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8 Apr

How to get rich without getting lucky (Countries' Edition): Part 2

Before we delve into part 2, I would like for you to look at the following graph, which represents the total share of services in global trade.

Even the most liberal estimates never peg services to be more than one-fifth of global trade. The reason I’m saying this is because the India growth story as we know it is largely pegged on services. As a thumb rule, the services sector is not good at absorbing labor because it requires a lot of training to get a services professional to get up to speed and be effective at what they do. My experience running Stoa only affirms this unassailable truth.

Here’s Joe Studwell on the pitfalls of a developmental strategy built around services:

“Any country which bases its development policy on its service sector faces higher barriers to exports than one with a traditional manufacturing-oriented policy. It should be no surprise that the share of services in total world trade has been stuck at around one-fifth for the past two decades.”

In the last edition, I spoke about how agriculture-led development can give countries a good start in absorbing labor and acquiring much-needed foreign exchange. Unfortunately, this strategy can only hold for so long as it begins to plateau in about a decade or so.

To move to the next frontier of economic development, the money that was earned from agricultural surplus needs to be routed into something more productive. Something that has more leverage and bright economic prospects. That something is manufacturing.

Countries seeking to shift to the developmental fast lane should get into manufacturing as it is the most frictionless way to accelerate technological learning.

If this doesn’t sound convincing, it is perhaps worth reminding ourselves of how the world’s richest countries became rich in the first place.

Britain, the first of the lot to industrialize had a first-mover advantage, wherein the regime employed extreme measures of protectionism to nurture infant industries till the point they came into their own. Since they were the first to do so, they didn’t need to fear competition overseas. Being a colonial power lowered the likelihood of being invaded by a foreign power.

Shortly after seceding from Britain, a newly independent United States of America followed a similar strategy. Under the able guidance of Alexander Hamilton, the first secretary of the United States treasury, the U.S.A. benefitted from extreme protectionism in the early years which allowed its entrepreneurs to acquire technological know-how.

Across the Atlantic, Friedrich List, a highly influential (and contrarian) economic thinker, drew inspiration from Alexander Hamilton and advocated the same in Imperial Germany.

Imperial Germany turned out to be the inspiration for bureaucrats in Meiji Japan, who, through several visits to the German empire realized the importance of industry and began an aggressive industrialization drive. This allowed them the distinction of being the first Asian power to be reckoned on the World High table. Korea and Taiwan, being former Japanese colonies absorbed the same sentiment, which ultimately set the stage for their economic growth.

So, how does one go about setting up strong manufacturing capabilities?

Simple. By arm-twisting entrepreneurs into focusing on learning and long-term growth instead of short-term profits.

Taming the Bull

Capital, by its very nature, is greedy. It always seeks the quickest avenue of returns and is all but blind to the long-term requirements of a developing nation. There’s no further proof of this than the Indian startup ecosystem where SaaS firms routinely attract exorbitant amounts of money when compared to manufacturing firms.

This is one of those instances where governments do a better job by directing national resources towards activities that may not give adequate returns in the near or medium term. State-led manufacturing strategies normally operate on two levers: protection and subsidies.

Protection from foreign competition ensures that local firms get enough time to build their technological capabilities, at least to the point where they can cater to local demand. Subsidies allow entrepreneurs from all walks of life to participate in manufacturing, a much-needed boost to societies that are only just transitioning from feudalism.

Naturally, this can lead to rent-seeking behavior, wherein firms try to convince the bureaucrats of all the hard work they are doing despite being globally uncompetitive. The solution? Force manufacturers to export and cull out the losers.

Judging firms by how well they do in the foreign market, however basic the products may be, raises the stakes. Poor performance in foreign markets allows governments to recognize which firms to not invest in. By repeating this process, subsidies will eventually only be directed to those firms that are constantly going up the learning curve.

This is precisely what happened in East Asian countries. Japan, South Korea, and Taiwan all had departments that were dedicated to identifying and rewarding manufacturing firms that were investing in acquiring technological know-how as opposed to raking in short-term profits.

But doesn’t India have prominent manufacturing firms?

Yes and No.

India does have a reasonably prominent manufacturing base, but this is much below that of its East Asian counterparts. Moreover, those that do exist were never held to strict export standards, nor did they get the kind of state support that allowed them to experiment with new technologies.

Nearly 50 years of being a closed economy, coupled with a draconian license Raj permanently altered the psyche of the Indian entrepreneur. The relationship between the business class and the state is primarily adversarial. The government is seen as more of an obstacle to overcome than as a strict, but benevolent partner.

It’s not all doom and gloom.

Global supply chain shocks and the rising cost of Chinese labor have led to companies considering India as a potential global manufacturing hub. This would not only mean more manufacturing jobs for fresh-off-the-farm labor but also an opportunity for technology transfer.

If implemented effectively, we could start seeing a lot more ‘startups’ heading into manufacturing, as opposed to software. Software may be an excellent medium for improving individual prospects, but it is manufacturing that strengthens the economic backbone of a nation.

If agriculture is the route to improving food security, it is manufacturing that ensures military security and economic security. Excessive reliance on services is a distinctly Anglo-Saxon phenomenon, one whose ill effects are already starting to make themselves apparent.

In the final edition of this trilogy, I shall discuss the limited (but important) role that Finance plays in allowing countries to get rich (hint: it’s the exact opposite of what the World Bank and the IMF advocate).

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