Manufacturing versus services: A false binary - Hindustan Times
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Manufacturing versus services: A false binary

Feb 20, 2024 10:00 PM IST

India does not need to choose between manufacturing and services. India has the capacity and means to succeed in both manufacturing and services.

The debate around India’s policy focus — whether it should be on manufacturing or services — is once again heating up. There is a well-reasoned case being made that given the larger share of services in India’s domestic output and its strong position in business and IT services exports, the country should focus on sharpening its advantages in these sectors. Accordingly, the argument goes, more investment in education and health care should be the policy priority.

Global services exports account for only ~22% of total exports.. (AP) PREMIUM
Global services exports account for only ~22% of total exports.. (AP)

On the face of it, this reasoning cannot be faulted. Indeed, India is a global leader in services exports, especially in areas that need technical skills, given its large pool of engineering and science graduates. This, combined with English language skills, affords India the opportunity to consolidate its leading position further. India’s investment in social sectors has been relatively low compared with advanced, or even peer economies. Developing the nation’s human capital is indeed a pre-condition for India to fully achieve its growth and development potential.

Still, for a country of India’s size — with an economy that appears well-placed to remain the world’s fastest-growing in the medium term — can we afford to ignore the manufacturing sector? As India’s consumption per capita grows, its demand for goods, along with services, is going to rise in tandem, if not faster. Historically, periods of high growth in India have been accompanied by large current account deficits, as higher demand also increases imports. To ensure that India’s growth ambitions are not constrained by forex needs to pay for imports, we need to focus on diversifying our export products and markets.

We fundamentally agree that exports are what will drive India’s trade account surpluses. But ignoring the manufacturing sector, or not prioritising it, may not actually be a choice, given the dominance of goods in global exports. Global services exports account for only ~22% of total exports. So, the size of the pie to capture is smaller. And unless the services sector expands dramatically, the potential for India is for only incremental gains. India’s share of global services exports is currently ~4.4%, and the country is already the largest provider of telecom and information services. On the other hand, India’s share in the global goods export is ~1.9%, which shows a greater potential for growth. Increasing the country’s share here is even more critical if it is viewed as an opportunity to boost employment, particularly better-paying jobs in the manufacturing sector. The largest proportion of the labour force continues to be employed in agriculture (~45% of total) and construction (13%), where productivity is low. Consequently, wage growth is also subdued. Services, being relatively less labour-intensive, cannot fully absorb the excess labour in the economy. Hence, more manufacturing jobs need to be created for India to reap its demographic advantage.

Another argument for the manufacturing push comes from lessons learnt post-Covid. The disruption of supply chains during the pandemic shows that we cannot afford to remain import-dependent in areas of strategic importance or national security (think semiconductors and solar cells). India’s policy push towards manufacturing via production linked incentive schemes (PLIs) is one such avenue to reduce import dependency as well as strengthen export-oriented businesses. The success of mobile phone manufacturing in India is a case in point. Exports of telecom instruments totalled $12 billion in FY23, more than double the $4.8 billion in FY20. While India is still largely an assembly location — which is why imports of mobile components have also increased — exports have grown much faster. This has reduced the trade deficit in telecom products to $3.5 billion — from $9.4 billion — over the same period. In this case, value addition in exports has significantly contributed to the reduction of the trade deficit. That said, the performance of other PLI sectors has been mixed, with applications still being approved, and many firms yet to start production, leading to an extension of the scheme beyond the original five-year term for many sectors.

The other pillar of the country’s export strategy — services exports — is where India already has a competitive advantage. While IT/ITeS (IT-enabled services) services have been the mainstay of the economy’s services exports, business and professional services (across areas of finance, research, human resources, and consulting) have grown exponentially in the past few years. The task now will be to sustain this leadership position and expand the country’s services offering to include tourism as well, where India lags considerably despite much potential.

The pandemic has reoriented the policy focus towards supply-chain resilience in global trade. The China+1 strategy is part of this change. India is viewed as a viable candidate in this strategy, given its political and economic stability as well as its large domestic market. So far, however, Southeast Asian economies such as Vietnam and Malaysia, arguably, have benefited more from this shift, given their greater integration into global value chains and proximity to China. Going ahead, the challenge will be to move up the value chain.

Increasing exports is necessary not just from the point of view of their contribution to growth, but also to maintain external stability. India does not need to choose between manufacturing and services. Given the country’s global leadership position in the export of services and the opportunity provided by the China+1 strategy, we argue that India has the capacity and means to succeed in both manufacturing and services.

Rahul Bajoria is managing director and head of EM Asia (ex-China) Economics, and Amruta Ghare is a regional economist, Barclays. The views expressed are personal

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