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View: Some useful economic history lessons on how we manage to handicap ourselves

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It has gone virtually unrecognised that the goal of economic self-sufficiency single handedly held the Indian economy back for nearly four decades. All else, including the licence permit raj, small scale industries (SSI) reservation and heavy presence of the public sector was either a by-product of this goal or sideshow.

PM Nehru viewed economic self-sufficiency as necessary for the preservation of political freedom. He held that depending on imports for railways, airplanes and guns amounted to being slaves of foreign countries. “Whenever these countries wished they could stop sending these things … we would thus remain slaves.”

Unfortunately, there was an inherent conflict between such self-sufficiency and productive efficiency. In 1950s India, both income and savings rates were extremely low. That translated into meagre savings. With ample labour supply available, the key to fast development therefore lay in the conversion of these savings into the most productive investments. Self-sufficiency stood in the way of such conversion.

Self-sufficiency required rapid expansion of the economy into a diverse set of products ranging from bicycles to automobiles to railways to airplanes, their components, as well as metals and machinery necessary to manufacture the products and components.

Broadly, manufactures could be divided into two categories: Capital-intensive products such as those just mentioned that had to be produced by large scale enterprises, and labour-intensive products such as clothing, footwear, kitchenware and furniture that could be produced by small scale enterprises referred to as the “cottage industry” in the contemporary nomenclature.

Given the need for diversification, it was only natural that scarce savings be reserved exclusively for large scale enterprises with cottage industry relying on its own internal savings. The compulsion to spread the scarce savings over as many products as possible even within the capital-intensive category meant that each of these products was allocated just enough capital to operate on the minimum technologically feasible scale.

This scale was generally significantly smaller than the one at which counterpart enterprises in other parts of the world operated. At this scale, production in India was inherently costly relative to that in other countries. Survival of the enterprises then required prohibition of imports through strict import licensing.

Instruments deployed to allocate scarce savings were the manufacture of certain heavy industry products in the public sector using revenue resources and investment licensing for the private sector whereby any investment in plant and machinery exceeding Rs 1 million (revised to Rs 2.5 million in 1964) came to require a licence issued by a government agency.

To exclude light manufactures from accessing scarce savings, initially the government adopted a policy of denying licences for their large scale production. Later, in 1967, it adopted the SSI reservation policy, under which it drew up a long list of labour-intensive products and reserved them for exclusive manufacture by enterprises with Rs 1 million or less in investment in plant and machinery.

Under this system, India became uncompetitive against foreign products even in labour-intensive manufactures. With investment in plant and machinery limited to Rs 1 million, costs and quality of even these products could not match their foreign counterparts. They too had to be protected via import licensing.

With imports shut down and investment licensing blocking entry of new domestic enterprises, all sources of competition were eliminated. Inefficiency from a lack of competition was thus piled on top of the inefficiency of scale.

Even so, with imports strictly controlled and domestic output limited by licence, products such as steel, scooters, automobiles and cement had the potential to generate large profits for those lucky enough to get licences. Price controls were adopted as the solution but that created shortages of the items. Distribution controls requiring a government issued permit to procure the items followed.

From a development standpoint, industry came to be divided into a formal, capital-intensive sector and an informal cottage industry sector. Capital got concentrated almost entirely in the former and labour in the latter. Hardly any attractive job opportunities opened for unskilled workers except in the public sector. India remained primarily agricultural, with 66% of the workforce trapped in that sector till as late as 1987-88.

Efficiency required the allocation of scarce savings to light manufactures, allowing them to achieve scale and product quality necessary to compete in the vast global economy. That would have created jobs for the unskilled at decent wages and facilitated rural-urban migration. Resulting rising incomes would have led to rising savings and provided investible funds for investment in progressively more capital-intensive products. Diversification could, thus, have been achieved over time. This is precisely the strategy South Korea, Taiwan and Singapore followed in the 1960s and 1970s.

The proverbial dualistic structure with capital concentrated in formal, capital-intensive sectors and labour in informal, SSI sectors has continued to haunt India till date. The rise of services sectors has only reinforced this structure by concentrating skilled labour in formal employment and unskilled labour in self-employment or micro and small services enterprises.

Hardwired for it, our successful entrepreneurs, who walk away with much of the available bank credit, remain disinterested in investing in labour-intensive light manufactures. With policy makers focussed on either capital- and skilled-labour-intensive sectors or micro and small enterprises as well, medium and large enterprises in light manufactures remain orphans.

(The writer is Professor of Economics at Columbia University. Views expressed are of the author’s and not of www.economictimes.com)



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