DIRECTOR PROJECTS ASSIGNMENT-2

WHY CANT INDIA MATCH ECONOMIES OF SCALE IN THE MANUFACTURING INDUSTRY

PRESENTED BY BIBHAS KUMAR ROLL 2010G24 EX-MBA (2010-13)

WEEKEND BATCH II
Come any occasion and the Indian consumer is ready to make a beeline to purchase another of those Chinese goods. For one, these Chinese goods are substantially cheaper than Indian goods and come in wide varieties. The cost of production being less in China is an obvious answer, chinese goods are known for their moderate quality, prompt delivery and affordable prices in comparison to Indian goods. Chinas imports are surging into India on account of their product diversification and competitiveness. The reality is that 72% of the products imported are at par with Indian Quality or even superior. Following are some of the reasons behind Chinese goods being cheaper than Indian goods 1. China does not have stringent intellectual property rights (IPR) issues so come any new product in the world market; China is ready with a cheaper alternate. Thus there is no cost of research, designing and redesigning of any product. 2. Advantages of the high economies of scale and higher level of Productivity achieved by highly skilled labor. The cheap Chinese labor is another major reason for the dirt cheap Chinese goods especially like toys where intensive labor techniques are employed, the labor is not demanding and does not go on strike. 3. Where most Indian companies are striving for a Total Process Review (TPR) for quality satisfaction, Chinese companies are not so particular. 4. China does not have any after sales tax on its products leading to a further lowering of costs. 5. Lower rate of Indirect taxes on Inputs 6. High level of cash subsidies being offered by the Chinese government to its producers and exporters 7. Lower taxes enable the Chinese companies to participate in the world market at a lower margin and thus dominate it. Adopt the business model focused on higher volumes is a natural progression in this scenario 8. With the removal of quantitative restrictions (QR), the ending of the textile quota regime and Chinese accession to WTO, the dumping activity by Chinese has increased manifold. 9. China produces in bulk and sells in bulk. China works on reverse model of manufacturing i.e. Rather than waiting for the orders and then producing, Chinese have mastered the art of producing

first and selling it later. This is possible due to low interest rates and low taxes Chinese government imposes. This model helps the buyers as they do not have to wait for the produce. They can inspect, pay and ship the delivery in a single day. The Chinese economy has grown at an average annual rate of 9 per cent between 1985 and 2010. It is the sheer duration for which this expansion has been sustained rather than the sheer growth numbers themselves that is awe inspiring. China's growth was founded on a labour-intensive, mass manufacturing revolution driven by foreign direct investment, predominantly by non-resident Chinese based in Hong Kong and Taiwan. Tax reforms that allowed local governments to retain the dominant share of tax revenues for local development, FDI, labour reforms and incentives towards economic agglomeration -- all played a role in providing a massive fillip to manufacturing. The exchange rate policies introduced in 1994, which kept the renminbi artificially low, made exports more competitive and in turn contributed to China's huge trade surpluses over the next decade. The creation of Special Economic Zones in the early 1980s symbolises China's sharpest break with the past. The SEZs provided unique benefits, such as flexible labour laws and superior infrastructure not available outside their domain.China's SEZs were distinguished from Exclusive Economic Zones elsewhere by the sheer scale on which these provisions were introduced. While the world initially reacted with caution to China's new 'open door policy' (men hu kai fan), investment flooded into China within a decade. All FDI was vertical (export-seeking). Primary products and semi-finished goods entered the SEZs, located near ports, and were re-exported after being assembled into finished goods within. While to the global investor community, SEZs were the incontrovertible symbol of China's economic integration with the world, China's motivations for doing so were not as uncomplicated. This arrangement worked to the enormous mutual benefit of China and the Foreign Funded Enterprises, by rapidly boosting foreign

exchange reserves respectively.

and

by

sharply

reducing

input

costs,

China's rural migrant workers, estimated to number 120 million, are the most frequent victims of this no-holds barred approach. China's emergence as a manufacturing hub is due to a combination of favourable circumstances and astute policy formulation. China's authoritarian political system allowed it to handle the social and political fallout of the regional disparities and worker dissatisfaction. Chinas manufacturing policy though very much illegal in terms of WTO has been highly effective. The country has surpassed Japan in becoming the worlds second-largest economy, passed Germany as the worlds biggest exporter, much of this growth is driven by Manufacturing. Exports of manufacturing have risen at a rate of 15 percent per year China will likely knock the U.S. off its top spot as the worlds biggest economy by 2030. Chinas consistently much higher annual growth rate of over 15% in the manufacturing sector over a similar time span. Incidentally, Indias share of manufacturing in its GDP at 15% is abysmally lower than the share of many other rapidly growing Asian economies like China, Thailand, Malaysia, South Korea where this percentage is between 26% to 40%. Equally importantly, Chinas share of world manufacturing exports was 1.9% in 1990, while Indias was around 0.5%. But over the next two decades, Chinese share of world manufacturing exports leapfrogged to almost 10%, while Indias share improved to just under one per cent. Industry and construction account for 46.8 of China's GDP. In 2009 around 8% of the total manufacturing output in the world came from China itself and China ranked third worldwide in industrial output that year (first was EU and second US). Research by IHS Global Insight states that in 2010 China contributed to 19.8% of world's manufacturing output and became the largest manufacturer in the world that year, after the US had held that position for about 110 years

Nominal GDP sector composition, 2010 (in percentage and in millions of dollars) Count nominal ry GDP 6,29,09,2 World 74 58,78,25 China 7 15,37,96 India 6 Agri. Indus. Serv. 63.60% 43.60% 55.30%

5.70% 30.70% 9.60% 46.80% 16.10 28.60% %

Factors Leading to Chinas Success in manufacturing are: Preferential Government Policy Among developing countries, the openness of Chinas trade and industrial policy are often cited as its comparative advantage. The manufacturing sector requires large provision of investment capital, coordination of the localization process and the monitoring of technology transfer. To further develop these industries, the government needs to be more interventionist. Local governments such as Shanghai have been very successful in coordinating investments across firms in the automotive industry to ensure a smooth supplier network. To date, the Shanghai area is considered one of the most robust manufacturing centres for electronics and automotive parts. The Chinese government has led investment in the manufacturing sector by giving preferential loans to targeted industries. In recent years, the government has promoted growth in the value added manufacturing industries such as electronics and automotive components. Additionally, the ease of doing business in China is very important. Compared to other countries in the Asia-Pacific, the cost and time to start up and close a business are lower in China. Moreover, the costs and procedures involved in importing and exporting a standardized shipment of goods in China are less than countries in the region.

Foreign Investments By welcoming foreign investment, Chinas open-door policy has added power to the economic transformation. In 2005, China received $153 billion in foreign direct investment (US China Business Council). This foreign money has built factories, created jobs, linked China to international markets, and led to important transfers of technology. Through this strategy, multinationals have brought large sums of capital and senior talent to China, helping China develop its manufacturing arm without relying on local institutions. Joint venture firms have also been a huge boon for the Chinese manufacturing sector. By employing local managers and workers, foreign-invested companies teach management, production, and marketing skills to local employees. FDI is playing a big role in Chinas technological process with China becoming an attractive destination. India and China are considered at par in terms of investments. India with its paranoid behaviour is lacking in many respects to provide a suitable ground to MNCs to invest in the country thus losing big on FDI. Infrastructure Investment One of the most important success factors is Chinas superior infrastructure. It is especially essential in manufacturing. Good roads are needed to transport raw materials and finished products. Resources such as power supply and sound facilities are needed to prevent the interruption of production. China invests heavily in maintaining its transport system. It makes enormous efforts to lower congestion levels on main railways. Additionally, China has built 25,000 km of four- to six-lane, accesscontrolled expressways in the past 10 years. Having a stable power supply is very vital to manufacturing efficiency. Power outages can lead to loss of sales by forcing downtime or idle capacity on managers. Power disruptions waste material, damage equipment, add maintenance and repair costs, thus increasing the overall cost of doing business in a country. In China, power outages happen on average every other week, which

is considered low, compared to other developing countries. To prevent power shortages, China is continuing to invest in power generating structures. The Chinese government continues to pay close attention to investing in infrastructure such as roads and transportation systems, manufacturing machinery, and communications systems. Human Capital In addition to its vast supply of cheap but skilled human capital, China has large numbers of foreign educated people coming back from Silicon Valley and other centers of innovation. China currently has 1,731 universities and continues to build more universities and trade schools. In 2005, there were an estimated 3.4 million college graduates. Lessons Learned from Chinas In capital intensive industries, government interventions such as preferential industrial and fiscal policies are needed to channel growth. Foreign direct investment is important in facilitating technology transfer and capital investments. Manufacturing sector requires good infrastructure such as transport system and power supply. Investment in tertiary education is vital in the promotion of hitech industries because human capital is the key in a firms expansion strategy. The World Bank gives India a low rank of 40 out of 46 countries in terms of its manufacturing prowess

Factors Slowing Indias Growth in Manufacturing Lower Levels of Foreign Investment than China Since the beginning of the 1990s, India has improved its manufacturing environment. In the first half of the 1990s,

manufacturing exports grew 30% higher than the world export market, but during this time Chinas exports grew at a rate of 57% higher than the world market. One main factor that contributed to Chinas higher rates of growth was that during that time China averaged US$40 billion in foreign investment annually while India averaged foreign investment was only US$3 billion only during the same period of time. The main obstacles preventing investment were the regulatory quality and corruption, and provision of infrastructure (World Bank). Ease of Doing Business And Taxes Chinese tax breaks, business tax exemptions given to foreign firms which has not happened in India. These are few of the factors which raises the cost of production for Indian goods making it difficult to compete on price basis with Chinese. One supporting example of this fact is that it took 89 days to start a business in India, but it only took 41 days to start a business in China. In addition, India also has stricter labor laws, which makes it much harder to hire and especially fire workers.

Lack of Infrastructure & Supply Chain

Infrastructure is often cited as the biggest impediment to growth of the manufacturing sector in India. Gains made through low labor costs are often lost through bottlenecks in power supply, telecommunication, and transportation. Lack of good, physical infrastructure in India such as roadways; sea and airports, effective layout of city and regional functions, and reliable energy sources all contribute to the missing underlying foundation required to support the general framework from which a good Indian supply chain can begin to develop and thrive. They have to pay high level of taxes, to remain in the reserved sector to get certain privileges by the Government they have to remain small and cant then enjoy the Economies of scale as enjoyed by their Chinese brethren. The major manufacturing projects are currently bogged down and likely to be confronted with a host of issues of land acquisition, environmental clearances, mineral resource allocations, perennial power shortages, lack of center-state coordination, and so on. India and China produce similar kinds of goods in terms of their export basket to the West. China has highly skilled labor and a comparative advantage in the assembly stage of technology. India has to improve its manufacturing prowess. Policy Formulation and Implementation The only difference between China and India is that they (China) have a regime which passes legislations and policies quicker than in India. In China, policy is implemented fast. They are result oriented and not process oriented. Indian government and industry are process oriented. Chinas rapid penetration into industrial markets accounted for significant migration of global manufacturing capacity to the mainland, backed by rapid move towards capital-intensive and high-technology industries rendering its goods cheaper and most competitive globally. On the other hand, manufacturing in India has been plagued by draconian laws, inefficient infrastructure facilities, land acquisition controversies, regulatory hurdles and various other bottlenecks to the path of industrial growth.

Chinas policy processes still continues to reflect the heritage of command economy, given the well entrenched stronghold of communist party and its ideology in its political system, even granting the fact it has been at least 12 to 15 years ahead of us in launching market-driven new economic reforms. Majority Of Investment By State As Compared To Private Sector While a vast majority of Chinas growth comes from state-owned companies, Indias economic miracle can be largely attributed to its private sector story. Having said this, even Indias state-owned companies are gradually logging change from its conventional business model hit by red-tapism. Chinas state-owned and subsidized model has led to unfair competition and frequent government interventions paving way for difference in decision making and executive talent within the two countries. In China, the business hubs are already established and running with efficient administration in place. However, India isnt up to China standards yet when it comes to development and execution of large-scale projects including infrastructure solutions. China is growing at so rapid rate that at present the proportion of people in poverty are diminishing and a new generation middle class is formed. The Government there is so proactive that it is continuously implementing new policies, investments and right international strategies trying to beat the expectations. Scarcity of Trained Worked Force as compared to China Chinas current working age population dwarfs Indias by 230 million, however, by 2050 Indias working age population will exceed Chinas by the same amount. According to the Planning Commission data Indian manufacturing contributes currently to only 12% of employment compared 28% in China. A crude estimate suggests that India will have to create about 50 million new jobs in the manufacturing sector over a span of next decade, while the cumulative employment over the last about six decades of economic planning efforts of has been to take the manufacturing employment to the prevailing level of just about 50 million!

Future Prospects- As all good things come to an end so will the heavenly rights enjoyed by China. The price of Chinese products in near future will be more realistic as IPR is enforced. Though China has maintained the price of its goods as static to capture large share in world volumes but it is sooner or later going to face the rising cost of raw materials. China would soon increase its prices when it enters the market economy status which is 2016 for US. Recommendations for Indias Manufacturing Sector Given Chinas Success Based on Key Lessons from Chinas Success in Manufacturing and Indias Obstacles to Growth in Manufacturing, it is quite evident that India needs to increase its FDI flows and improve its infrastructure to increase growth in manufacturing.

Recommendation 1: Increase FDI Inflows Recommendation 2: Improve Infrastructure The NMP outlines the following four key well-meaning objectives and there can be no two views about the importance of the same in the strategic formulation of Indias manufacturing growth strategy for the coming years: 1. First, to promote investments in the manufacturing sector and make the country a hub for both domestic and international markets; 2. Second, to increase the sectoral share of manufacturing in GDP to 25% by 2022. 3. Three, to double the current employment level in the sector; and 4. Four, to enhance global competitiveness of the sector only faster manufacturing expansion would have the potential of generating massive employment for realization of Indias perceived/potential demographic dividend. It is being argued that the last two decades have revealed the immense growth opportunities of Indias services sector both for domestic as well as global markets. The employment intensity of the manufacturing sectors growth is also found to be much less

than the similar growth situation of the services sector. Moreover, compared to actual or potential competitive advantage of Indias services sector, the manufacturing sector is invariably found to be far more capital-intensive, infrastructure-intensive and natural resource consuming-intensive in nature. Over the last two decades of economic reforms, India has come a long way in recognizing the importance of manufacturing sector in the economy. The erstwhile industrial policy was deeply entrenched in license-quota-permit raj through its extensive and exasperating system of industrial and import licensing, monopoly controls, pricing and distribution controls, high tariff structure, burdensome and cascading indirect taxes (excises and sales tax), and dominance of public sector investments. These have since then been progressively reformed and rationalized. The industrial landscape of the country has witnessed remarkable transformational shifts as a consequence, releasing new energy, enterprise, investments and growth largely through private sector initiatives and efforts. The shift from new 8.4% high annual manufacturing growth to 15% over the next decade will certainly call for doubling of efforts in Governments (Center and States together) policy reforms and creation of very stable and promising investment-friendly business environment. Even an acceleration of fifty percent in annual manufacturing growth from about 8.4% to 12% appears a tough proposition given our prevailing milieu of political economy! Also, we cannot claim to be (or even wish to be!) anywhere close to authoritarian regimes of China and most of the erstwhile East Asian tiger economies in the implementation of policy reforms. But our experience so far is far from satisfactory thanks to the fact (a) Indias manufacturing growth rate has relatively been modest, as compared to China and many other successful East Asian countries; (b) Indian manufacturing is found to be less employment intensive, given the growing preference of Indian medium and large industry in particular towards capital and technology intensive areas of manufacturing; and (c) India has so far failed to initiate major labour policy reforms that could have empowered the management with greater autonomy

and flexibility in their labour and employee relationship, and in the process facilitating provision of more and more jobs in the manufacturing sector over the medium to long-term.