India's imminent manufacturing renaissance

Gleaming glass towers rise sphinx like over the dull haze of a cold winter morning in the city of Ordos, Inner Mongolia. Eerily enough these towers are all vacant. Miles upon miles of empty streets and uninhabited apartments dot the landscape of this vacant city, perpetually in wait for inhabitants. It's a ghost town created in the middle of nowhere and is emblematic of the crazed infrastructure spending that China embarked upon over the last decade. This infrastructure creation, though at times excessive, enabled China achieve its pre-eminent status as the world's manufacturer. A massive shop floor for the entire world - driven by cheap labour and spanking new infrastructure. However, the glorious Chinese manufacturing story may be coming to an abrupt end. And it provides India with an opportunity rivalling, if not exceeding, the famed IT services tsunami that launched it on the global platform.

In 2012, the official Chinese statistical handbook reported that the number of working-age Chinese fell by 3.45 million, to 937.27 million. It is the kind of interesting-but-irrelevant statement that doesn't usually hold more than a moment's attention. However, it represents the first ever recorded decline in the total sum of labour available for China's manufacturing sector. It also marks the start of a long term decline in Chinese labour supply and a trend that is expected to further accelerate over the next two decades. In short, China no longer has the inexhaustible supply of young workers who formed the backbone of its manufacturing revolution. This has led to a sharp spurt in manufacturing costs in China, which have risen 40 per cent in the last five years. In another two to three years it will be cheaper to manufacture a bulb in California than in Shanghai. This is precisely the opposite of the trend in India. India's working age population has grown at an average rate of eight per cent over the last 10 years. And India is widely expected to maintain, if not accelerate, this growth rate over the next few decades. While this divergence in labour supply between India and China has been in the making for a few years, it has now reached a critical inflection point. The average monthly wage of a Chinese worker in Shanghai, at $275, is more than three times what his India counterpart in Mumbai earns - $81 per month. This divergence is as much a function of rapid growth in India's working age population as it is of decreasing availability of Chinese labour. According to demographic projections, India will single-handedly contribute two-thirds of the global increase in the labour force over the next decade. In fact such has been the growth in India's labour force that, in spite of rapid economic growth, the average industrial wage level is now amongst the lowest in emerging Asia. Barring Cambodia ($66/month), Myanmar ($45/month) and Bangladesh ($56/month), no other Asian country provides labour at a rate cheaper than India does. Surprisingly, even Pakistan's ($88/month), Nepal's ($157/month) and Vietnam's ($92/month) average wage is higher than India's. In effect, there is no Asian country that can match India's scale and low labour wage rate - both critical factors for global manufacturing operations. A trend that has been in the making for decades has reached a point where India, due to its scale, geographical proximity and significantly lower labour cost, is now a natural alternative to Chinese manufacturing.

Whereas the nature of the opportunity that this cost arbitrage provides India with is fairly straightforward, most don't realise its magnitude. China exports $1.5 trillion worth of manufactured goods every year. Every third air conditioner in the world is made in China. Every second shoe is currently made in China and every fourth CFL lamp is manufactured in China. As context, if India manages to garner even 10 per cent of this manufacturing demand from the rest of the world, its GDP growth rate will double. It would in one single swoop solve one of India's deepest structural problems - lack of employment for the massive new wave of youth entering its workforce. India needs to generate more than 100 million new jobs over the next 10 years to employ, feed and clothe this emerging labour force. This is in comparison to the less than 20 million jobs generated over the last 10 years.  As a conservative estimate every single percentage point in manufacturing market share that India gains from China will create 8 million new jobs in India. A 10 per cent market share will nearly employ the entire excess labour force generated over the next decade. India's labour cost advantage over China could not have come at a better time.

Clearly, cost advantage alone isn't enough. Specifically, Chinese infrastructure is light years ahead of India's. However, despite popular perception to the contrary, India is catching up. Even in absolute dollar terms, India's planned infrastructure investment of $585 billion, over the next five years, is larger than China's $500 billion. (China has quite literally run out of places to create ghost cities in!). Also, India has key advantages in soft, non-physical infrastructure, whose impact is usually over-looked. India's corporate framework, specifically pertaining to private competition, is free from the rampant and ad-hoc government intervention seen in China. Only about 10 per cent of the companies listed on the Bombay Stock Exchange have some sort of government investment against 90 per cent of those in Chinese exchanges. This suggests that coming up against government-backed competition is far more likely in China. Further, in many other key enabling areas viz. patent protection, banking and finance and repatriation of profits, Indian laws offer a far better deal to budding entrepreneurs and manufacturers. For instance, it is far easier to open a bank account in India than in China, where foreign investors are restricted to having a basic RMB account with limited capital flows. In addition to these soft infrastructure areas, there are other key physical infrastructure segments e.g. telecommunications, where India is ahead of China. Call rates are significantly lower in India (on average 60 per cent lower), mobile penetration is growing faster and legacy technology issues are fewer. Hence, whereas India continues to lag behind in infrastructure, the extent of the disadvantage in overstated.

In fact a recent survey, conducted amongst expat CEO's, reported that close to three fourths of them thought India was a far easier place to live in. They felt that whereas Indian operations in general, and labour in particular, were more inefficient than China's, India was far more predictable than China. In a sense India's predictable inefficiency is preferable to China's unpredictable efficiency. And predictability is highly desirable from a risk management perspective. The bottom line is that while China may be extremely efficient in executing complex manufacturing projects, and may have world class infrastructure, the difference is not insurmountable.

The point is not even that Indian manufacturing needs to overtake the Chinese juggernaut. But only that cost and soft infrastructure issues have reached a point where it is feasible to expect India to start chipping away at China's overwhelming global manufacturing market share. And that every percentage point that it can gain from China has massive ramifications for India's emergence as a global player.

However, this does assume that India's political establishment will have the vision and intent to grab this window of opportunity. That it will shed its regulatory ambivalence and create an environment where entrepreneurs feel empowered to create value- both for themselves and for the country at large. That it will show the conviction to move the planned $580 billion infrastructure investment, from paper to reality. That, at the very least, it will recognize that an opportunity exists to quite literally transform India's economic future- as it did for China.  However, the biggest question of all is, how do we manufacture a sensible political establishment that makes investment worthy decisions? If only we could pick that up from the Chinese factory.

The author is an analyst at a global investment firm in New York. Views expressed are personal.