A look at binding constraints stunting India's growth engine

One of the key aspects of government’s policy response is to attract manufacturing activity including supply chains that are looking at alternative destinations. This approach has combined modest protectionism, structural reforms and production incentives with a vision to attract sizeable investments into the country.

However, we must recognise that India’s population, while sizeable, still has limited capacity – and thus, we will have to look at global markets to be able to sustain the kind of transformation of our manufacturing sector that is warranted.

For a faster pace of industrialisation and to be able to achieve economies of scales, we will have to invariably look at exports which make signing of free-trade agreements with open economies critical.

However, there is another constraint that is important which has been ignored. This constraint is of raw materials and critical supplies – more so in sectors that are heavily monopolised by certain countries. The real constraint in the short-run will come in the form of access to such raw materials and rare-earth minerals while global disruptions too will act as a constraint.

The world is already witnessing some of these disruptions as a consequence of the pandemic – especially with regards to shortages in the semiconductors industry. This shortage has created major issues for automotive majors that rely on such products as key inputs for their vehicle assembly lines.

This shortage is a direct outcome of the restrictions imposed by United States on export of critical inputs and minerals to China which has disrupted the semiconductors supply. Similarly, there was a shortage of containers due to low volume of international trade which resulted in an increase in shipping costs. Thus, in essence, economies are far more interlinked these days which means that they have significant forces that interact on a daily basis.

The important point here is that on one end we face a constraint in terms of a limited set of market for people with high disposable income (even this limited set of market is huge, but not sufficient for global economies of scale), on the other we face concerns of overdependence on specific countries to ensure steady supply of raw materials for our domestic industry. Thus, even if we were to protect our industry, we will be susceptible to volatility induced by factors in countries that are our key suppliers for raw materials.

The fact is certain sectors have been monopolised by certain countries – and most nations depend on these countries to provide adequate resources to their domestic industry. This concern is a major reason why most countries, including India itself, is rethinking its trade policies as it attempts to boost domestic manufacturing. Similar such interventions have been already announced by countries such as Japan and the US.

However, such efforts in isolation may not be the best possible course of action – and will very likely be sub-optimal. For instance, India may succeed in shifting some of the pharmaceutical API manufacturers and push a major part of the electronics manufacturing space to India.

However, the semiconductor industry will not find it viable to establish semiconductor fabrication units solely for India alone. Several such industries require massive investments which will generate returns only in the medium term. Therefore, even if India manages to move a major part of electronics manufacturing into the country, it will have to depend on others for raw materials such as components and semiconductors. Thus, our import bill will see a shift in its composition as we will go from importing electronic products to importing electronic components till we can set up a semiconductor manufacturing ecosystem in the country.

This is why free-trade agreements will be instrumental in building a collective block. This will ensure we have a sizeable market available for our private sector to sell their produce. More importantly, it will give a strong economic justification for creating companies of global scale and capacity for critical raw materials. Thus, this can serve as a strategy to systematically break down  monopolies of such commodities and promote greater economic cooperation.

We must recognise that there are certain binding constraints that will prevent us from sustaining a growth rate beyond 8% for more than a couple of years. Some of these are on the supply side while others are on the demand side. While the present set of reforms will improve productivity and thus enable us to sustain a 7.5% growth rate, addressing some of these constraints through trade-agreements could be vital for pushing growth beyond this level.

(The writer is an economist and policy-researcher. Views expressed are personal)