Some people argue that Japan, South Korea and some European countries succeeded in catching-up richer countries through an intelligent mix of economic liberalization and industrial policies aimed at picking winning industries (which generally include the car industry). The empirical evidence on industrial policies is at best mixed: Beason and Weinstein for a criticism of the Japanese industrial policy; Rodrik has the case for some forms of industrial policy; Acemoglu, Aghion and Zilibotti (2006) provide a more nuanced approach and look for the economic environment necessary for industrial policies to work. Yet, politically, they can be tempting - the latest example being the ailing U.S. car industry (see here for the case for and here for the case against). Swaminathan Aiyar in the Economic Times (thanks to Ajay Shah for the pointer) has the latest about the fastest growing car industry in the world, which, it seems, does not benefit from any form of state planning. The secret: a competitive industry, open to foreign technologies together with a booming and large-enough domestic market.
India has overtaken China as a car exporter this year, exporting 201,138 cars in January-July against China’s 164,800. What accounts for India’s success? Visionary planning? Long-term strategy? No, India’s triumph was completely unplanned. No planning document ever envisioned or planned for beating China.
Analysts say China has become a great auto exporter because of huge subsidies, an undervalued exchange rate and dirt-cheap credit. But India never aimed at an undervalued exchange rate to pile up large trade surpluses — rather, it aimed to keep the real effective exchange rate unchanged from 1993 onward. India’s interest rates were always among the highest in Asia. It stubbornly refused to reform its inflexible labour laws, with adverse effects on productivity and wages relative to Asian competitors. No Indian strategic vision targeted special provisions or subsidies to the auto sector. Indeed, the sector for years suffered exceptionally high excise duties and sales tax.
How then did this sector become world class? In the early 1990s, auto production was freed for investment by any domestic and foreign investor. Indian planners as well as foreign investors regarded India as a low-skilled, low-productivity country producing third-rate cars like the Ambassador and Premier. Foreign investors came only because car imports were virtually banned. The small size of the Indian car market created serious scale diseconomies.
Nobody foresaw what fierce competition would do. Auto companies compete by constantly producing new models with improved features like fuel efficiency. Indian consumers are very price-sensitive, so design changes to reduce costs are also vital. India’s auto parts companies had rarely been asked for innovative changes during the old licence-permit raj, when the Ambassador and Premier faced little competition. But MNCs brought in competition, and started a dialogue with auto ancillary manufacturers on constant design changes. To their surprise, they found that Indian engineers had considerable skills, and could make improvements quickly and cheaply.
Incidentally, Aghion, Burgess, Redding and Zilibotti (2005) have an interesting paper about the dismantling of the licence raj in India. They show that de-licensing (and hence increased competition) did not benefit all Indian States equally: those who have more more flexible labour law (more generally pro-employer labour law) benefited more than those who are more “pro-workers.”
