To achieve ‘Developed India’, Modi’s new government will prioritize the manufacturing sector – for better or worse

Respected economists believe New Delhi’s priority should be developing the services sector. But geopolitical competition with China will keep manufacturing at the forefront.

Expert comment Published 6 June 2024 3 minute READ

However bruised he has been by the election result, Indian Prime Minister Narendra Modi will need to think hard now about the best path to Viksit Bharat, or ‘Developed India’. This is the government’s centennial goal for the republic, which sets 2047 as the year by which the country will have shaken off its status as an emerging economy.

To get there – to accelerate GDP growth sufficiently to provide jobs, end poverty, create wealth and enhance India’s global influence – one basic question needs an answer: should India tilt more towards excellence in manufacturing, or should it devote more effort to developing its services industries?  

There might be some decent arguments to bias the Indian economy in favour of services. But the reality is that Modi will maintain a fairly uncompromising focus on boosting India’s manufacturing prowess.

The government’s bias towards manufacturing is most evident in the array of subsidies it has put in place to support the sector. 

At the centre of this is a set of Production-Linked Incentives, which offer a total of $28 billion of subsidies for firms in fourteen sectors as a way of encouraging increases in output. 

The semiconductor industry has also been on the receiving end of government largesse, for which an additional $10 billion has been made available.

The wisdom of Modi’s fondness for manufacturing has most recently been questioned by Raghuram Rajan, one of India’s most distinguished economists.

Investment in physical infrastructure has been another signal of New Delhi’s seriousness in boosting manufacturing: central government capital expenditure has effectively doubled in the past 10 years, from 1.6 per cent of GDP in fiscal year 2015 to 3.2 per cent currently.

What about services?

Yet the wisdom of Modi’s fondness for manufacturing has most recently been questioned by Raghuram Rajan, one of India’s most distinguished economists. Rajan (no fan of Modi’s), argues in in a recent book that more attention needs to be paid to India’s services industries. Three strands of Rajan’s argument stand out.

First, it will be difficult and unwise for India to compete meaningfully in manufacturing with more autocratic incumbents like China and Vietnam, who have fewer qualms about suppressing workers’ rights.

Second, India’s protectionist instincts have left the country out of the trade and investment agreements that would integrate its manufacturing sector more robustly with other countries, and allow India to play a full role in global supply chains.

India’s absence from Asia’s Regional Comprehensive Economic Partnership (RCEP) is an especially notable example, reflecting an overall frostiness towards trade deals.

Consistent with that protectionist bias, India’s average import tariff rose from 13.5 per cent in 2014 to 18 per cent in 2022. Arguably, India’s Production-Linked Incentives are an expensive way of compensating for the economy’s international isolation.

Finally, Rajan argues that most of the value-added in a product often comes not from the manufacturing itself but in manufacturing-related services – the research and development, design, marketing, packaging and branding that surround it. That’s one reason why Apple is worth many more times than Foxconn, its manufacturing contractor.

Rajan might well be right in encouraging a bias towards services development. This is a vast sector of the Indian economy which includes IT, legal, accounting, logistics and consulting.

Manufacturing troubles

And it’s worth noting that, on some measures, Indian manufacturing hasn’t performed terribly well during Modi’s first two terms in office. 

Inflows of foreign direct investment (FDI) to India have fallen in recent years. 

Manufacturing value-added as a share of the total economy was actually slightly lower last year, at 17 per cent, than when Modi first took office in 2014. 

And India’s share of global manufacturing remains anaemic. In the past 10 years China’s share of global manufacturing has risen from 25 per cent to over 30 per cent, while India’s remains stuck below 3 per cent.

Perhaps even more astonishing, given all the recent hype about India’s growth potential and its attractions as a ‘China +1’ destination for manufacturers, is the fact that inflows of foreign direct investment (FDI) to India have fallen in recent years. 

These days India is attracting gross inflows of FDI of less than $30 billion annually, a notable decline from the $50 billion-plus that India was able to attract on average between 2019 and 2022.

In the light of all this, there are laudable arguments in favour of paying more attention to India’s services sector, which can easily take advantage of India’s cultural appeal and its command of the English language. All that said, though, it’s probably worth betting that Modi will keep manufacturing prowess at the centre of his ambitions for the economy.

Modi and China

One big reason for this is geopolitics. The pursuit of national greatness is, essentially, a relative game, and for India the comparison that matters is with China. Just as India’s ambitions are shaped by Viksit Bharat, the People’s Republic of China also has a centennial goal for 2049, by which time Beijing intends the country to be a great power. Competition for economic leadership in Asia is in the air.

Whenever self-reliance is a policy priority, an obsession with manufacturing is likely to accompany it.

And it is difficult to imagine either India or China believing they can compete without manufacturing. Both countries are keen to emphasize the role of self-reliance in fulfilling their ambitions. In China the relevant slogan is zili gengsheng (‘self-reliance’), while India refers to Atmanirbhar Bharat (‘self-reliant India’). 

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Whenever self-reliance is a policy priority, an obsession with manufacturing is likely to accompany it.

But progress in Indian manufacturing will require a lot of reform, in two areas above all: land and labour. Land reform is needed because of the difficulty of getting land approved for non-agricultural use, and because of the shakiness of India’s land ownership records. In a country where it can take 20 years to resolve land disputes, this is a high priority.

The labour reforms most urgently required to boost India’s manufacturing sector result from the overlapping responsibilities of the central government and state governments, and the uncertainty this creates for firms in making hiring and firing decisions.

Modi gives every indication that he’s very keen to implement these reforms to boost Indian manufacturing. Deprived of a parliamentary majority, though, it remains to be seen if he’ll be as able as he is willing. The factors that have held Indian manufacturing back so far might be difficult to overcome.