Exports, capabilities, and industrial policy in India

An extensive literature argues that India’s manufacturing sector has underperformed, and that the country has failed to industrialize; in particular, it has failed to take advantage of its labor–abundant comparative advantage. India’s manufacturing sector is smaller as a share of GDP than that of East Asian countries, even after controlling for GDP per capita. Hence, its contribution to overall GDP growth is modest. Without greater participation of the secondary sector, the argument goes, the country will not be able to develop and become a modern economy. Standard arguments blame the “license-permit raj”, the small-scale industrial policy, and the labor laws. All these were part of the industrial policy regime instituted after independence. This regime favored the heavy-machinery subsector. We argue that despite its shortcomings and misallocations, the bias towards machinery, metals, chemicals, and other capital- and skilled labor-intensive products allowed Indian manufacturing to accumulate a wide range of capabilities. We show that India’s manufacturing sector is more diversified and sophisticated than one would expect given the country’s income per capita. This positions India well to continue expanding its exports of other sophisticated products. India’s failure, however, lies in not being able to diversify into labor-intensive sectors and generate the type of structural transformation seen in China.