We can’t keep growing without ‘sweatshops’

Some 10 years ago, the Indian economy passed a defining milestone when the service sector - represented by the ‘soft’ side of the economy as distinct from agriculture and manufacturing - accounted for the first time for over 50% of GDP.

The fruits of the ‘shotgun’ economic liberalisation of the early 1990s were at that time beginning to ripen, and an explosion in consumer credit gave birth to a discretionary spending binge, which propelled the service economy at a furious pace. It was also the high tide of the dotcom boom, and new-age outsourcing service providers from India were beginning to spread their wings around the world.

‘Call centres’ were beginning to mushroom in Indian cities, opening up gainful employment opportunities for a new generation of young Indians, whose somewhat less inhibited spending in turn kept the service economy humming.

The passing of that economic milestone gave rise to much feisty celebration over the fact that India had evidently catapulted straight from an agrarian economy to a ‘post-industrial’ stage of economic evolution, bypassing the natural order of transition from agriculture/mining to industry and then on to services.

It was fairly uncharted territory in economic history: no other country of India’s size had achieved such an economic ‘short-cut’. China, the only other country with a comparable billion-plus population, was going by the playbook of economic evolution with its low-end export-oriented manufacturing ‘sweatshops’ that drew migrant workers from China’s villages to the manufacturing centres.

In the decade gone by, India’s GDP growth has, of course, gradually edged up into a higher orbit, getting to within striking distance of China’s double-digit growth. Yet, structurally the two economies couldn’t be more different from each other.

For instance, UBS economist Jonathan Anderson points out that during the 10-year period to 2007-08, India’s record of overall industrial export penetration was outright mediocre, registering an increase of barely 2% of GDP over that period. On the other hand, China, riding high on the strength of its ‘sweatshop economy’, registered a gain of 18 percentage points.

Specifically in the area of electronics and light consumer exports (toys, textiles, footwear and furniture), India’s performance - or lack thereof - is even more striking. India’s total annual export turnover is about one-seventh of China’s, and total exports to the US and to Europe is about one-ninth of China’s. But India’s share of electronics and light consumer exports is barely about one-thirtieth of China’s.

Why should this be a drag on growth? Because, as Goldman Sachs analysts Tushar Poddar and Pragyan Deb noted recently, given the demographic transition under way here, India will likely provide the largest increase to the global labour force over the next decade, an estimated additional 110 million by 2020.

More specifically, there will be a rapid increase in the Indian population in the 30s and 40s (or the ‘thorties’, as they’ve been dubbed) over the next two decades. By some estimates, their numbers will account for nearly half of overall population growth. (By contrast, in China, which is demographically over the hill, the age 30-49 population will shrink by 20 million between 2011 and 2030.)

This favourable demographics is generally accepted as a key element of India’s growth story. However, for India to reap the ‘demographic dividend’ from this ‘labour force army’, it has to generate millions of jobs over the next two decades.

And since services (including construction) can likely provide employment for only about half of the addition to the labour force, the manufacturing industry, which has traditionally underperformed the service sector in job creation, has to step up and generate jobs for the rest.

And within the manufacturing sector, it isn’t the heavy industrial sector that typically generates the most employment per unit of invested capital: it’s the light industrial sector that does it, according to Anderson. In China, for instance, of the 120 million or so rural migrants who are currently employed in non-farm activity, more than three-fourths work in just two sectors - construction and light industry.

There’s another compelling reason why India needs to tap into the light manufacturing export economy: the need to maintain its balance of payments.

Despite its strong services exports since the 1990s, which makes a positive contribution to its foreign exchange balance, India’s merchandise trade deficit has widened even faster.

In other words, if India is to keep its gathering ‘labour army’ gainfully employed and generate sufficient foreign exchange to bridge its merchandise trade deficit, it needs export-oriented ‘sweatshops’.

The risks, says Anderson, is that if India doesn’t get this part of the economy right, it will face higher unemployment pressures, weaker trend consumption and fading growth rates over time.