McKinsey: Tremendous Manufacturing Opportunity for India

Econintersect:  The March 2012 McKinsey Quarterly contains an article which discusses the tremendous growth potential for manufacturing in India.  The article suggests that the manufacturing sector could grow 6-fold by 2025 to an output of $1 trillion and with added employment of as many as 90 million.  There are four areas that McKinsey has identified needing government initiatives (see details after the “Read more…” break).  However, the article maintains that the bulk of the changes needed must come from the private sector.  McKinsey says that manufacturing could grow to provide 25-30% of GDP by 2025 and the country would join the ranks of the world’s leading manufacturers, along with Germany, China, Japan and the U.S.

The areas that Indian manufacturers need improvement to grow into the top echelon of global manufacturing are outlined in the following graphic.

Click on graphic for larger image.

Some industries have already made progress.  The article cites an 8-fold increase in output per worker by Tata Steel between 1998 and 2011.

But there are significant challenges to the India government, as outlined in the following excerpt:

India’s central and state governments must eliminate four barriers that slow down the efforts of the country’s manufacturers to improve their capital and labor productivity.

1. Product market and ownership barriers. More than half of India’s employees in the organized sector (regulated by labor laws for hiring and firing) still work in government-owned institutions—for example, in the base-metals, petroleum, and power generation industries. Product market barriers and government ownership tend to lower productivity and distort markets significantly.

Yet receding levels of government ownership have dramatically improved the productivity of labor and capital in other parts of the economy. India’s automotive sector, for example, was among the first to be liberalized, in the early 1990s, and the entry of multinational and domestic players sparked a competitive transformation. Subsequently, between 1995 and 2005 the automotive sector’s GDP per manufacturing employee grew by a factor of 15. Today, India produces nearly three million small cars a year, of which about one-quarter are exported. To be sure, India’s government might well deem some sectors (aerospace and defense, for example) as strategic and limit the extent of foreign participation. Yet for a majority of sectors, greater private and multinational participation in India can help unlock productivity structurally.

2. Land market barriers. Distortions in the land market (including high stamp duties and cumbersome regulations) are a huge barrier to productivity improvements in India. In the steel industry alone, we estimate that more than $60 billion of committed capital currently awaits environmental or land clearances. Much of this planned investment has already been delayed by three to five years.

Challenges to aggregating land in India also make it tough for suppliers and manufacturers to raise their overall productivity by locating facilities closely together and thus reaping network effects enabled by streamlined supply chains, the sharing of infrastructure, and mutual learning opportunities.

3. Labor barriers. Stringent labor laws make it difficult for Indian companies to restructure and thus to increase their productivity and expand output. Firing underperforming workers is difficult in India, and this ongoing problem translates into high levels of unproductive labor at many companies there. India’s government should consider liberalizing its labor laws by encouraging reskilling programs that could help workers become more productive and prepare them for new jobs. Encouragingly, India’s National Skill Development Corporation (NSDC) is experimenting with ways to use public–private partnerships to strengthen vocational training. Coupled with sensible labor laws, such moves could quickly begin to make a difference.

4. Infrastructure. Urgent attention is needed to create more railways, roads, ports, and power-generating capacity across India. Poor infrastructure saps industrial productivity and leaves the country at a huge disadvantage compared with others. Bad road conditions, for example, limit trucks carrying cargo in India to an average distance of only about 250–300 kilometers a day, compared with the developed world’s average of 500 kilometers. Similarly, turnaround times for ships loading and unloading in India’s ports can be up to four days, compared with only 10 to 12 hours in Hong Kong.

Recently, India’s Ministry of Commerce & Industries called for the development of National Investment and Manufacturing Zones (NIMZs).¹ The encouragement of such industrial clusters is a positive development, since they are a proven way of catalyzing the efforts of the public and private sectors to address infrastructure challenges. In the Indian state of Jharkhand, for instance, a cluster in the city of Jamshedpur attracted dozens of industrial companies that teamed up to improve the local infrastructure. The benefits extend beyond better roads, power, and water supply: companies in Jamshedpur actively collaborate to improve workers’ skills and have even, in some cases, developed shared pools of workers. The learning benefits for companies are substantial, too, as industrial clusters help spark the kinds of supplier ecosystems that help innovation thrive.

Notes

¹ For more, see the government’s recently announced National Manufacturing Policy (NMP), available at www.india.gov.in.

John Lounsbury

Source: Fulfilling the promise of India’s manufacturing sector (Rajat Dhawan, Gautam Swaroop, and Adil Zainulbhai, McKinsey Quarterly, March 2012)