Inequality is stifling the manufacturing sector

The other day, while leafing through my daughter’s 10th-standard economics textbook, I found an oft-repeated generalisation about modern economies. The book said that countries that are less developed depend heavily on agriculture and mining. Countries that are developing have a well-developed factory sector. Finally, economies that are already developed — like the USA or the UK — have an oversized service sector.

Where does India fit in this scheme? We are the fastest growing big economy in the world, but our factories aren’t doing too well. In the past 11 years, since Narendra Modi became Prime Minister, our economy has grown at an average rate of 6.1 per cent. But we have to account for the Covid period here. Our output fell during the lockdown year and it took another six months for our economy to recover to where it was right before Covid hit us. If we adjust for that lost time, it would be fair to say that our economy has grown at 7.1 per cent per year during the Modi years.

What about the manufacturing sector? In terms of gross value added, it has marginally lagged behind the GDP, growing at 6.9 per cent. But if we look at the actual output growth — the Index of Industrial Production (IIP) gives us a better picture here — then factory output has grown at just 3.7 per cent per year. Do note that in both cases, I am adjusting for the 1.5 years of Covid-induced loss in output.

Even this hides the true picture of how India’s factories have been languishing. Most of this growth has been driven by the infrastructure sector, which grew at 6 per cent per annum (adjusted for the Covid years). This was almost entirely driven by government spending and not independent private investment or household consumption.

One way to measure whether India’s corporates have been investing more in manufacturing is to check the growth in the production of capital goods — products that are used to manufacture more products, such as machines, equipment, commercial vehicles, etc. The output of capital goods, adjusted for the Covid time, has grown at a measly 1.7 per cent per year between 2013-14 and 2024-25. This number would have been even smaller had the production of ships and railway equipment not grown at a very fast pace.

What about goods for consumers like you and me? Consumer goods output has grown at just 2.7 per cent per year — again adjusted for the 1.5-year production loss during the Covid period. Within this, consumer non-durables — things like packaged milk, soaps, hair-oil and medicines — have grown at an annual pace of 3.6 per cent. Consumer durables — ranging from passenger cars to plastic bottles — grew at just 1.6 per cent per year, barely beating the annual average growth rate of our population.

Why is there this great divergence between the rate of growth of value added in our factories and the growth of actual output? The most likely reason for this is our stark income and wealth inequality. The World Inequality Lab estimates that the richest 0.5 per cent of the Indians earn about 17.5 per cent of the total private income. That is equal to what the poorest 55 per cent earn. The inequality is even more stark if we look at the share of wealth. The richest 0.5 per cent of Indians own roughly 36.5 per cent of the total net personal wealth in the country. This is the same as the total personal wealth of the bottom 91 per cent!

Compare the numbers: Seven million Indians at the top earn the same as 770 million at the bottom. And these seven million richest Indians own the same personal wealth, in total, as 1.3 billion Indians!

That is why Indian companies have no interest in expanding the absolute number of the goods they produce. Their only interest is in increasing productivity and moving up the value chain since the only people who can buy manufactured goods in India are those at the very top. So, value added by the factory sector is growing —because our factories cater to the affluent — but the total output growth is creeping at a petty pace.

It is not as if this value added in manufacturing is growing at a scorching pace, either. As pointed out earlier, it is still lagging behind the overall growth rate of our economy. Again, this is inevitable, given our income and wealth inequality. The affluent buy very few Indian-made goods. More often than not,  the consumer durables they buy — cars, laptops, smartphones, washing machines, air conditioners, microwave ovens — are either imported or just assembled in India, using foreign-made completely knocked-down kits or imported parts.

Open an Indian-made Bluetooth speaker, and everything inside is most likely to have been manufactured in China. Many consumer durables — from kitchen utensils to lamps — are ‘white-labelled’, which means they are imported in bulk and a local label is stamped on them.

Even if we look at consumer non-durables, a large part of the inputs that go into making them comes from abroad. For instance, estimates suggest that roughly 50 per cent of the raw materials that go into manufacturing soaps is imported.  Depending on the type of drug being manufactured, our pharma industry imports 50-80 per cent of the raw materials.

The reason why textbooks say that the manufacturing sector grows the fastest in developing countries is that economists assume that industrialisation results in better jobs and widespread prosperity. That, in turn, makes people consume more goods and boosts the demand for manufactured products.

Inequality disrupts this typical pattern of economic growth. The only way for us to become a manufacturing powerhouse is for our companies to go down the value chain and produce for the mass market. But for that to happen, there has to be a significant reduction in income and wealth inequality in India. That will be a very difficult process, especially at a time when the professional ‘middle class’ is facing job losses and stagnant salaries. In such a situation, the only option is for the government to artificially stimulate the factory sector. But that is another story.

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