GS Notes

6. Economics Notes 37

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Elaborate Notes

Evolution of Indian Industry: Pre and Post-1991

  • State of Industry Post-Independence and Share in GVA:

    • At the dawn of independence, India inherited a colonial economic structure characterized by a weak industrial base, with a predominance of consumer goods industries like textiles and sugar, and a near-absence of capital goods industries. The share of industry in the national income was consequently low.
    • As of the financial year 2021-22, the industrial sector contributes approximately 28% to India’s Gross Value Added (GVA) at current prices. This figure is significant but remains below the average of around 35% observed in many other peer developing and emerging economies, indicating a potential for further industrial deepening. The phenomenon of premature de-industrialisation, where the services sector’s growth outpaces industry’s before the latter’s full maturation, is a subject of academic debate in the Indian context, as noted by economists like Raghuram Rajan.

  • Industrial Performance (1950-1980): The Era of State Control:

    • This period was marked by slow industrial growth and poor productivity, often termed the “Hindu rate of growth” by economist Raj Krishna (1978) to describe the sluggish average annual growth of about 3.5%.
    • The policy framework was rooted in the Nehruvian-Mahalanobis model, which underpinned the Second Five-Year Plan (1956-61). This model, developed by Prasanta Chandra Mahalanobis, advocated for a focus on heavy industries under state ownership to build a self-reliant economy.
    • The policy regime was characterized by:
      • Dominance of the Public Sector: The state assumed control of the “commanding heights of the economy,” believing that the private sector lacked the capital and risk appetite for long-gestation heavy industrial projects.
      • Extensive Control over Private Investment: The “License-Permit-Quota Raj,” a term popularized by C. Rajagopalachari, described the intricate web of licenses and regulations required for a private firm to establish, expand, or diversify its operations. The Industries (Development and Regulation) Act, 1951 was the primary instrument for this control.
      • Protectionist Trade Policy: A highly protective trade regime based on Import Substitution Industrialization (ISI) was adopted. This involved high tariffs, import quotas, and stringent licensing to shield domestic industries from foreign competition.
      • Inflexible Labor Laws: Rigid labor laws, such as the Industrial Disputes Act, 1947, made it difficult for firms to retrench workers, which discouraged formal sector employment and large-scale manufacturing.
      • Other Objectives: The policies also aimed to promote Small-Scale Industries (SSIs) through reservations and fiscal incentives, and to achieve regional balance by encouraging industrial development in backward areas.

  • Post-Mid-Sixties Policy Intensification:

    • Following economic strains from wars (1962, 1965), droughts, and devaluation of the rupee (1966), the state’s control intensified. An aggressive import substitution regime was pursued, and domestic regulatory structures were strengthened through legislation like the Monopolies and Restrictive Trade Practices (MRTP) Act of 1969.

  • The 1991 Reforms: A Paradigm Shift:

    • Facing an acute Balance of Payments (BOP) crisis in 1991, triggered by factors including the Gulf War’s impact on oil prices and declining foreign exchange reserves, India initiated a comprehensive economic reform program under Prime Minister P.V. Narasimha Rao and Finance Minister Manmohan Singh.
    • This marked a radical departure from the four-decade-long inward-looking policy. The reforms moved India towards a market-oriented, deregulated, and liberalized economic framework, integrating it with the global economy. This shift was intellectually supported by economists like Jagdish Bhagwati and Arvind Panagariya, who had long advocated for liberalization.

Industrial Policy Resolution, 1948

  • This was the first major industrial policy statement of independent India, laying the foundation for a “mixed economy.” It sought a middle path between a fully socialist and a capitalist model.
  • It classified industries into four categories to delineate the roles of the public and private sectors:
    1. Strategic Industries (Exclusive Public Sector): This category was under the exclusive monopoly of the Central Government. It included three key sectors: Arms and Ammunition, Atomic Energy, and Rail Transport.
    2. Basic/Key Industries (Public-cum-Private Sector): This category included six industries vital for national development: Coal, Iron and Steel, Aircraft Manufacturing, Ship-building, manufacture of Telephone and Wireless apparatus, and Mineral Oils. New units were to be set up by the state, but existing private enterprises were permitted to continue and expand.
    3. Important Industries (Controlled Private Sector): This was a broad category of 18 industries, including heavy chemicals, sugar, cotton and woolen textiles, cement, paper, etc. These were to remain under private ownership but would be subject to Central Government control and regulation.
    4. Other Industries (Private and Cooperative Sector): All remaining industries were left open for private enterprise and the cooperative sector.

Industrial Policy Resolution, 1956

  • Often referred to as the “Economic Constitution of India,” this policy replaced the 1948 resolution and provided the definitive blueprint for India’s industrial development for the next three decades. It was deeply influenced by the Mahalanobis model and the objectives of the Second Five-Year Plan.
  • It re-classified industries into three schedules:
    1. Schedule A: Comprised 17 industries that were to be the exclusive responsibility of the State. This expanded the public sector’s domain significantly and included key sectors from the 1948 policy plus others like heavy machinery and electricals. The private sector could operate only if national interest demanded it and under state license.
    2. Schedule B: Included 12 industries where the State would take the lead in establishing new units, but the private sector was expected to supplement the State’s efforts. Examples included aluminum, fertilizers, and machine tools.
    3. Schedule C: All industries not included in Schedules A and B were left to the private sector, though they remained subject to the IDRA, 1951.
  • Key Features: The policy emphasized the need for a large and growing public sector, encouraged small-scale and cottage industries as a source of employment, and aimed to reduce regional disparities by offering fiscal concessions and directing public investment towards backward regions.

The Monopoly Commission and Subsequent Policies (1969-1980)

  • Monopoly Commission and MRTP Act, 1969:

    • The Hazari Committee (1967) and the Dutt Committee (1969) highlighted the growing concentration of economic power and the disproportionate benefits of the licensing system accruing to large industrial houses.
    • Based on these findings, the Monopolies and Restrictive Trade Practices (MRTP) Act was enacted in 1969. Its primary objective was to prevent the concentration of economic power and control monopolies. It mandated government approval for the establishment, expansion, merger, or takeover of any undertaking with assets above a specified limit (initially ₹20 crore).

  • Industrial Policy Statements of 1973 and 1977:

    • The 1973 policy further clarified the role of large industrial houses, demarcating specific areas for their investment (core industries) to prevent them from overwhelming small entrepreneurs.
    • The 1977 statement, under the Janata Party government, reflected a Gandhian influence, placing strong emphasis on the development of small-scale, tiny, and cottage industries. It adopted a restrictive approach towards large-scale industries and sought to decentralize industrial production.

  • Industrial Policy of 1980:

    • With the return of the Congress government, the policy focus shifted towards improving efficiency and productivity. It aimed for “effective management” of the public sector and began the process of liberalizing industrial licensing.
    • It introduced concepts like “automatic expansion” of capacity for certain industries and raised the asset threshold under the MRTP Act to reduce the number of companies under its purview. The investment limits for defining small-scale (from ₹10 lakh to ₹20 lakh), tiny (to ₹2 lakh, not ₹1 lakh as in summary), and ancillary units (from ₹15 lakh to ₹25 lakh) were increased to promote their modernization and growth.

Assessment of Pre-1991 Industrial Policy

  • Achievements:

    • Diversified Industrial Base: India successfully created a broad and diversified industrial structure. It achieved self-reliance in a wide range of goods, from basic consumer products to complex machinery.
    • Growth of Capital Goods Sector: A major achievement was the development of a strong capital goods sector. Its share in total industrial output rose from less than 4% at independence to nearly 24% by 1991, a critical foundation for industrialization.
    • Development of Technical Manpower: The focus on heavy industries and public sector enterprises helped create a large pool of skilled engineers, technicians, and managers.

  • Failures and Criticisms:

    • Inefficiency and High-Cost Economy: The lack of competition, both domestic and foreign, bred inefficiency. The “license raj” protected firms from market forces, leading to a high-cost industrial structure where consumers paid high prices for low-quality goods.
    • Corruption and Rent-Seeking: The discretionary power vested in bureaucrats under the licensing system created vast opportunities for corruption and rent-seeking, as documented by scholars like Anne Krueger (1974).
    • Barriers to Entry and Stifled Competition: The system restricted the entry of new firms, protecting incumbent, often inefficient, players. It stifled entrepreneurship and innovation, and capacity constraints under licensing prevented firms from achieving economies of scale.

The New Industrial Policy (NIP), 1991

  • The NIP 1991 represented a fundamental shift in India’s industrial development strategy, moving from a state-led, inward-looking model to a market-led, outward-looking one.
  • Core Philosophy: The policy’s stated aim was to “unshackle the Indian industrial economy from the cobwebs of unnecessary bureaucratic control,” promote international competitiveness, and integrate the Indian economy with the global economy.
  • Redefining Self-Reliance:
    • The old definition of self-reliance, shaped by the ISI strategy, meant producing everything indigenously, regardless of cost or quality.
    • The NIP redefined self-reliance as the ability to pay for imports through export earnings. This implied focusing on areas of competitive advantage and importing goods and technology where domestic production was inefficient.

Key Elements of the New Industrial Policy

  1. Abolition of Industrial Licensing (Delicensing):

    • Industrial licensing was abolished for all industries except a short list of 18, which has since been pruned. Currently, licensing is compulsory for only a few industries, such as alcoholic drinks, cigars and cigarettes, electronic aerospace and defense equipment, industrial explosives, and specified hazardous chemicals.
    • This freed entrepreneurs to make investment decisions based on commercial logic rather than government fiat, promoting dynamism and competitiveness.

  2. Dereservation of Public Sector and Privatization:

    • The number of industries reserved exclusively for the public sector was drastically reduced from 17 to 8 in 1991, and subsequently further down. Currently, only two sectors are reserved: Atomic Energy and Railway Operations (though private participation is now allowed in many railway-related operations).
    • Disinvestment: A policy of selling government equity in Public Sector Undertakings (PSUs) was initiated to raise resources, improve corporate governance, and introduce market discipline. The policy aims to bring down government equity in non-strategic PSUs to 26% or lower.
    • Restructuring and Revival: A structured approach for dealing with sick PSUs was adopted. The Board for Industrial and Financial Reconstruction (BIFR), established in 1987, was tasked with formulating revival or closure plans for sick PSUs. (BIFR was later dissolved in 2016 and its functions were absorbed by the National Company Law Tribunal - NCLT).
    • Manpower Rationalization: Voluntary Retirement Schemes (VRS) were introduced in PSUs to reduce surplus labor.

  3. Amendment of the MRTP Act:

    • The NIP 1991 significantly amended the MRTP Act by removing the pre-entry restrictions related to asset thresholds for investment, expansion, mergers, and acquisitions. The focus shifted from controlling size to controlling anti-competitive behavior.
    • Eventually, the MRTP Act was repealed and replaced by the Competition Act, 2002, which established the Competition Commission of India (CCI) to promote and sustain competition, and prevent practices having an adverse effect on it.

  4. Liberalized Foreign Investment Policy:

    • The policy was radically transformed to attract foreign direct investment (FDI) and foreign technology. Automatic approval for FDI up to 51% equity in high-priority industries was introduced. This limit has been progressively raised, and today, 100% FDI is permitted under the automatic route in most sectors.
    • The restrictive Foreign Exchange Regulation Act (FERA), 1973, which treated foreign exchange as a scarce national resource, was repealed and replaced by the market-friendly Foreign Exchange Management Act (FEMA), 1999.
    • The Indian stock market was opened to Foreign Institutional Investors (FIIs), now termed Foreign Portfolio Investors (FPIs), to deepen capital markets.

  5. Dilution of Protection to Small-Scale Industries (SSI):

    • The policy of reserving items for exclusive manufacture in the SSI sector, which had been a cornerstone of industrial policy since the 1970s, was gradually dismantled. The number of reserved items was progressively reduced and the policy was completely abolished in 2015.
    • The focus shifted from protection to promotion of competitiveness by addressing core issues of the sector like access to technology, finance, and marketing.

Assessment of the New Industrial Policy

  • Positive Impacts: The reforms of the 1990s successfully dismantled the license-permit raj, opened the economy to foreign investment and trade, and fostered a more competitive industrial environment. This led to higher growth rates, improved product quality, and greater consumer choice. Sectors like telecommunications, IT, and automotive manufacturing witnessed transformational growth. The removal of quantitative restrictions on imports in 2001 further intensified competition.
  • Challenges and Slow Progress:
    • The pace of “second-generation” reforms, particularly in microeconomic areas like labor laws, land acquisition, and judicial processes, has been slow. This has constrained the manufacturing sector’s ability to create formal jobs at a large scale.
    • Attracting private investment into infrastructure sectors like roads, ports, and power remains a major challenge due to issues related to project viability, regulatory uncertainty, and financing. The Foreign Investment Promotion Board (FIPB), which was set up to fast-track approvals, was abolished in 2017 to further ease the investment process.
    • The reforms have been criticized for leading to a rise in inequality and for the phenomenon of “jobless growth,” where GDP growth is not accompanied by a commensurate increase in employment.

Prelims Pointers

  • Share of Industry in India’s GVA (2021-22, at current prices) is approximately 28%.
  • The “Hindu rate of growth” term was coined by economist Raj Krishna to describe the slow growth period from the 1950s to the 1980s.
  • The Industrial Policy Resolution of 1948 classified industries into four categories: Strategic, Basic, Important, and Other industries.
  • Strategic industries (1948): Arms and Ammunition, Atomic Energy, Rail Transport.
  • Basic industries (1948): Coal, Iron & Steel, Aircraft Manufacturing, Ship-building, etc. (Total of six).
  • The Industrial Policy Resolution of 1956 is often called the “Economic Constitution of India.”
  • IPR 1956 classified industries into three schedules:
    1. Schedule A: 17 industries, exclusive monopoly of the state.
    2. Schedule B: 12 industries, progressively state-owned but private sector could supplement.
    3. Schedule C: All other industries, left to the private sector.
  • The Monopolies and Restrictive Trade Practices (MRTP) Act was enacted in 1969.
  • The MRTP Act was replaced by the Competition Act, 2002, which established the Competition Commission of India (CCI).
  • The Foreign Exchange Regulation Act (FERA) of 1973 was replaced by the Foreign Exchange Management Act (FEMA) of 1999.
  • The New Industrial Policy (NIP) was announced in 1991.
  • Under the current policy, only two sectors are reserved for the public sector: Atomic Energy and Railway Operations.
  • The Board for Industrial and Financial Reconstruction (BIFR) was established in 1987 to deal with sick industrial units. It was dissolved in 2016.
  • The policy of reserving items for exclusive production by Small-Scale Industries (SSI) was completely abolished in 2015.
  • The Foreign Investment Promotion Board (FIPB) was abolished in 2017.
  • Investment limit changes in 1980:
    • Tiny Sector: raised to ₹2 lakh. (Note: The summary says 1 lakh, but the official figure was 2 lakh in 1980)
    • Small-Scale Units: raised from ₹10 lakh to ₹20 lakh.
    • Ancillary Units: raised from ₹15 lakh to ₹25 lakh.

Mains Insights

1. The Pre-1991 Industrial Strategy: A Critical Evaluation

  • Rationale (Cause): The inward-looking, state-led industrial strategy (1950-1990) was a product of its time. It was influenced by Fabian socialism, the success of Soviet planning, and a deep-seated suspicion of foreign capital rooted in the colonial experience. The primary goal was to achieve economic sovereignty and self-reliance through Import Substitution Industrialization (ISI), focusing on heavy industries (Mahalanobis Model).
  • Consequences (Effect):
    • Positive: The policy succeeded in creating a diversified industrial base and a strong capital goods sector, which were crucial foundations. It also nurtured a large pool of scientific and technical manpower.
    • Negative: This strategy led to the “License-Permit-Quota Raj,” which fostered inefficiency, high costs, and low-quality products due to lack of competition. It created a sheltered market where producers, not consumers, were king. The system also institutionalized corruption and rent-seeking behavior. The slow growth rate during this period is a testament to the model’s limitations.
  • Historiographical Debate: Was the Nehru-Mahalanobis model a failure?
    • Proponents argue that it was necessary for a newly independent, capital-scarce country to build foundational industries that the private sector could not. They credit it with laying the groundwork for future growth.
    • Critics (e.g., Jagdish Bhagwati, Arvind Panagariya) argue that an export-oriented strategy, like that of the East Asian Tigers, would have led to faster growth, more employment, and greater efficiency by harnessing India’s comparative advantage in labor. They view the inward-looking policy as a costly historical mistake.

2. The 1991 Reforms: A Watershed Moment

  • Causality: The 1991 reforms were not just a voluntary policy shift but a response to a severe Balance of Payments crisis. This crisis acted as a catalyst, forcing policymakers to abandon the long-standing statist model and embrace liberalization, privatization, and globalization (LPG).
  • Nature of the Shift: The NIP 1991 was a paradigm shift. It redefined the role of the state from a primary producer and controller to a facilitator of economic activity. The redefinition of ‘self-reliance’ from indigenous production to the ability to pay for imports through exports was central to this new thinking.
  • Analytical Perspective: The success of the 1991 reforms can be seen in the subsequent acceleration of India’s GDP growth. However, the reforms remain an “unfinished agenda.”
    • Successes: Dismantling of licensing, opening up to FDI, and deregulation of markets spurred growth in services and certain manufacturing sectors.
    • Shortcomings: The reforms have been less effective in tackling structural rigidities in factor markets (land, labor, capital). Labor law reforms remain contentious, hindering the growth of large-scale, labor-intensive manufacturing which is crucial for job creation. This has contributed to the problem of ‘jobless growth’ and rising inequality.
    • Institutional Constraints: The efficacy of policy reforms is often blunted by slow judicial processes and administrative bottlenecks at the state and local levels, highlighting the need for deeper governance and institutional reforms to complement economic liberalization.

3. Public Sector vs. Private Sector: An Evolving Debate

  • Pre-1991: The public sector was seen as the engine of growth, occupying the “commanding heights.” However, most PSUs were plagued by low productivity, overstaffing, and political interference, becoming a drain on the exchequer.
  • Post-1991: The policy shifted towards privatization and disinvestment, based on the belief that private ownership brings greater efficiency and market discipline. The objective changed from public ownership to ensuring that consumers have access to competitive and efficiently produced goods and services, regardless of who the producer is.
  • Contemporary Relevance (GS Paper II/III): The debate now centers on the model of disinvestment (strategic sale vs. IPOs), the valuation of PSUs, and the role of the state in strategic sectors. The challenge is to balance the goals of fiscal consolidation and market efficiency with the welfare of employees and the preservation of national assets. The performance of PSUs that have been granted greater autonomy (e.g., Maharatnas, Navratnas) provides a middle-ground perspective in this debate.

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