A new approach to industrial policy

India wants to grow its economy to US$ 5 trillion. People want jobs and their incomes to grow. India needs its industrial sector to grow to absorb the millions of people coming off agriculture as they will with productivity in the agricultural sector improving. India cannot rely only on its service sector: it needs industry and manufacturing to grow much faster to create jobs with good incomes and to enable the economy to grow to $5 trillion. Ergo, India needs a good policy to grow industry at this juncture in its economic history.

Even the US, confronted with the growth of China’s industries supported by the Chinese government’s policies, is feeling the need for an industry-cum-trade strategy to counter China. India cannot avoid, any longer, the necessity for a good policy to grow its industries. The problem is, what sort of policy should India have—how much should it leave to the market, and what should be the government’s role?

India had avoided framing any industrial policy after the liberalisation of its economy in 1991, because ‘industrial policy’ had become taboo in the ‘leave it to the market’ ideology of the Washington Consensus, which said that any deliberate attempt by government to grow industry would always be counter-productive. The only way to grow a vibrant, entrepreneurial industrial sector was for government to get out of the way of unleashed animal spirits of entrepreneurs, it said, ignoring the history of industrialisation in all countries, including the US, where governments have nurtured industries and meddled with trade policies to foster industrial growth. Now, even the US, confronted with the growth of China’s industries supported by the Chinese government’s policies, is feeling the need for an industry-cum-trade strategy to counter China. India cannot avoid, any longer, the necessity for a good policy to grow its industries.

The problem is, what sort of policy should India have—how much should it leave to the market, and what should be the government’s role? Any policy, and the way it is made, must fit the system and the situation for which a policy is required. Therefore, one must step back to understand what the process of industrialisation is.

Industrialisation is a process by which a large system acquires capabilities to do what it could not do before. Japan became a global power in the automobile industry after the Second World War because Japanese manufacturers learned rapidly to do what they could not do before. Their suppliers learned too, while managers and workers within the industry were rapidly learning and improving their skills. Along-side them, the government was facilitating the process of building capabilities in industries and learning along with them too.

Complex systems acquire capabilities they do not have when the inter-dependent sub-systems within them learn to do what they could not do before. Industrialisation is a process of a complex system, and its parts, learning in action together. Beyond raw material resources it may have in abundance, the only source of competitive advantage a nation has its ability to learn and improve its competitive capabilities faster than all other nations. With a participative process of shaping industrial policy, facilitated by government, Japan developed its steel, chemicals, and automobile industries into world-beaters, though it did not have any raw material resources.

Unregulated markets can become chaotic, as the world realised when the financial crisis happened. Government regulation is necessary. However, India will not want to go back to the ‘engineered-controlled’ model of industrial policy, which is inappropriate for a dynamic, learning process. India should adopt the third archetype, of ‘complex self-adaptive systems’, which is the appropriate model for industrial growth.

Systems can be sorted into three archetypes: engineered-controlled systems, open-chaotic systems, and complex self-adaptive systems. The structures within engineered systems are designed by experts. Experts can manipulate and control the system if they understand the forces within the system completely. Technologists have designed amazing machines with which human beings have been able to do what they could not do before—like flying to the moon. In an engineered system, the designer sits outside the system while designing it. This approach to designing an industrial policy will not work because the policy-maker must be a participant within a dynamic system, learning within it through multiple feedback loops. The policy-maker cannot be an expert sitting in an ivory tower above the system providing it a detailed blue-print to function. This was the fundamental problem in India’s approach to industrial policy until the 1980s. Industry, which was learning, found that government was controlling without understanding what industrialisation was about.

The sweeping in of the ‘Washington consensus’ ideology of ‘government is not the solution, it is the problem: leave it to the market’, swung the pendulum towards the open-chaotic systems archetype. The idea of ‘industrial policy’ became taboo. When many countries, including the US, began to realise by 2008 that governments must do something to grow industries and jobs in their countries, they had to contrive other names for what was required, such as ‘innovation policy’ and ‘entrepreneurship policy’.

Unregulated markets can become chaotic, as the world realised when the financial crisis happened. Government regulation is necessary. However, India will not want to go back to the ‘engineered-controlled’ model of industrial policy, which is inappropriate for a dynamic, learning process. India should adopt the third archetype, of ‘complex self-adaptive systems’, which is the appropriate model for industrial growth.

India has a rich industrial eco-system with competent industries in many sectors and millions of large and small enterprises. Each constituent within the system will see the system from its own perspective and will lobby for its own interests. It is essential for the policy-maker guiding the process, and for the constituents too, to foresee the consequences of fixing any part of the system on other parts of the system, to avoid fixes that can back-fire elsewhere, or later on, and harm the system.

Industrial policy is not a document: it is a process. It is a process of learning in action that brings together the constituents of the industrial system. Indian industry is not a clean sheet upon which a policy-maker can impose a policy. India has a rich industrial eco-system with competent industries in many sectors and millions of large and small enterprises. Each constituent within the system will see the system from its own perspective and will lobby for its own interests. It is essential for the policy-maker guiding the process, and for the constituents too, to foresee the consequences of fixing any part of the system on other parts of the system, to avoid fixes that can back-fire elsewhere, or later on, and harm the system. Inverted duty structures, which harm industry, arise when changes are made to make life easier for one industrial sub-system but damage others. Lop-sided labour reform to make firing easier, can produce shorter-term benefits, harming longer-term processes of capability building.

India has recognised the need for an industrial policy and ground-work has been done, with consultations with many stakeholders, both by UPA-2 in the 12th Five Year Plan, and by the previous Modi-led government. Both times, the need for an ongoing, consultative, learning process was stated. The government should take a bold step soon to install this process if it wants to grow industries, create jobs, and take the Indian economy to $5 trillion and beyond.

(The writer is Chairman, HelpAge International)