreement between the ASEAN economies of Southeast Asia and six of its regional partners, does not augur well for trade liberalisation in India. A promising avenue to pursue would be to expand the number of special economic zones, which already account for a growing share of exports.
Transport and energy infrastructure is critical for participating in manufacturing GVCs. But infrastructure has long been a bugbear for doing business in India, even if it is improving. It ranks only 70th out of 141 countries for infrastructure in the World Economic Forum’s Global Competitiveness Report. Labour regulations and employment protection legislation also weigh heavily on the competitiveness of manufacturers.
In conclusion, India’s dynamic service sector exports have demonstrated the great potential for the country to achieve sustained economic development. But to realise its full potential, and above all to provide jobs for 11 million people entering the labour market, it is imperative that the government make much greater efforts to improve the export competitiveness of India’s labour-intensive manufacturing sector.
- OECD Economic Survey of India
- Santosh Mehrotra. Why an industrial policy is crucial
- MAKE IN INDIA: THE VISION, NEW PROCESSES, SECTORS, INFRASTRUCTURE AND MINDSET
- OECD’s Foreign Direct Investment Regulatory Restrictiveness Index
- World Economic Forum’s Global Competitiveness Report
The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of The Kootneeti Team