More foreign investment would ramp up India's engineering capacity.

Photographer: Tobias Schwarz/AFP/Getty Images

Modi Needs German Lessons in Manufacturing

Dhiraj Nayyar is a journalist in New Delhi. Trained as an economist, he has worked at the Financial Express, India Today and Firstpost.com. He is editor of "Surviving the Storm: India and the Global Financial Crisis."
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On his first trip to Germany this Sunday, Indian Prime Minister Narendra Modi will join Chancellor Angela Merkel to inaugurate the world’s largest industrial fair, Hanover Messe. No doubt Modi’s eager to showcase his “Make in India” campaign in the manufacturing powerhouse of Europe. But it’ll take much more than a slick marketing campaign to attract fair participants to set up shop in India. Unlike Germany (or indeed Japan, the U.S. and China) India has never been a leading manufacturing hub -- not during its socialist years, nor since the country shifted to a market economy more than two decades ago.

To this point, Modi’s drawn inspiration and ideas for his program from the East Asian experience, in particular China’s rise as the world’s factory. Much to the dismay of free-market economists, he’s shown quite clearly that while no socialist, he’s no Ronald Reagan or Margaret Thatcher either. He has no plans to replicate the Anglo-Saxon model of aggressive privatization and extensive deregulation of markets. He believes in a role for the state, as have other Asian leaders since the end of World War II.

The trouble with the East Asian model is that past successes largely depended on an authoritarian state ramming through difficult policies that could kick-start manufacturing -- repressing wages, acquiring land, giving away natural resources at cheap rates. India’s noisy democracy would never permit Modi such untrammeled power, as he’s quickly discovered.

On the other hand, the German (actually West German) model built up after the war gives primacy to the golden principle of free-market economics: competition. German governments did not intervene by running businesses (as in China or India), but by issuing regulations that ensured competition rather than oligopolies reigned in all markets. (They also set up a generous safety net to catch those who would inevitably be left behind.) In India, by contrast, there are still too many barriers to competition and regulation is patchy or absent in some sectors.

India’s Aspirations

The German manufacturing system thrives at two levels. India, too, has a large network of small and medium enterprises similar to Germany’s Mittelstand companies, but these usually operate below optimum scale, are starved of credit and have few links with global value chains. Modi needs to focus on lifting regulations that force such enterprises to operate inefficiently, such as tax breaks that encourage companies to remain below a certain size. It may be tough for India to replicate quickly the precision engineering of Germany’s automakers and other large enterprises. But by opening up more sectors such as defense to foreign investment, it should be possible to leverage the technical know-how evident in the IT sector for industry. After all, the one manufacturing industry that’s done well in India so far is automobile components, a result of opening up the sector to FDI.

Germany also highlights the need to create an inclusive environment for decision-making. For example, labor unions have always found a seat at the high table in German companies, but in exchange for that power, they’ve acted responsibly. If India is to make progress on reforming labor laws or land acquisition laws, the government needs the consent of workers and farmers. Representatives from these groups need to be consulted more actively than has been the case.

The key ultimately is to form a national consensus around a set of policies that will create jobs by giving a boost to manufacturing. In Germany, the right-wing Christian Democratic Union, largely populated by economic liberals after World War II, was able to forge just such a consensus around developing a social market economy. Governments have come and gone but the basic faith is unchanged. In India, there exists absolutely no agreement on economic reforms -- if anything the consensus leans the other way, forcing reformers to act by stealth.

Modi has an opportunity as unique as the Christian Democrats did in the late 1940s. The last five years have demonstrated quite clearly the damaging effects of poorly-directed state intervention on livelihoods. The people of India gave Modi the first single party majority in 30 years and with it a mandate to forge a new policy consensus. It was always too much to expect him to deliver a Thatcherite revolution. But he should strive to deliver a gentler, less-abrasive, more inclusive, but highly productive version of reform as Germany has.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Dhiraj Nayyar at dhiraj.nayyar@gmail.com

To contact the editor on this story:
Nisid Hajari at nhajari@bloomberg.net