The NITI Aayog had its introductory session last week, with the prime minister presiding over a discourse of ideas that called for the now familiar stances of fiscal prudence, infrastructural development and deregulation. The Aayog – whose exact modus operandi is still not clear – is set to further Prime Minister Narendra Modi’s vigorous Make-in-India campaign. Yet, given the ideological predisposition of its principals, the goal of making India a manufacturing nation may remain unreachable.

Consider the economic framework – outlined in my last essay – in use by the economic advisors led by Arvind Panagariya. Macroeconomic irresponsibility – increasing inflation and deficits – and “policy paralysis” are the chief culprits behind the current drop in investment. To increase investment, the private sector has to have “certainty”. This suggests that policymakers should pursue a shaft of ‘supply side’ economics, whereby labour and land regulation is ruthlessly diminished, macroeconomic stability is priced over production expansion and stable policy regimes end uncertainty.

Yet, this is unlikely to be successful because of two reasons. One, it assumes a pre-modern understanding of production and exhibits an overreliance on laissez faire allocation of capital.

Neoclassical economic discourse, in which Panagariya and his team are immersed, accepts that land, labour, entrepreneurship and capital form the factors of production. Thus, the government ought to liberalise each of these factors – labour deregulation, land deregulation, end of licensing for entrepreneurship and capital liberalisation – and growth shall automatically follow. Such a belief also underpins the faith that rising labour costs in China would have a positive impact on the Indian manufacturing scenario, if only India deregulates and pursues macroeconomic stability.

Need for institutional entrepreneurship

Yet, for a management consultant or a thoughtful high-ranking executive in a corporation, the building block of the modern economy would be something that usually slips past the nose of Ivy League educated neoliberal economist – institutions. By institutions, I mean giant corporations, agencies and other bureaucracies that marshal, organise and execute the use of resources, labour, technology and production techniques.

China’s manufacturing bonanza is not simply a result of investment in human capital, general infrastructure and suppression of labour market rigidities – as many economists would explain. It is a product – as made evident by works of Usha and David Halley – of careful nurturing of manufacturing industry as it learns the “how to” part of making things. Modern industry of corporations and companies represents the sync of managerial, engineering and design talent. Such “collective entrepreneurship” cannot simply be assumed and takes time to institutionalise itself.

Similar institutional growth underpins the success in creating the hyper-innovative ecosystem of universities and infrastructure in the Silicon Valley or high-tech manufacturing in Germany.

That the world recognises the importance of these executive and managerial abilities is evident from the premium that job seekers put on business school education. The real puzzle is why this most important fact of modern production accounts for so little for neoclassical economists.

Upgrade production capabilities

The institutional advantage is also a cardinal reason why foreign capital lending in developed countries results in further industrialisation, and why similar capital infusion in developing nations leads to laundering or commodity and real estate booms. Even though World War II had decimated Western Europe’s industrial base, the infusion of American capital through the Marshall Plan worked because corporations, companies and industrial experience existed and could channel the capital to productive ends. As Raghuram Rajan noted in Fault Lines, efforts of international funds to conduct similar capital infusion in many developing nations have failed because of their institutional infirmity.

It follows that a government attempting to build an economic base must nurture these institutional foundations of modern economic growth. Indeed, modern India at the time of independence lacked such “forces of productions”. Industry mainly composed of textiles, and there were at best a handful of steel mills across the subcontinent. It is for this reason that the Nehruvians took painstaking efforts to enter steel, cement and other heavy and chemical industries, even when they were not profitable. Similar concerns pushed General Park He of Korea – against the wishes of the international financial community of his time – for the creation of the state-owned POSCO. POSCO would eventually become one of the most efficient steelmakers across the world.

The secret of becoming rich, therefore, lies in this consistent upgrading of productive capabilities. This is what many developing nations – especially East Asians – post-World War II understood. They constantly pushed their industrial houses into new and more sophisticated economic activity and gave protection to them in order for them to learn and become adept at the production method.

Critics – including the very economists sitting with the prime minister at Aayog – may note that pursuing sophisticated production is not in the country’s “comparative advantage”. While that is certainly true, the essential point of a developmental strategy is to forego current comparative advantage in the pursuit of a more productive and technologically advanced comparative advantage in future. Short-term profitability ought to be sacrificed for long-term building of industrial base.

Judicious manipulation of markets

To borrow from Korean economist Ha Joon Chang’s analogy, would you ever force a six-year old to compete with a 26-year-old doctor for jobs? No, because it would not be fair game. You would first invest in the six-year old’s education and training and make him competitive for the job market. Free trade for a nation’s industrial base follows a similar trajectory.

Yet, the nurturing of competitive industries through aggressive and subsidised financial support is not on the table for the current crop of economic advisors. The government, as per its advisors, remains committed to trade and financial liberalisation, and deems aggressive government intervention to organise or stimulate production as distortionary. Bibek Debroy, a full-time member of the NITI Aayog, in his latest op-ed for The Times of India made it quite clear that government’s role is restricted to “providing goods and services where there are market failures and subsidising merit goods for those who are poor and truly need them”.

But free market cannot be expected to attend to the needs of building an industrial base simply because capital usually follows short-term profitability. As the travails of Indian electronic-makers (who import 90% of the value of their products from East Asia) make clear, manufacturing in India is not an option in spite of rapidly rising cost of labour in China. In China, the electronic-makers get a ready army of engineers, factories and their suppliers who have perfected the trade; in India they would have to build from scratch. The key is to understand that the process of perfection cannot be assumed, and – like any skill or art – needs to be practised. Hence, even if India gets the required labour, land and capital (machinery) for making electronics, it needs to understand and perfect the organisation and execution part of it all.

If India is serious about building its industrial base, its developmental state needs to set the objectives (as opposed to the market dictating them) and judiciously manipulate the market to attain them.

The only thing that may stand between Modi’s economists and the wholesale abandon of the developmental state is Modi’s pragmatism, derived from his grassroots experience of overseeing industrialisation in Gujarat. While the prime minister may not be a man of ideas, he must learn to trust his intuition, and take every piece of advice with utmost scrutiny and scepticism.