Thursday, October 6, 2022

Some thoughts on PLI as industrial policy

Two recent articles in Business Standard drew attention to the apparent success of the Government of India's Production Linked Incentive (PLI) scheme, at least in mobile phone manufacturing. 

The first was about the transformation being brought about in Koothanapalli, a village about 20 km from Hosur in Tamil Nadu, where Tata Electronics is setting up a factory to design and manufacture mechanical parts for iPhones. The second article is about Pegatron joining Foxconn and Wistron in setting up iPhone manufacturing facilities in India, and about Apple's plans to have a quarter of all iPhones manufactured in India by 2025. 

This is a teachable example of the complex nature of public policy which often conflict with the classical theories of industrial development and evidence-based policy making. In many cases, the substance of the policy is far outweighed by the stories and narratives that emerge around the policy. 

When compared to the task at hand, relocating supply-chains especially from China and attracting global contract manufacturers in various sectors to establish facilities in India, the PLI scheme outlay at Rs 1.97 trillion (~$25 bn) over five years is modest. The scheme extends 4-6% subsidy on incremental sales. However, this is only a small share of the at least 18-20% cost advantage, not to speak of several other locational and supply-chain advantages, enjoyed by manufacturers in China and Vietnam. This coupled with stiff production expansion targets the inevitable bureaucratic difficulties with accessing these benefits mean that the substantive benefits from PLI Scheme are limited. In fact, a recent Bloomberg Intelligence report estimates that it would taken about 8 years to move just 10% of Apple's production capacity out of China. 

In theory PLI is a good example of an incentive compatible industrial policy. However, in practice, purely by itself the PLI is unlikely to be substantive enough to be a game changer for India's manufacturing sector. 

It's therefore not surprising that despite the success of Apple's manufacturers, the Scheme itself is facing several problems. As I have written on multiple occasions, the success of the Scheme will depend on how nimble, flexible, and courageous are the relevant Ministries of Government of India in responding to emergent problems and trends and adapting the scheme guidelines(say, in calibrating import duties up the value chain). Policy making will have to become entrepreneurial in being able to reap gains from the PLI Scheme. 

However, I'm inclined to believe that despite the modest outlay and incentives, when compared to its objectives, and even if it does not achieve its quantitative targets within the scheme period, the PLI Scheme has the potential to move India's manufacturing ecosystem to the next level in both value addition and scale. I feel that PLI Scheme provides the policy instrument complement to the marketing campaign of Make in India, which is required to trigger animal spirits and investor confidence. It may be enough to attract the critical mass of a few big contract manufacturers to establish massive manufacturing facilities in the country, a crucial missing element (also here and here) in India's industrial landscape. 

These initial large manufacturers not only create jobs and bring technology, they also signal to prospective large foreign manufacturing investors that India is a serious and credible investment destination. Also, large manufacturers bring along with them the ecosystem of component and ancillaries manufacturers, which in turn both expands the base and productivity of manufacturing sector in the country. This is the catalytic effect of large manufacturers, an acutely felt deficiency in India's manfacturing sector. 

Independent of its own outcomes, if the PLI Scheme can help push India's manufacturing sector to its next level as mentioned above over this decade, then the Rs 2 trillion is more than well spent. It would be one of the highest Return on Investment (RoI) industrial policy examples. 

This is perhaps an example to avoid evaluating policies based solely on their substantive merits. The circumstances and their externalities matter, and are often more important than the policies themselves. To put this in perspective, if India's manufacturing sector moves to the next level in scale and productivity towards the later part of the decade, I'm inclined to argue that while the PLI's contribution by itself would be small (say, less than a tenth), it could not also have happened without the PLI Scheme. 

When examining policies, researchers and commentators fail to see the larger context in which they are being implemented. They are blind to the complex theory of change associated with major policies. More often than not, transformational changes in health, education, nutrition etc are not brought about through technocratically designed and targeted policies. Instead they are brought about by community and stakeholder mobilisation, which engenders a virtuous cycle of ownership and engagement, and which can in turn be triggered by standard policies and programs which are effectively implemented. The entire process has space for improvisation and innovation to improve design and implementation quality.

On the issue of attracting investments, assuming a reasonable level of development and macroeconomic stability (as in the Southern and Western Indian states), the argument in this post also draws attention to the importance of signalling intent and commitment by governments more than any hard fiscal subsidies. I had blogged last week on the stability premium which countries like India and Indonesia currently enjoy. I had also blogged earlier on the issue of signalling and ensuring hassle-free set-up and operational environments for investors. 

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