Industrial policy key to economic transformation to a sustainable future

industrial policy and sustainability
An industrial policy is essential for addressing global challenges and fostering #inclusivegrowth through #innovation and environmental protection.

The world economy is reeling under various problems such as supply chain disruptions, climate change, and geopolitical crises which have reignited discussions around the role of industrial policy and government interventions in strategically important industries. Since India’s last Industry Policy in 1991, the development paradigm has undergone significant changes.

Traditionally, industrial policy has focused on enhancing productivity through the utilisation of imported technology-embedded capital goods. This approach was considered crucial in generating increasing returns to capital and labour, thereby fostering economic growth and prosperity. However, on a global scale, the goals of industrial policy have expanded. Nowadays, industrial policy agencies aim to influence structural changes that reduce regional disparities, promote labour-intensive industries and small enterprises, and foster a more environmentally sustainable economy.

Until 1980, most countries employed some form of industrial policy, either based on protectionism or public sector dominance. Since then, globalisation, the collapse of the Soviet Union, and the setting up of the World Trade Organisation prompted governments to perceive industrial policies as outdated, favouring market-based mechanisms as a more efficient option. It is encouraging to observe governments and policy advocacy organisations reevaluating the concept of industrial policy and placing it back on the agenda. There has been a surge in government-led initiatives globally that seek to enhance productivity and develop domestic capabilities in strategic sectors.

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Industrial policy back in vogue

In August 2022, the United States enacted the Inflation Reduction Act, aiming to stimulate investments in domestic manufacturing capacity, promote domestic procurement of critical supplies, and accelerate research and development and commercialisation of cutting-edge technologies such as carbon capture and clean hydrogen production and storage. This legislation represents the third initiative since 2021 aimed at improving economic competitiveness, innovation, and industrial productivity. The Bipartisan Infrastructure Law allocated $550 billion for infrastructure development between 2022 and 2026, covering roads, bridges, mass transit, water infrastructure, electric vehicles, power grids, and broadband. Another major initiative is the CHIPS Act, which has a budget of $280 billion over the next 10 years, allocated to research and development, commercialisation, and manufacturing.

The interventions by the US government are noteworthy because historically, the United States has been hesitant to employ industrial policies, considering them as unwanted government interference in business affairs. In the past, policy interventions were employed in response to external threats, such as those from the former USSR, or as a countermeasure to initiatives like Made in China 2025. The strategic MIC 2025 is particularly relevant in the Indian context. Introduced in 2015, MIC2025 encompasses various industrial plans aimed at enhancing China’s competitiveness in the global manufacturing value chain. It focuses on substantial investments in identified and emerging technologies, reducing reliance on foreign firms and materials, and achieving technological breakthroughs in ten specific sectors.

In November 2022, the Chinese Communist Party reiterated its emphasis on technological innovation as the core driver of China’s development. China’s industrial advancements over the past 45 years can be attributed not only to market-oriented reforms and a more open domestic market but also to a strategy of regular annual reviews of industrial policies based on the status and stage of industrial growth and the changing international environment. Building upon this trajectory, MIC2025 now places greater emphasis on advanced manufacturing, including semiconductors, with the aim of transforming China’s economy from a mere assembler of goods to an inventor of products. If India were to become a global economic power, it must align its focus on advanced manufacturing and innovation.

In a broader sense, an effective industrial policy should foster strong collaboration between the government and private industries. This collaboration encourages new activities, expansion, skill development, research, innovation, and promotes exports, ultimately leading to higher incomes. It is crucial to recognise that the nature of industrial policy differs between protected controlled economies and open globalised economies. Moreover, the objectives of industrial policy cannot be achieved in isolation. Therefore, policies for industrial or manufacturing growth should be closely linked to education policy, the research and development ecosystem, future energy requirements, social goals, and environmental concerns. Industrial policy extends beyond the industry itself and often intersects with other policy areas, including tax policies.

Developing countries should tailor their industrial policy packages to specific national priorities and desired structural transformation, considering their unique circumstances and challenges. There is no one-size-fits-all solution, despite a strong interest among developing economies in studying the experiences of industrialised nations.

Focus on self-sufficiency

For emerging economies like India, which face significant inequalities, the focus is on achieving rapid industrialisation by restructuring and moving up the value chain to attain high-income status. The promotion of self-sufficiency, or “atmanirbharta,” holds a prominent place in policy-making due to increased dependence on imports, particularly from China, for strategically important consumer goods and production inputs. This reliance has exposed external risks, as witnessed during supply chain disruptions, which is why India is prioritising self-sufficiency as a growth strategy. This entails increasing domestic production of critical inputs, strategically relevant goods, and innovative products.

The Production-Linked Incentive (PLI) scheme aims to achieve these objectives and is a key element of the government’s efforts to build an Atmanirbhar Bharat. However, the PLI scheme or trade liberalisation alone cannot replace comprehensive interventions in areas such as technological innovation, energy transition, market aggregation, logistics cost reduction, unlocking the growth potential of small and medium enterprises (SMEs), and developing a sustainable circular economy. To address these challenges, a remodelling of industrial policy is now deemed necessary as economic growth faces resource constraints, rising commodity prices, growing inequality, insufficient poverty reduction rates, and the impacts of climate change. Currently, four specific areas for government intervention in policy formulation are under discussion to explore how industrial policy provisions can address economic inclusion, technological change, and climate change challenges.

Promoting innovation is a crucial aspect of industrial policy, requiring government support for the innovation ecosystem, starting from universities and research institutes engaged in basic research, leading to the commercial viability of new products and services. Research and development (R&D) and innovation will play a major role as the world transitions to a knowledge-based economy. The impact of innovation on manufacturing is evident in increased output, exports, and well-paid jobs.

Exports play a pivotal role in enabling countries to achieve economies of scale, even when their domestic markets face constraints such as low purchasing power and small size. This is why technology development holds significant importance in the industrial policy frameworks of industrialised and emerging economies like China and South Korea. India’s aim to achieve long-term competitiveness also relies on technology development. However, global competitiveness cannot be attained without a strong productive partnership between academia and industry, supported by substantial financial investment in industrial research from the government, as the private sector has not adequately invested in R&D. Despite the government’s commitment to provide Rs 50,000 crore over five years, the proposed National Research Foundation (NRF) could not be established.

Moreover, the coexistence of the NRF with other research funding agencies in the country is confusing. Allocation of Rs 2,000 crore for NRF in the last Union budget failed to address many questions regarding its functioning. India’s R&D expenditure as share of GDP has stagnated at around 0.7% in recent years. Under the National Education Policy (NEP) 2020, a recommendation was made to restructure all higher education institutions into three categories, with the first category consisting of research universities that equally emphasise research and teaching.

A survey of the 23 IITs has revealed that the newer institutes significantly lagged the original five in terms of research work, filed patents, and granted patents. It is an opportune time to designate these 23 institutions as research universities, with appropriate government support in terms of infrastructure that caters to the needs of surrounding industrial clusters for industry-specific development work. This move will also enhance the employability of students studying in the newer IITs. Aligning the industrial policy with the education policy is essential for holistic development.

Reducing regional disparities is another crucial aspect that needs to be addressed. Industry 4.0, which encompasses technologies such as artificial intelligence, machine learning, and the Internet of Things, is expected to enhance productivity and competitiveness. However, there are concerns about a select few highly skilled individuals benefiting, leading to a potential widening of economic inequality. In a country with significant income disparities, these risks are substantial.

To bridge regional disparities, less developed areas need to experience much faster growth compared to developed regions. Disparities within regions are also alarming. Unfortunately, economic growth rates of 6-7% have a lesser impact on poverty reduction. Understanding the causes of regional underdevelopment is crucial for formulating appropriate policy approaches. Broadly, it involves unlocking the underutilised economic potential of these regions. Solutions can be explored through policies aimed at transforming the structure of local economies, ensuring long-term sustainable growth, and fostering the development of local production systems.

In general, globalisation and trade liberalisation have a significant impact on reducing poverty levels, but their influence on reducing disparities is limited or insignificant. Foreign direct investment (FDI) does not directly correlate with regional or individual inequality within an economy. It depends on various factors such as the sectoral composition and regional distribution of FDI as well as its impact on the demand for unskilled or semi-skilled workers. The economic reforms in India were not adequately complemented by efforts to enhance agricultural productivity, improve market logistics for agricultural products, develop rural infrastructure, and make substantial investments in education and skill development.

The lack of industrial infrastructure and skilled manpower resources in traditionally underdeveloped areas has led to more than 80% of cumulative FDI received in India being concentrated in just four states. Moreover, most of the foreign investment go to the services sector which requires specific skills. After liberalisation, the private sector has the freedom to choose locations for setting up manufacturing units, and understandably, it prefers developed states, further widening the disparities. Therefore, government intervention needs to be tailored to the specific realities of each region. These interventions should be supported by targeted government initiatives.

Development of MSMEs

There is a broad agreement that the growth of MSMEs is crucial for job creation. With a liberal FDI policy and incentives under the PLI scheme, India can attract large multinational corporations to invest in manufacturing. However, these multinational corporations require a robust and diverse network of suppliers as ancillary units to expedite the localisation of their products, reduce costs, and decrease import dependence. Additionally, due to significant realignment in global supply chains, these global companies are compelled to consider sourcing their supplies from locations outside of China. Indian policymakers must fine-tune the industrial policy to enhance the competitiveness of Indian MSMEs in terms of both cost and technology. Such support could be based on four pillars: financial assistance and incentives, streamlined regulatory compliance, cluster-based support for shared facilities and logistics, and marketing support through procurement policies.

Environmental protection

With mounting evidence of the adverse effects of conventional industrial activities on the environment, policymakers worldwide are exploring environmentally friendly growth paths for their industrial sectors. As there is recognition of the importance of addressing global warming, there is a growing emphasis on transitioning towards sustainable practices. Traditional industrial processes have been associated with excessive resource exploitation, depletion, and environmental degradation.

Industry accounts for a third of global energy consumption and nearly 40% of energy-related carbon dioxide emissions. It is widely acknowledged that averting an environmental catastrophe is imperative. India is the third-largest emitter of greenhouse gases after China and the United States. Considering the adverse environmental consequences of expanding production activities, reducing greenhouse gas emissions should be a crucial consideration when redesigning industrial policy to minimise the carbon footprint. Developing countries cannot afford to adopt highly resource-intensive or energy-intensive production processes due to the associated high production costs. India, with just 2.4% of the world’s land area, accommodates nearly 18% of the world’s population.

India needs to adopt technologies to facilitate the decarbonisation of its economy. Active encouragement and support should be provided to increase the share of renewable sources in power generation and transition to electric energy for various purposes like vehicle operation and cooking, thereby replacing fossil fuels. These efforts should not solely rely on market mechanisms but should receive focused support under the industrial policy. Priority should be given to interventions on both the supply and demand sides, as well as recycling of industrial waste. The first step towards cutting emissions from the industrial sector is collection and analysis of pollution data.

In 2021, the National Green Tribunal issued an order directing pollution control boards to compile and share detailed data from the Online Emission and Effluent Monitoring System (OCEMS) of specific polluting industrial units. This was a follow-up to an earlier Supreme Court order from 2017, which required all Indian states to install OCEMS and make their industrial emissions data publicly available. A few states have not complied with this directive. Industries such as aluminium, zinc, copper, power, cement, distilleries, fertilisers, steel plants, oil refineries, and petrochemicals account for 30-50% of the total urban pollution.

Industrial agencies should conduct detailed assessments of existing companies to propose incentives that promote environmentally friendly practices. A sustainable industrial development strategy should strive to integrate environmental concerns and sustainable development. To achieve this, more support for the MSME sector is required to facilitate their transition to sustainable business models, considering the significant costs and risks involved. It is time for a change in the paradigm of industrial growth, aligning it with the needs of the 21st century, considering the nation, citizens, and environment.

Laying the industrial roadmap

The Department for Promotion of Industry and Internal Trade (DPIIT) has been working on a new industrial policy since 2017. A revised version was circulated in 2022, placing greater emphasis on improving access to finance for industries and proposing the development of mega clusters dedicated to priority sectors and their integration with global supply chains. Once finalised, this policy statement will be the first in the new millennium.

While the stated objectives are commendable, it is crucial to design industrial policies that address the challenge of transitioning economic structures, enhancing incomes, and substituting environmentally unsustainable processes with sustainable alternatives. A range of complementary policies is required, including education policies to improve workforce skills, promoting green research and development (R&D), and adopting green technologies, as well as creating adequate infrastructure to reduce logistic costs, particularly for small units, while prioritising resource efficiency and the circular economy.

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Krishna Kumar Sinha is an industrial policy and FDI expert based in New Delhi. His last assignment was as an industrial adviser in the department of industrial policy and promotion, DIPP, currently known as DPIIT, under the ministry of commerce and industry of the government of India.