POLICY FOR GROWTH: PRO-BUSINESS OR PROMARKET?

CONTRASTING POLICIES IN INDIA’S AUTO INDUSTRY OFFER SOME USEFUL INSIGHTS

Should governments actively support businesses to grow or should they merely act as handsoff facilitators? The two approaches are quite different and may be termed as being “pro-business” or “pro-market”.

Under a pro-business policy, the government actively supports selected business – through subsidies or protectionism. By contrast, a pro-market system does not support specific sectors but focuses on improving the overall environment, reducing restrictions to trade and investment. The pro-market approach relies on competition to drive productivity. The policy would focus on removing restraints to competition-simplifying regulations, removing trade barriers etc. When competition increases, it forces firms to improve efficiency and innovate. Weaker firms exit while the efficient survive. A pro-business approach attempts to improve efficiency by supporting targeted businesses to “learn by doing”, buying them time to learn the tricks for increasing productivity. For example, the domestic market may be protected (by tariffs) until the efficiency of local firms catches up to the levels of advanced firms. A pro-market approach would favor foreign competition in the domestic market, while a pro-business approach would restrict it. Other pro-business tactics could include subsidies (to compete in export markets), support for technology acquisitions, etc.

Note that the ultimate aim of both approaches is efficiency or productivity. Th e key to growth is productivity—higher output per worker is what supports higher wages. Rising incomes only result from rising productivity. If productivity stalls, so will lifestyles. “A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.” (Krugman).

The problem is if pro-business policies fail to increase efficiency, it will not benefit the economy because these policies are not cost-free. For example, if subsidies were being granted, tax revenues must be diverted from other welfare projects to the selected businesses. If protective taxes were hiked, increasing the price of imports, it would allow local products to command a better price, but consumers would need to pay high costs. Therefore, while pro-business policies help business, they lead to certain welfare losses in the rest of society. The two interests must be balanced: the losses are worth carrying only if it translates to improved productivity.

For this to take place, the policy must be designed to improve competitiveness. Global competitiveness depends not just on wage level but also on the productivity of labour and its effectiveness in converting expensive (often imported) inputs into outputs. This depends not just on formal education, but more significantly on their tacit knowledge embodied in routines of production that can only be learnt through actual practice. Th is is not easy to achieve.

KEY TO GROWTH IS PRODUCTIVITY —HIGHER OUTPUT PER WORKER SUPPORTS HIGHER WAGES

“Without periods spent in learning-by-doing, a developing country typically has productivity levels that are too low for it to competitively engage in production. Th is is even true for many relatively low-quality and basic production processes. As a result, a new firm or even an entire country can find entry into even low-quality production blocked.” (Khan)

Put this way, the case for supporting industries seems compelling. Therefore, he argues, protecting domestic markets by granting export subsidies can provide infant industries in developing countries with the ‘loss-financing’ to engage in production and learning-by-doing. The contrasting policies in India’s auto industry offer some useful insights. In 1928, General Motors commenced assembling trucks in India, followed two years later by Ford. Local businesses, Hindustan Motors and Premier Automobiles were established in 1942 and 1944; they started by assembling Morris Oxford cars and Bedford trucks, gradually indigenising the components. In 1949, India banned the import of completely built vehicles and from 1953, refused permission to Indian manufacturers to assemble imported vehicles, without increasing local content. GM and Ford exited the market, and in 1957, the Morris Oxford, substantially indigenised, re-emerged as the Hindustan Ambassador.

“In the 1950s and 1960s, centralised Indian industrial policy helped to build up a car industry that produced around 40,000 cars annually but of generally low quality. A protected domestic market and other implicit subsidies provided the loss-financing to low-competitiveness producers, which enabled them to produce Indian cars. However, low levels of compulsion for eff ort meant that the low-tech Ambassador never became a globally competitive product.”(Khan, 2011).

During 1950-80, to encourage upstream integration, auto component manufacturing was reserved for small-scale industry, but in the absence of economies of scale, the industry remained highly fragmented and technologically underdeveloped.So far this is a familiar, if depressing, tale but an accidental train of events transformed this. Sanjay Gandhi was trying to build a people’s car in the 1970s, but his sudden death in 1980 left a factory with no immediate prospects of producing anything. “The potential loss of prestige for the Gandhi name made Indira’s government look for effective policies that in effect created new financing instruments for the transfer of technological and organisational capabilities to India…after a long and committed search by top Indian bureaucrats for a foreign technology provider, an agreement was signed with Suzuki in 1982.”(Khan,2011)

“Suzuki, then mainly a motorcycle manufacturer with a relatively minor interest in automobiles had the advantage of knowing the Indian market and political system as they had been scouting for business in the motorcycle sector for some time. Suzuki’s experience in India allowed them to recognize that the Indian government was serious about making this project work. Th e Indian government was effectively willing to open up the protected domestic market with the large rents that had previously been available for domestic learners to a foreign investor if the latter was willing to make a significant investment in transferring capabilities.”

The JV with Suzuki specified 70% non-company value addition, of which at least 60% would be locally procured.

India’s protected automobile market (with tariff s of around 85%) was attractive, but to be able to sell in this market, Suzuki first had to make the Maruti-Suzuki car with 60% domestic content within five years. This meant the organizational capabilities of Indian Tier 1 and Tier 2 component producers to meet the domestic content target and yet produce a car that would be of higher quality than existing Indian cars like the Ambassador. There were additional reasons for not compromising on quality, including the reputation risk for the global Suzuki brand. The design of the system clearly created strong incentives and compulsions for effort because Suzuki had no interest in drawing the process out and every interest in completing it quickly. Moreover, there was a very strong likelihood that without fulfilling the domestic content requirement, the company could be barred from the local market for contract violation.

IN 2016, INDIA WAS THE WORLD’S SIXTH-LARGEST VEHICLE MANUFACTURER

The result was a remarkable transformation of the competitiveness of the Indian automobile sector based on a significant transfer of technological and organizational capabilities. In the 1990s, DaimlerChrysler, Fiat, Ford, GM, Honda, Hyundai, Toyota and others followed Suzuki in similar deals. By the end of the 1990s, Indian component manufacturers were winning Japanese awards for quality.

In 2016, India was the World’s sixth-largest vehicle manufacturer  with a total production of 24 million units and the fifth-largest in the passenger vehicle market. In the same year, this sector accounted for 7.1% of the country GDP, 27% of industrial GDP, 54% of manufacturing GDP and employed 19 million people.

What lessons can we draw?

The first phase of the development (1950-1980) shows the effect of standard protectionism- India did develop the ability to make cars, but of poor quality. Post-1980 shows the benefits of facilitating foreign participation, technology transfer and creating the right incentives for firms to strive for efficiency. This was also the reason for the success in Korea: “The financing provided to the chaebol through low-interest loans, protected domestic markets and export subsidies came with conditions, for instance, for achieving export targets. These conditions ensured high levels of effort because the enforcement of these conditions was credible. The state could not only withdraw subsidies, it could also reallocate plants to different owners if they were more likely to enhance competitiveness.”

Instead of open-ended protection, benefits must be tied to productivity. The threat of withdrawal will only be credible if administered by a competent, independent bureaucracy. The policy can offer a carrot, but to work, it must also carry a stick. Without the two, industries can end up building equivalents of the Ambassador.