INDUSTRY

Indian economy has taken a peculiar developmental trajectory, as can be seen by

the following table that summarizes sectoral shares in GDP in percentage terms

Sector 1972-73 1993-94 2009-10

Primary 41 30 15
Secondary
(Manufacturing, mining,
23 25 26
quarrying, electricity, gas
etc.)
Manufacturing (part of 13.5 14.5 15.4
secondary)
Tertiary 36 45 59

As can be seen, the share of primary sector has significantly reduced from 41%
to 15%; secondary sector and manufacturing have more or less maintained their
shares, while the share of the tertiary sector has shot up. This clearly shows that
India has been an exception to the Kuznet’s hypothesis, and has witnessed a
services-led growth.

On the other hand, in terms of % shares of employment:

Sector 1972-73 1993-94 2009-10

Primary 74 64 51
Secondary 11 15 22
Manufacturing (part of 9 10.5 11.5
secondary)
Tertiary 15 21 27

Thus, the agricultural sector still provides employment tomajority of the labour
force, despite drastic reduction in its contribution to GDP. Also, manufacturing
has had a low and stagnant share in employment.

India v/s China

China’s growth is manufacturing-led, as against India’s services-led. However,

agriculture continues to provide the major chunk of employment in both
countries, even though its share in GDP is significantly lower for China (just
about 9% as compared to India’s 22%):

GDP shares:
1978 2004
Sector
China India China India
Primary 28 44 9 33
Secondary 48 24 58 28
 Tertiary 24 32 33 39

Employment shares:
1978 2004
Sector
China India China India
Primary 71 71 47 57
Secondary 17 13 23 18
Tertiary 12 16 31 25

1947-1980:
At the time of independence, because of the policies followed by the British, the
industrial sector had the following features:

 Production was focused more on consumer goods than producer goods

 Weak infrastructure
 Export orientation was against India’s interests (focus was to export raw
materials and import finished goods)
 Technical and managerial skills were in low supply

Thus, the policymakers thought that economic sovereignty and independence lay
in rectifying this situation by focusing on the industrial sector. During the first
few years, and in the first FYP, the thinking was that the government should
control those sectors of the economy in which the private sector would be unable
or unwilling to invest- such as arms and ammunition, atomic energy, railways,
coal, iron, steel, aircraft and shipbuilding etc.

The idea was that the rest of the field would be left open for the private sector.
However, by 1956, things had changed towards an explicit preference for state
control of most of the economy. Thus, although the second FYP is seen as the
cornerstone of Indian economic planning, it was in fact the first plan that
understood the nuances of good economic policymaking- it focused on indicative
planning, rather than concern itself with allocation of public resources, which
became the focus of future plans.

The industrial licensing regime controlled every key aspect of the economy,
ranging from controls on foreign trade, capital issues, foreign exchange,
transport (including raw materials), price controls, and allocation of credit. Over
time, regulations began to cover everything from location, product, access to
credit, foreign collaboration, use of raw materials and technology, for each of
which the investor required a separate clearance from a different ministry.
Further, a number of items were reserved to be produced by SMEs, and MRTP
had all sorts of laws. The licensing regime was thus so tight and widespread that
the focus of policy became regulation, rather than development.

Vested interests:Promotion of such a restrictive industrial policy had a common

appeal to the state (which could maximize revenues by a multiplicity of tariffs),
politicians and bureaucrats (with ample space for kickbacks), urban
manufacturers who were sheltered from competition, and multinationals that
provided technology and capital at high rates.

Thus, by the 1980s, Indian industry was characterized by low productivity, high
costs, low quality of production, and use of obsolete technology.

Changes during the 1980s (‘Hesitant experimentation in domestic

deregulation’):Several government committees recommended relaxing some of
these controls to remove the chokehold on the Indian economy, and there was
some improvement in deregulation:
 By 1988, all industries were exempted from licensing apart from a
negative list of 26 industries. However, this exemption was subject to
investment and location limitations, and came with its own set of myriad
rules which significantly reduced the effectiveness of the exemptions
 Exporters could access inputs at international prices, but import tariffs
increased further, to protect domestic industry

This led to significantly higher industrial growth in the 1980s; industry grew by
about 6% p.a., and exports at 8.5%.

1990s

In 1990-91, industry (manufacturing) contributed 26% (15%) of GDP, employed

15% (12%) of the workforce, and used 39% (24%) of the economy’s capital
stock.

While industrial growth rose in the 1980s, the government’s fiscal situation
rapidly got out of hand due to rising interest payments, defense, and subsidies-
gross fiscal deficit rose to 8.3% in 1990-91.There was agreement that industrial
growth seen in the 1980s could not be sustained in this fiscal environment, and
more domestic deregulation and foreign competition were needed. This point
was exacerbated and driven home by three factors:

a. The Gulf war, which led to drying up of inward remittances and exports
b. Collapse of the USSR, which was then India’s biggest trading partner
c. Domestic political uncertainty

All these factors together led to the BoP crisis.

New Economic Policy: After the BoP crisis, wide-ranging reforms were brought
in. Stabilization policies focused on correcting macroeconomic balances, whereas
structural reforms were brought in to reduce public sector interventionism:
 Several barriers to entry were removed, such as:
 Removal of industrial licensing for investment
 Opening up all but a few strategic areas to private investment
 Reduction in the list of items reserved for production by small scale
enterprises, as there were said to have bred inefficiency and labor-
intensive manufacturing
 Removal of many output and investment controls
  In April 2015, the government has de-reserved all 20 remaining items
on the list; there are now no items reserved for production only by
MSMEs. Apart from allowing large firms to manufacturing these items
(such as pickles, mustard oil, groundnut oil, glass bangles, safety
matches etc.), these items can now also be imported

 Foreign trade and investment:

 Attracting foreign investment was expected to help improve the fiscal
situation and release critical supply constraint for infrastructure
 Export/ Import tariffs were reduced, and quantitative controls over
imports were dismantled, in the hope to promote competition (to
reduce costs)
 Foreign investors were now allowed to own majority shareholdings
over a wide spectrum of industries
 The overall policy moved from focusing on technology transfers to
focusing on building global strategic alliances to penetrate world
markets

 PSUs:
 Better performing PSUs were given greater autonomy and were
allowed to access capital markets; budgetary support was reduced for
non-performing PSUs
 In the initial years of reforms, the focus was on selling minority
shares of PSUs (‘disinvestments’), instead of privatization, with the
aim of financing fiscal deficits rather than improving the productivity
of capital employed in these PSUs

The thrust of the policy was to create a more competitive environment, to

improve productivity and efficiency of the system.Private sector was to be given
a larger role in the economy. Thus, protectionism and quantitative restrictions
were reduced; even still, rates of tariff remained higher than in most developing
economies.

Lessons in planning from the experience so far clearly show that the role of the
government is to improve the interaction, collaboration, and learning between
producers, rather than top-down control of activity with the government
deciding who should produce what, where, and how much, and what technology
they should use.

Phases of industrial growth in India

A note on measuring growth in the industrial sector: There are multiple indices
that can be used:
 Manufacturing (registered/ unregistered): components are capital
goods, intermediate goods, consumer durables, and consumer non-
durables
 Registered manufacturing accounts for about 70% of total
manufacturing GDP, but only for 15% of manufacturing employment
  IIP: Manufacturing + Mining + Electricity
 Unless stated, numbers below are for total manufacturing (registered
and unregistered)
________________

Several distinct phases since independence:

(*all the growth rates below are for industrial sector as a whole)

 1930-1947: 1.2%
 1951-1965: Evolution of industrial development strategy (relatively rapid
growth- 6.3%; note that for 1959-1965, figure is 8.3%))
 1966-1980: Inward orientation and industrial stagnation (slow growth-
4.1%)
 Strengthening of ISI, imposition of various government controls (bank
and insurance nationalization, foreign exchange regulation act,
reservations for SSIs, MRTP)
 1981-1990: Deregulation and acceleration of growth (hesitant reforms,
and growth revival-7.1% avg., went up to 8-9% in the second half)
 Efforts at industrial liberalization
 Better agricultural performance due to green revolution
 Increasingly expansionist fiscal policy
 1991-2000: 5.7%
 1991-1995 (schizophrenia; expected dip in 1991-92, but next four
years, output grew at 13%)
 1996-2001 (petering out of growth, steep deceleration, in part due to
the Asian Financial Crisis)
 2001-2010: 7.8%
 2002-2007 (revival)
 2008-2013 (international crisis, moderation, and revival)

Growth slowed down between 1965 and 1980s because of:

 Slowdown in public investment
 Poor infrastructure
 Slow growth of agricultural incomes
 Restrictive industrial and trade policies (import substitution)

The rectification of these concerns led to a growth revival in the 1980s.

Industrial growth in the 1990s:

1990s were kind of schizophrenic when it came to industrial growth; we saw

everything from crisis (1991-92, growth was minus 2.3%), reform, adjustment,
recovery, rapid growth (1993-96, avg. growth 13%), and a downward slide
(1997 onwards; brought down the decadal average to 9%).

From 1991 to now, consumer durables have grown the most (8% p.a.), followed
by capital goods (7.4% p.a.)
 Share of capital goods in industrial production declined drastically: During
the 1990s, relative contribution of capital goods in industrial production
reduced, whereas that of intermediate and consumer goods rose – basic and
capital goods provided about 70% of total industrial production in 1980-
1991, but only 43% in the next decade. This reflects a decline in investment
demand in the economy, partly due to trade liberalization and consequent
ease of imports, and financial liberalization

 Shift in favor of registered manufacturing against unregistered:Even

within registered manufacturing, share of modern sectors (such as metals,
electrical machinery etc.) increased at the expense of traditional sectors (such
as jute, textiles etc.), possibly due to low growth in productivity and reduced
access to credit for these traditional sectors

 Employment growth in organized manufacturing declined:Traditional

manufacturing sectors such as cotton and jute textiles were high employment
generating industries; with a decline in growth in this sector, the employment
growth turned negative at -2% in the latter half of the 1990s. Most of the
growth in manufacturing that occurred, occurred in the unorganized sector

 Export-oriented industries played a large role in growth of manufacturing

employment in the 1990s

 Share of manufacturing in GDP stagnated:It stayed at about 25%, whereas

in countries with comparable levels of development, it is usually 28-50%

 In general, there was a significant slowdown in manufacturing between

1996 and 2002, because of two primary reasons:
 Satiation of pent-up demand: There were a lot of goods that couldn’t be
assembled/ produced domestically before 1991 because of import
restrictions; after these import restrictions were lifted, there was a short-
run increase in domestic demand, which the producers mistook as a long-
term change, and invested in huge capacity buildup. By 1996, this
transitory domestic demand was pent up, and Indian manufacturers for
these products weren’t yet globally competitive, so export demand was
also minimal
 Credit crunch: Around 1996, there was an unexpected and temporary
tightening in liquidity by the RBI, in face of forex market volatility. This
was misread by the markets as a permanent squeeze, and credit dried up
for a while

 Labour productivity in manufacturing declined during the 1990s,

especially during the second half of the reform period, due to faltering pace
of implementation of structural reforms, binding infrastructure constraints, and
lack of required industrial restructuring

Industrial growth from 2002-present:

10th plan period (2002-2007):
Industrial growth recovered significantly between 2002 and 2007 (10 th plan),
and remained around 9% on average (growth in manufacturing), as compared to
only about 4% in the 9th plan (1997-2002). Some features:
 Growth was investment led: Capital goods sector witnessed double digit
growth since 2003; manufacturing sector’s share in GFCF went up from
27% in 1980s to 40% in 2000s
 Sectoral share of industry in GDP started rising after several years of
decline (was about 27% in 2006)
 Exports grew rapidly, from 6% p.a. in 9th plan to 19% during 10th plan

This growth momentum was gained due to rising demand both domestically and
externally, and also because of the cumulative effect of industrial and trade
policy changes carried out since 1991.

However, due to the financial crisis in 2008 and its knock-on effects, growth in
industry (IIP) reduced to only about 2.5%. Some of these effects were:
 Increase in input costs:increase in price of crude oil and other inputs such
as metals and ores
 Decline in export demand: export growth declined from 29% in 2007-08 to
4% in 2008-09
 Decline in access to funds:Freezing of trade credit by foreign banks,
depreciation in rupee

2008-present:
Subsequently, industrial growth recovered between 2009-11, but again lost
momentum thereafter; industrial sector grew by just 1% in 2012-13, and 0.4% in
2013-14. Capital goods sector showed a very weak performance, after being hit
by a steady deceleration in fixed investment. Core industries (coal, steel,
electricity, fertilizers, crude oil, natural gas, cement, and refinery products) grew
only by 2.3%, as compared to 5+% during the two preceding years

Primary reasons were decline in credit flows and investment, and fragile
economic recovery post 2008:
 Decline in investment; particularly, corporate investment declined, and
debt levels rose; this also put pressure on domestic banks by increasing
NPAs, which led to further credit crunch
 High inflation and consequent high interest rates led to higher input costs
 Drop in domestic and external demand
 Government policies: difficult business environment (India ranks 134 in
WB’s Ease of DB index), labour deployment rigidity, infrastructure deficit,
environmental clearances, difficulties in land acquisition, and high costs
of commercial bank credit, especially for SMEs (long processing times,
high collateral demand)

Share of manufacturing in employment has been stagnating. This reflects the

failure of the reforms to promote labor-intensive manufacturing. Overall,
employment opportunities available in the manufacturing sector in 2009 were
less than what were available in 2004. Some possible reasons:
 Growing capital intensity of production
 Sub-contracting of manufacture of parts and auxiliary services to the
unorganized sector might mean that some of the employment seen to be
lost from the registered sector reappeared in the unorganized sector, but
there is no way to confirm this

Comparing India’s industrial performance between 1981-1991 and between

1992-2008, overall, the manufacturing GDP grew by 6.3% p.a. in 1980s, and
6.5% since 1991, which is hardly a significant increase. This shows that the
dismantling of the much reviled ‘permit raj’ has not led to the acceleration of
industrial growth or of labor-intensive manufacturing, but there hasn’t been any
de-industrialization either as the critics feared (share of industrial output and
employment in total have not declined)

Manufacturing’s share in GDP has thus stagnated, and its share in merchandise
exports has declined in favor of primary products

Reforms

Thus, overall performance of the industrial sector can be summarized as follows:

 There have been some gains from reforms:
 Many lines of manufacturing have become competitive
 Relative price of capital goods has declined
 Share of PSUs in manufacturing GDP has declined by half since
1991 to 8%
 Competition has increased, with easier import and entry of new firms
 Boom in IT services can be traced back to early focus on heavy industry
and technical education
 The restructuring and competitive pressure seem to have spurred
innovation and product development; global competence has been
gained by some Indian companies, who have been acquiring firms in
developed countries
 Industry’s share of domestic output and employment has stagnated
 Share in exports has declined, with rising share of primary exports (such
as iron ore)
 Reforms have failed to promote labor-intensive, export-led growth

The reforms clearly failed to yield faster output, employment, and labor-
intensive growth; manufacturing sector, especially, has remained slack. This
isbecause of:

 Supply factors:
 Persisting labour-market rigidities:
 Infrastructural bottlenecks: pre-1991, public sector used to provide much
of the infrastructure, like in most industrializing economies. Reforms
encouraged entry of private and foreign capital in infrastructure services;
 this might be ill-founded, given the long gestation periods and low rates of
returns associated with such projects
 Poor market integration
 Badly drafted and regressive anti-competitive regulation, and bankruptcy
laws
 Incomplete financial integration including full convertibility of the
currency
 There is a dominance of large-sized factories in manufacturing Indian
firms are either too large (1000+ workers), or too small (<10); firms
employing 100-500 people are relatively less; international evidence
shows that mid-sized firms are much more efficient than the other two
kinds, but India suffers from this ‘missing middle’

 Demand factors (not that important; even the author, Nagraj, says that there
aren’t many takers for this view):
 Public investment has been declining
 Farmers are getting more impoverished, as the growth rate of crop
production has declined, and mass suicides in several areas are becoming
common. If we believe that the pace of workforce transformation depends
on agricultural productivity to sustain non-agricultural employment, then
poor agricultural growth is surely retarding industrial progress

In this scenario, self-help by industry emerges as a major way forward in

rectifying the slow-growth situation of manufacturing and overall industry in
India. Some of the steps that industry could take collectively are:
 Expansion of training institutes run by industry
 More focused collective action to demand quality and accountability for
delivery of public services in a time-bound manner from the government
 Large industries must adopt a nurturing attitude towards their suppliers,
which are invariably MSMEs
 Increase R&D expenditure

On the government side, there is a need for the government to move from
focusing on budgets and controls towards promoting coordination between
producers and policymakers, and to set-up a good quality business regulatory
environment that has:
 Low compliance cost for doing business in India
 Simple regulations (in land and environment, labour etc.)
 Fair competition
 Stability in policy regime

Other policy reforms needed are:

 A more flexible labour regime
 A transparent bankruptcy law
 Land acquisition laws
 Reforms in higher education
 Modernizing social safety nets
 Agriculture reforms
  Infrastructural reforms
 Further trade liberalization

MSME Sector

MSMEs are very important in the Indian economy. This sector contributes about
7% to national GDP, 45% of manufacturing output, 40% of total exports, and is
the largest employment generator after agriculture. It is an instrument of
inclusive growth, as it provides employment to the most vulnerable and the most
marginalized communities, such as women, Muslims, SCs, STs, and also to the
most skilled people. Role of MSEs in Indian economy:

 Generate large-scale employment (highest employment generation per

capita investment), check rural-urban migration by providing rural jobs
 Increase exports and sustain economic growth
 Often act as ancillary units for large-scale industries, and provide them
raw materials, vital components, and backward linkages
 Promote inclusive growth, and empower some of the most vulnerable and
marginalized communities by breaking the cycle of poverty and
deprivation

Challenges to MSMEs:

 Availability of credit and institutional finance

 Outdated technology and innovation
 Need for skills development and training
 Inadequate industrial infrastructure
 Underdeveloped state of marketing and procurement

Small-Scale Industrialization in India (not to be confused with Small and

Medium Enterprises): An SSI unit is one that has original investment in plant
and machinery, not exceeding Rs.10 crores.

The growth rate of SSIs, on average, has declined considerably in terms of units
(9.5% p.a. growth in units pre-liberalization, and only 4% after) and even
employment (7% v/s 4%), but has improved marginally in terms of output
(3.5% v/s 4.3%) and exports (12% v/s 12.6%), in the post-liberalization period
as compared to the pre-liberalization period.

Thus:
- Number of units and employment share of SSIs has been growing
considerably slowly as compared to before, but the output and
employment growth rate have remained almost the same
- This points to higher productivity, higher degree of internationalization
(penetration of international markets), and enhanced competitiveness of
SSIs in India, and there isn’t much evidence to suggest that
globalization has adversely affected SSIs in India
Possible reasons:

 Growth rate of new units might have slowed due because of threat of
competition; this would also have a direct effect on employment
generation
 New SSI units that have come up in the liberalization period might be
much more capital-intensive than those that have come up in the past,
utilizing the opportunities for technology upgradation and modernization
provided by participation in the global market

When we consider registered SSIs, the performance in much better; although

growth of units has slowed down, employment growth has increased from 4% to
9%; output from 4% to 27%, and exports from 4% to 47%. Also,
 Industrial sickness has declined
 There’s a higher degree of internationalization of Indian SSI, shown by
increasing exports (% of value of exports in total SSI output was 6% in
1987, and 10% in 2006)

Public Sector Performance since independence

Contrary to popular perceptions, efficiency in physical terms, and financial

performance, of the public sector in India has, in aggregate, improved
significantly during the last 3 decades.

The public sector currently contributes about 25% to India’s GDP. It can be sub-
divided into the following:
 Administrative Departments: 8-9% of GDP
 Natural monopolies such as railways, postal services etc.: 3-4%
 Non-Departmental Enterprises (NDEs), producing many goods and
services, and utilities and infrastructure: 12-13% of GDP; two types:
 Financial (RBI etc.)
 Non-Financial- these have accounted for much of the growth in the
public sector output during the last half a century

Since the 1990s, the government has followed a policy of diluting public
ownership in order to impart capital market-based discipline on public sector
management. However, experience and political expediency seem to have
changed the stance from disinvestment and privatization to PPP. However, it’s
performance has been largely good:

1. There is a distinct improvement in the efficiency of resource use in the

public sector since the 1980s: Since the late 1980s, (when the share of the
public sector in investment peaked; public investment was 12.5% of GDP in
1986, declined to 6.4% in 2001), the investment share has been halved, but the
public sector has impressively been able to deliver roughly an equal share of the
accelerating domestic output as before, which signifies massive increase in
productivity.
Within public investments, the composition has moved towards infrastructure,
and away from the much contested manufacturing sphere, which has largely
been left to private concerns (who have failed to deliver an increase in the share
of manufacturing either in GDP or in employment)

Thus, the public sector has shown remarkable progress, which has virtually gone
unnoticed.

2. This improvement in efficiency in part derives from reduction in public

sector employment growth: An oft-cited argument against public enterprises is
their bloated workforce; however, the growth rate in public sector employment
has reduced starkly, and was negative (-1%) in 2002-03 for central PSUs. This
might have contributed to the productivity increase mentioned above.

3. Profitability of the PSUs, as measured by gross profit to total capital

employed, has increased from about 8% in 1970s to 21% in 2003 (profit to net
worth/ equity is not the appropriate measure of profitability for PSUs, because
they provide public goods that have very low rates of financial returns (if any),
they address market failures, and they usually start with government debt on
their books).

4.Despite this, the financial health of the public sector is poor- (savings rate
of PSEs is negative check). This is largely due to financial distress in
infrastructure services, such as SEBs, RTCs, Railways etc. The real culprit for this
isn’t inefficiency, but inadequate pricing of the utilities and infrastructure
services, and lack of recovery of user charges for the services
tendered(ratio of price deflators for public sector output and GDP was only 85
in 2011). Due to subsidies and other bad pricing practices, public sector prices
have risen at a slower rate than the overall prices in the economy over the long
run, adversely affecting its financial position. With a growing fiscal imbalance,
reasonable pricing is the only avenue to compensate for the services provided by
PSEs. However, this remains unlikely due to political reasons. (SEE PAGE 479).

As can be seen, the liberal reforms incorrectly diagnosed public ownership to be

the main culprit for poor performance of PSEs. Given the nature of industries
that PSEs are engaged in, ownership changes to encourage more private
concerns may not reduce the inefficiency induced by sub-optimal pricing
adequately. Even though there will be greater initial freedom for private
concerns in these areas to charge market-related prices to consumers, it needs to
be kept in mind that since public utilities and infrastructure are network
industries with considerable externalities that attract regulations,
entrepreneurial freedoms might have little practical significance.

Reasons for this performance:

i. A hardening of the budget constraint, accompanied by a greater

managerial autonomy
ii. Growing competition in the product market
 iii. Changes in market conditions and financial governance have ensured
greater accountability and cost consciousness

----
The above was Nagaraj’s view; Kelkar suggests that performance of PSEs hasn’t
been so good, and recommends strategies for disinvestment and privatization
----

Net profits for the central PSUs work out to be only 2.2% of their total assets, and
in general, net return on capital employed also seems to be lower than for the
Indian private sector. In this light, what should the composition of the public
portfolio look like?

There are two areas where private ownership works quite well:

 Goods and services in ordinary competitive markets, such as steel. Private

sector ownership generates the best incentives for cost-minimization,
innovation, and dynamic adjustment of corporate strategy
 Regulated industries, such as finance and infrastructure. Here, the
government should regulate, and the multiple firms should compete in the
private space. This would avoid the conflict between the government being
the player as well as the regulator, a scenario that makes the private players
hesitant in making investments

Barring a few natural-resource based areas such as hydrocarbons, and maybe

universities, the state should not produce things that can be produced in
competitive markets, and the state should not be a player in regulated industries,
like airlines, shipping, telecom, banking, or insurance.

Even if full-blown privatization takes time, the simple act of sale of minority
shareholdings improves productivity, as it induces transparency, brings pressure
on senior managers as stock prices indicate daily performance evaluation,
corporate governance improves, and if the employees are given some shares,
they become more aligned towards the growth of the organization.

When it comes to privatization, there are two broad approaches: strategic sales,
and open-market sales:

 Strategic sales serve to increase the concentration of power and wealth in the
hands of a few business houses (which proved to be detrimental in some Latin
American countries and in Russia), but provide the following benefits:
 Sometimes, the buyer brings in essential technology/ expertise
 Buyer can exert sound governance inputs into the firm
 If share prices fall below a certain mark, buyers can completely buy out
the government

Strategic sales have been often used in countries which lack domestic capital
markets, but this is not a constraint that India suffers from
 Open-market sales lead to dispersed ownership, and strengthen institutions
and corporate governance in the country

 Another instrumentality for partial disinvestment could be the sale of

underperforming or underutilized assets of the PSUs, such as excess land

Whatever the mode of privatization, the resources generated through it are

currently channelized through the National Investment Fund (NIF). This is a
restrictive policy (why?), and there is a case to be made forallowing the
government to use these resources as a part of the budget (that could be shared
with the states as per the recommendation of the finance commission) to create
new capital assets.

India’s Labour Market and Employment Structure

India’s employment remain primarily agrarian (51%); outside of agriculture,

unorganized/ informal firms can be defined as firms that employ less than 10
people and don’t use power, or employ less than 20 people and use power.

In 2004, about 92% of all of India’s employment was in the unorganized sector,
and did not have any labour rights to speak of. Thus, there exists a dichotomy
where labour laws create rigidities in the organized segment, while even
minimal labour rights are non-existent in the unorganized sector. Thus rigid
labour laws discouraged growth of firms out of the informal sector; thus, we are
left with the current structure of Indian industry characterized by the ‘missing
middle’.

Rigid labour laws include factors that affect minimum wages, hiring and firing
regulation, centralized collective bargaining, mandated costs of hiring, and
mandated costs of worker dismissal. There is empirical evidence to suggest that
states in India that have more pro-worker regulations have lost out on industrial
production in general.

Added to the rigid labour laws, other reasons that encourage informality are: tax
avoidance, complicated transactions costs of registration, rent seeking, and few
perceived benefits from formalization.

State intervention and the inspector raj: There are many labour laws in India
that go way beyond industrial relations; for example, the Factories Act
empowers the states to prescribe the number of urinals, spittoons etc. in
factories. There is a gamut of assorted laws (about 45 central laws and numerous
state laws, as labour is a concurrent subject), and a variety of inspectors can
descend under any one of these laws. There are procedural laws affecting all
stages of an enterprise’s life: entry, functioning, and exit; these impose
transaction costs and render Indian businesses uncompetitive.

The inspector-raj facilitated by this law structure gives ample opportunity for
rent seeking, discretionary use of powers, and harassment. While these
problems have been recognized for a while now, thee hasn’t been much
movement on amending these laws, because of various reasons:
 Resistance from trade unions
 Tendency of the central government to pass the buck to the states
 Conscious attempts to tackle the problem in enclaves/ SEZs

Industrial Relations: There are 3 statutes that impinge upon industrial relations
in India:
 Contract Labour (Regulation and Abolition) Act: Contract labour offers
flexibility and permits outsourcing, but under this act, there have emerged
pressures to make contract labour permanent, and offer them preference
over appointing new permanent workers
 Trade Unions Act: Under this act, any 7 people can forma trade union.
This leads to multiplicity of unions, which impinges on collective
bargaining.
 Industrial Disputes Act: This act requires government permission before
lay offs, retrenchment, and closure. This makes the labour market
artificially rigid, and incentivizes employers to adopt higher capital
intensity

Under all of these acts, labour courts and tribunals are not particularly
efficient and have a large backlog, with an average adjudication of 3-5
years.

Unless some of these issues can be addressed, firms will go on utilizing

more capital-intensive techniques, and higher GDP growth in India will not
translate into higher employment.

May 2015: The BJP government has made it significantly harder to form trade
unions; previously, any 6 workers could form a union; now, at least 10% of a
company’s workers, or 100 workers (whichever is lower) need to come together
to qualify as a union. The same person cannot form more than 10 unions, and
strike actions, such as gheraoing, will not be allowed close to the houses of
managers etc.

----
(Try and find a newer paper on this topic, this one is kind of outdated)

Manufacturing sector in India has been characterized by the presence of

dualism; there is a strong concentration of employment at the small and
large size-groups of establishments, with a conspicuous ‘missing middle’.
The fact that post-reform growth in India has been led by the tertiary sector
(both in value added and employment), and not by manufacturing, can be
explained by this dualism.

By international standards, India’s services-led growth has been an anomaly;

usually, on a country’s growth path, manufacturing first captures the decreasing
share of employment in agriculture, and services kick in at a later stage. In India,
the share of manufacturing in employment and GDP has remained more or less
stagnant. Also, the growth in tertiary sector in India has been productivity led
and not employment led.

Within the ‘small’ enterprise group, (<10 employees), one can subdivide
industries into 3 categories:
i. Household enterprises, that don’t employ any wage laborer; these account
for 56% of total employment in manufacturing
ii. NDMEs (2-5 workers, at least one hired on wage basis); 12.4% of
manufacturing employment
iii. DMEs (6-9 workers): 14.4%

Thus, much of the employment in small-scale enterprises comes from low-

productivity household enterprises. Also, much of the employment growth in
manufacturing seen in the post reform period has come from the 6-9 category of
firms- between 1994 and 2000,manufacturing added about 48 lakh jobs. Out of
these, organized manufacturing (10+ people) accounted for only 64 thousand
new jobs, and all the rest came from firms with less than 10 people!

Now, considering this with the ASI classification, we can see clear evidence of
strong dualism in Indian manufacturing:

% employment Index of labour

Size of firm (people employed) distribution productivity
1984 2000 1984 2000
6-9 40 41 0.2 0.1
10-499 29 36 ≈1 ≈1
500+ 31 23 >1 >1

As we can see, an overwhelming majority of the employment in

manufacturing is found in firms that employ either 6-9 or 500+ people, and
the situation has hardly budged in the last 3 decades.

This dualism is bad for the Indian economy because of:

1. It’s impact on allocative efficiency and wage growth: Productivity of

workers in large firms is much, much higher when compared to that of
workers in small firms. However, even when wage per worker has been
controlled for measurable human capital attributes and machine-led
productivity, the wages are significantly higher in large firms. It would
seem that workers in large firms make more money simply by the
virtue of being in a large firm, rather than any other attributes. This
perpetuates wage inequality

2. Impact on dynamic efficiency and employment growth: ‘Missing

middle’ implies a weak process of graduation of small firms and
development of entrepreneurship. Similarly, dualism also slows down the
growth of the labour force with industrial skills, which is especially true in
a developing economy like India where most of the industrial skills are
acquired on the job rather than in schools. This shortage of skilled labour
 then feeds back into utilization of more capital intensive production
techniques, thereby retarding growth of employment in manufacturing

3. Dampening the growth of markets: The market for industrial goods is

split into low-quality goods catering to the need of low-income consumers
and supplied by small units, and higher quality segments which the large
establishments supply to a limited number of high-income consumers.
The lack of existence of medium-sized enterprises act as a bottleneck in
the development of mid-sized consumer markets

Causes of emergence of dualism:

1. Labor legislation
2. Education policies have been biased towards the promotion of tertiary
education and have neglected basic and lower secondary education,
thereby creating shortages of skilled labour
3. Protections provided to small-scale units have encouraged horizontal
expansion (with a number of small units) rather than vertical expansion
and graduation to mid-size; while these have been scaled back since 1991,
hysteresis effects still continue