COMMENT-Heeding Krugman's call to focus on manufacturing is key to Rising India

Nobel Prize winning economist Paul Krugman speaks during an interview in New York, May 4, 2012. REUTERS/Brendan McDermid (UNITED STATES - Tags: BUSINESS) - RTR31M2I

At the News18 Network’s Rising India event last week, Nobel laureate economist Paul Krugman warned that India could end up with mass unemployment if it does not grow its manufacturing sector.

This is a dire warning, but not necessarily surprising.

Conventional economic theory suggests when an economy progresses, it passes from being predominantly agrarian to having a preponderance of manufacturing, and then becomes services-driven as it attains maturity.

A look at the composition of Indian GDP shows we have given this progression the go-by: The fall in the share of agriculture has been made up by an increase in the share of services. Agriculture, which was close to 47 percent of GDP in 1961, is only 15 percent now, and industry has improved its share from 21 percent  to 31 percent over this period. However, the biggest change has been in services, whose share has jumped to 54 percent from 32 percent.

Economists call this phenomenon the ‘missing middle’ -- a scenario where growth in manufacturing & industry, with their ability to absorb large-scale labour, is missing, and jobs tend to be concentrated in either highly skilled service-driven industries like IT or financial services, or in very low-productivity farms. This has left India incapable of coping with an impending demographic wave, increasing the risk of the country falling into a low middle income trap with scores of jobless youth.

Despite great strides in services, its share in employment has not improved by similar proportion. India continues to employ excessively large number of people in agriculture, which has depressed earnings of the sector.

Direct agriculture continues to employ 41 percent of the employed population despite its falling share in the GDP. Industry is more balanced – employing 28 percent of the employed workforce while contributing to 31 percent of the GDP. Service presents a lopsided picture by employing 31 percent of workforce while contributing to 54 percent of the GDP. The latter may be explained by the dominance of India’s Information Technology sector where unit value added is much higher.

The tectonic shift in Indian IT sector with the advent of digital technologies implies that while the value added of this sector will remain meaningful, its ability to absorb labour will further dwindle. Therefore, the gap between employment generated by service sector and its contribution to GDP is only likely to widen.

While this analysis suggests productivity so far has been higher in services, the lower absorptive capability of services and falling value-add of agriculture points to the fact that India is staring at massive unemployment if it doesn’t get its manufacturing engine to fire.

If we look at the countries who have similar share of services to GDP as India, we are seen rubbing shoulders with countries like Russia, South Korea, Mexico, Argentina, Malaysia, and Slovakia etc. –whose per capita GDP (or GDP per head) is manifold ours.

The critical difference with our peers is their falling share of agriculture that is being taken up by manufacturing.

Almost all countries that have managed the transition from low to high income have undergone industrialisation, diversifying and upgrading their production structure, relinquishing dependence on agriculture and natural resources.

Only a few countries with valuable natural resources, and with small populations have gone through a period of sustained economic growth without advancing manufacturing production. India certainly is not one bestowed with either natural resource or scanty population. So adopting manufacturing with great seriousness is no more a matter of choice but a necessity.

Even to realise the much-flaunted goal of doubling per capita farm income by 2022, the need of the hour is to move people out of agriculture. Unfortunately, the wake-up call has come at a time when technology is changing the landscape of manufacturing at a fast clip as well.

India should first target re-skilling of the large number of redundant labour in agriculture into labour-intensive manufacturing. The endeavour should be to become a hub of labour-intensive manufacturing first.

However, eventually a massive improvement in skills is required, and that has to percolate through our education system at every level.

Modern manufacturing technologies are highly intensive in the use of capital (physical, human and embodied technology) and skilled workers and less intensive in the use of unskilled workers, a process of change accelerated by the information technology (IT) revolution.

Such technologically driven changes to the pattern of production are likely to have deleterious effects on the wages and employment prospects of unskilled workers and, by extension, are likely to lead to increased wealth and income inequality.

No wonder, even in the developed world, the clamour for protectionism is growing as manufacturing is increasingly creating fewer unskilled jobs.

Going by the current estimates, India will require a nominal growth of at least 16 percent for the next ten years to enter the bracket of middle-income countries. The task may be impossible unless the rhetoric of ‘Make in India’ translates into concrete action.

Creation of a manufacturing base that can be competitive in a globalised world will require massive upgradation of infrastructure. So far we have taken baby steps; the need of the hour is a sprint. Otherwise, we genuinely run the risk of slipping into a lost decade of unemployment and unrest, and a Rising India will be a major challenge.