Notes on “Re-aligning global value chains” Part II

Yesterday, we took a look at how China makes it difficult for supply chains to move away from that country. That happens through a combination of mind-boggling scale and efficiency, coupled with astute moves up the ladder in terms of no longer dealing with just cheap manufacturing. Think robotics, app development, advanced and skilled manufacturing units. After that, the gravity model takes over, and well, good luck moving out of China.

Today, we ask the following question: let’s assume that all that is somehow put to the side, and a country is looking to move out of China. What are the chances this firm will come to India?

Again, we’ll use Gulzar Natarajan’s excellent article as the basis of our discussion, and foray into other parts of the internet. Let’s begin:

First, a quote from within Gulzar Natarajan’s post:

“Nomura Group Study found that in 2019, out of the fifty-six companies which shifted their production out of China, only three of these invested in India; while 26 went to Vietnam, 11 to Taiwan, and 08 to Thailand. In April 2020, Nikkei noted that out of the 1,000 firms which were planning to leave China and invest in Asian countries, only 300 of them were seriously thinking of investing in India.”

300 out of 1000 isn’t great, you might think, but it’s not bad, surely. Well, read again: it’s “seriously thinking”, not actually relocated. If you want to take a look at action, not thoughts, it is 3 out of 56. About 5%.

Why?

Let’s begin with this tweet:

And here’s (to my mind) the most interesting quote from within the editorial:

“The situation is far worse when it comes to comparisons with China in the EoDB. It takes double the time to start a business in India as compared to China, around six times as much to register property and double the time—and also in terms of the value of the contract—to enforce a contract. And, this is without even looking at the policy flip-flops that this newspaper catalogues diligently.”

The real measure of success when it comes to the Ease of Doing Business ranking is not how far we’ve come, but far we have to go. And it’s going to be a long haul.

This article, which I got from reading Gulzar Natarajan’s post, is instructive in this regard.

Sample this:

““Navigating labour laws is a total mine-field because interpretation is left to the courts and the officers and can be done in more than one way and removing an incompetent worker is not easy,” Gopal said. “I can get a divorce faster than removing a factory worker for non-performance.” In Karnataka, an employer would have to give three warning letters, a show-cause notice, have two inquiries — one external and one internal, and then terminate an employee only if the charges are proved to be serious. “Theft is considered serious but if an employee is lazy and doesn’t perform, that may not be taken as serious,” Gopal says. “In one’s own company, one cannot hire and fire.””

This article is just about furniture, but there are similar problems in every single sector in India.

To which, usually, there are two responses:

  1. Yes, but we have to start somewhere, don’t we?
  2. Yes, but we’re so much better than we were before!

Yes, sure, in response to both of these statements. But keep in mind that firms who are looking to move here are not going to ask if we’re better than we were before. They’re going to ask if we’re better than our competition today. Are we better than Vietnam, for example? What about Bangladesh? And if the answer is no, why should firms come here?

For our domestic market isn’t (yet) a good enough answer, unfortunately.

Our domestic consumption wasn’t large enough or lucrative enough for firms to locate themselves here before the pandemic – it’s obviously reduced since then.

And bureaucracy (not to mention bureaucracy-speak!) has gone up:

“On Sunday, for instance, the home ministry issued a clarification intended perhaps to limit the numbers of those who would be allowed to travel to their villages to a category called ‘genuine’ stranded migrants. The letter from the Centre to chief secretaries in the state administrations reads: “The facilitation envisaged in the aforesaid orders is meant for such distressed persons, but does not extend to those categories of persons, who are otherwise residing normally at places, other than the native places for purposes of work, etc. and who wish to visit their native places in normal course.”

I think I am reasonably good at English, but I still don’t know what this means. Even if I were to understand it, I do not know how I would go about implementing it! And that’s me, a guy who teaches using the English language for a living, and writes a blog in the English language. What chance does a manufacturer have? What chance does a non-Indian manufacturer have?

Government, in plain simple terms, has to get out of the way. Unfortunately, we seem to be heading in the opposite direction.

R Jagannathan writes in the Livemint:

“Companies compete, while governments can only enable. Governments cannot create global champions, though mercantilist countries like Japan, South Korea and China did do so at one point. What governments can do is create an enabling policy and regulatory environment that fosters economic growth and lets companies scale up. Airtel and Reliance Jio did not emerge as India’s two big telecom survivors because the government anointed them as winners. Nor did TCS, Infosys and Wipro become global outsourcing giants because of the government. They became global biggies because the policy environment for their growth was positive both in India and abroad.”

I might wish to disagree with parts of that excerpt (Studwell alert!), but I am in complete agreement with the broad message:

“The government holds the lock but not the keys to Atmanirbhar Bharat. As long as the lock is well oiled, companies will find the keys on their own.”

As of now, though, the lock is far too rusty, far too old and far too much like a pre-1991 model.

Notes on “India’s Footwear Industry: A Reality Check”

Gulzar Natarajan has an excellent, excellent blogpost up on this blog, Urbanomics, titled “India’s Footwear Industry: A Reality Check“. In what follows, I make notes for myself about the post in terms of what it reminds me of, what I did not understand, and additional links or resources I learnt about while reading the post.

  • “The footwear industry makes 2 billion pairs, of which 286 million pairs were exported last year. It employs 2-4 million people, the vast majority as informal and contract labour and/or hired through manpower agencies and at very low salaries in the range of Rs 6000-10000.”
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    Reading more about this helped me land up on a website called worldfootwear.com, and I learnt of the existence of the 2019 World Footwear Yearbook. In 2018, the world manufactured 24.2 billion pairs of footwear, and the industry grows at about 3% a year in normal circumstances – give or take a few points.
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    90% of all shoes manufactured in the world come from Asia. That makes sense, as Asia is responsible for 54% of the world’s demand for footwear on an annual basis.
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    China alone was responsible in the year 2018 for about 70% of the world’s exports.
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    All of these snippets come from this page.
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  • “As a summary, the current state of the Indian footwear industry is characterised by small scale, very low productivity, low automation, stagnant growth, and pervasive informality.”
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    One of the reasons I liked reading this blogpost so much is because while I get to learn a lot about the footwear industry in India, I also get to reflect on how so much of what is true for the footwear industry is also true of other industries in India. The inability to break out of the small scale (about which much more below), the low levels of automation and the pervasive informality are to be seen in almost all industries in India. There is, perhaps, a sociological point to be made about whether the causality runs from the inability to scale to informality or the other way around (or indeed, both!), but we’ll save that for another day.
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  • “The highest value market segment is the mainstream global branded manufacturing in non-leather footwear. But this is a segment that has proved elusive even to the Chinese manufacturers, especially in the global market. It may well be outside the reach of Indian manufacturers, unless some particular brand breaks out due to a combination of exceptional entrepreneurship and even more exceptional good fortune.”
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    As you will learn later on in this blogpost, Gulzar Natarajn seems to be as big a fan of “How Asia Works” as I am, and perhaps a bigger one. One of my favorite questions to ask in class as a consequence of reading that book is this one “Name one globally recognized brand from ASEAN nations”. This applies to India, and to a lesser extent to China as well – that’s basically the point that is being made here. Being a manufacturing and export powerhouse is not the same as building globally recognized brands.
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    This brings to mind both the “manufacturing smile” as well as Peter Thiel’s distinction between technology and globalization. It also raises important questions about what paths India should choose between for the next two decades when it comes to manufacturing policy, but again, more on that later.
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  • “The next best alternatives may be to increase their share of the Indian branded manufacturing segment and become large scale contract manufacturers for global brands. This is the playbook of the Chinese footwear industry.”
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    Have you read Shoe Dog, by Phil Knight? Don’t know who Phil Knight is? Well, have you heard of Nike? Read especially the bits about his travels in Japan, in search of contract manufacturers.
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  • Gulzar Natarajan’s first recommendation when it comes to the footwear industry in India is to be a contract manufacturing hub. Easier said than done! (To be clear, that is not a criticism of the point he makes – it is a reinforcing of his message, and also a reminder to readers that India is not quite ready to this just yet, for a variety of reasons).
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    One of these reasons is actually mentioned in a more recent post by the same author, regarding Vietnam’s recent agreement with Europe about tariffs on Vietnam’s exports.
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    What about India and the EU, you ask?
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    “Negotiations for a comprehensive Free Trade Agreement (FTA) between the EU and India were launched in 2007 and suspended in 2013 due to a gap in the level of ambition between the EU and India.”
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  • The last bullet point was about India making for the world. Gulzar Natarajan goes on to point that we must also think about India making footwear for India.
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    “Any strategy to increase local branded manufacturing to capture this market has to focus on Make for India (and not Make in India for the world). This does not mean skimping on quality, but competing with the imported manufacturers by gradually improving productivity. This can be done only by efficiency gains to cut costs – improving labour productivity, local component manufacturing, greater automation (not full automation, but enough to enhance labour productivity), and economies of scale.”
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    He speaks about each of these four points: improving labor productivity, local component manufacturing, greater automation and economies of scale in his blogpost, click here to read those specific parts of the post.
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  • Gulzar Natarajan speaks about manufacturers having no incentive to train workers:
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    “In order to train the workers, the manufacturers have to incur the cost of trainings as well as bear their salaries. They have no incentive to bear this cost, even if a couple of months trainings can suffice.”
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    Well, maybe so. But this does remind me of an excellent excerpt from one of my favorite books to recommend to students about macroeconomics – Tim Harford’s “The Undercover Economist Strikes Back
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    The section on Ford and superior wages is especially worth reading. Perhaps I am missing an obvious point (which is all too possible), but I can’t help but wonder why Ford’s strategy cannot work in India – whether on footwear or elsewhere.
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  • “While capital investment subsidies are in general not a very desirable thing, some form of fiscal incentives may be necessary to encourage the smaller and medium sized manufacturers to increase their level of automation. Though targeting and tailoring these subsidies will be challenging, the government could consider a subsidy that is linked to some performance, either exports or on higher productivity growth.”
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    For those of you who have read the book, the reference is unmistakable. And for those of you who haven’t, I’ll say it again: How Asia Works is mandatory reading.
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  • “The Government of India already has specialised institutions on footwear design and leather research. There is a need to have them play a much more proactive role in supporting with supply of trained and quality designers. There may also be a need for an arrangement to access good quality designers at a reasonable cost. An incentive compatible subsidy mechanism may be required here too. This should be complemented with colour and fashion forecasting support.”
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    I actually find myself in disagreement here with Gulzar Natarajan. Reading this post made me aware of the Best Footwear Design and Development Institute (yes, it really exists), but isn’t this an example of government overreach? Facilitating a college like this is one thing, actually having government run it is quite another, no?
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    But the solution is in the quote above: incentive compatible subsidy mechanism. Another recommendation in this regard: please read In The Service of the Republic, by Vijay Kelkar and Ajay Shah. My notes on this book can be found here. Providing subsidies that are designed to keep incentives (preferably for both parties) in mind is a surprisingly powerful idea!
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  • “For sure, the industry will not collapse, but will meander along business as usual. There may even be the occasional mutant success. But there cannot be a sectoral exit out of the current low productivity and stagnation trap.”
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    It is oddly depressing to have Gulzar Natarajan be pessimistic about the growth prospects for this sector, particularly because it is so hard to disagree with him on this account.
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  • He is against tax breaks, particularly because of the inevitable equilibrium in terms of the lobbying that will take place.
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  • “The conventional wisdom in this regard blames poor quality of infrastructure, restrictive labour laws, difficulty in assembling large land parcels, high cost of capital, and pervasive red-tape. These are all, in general, factors of concern.”
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    My favorite book to recommend to students in this regard is Bhagwati and Panagariya’s book “Tryst with Destiny“. And of course, in terms of policy prescriptions, Gulzar Natarjan’s own book “Can India Grow?
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  • Gulzar Natarajan has an extended section on the “innate charactersitics of entrepreneurs“. It is too long to excerpt, but it did remind me of an excellent paper on why productivity in India is so very low. Worth reading, especially if you are a student of micro, IO or India.
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  • “The impact of reforms like GST, while certainly beneficial in the long-run, may have ended up squeezing the vast majority of the small manufacturers. For a start, for these small manufacturers, the compliance costs in terms of hiring accountants and IT requirements are a non-trivial share of their profits. Then there is the structure of the GST tariffs – 18% for the components and 5% for the final product. This means that the manufacturers capital gets locked up as receivables for a long time. For small manufacturers, these costs are prohibitive.”
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    This point is a little weird. Let me explain what I mean when I say “weird”. I think almost every economist is aware of this issue, and has spoken about it repeatedly. But the level of awareness otherwise is very, very low. Again, the GST is a great idea with poor implementation. The unique nature of India’s economy (a blend of formal and informal along the supply chain for many, many things) makes the implementation worse.
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  • And perhaps the coda to this excellent blog post, and for me the most important part:
    “It is important for the Government to play an important role if the footwear industry can move significantly forward. The market by itself is unlikely to have the incentives or the capacity to manage that.”
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    This is a classically Studwellian recommendation. The problem is that the “no but markets will work if you let them” brigade will never accept this line of reasoning. Additionally, there are far too many people in India (especially within government) who will interpret this to mean that government needs to actively participate in the actual ecosystem by getting into manufacturing and allied activities.
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    And hardly anybody will get what I think is the actual Studwellian message. Government needs to carefully design incentive compatible subsidy mechanisms and make it clear to producers that it (the government) carries a very, very big stick – and that it is not afraid to use it. And well, if push comes to shove, actually use it. Please, read How Asia Works!

ROW: Links for 12th June, 2019

  1. “Readers will by now be familiar with the list of industries impacted by the US China trade war. These include soyabeans, cars, steel, and semiconductors.But one commodity is increasingly important to how the tensions play out: students. The Chinese state media is now saying the government will issue a warning on the risk of studying in the US”
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    The FT reports on how Chinese students will now be discouraged from going to American Universities – in a sense, an expected move, but you would be surprised at just how dependent universities in America today are on foreign students. Interesting times.
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  2. “To summarize, based on the above I doubt that actual Chinese growth is more than 1% below the reported figures, at least up through 2018. Of course it’s possible that things have changed in 2019; if so I expect that to show up in upcoming airline travel data for China.”
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    Scott Sumner patiently reminds us that we should look at the data before making a claim, and having looked at the airline data, he rejects the notion that there is a dramatic slowdown in China. The truth, as usual, lies somewhere in the middle.
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  3. “Vietnam, like China really doesn’t import very many manufactures from the United States. That’s partially a function of the fact that the value added in Vietnam is often low, and thus Vietnam cannot afford a lot of top of the line U.S. capital goods (yet). But it is also a function of the fact that many of the global value chains that generate large (often offshore) profits for U.S. firms don’t give rise to that much U.S. production these days. There just isn’t much sign that the Asian value chains stretch back to include U.S. factories and workers. Fabless semiconductor firms that design chips likely export their designs to a low tax jurisdiction before they license their designs to an Asian contract manufacturer. The rise in Vietnam’s exports hasn’t been associated with a commensurate rise in exports from the United States to Vietnam.”
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    Brad Setser takes a look at whether Vietnam is the new China, and concludes that it kind of is, and kind of isn’t.
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  4. “It is not surprising that the CPC has worked so hard to extirpate the Tiananmen Square massacre from public memory. History – including the horrors of Mao Zedong’s rule – is too volatile a substance for the Chinese dictatorship. China’s leaders hold up their system of government as a model for other countries. But how can a regime be confident in the sustainability of its values and methods if it is afraid of its own past?”
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    Chris Patten (who knows a thing or two about this issue) reviews the Tiananmen square massacre, and ponders on what it means for China and Hong Kong today.
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  5. “Despite a small increase in young and female lawmakers—like Ms Suematsu, who is in her forties—local politics is still dominated by old men. “In these municipalities, candidates are so old they have a hard time putting up election posters,” says Shigeki Uno of the Nippon Institute for Research Advancement, another think-tank. Indeed, three-quarters of town and village assembly members are over 60. The oldest, aged 91, holds a seat on a city assembly in Shizuoka, in central Japan.Young people are loth to stand because local politics is not a financially rewarding profession. The law bans assembly members from holding other jobs concurrently. Their pay averages around ¥300,000 ($2,740) a month, hardly enough to support young families. “It’s basically a job for the retired,” sniffs Mr Uno. And for little pay, the workload is onerous.”
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    The Economist reports on Japan, and it’s ageing population – and what that means for democracy on the ground, at local elections.