India's Divided Economy -- and a Manufacturing Slump -- Slow Its Rise

By Bill Spindle 

When it comes to its economy, India is divided into two worlds.

One is rooted in its cities. Here enterprises trade on global markets, operate through banks and pay taxes. This more modern economy is made up of family owned and publicly listed companies. It's where almost all of India's new wealth has been generated in recent years.

Then there's the vast informal economy, which sustains as many as nine of every 10 Indians who work and accounts for almost half the country's economic activity. The informal economy is largely rural and comprises day-laborers, one-man shops and roadside haircutters. They operate in cash and pay no taxes.

A critical goal for India has been to enlarge the more-modern economy and shrink the informal one, but now progress is stalling. A deepening economic slump that started in the informal economy is hitting the more-developed parts hardest.

Whether India manages the economic transition matters far beyond its shores. It is projected to become the world's most populous country in 2024 and by then will also likely be the fifth-largest economy. With China increasingly closing itself off to foreign firms or being shunned by them in the trade war, India has emerged as the last huge growth market for companies ranging from digital trailblazer Amazon.com Inc. to old-line oil giant Aramco.

Prime Minister Narendra Modi's government has tried to keep India on track, by imposing a new nationwide tax plan, for example, among other policies. But economists say his changes haven't created jobs, particularly in manufacturing, which are needed to get Indians to shift away from the informal economy.

"You also have to have carrots," says Vivek Dehejia, an expert on the Indian economy at Carleton University, in Ottawa, Ontario.

Moving people into what economists call the formal economy could supercharge growth, because urban manufacturing and services wring more value from each worker than farm labor. Those industries pay better because they are more productive. That lifts people out of rural poverty, while simultaneously raising productivity back on the farm, since fewer laborers are usually able to produce the same crops.

The shift also vastly expands tax rolls, in theory giving governments resources to invest in infrastructure and other public goods to sustain the transition.

Western countries traveled this road through the industrial revolution in the 19th century, and much of East and Southeast Asia trod it via a manufacturing-export explosion in the 20th. India wants to take a similar path.

In trying to speed India's passage, Mr. Modi introduced the nationwide goods and services tax two years ago, replacing a patchwork of local tax regimes. The value-added tax requires all but the smallest businesses to sign up online, submit electronic filings and pay taxes on a common platform. In other words, join the formal economy.

That followed Mr. Modi's novel overnight move back in 2016 to ban cash notes worth almost 90% of the currency in circulation. The aim was to curtail tax evasion and official corruption. It also prodded the suddenly cashless masses to transact cashlessly on their mobile phones and through bank accounts the government provided to all poor Indians.

Replacing currency notes and broadening the tax system disrupted the informal economy but did little to stimulate the formal counterpart. As a result, business confidence and investment declined, stymieing the formal economy's ability to provide more and better jobs.

The auto industry, for example, saw passenger car sales fall 24% in September, the 11th straight monthly decline and the longest run of declines the industry has ever experienced. Growth for the overall economy posted a six-year low of just 5%. For a country with some 10 million young people pouring into the workforce each year, that's the equivalent of a recession.

To turn things around, the government recently cut corporate taxes, especially for manufacturers that set up new facilities, in hopes of attracting companies that are now considering moves out of China. Economists say more is needed to tackle deeper structural changes.

India's economic upgrading started to gain traction early this century, when the country became first call-center, then computer coder to the world. Those industries helped create an energetic, if tiny, new middle class.

Meanwhile, manufacturing's share of the economy has stagnated at around 17% for most of the past decade, as India has failed to attract significant pieces of the global supply chains that produce everything from iPhones to autos for world-wide consumption.

India would have to attract only a tiny fraction of China's share of that global manufacturing to break from a "vicious into a virtuous cycle, " says Carleton's Mr. Dehejia.

To do that, the Modi government would need to summon the political will to loosen labor laws and restrictions on land use. The former makes it onerous to set up large-scale manufacturing ventures while the latter impedes the consolidation of agricultural land.

If those changes aren't forthcoming, economists say much of India's vaunted economic potential could be squandered as most of its fast-growing workforce remains mired in the informal economy.

Write to Bill Spindle at [e-mail]

(END) Dow Jones Newswires

November 10, 2019 09:14 ET (14:14 GMT)

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