India: Inching up the value chain - Views on News from Equitymaster

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India: Inching up the value chain

May 24, 2002

Of the various schools that explain economic growth, the neoclassical model of economic growth pioneered by Robert M. Solow, proposes that growth is a function of two inputs, capital and labour. Thus, increase in capital (production capacity) and improvement in productivity, are primarily responsible for growth. According to the model, with unchanging technology, real wages will gradually stagnate due to law of diminishing returns. But economic history has a different story to tell. Real wages have certainly not stagnated in the twentieth century. The factor responsible for growth in wages is technological change that has significantly improved the productivity and capacity. According to Edward Denison, capital growth accounted for 32% of the growth in the American economy between 1929 and 1982. The contribution of education, research and development and other advances in knowledge was a significant 38%. Thus, while at one end India has to address basic pre-requisites for growth like infrastructure, the need for technology development is equally important.

India has traditionally been considered a laggard in technology. India's technology story, the software industry, derives a greater part of its success from its cost leadership strategy and still has to be recognized as an industry that can develop pioneering technologies. Infact, Israel that has a software industry much smaller to its Indian counterpart, is known as the pioneer in security software and the Irish are known for their database management skills. India, on the other hand, is globally renowned to be the 'sweatshop'. That is not to discredit the software industry. Though the industry has pain staking moved up the value chain, it still has a long way to go.

It is India's engineering and automotive industry that has taken the lead in pioneering technology. When Telco launched Indica, sales were below expectations due to the initial teething problems. The company faced a lot of criticism initially. However, not much attention was paid to the fact that the car was completely designed in India. And today the roaring success of Indica's V2 version establishes, rather emphatically, that the Indian auto industry taken a big leap forward with this small car project.

A business magazine recently carried a story on how the auto components industry is looking at not only selling finished products but also, technology know how to developing countries like Egypt, Nigeria, Iran. There is no denying that here too the Indian industry is undercutting. A comparable technology in India will cost 20% cheaper as compared to Europe. But the point is that the analytical skill of Indians has to be increasingly used as a competitive advantage. To highlight engineering maturity of India the story carries the example of Daewoo India achieving an indigenisation level of 70% by the second year of operation, while in Uzbekistan the indigenisation level is only 28%. India can strongly to leverage on this.

As per the Income Tax Act, companies spending on R&D are entitled to a deduction of 150% of their R&D investment. The society of Indian automobile manufacturers (SIAM) feels the deduction should be progressively linked to the amount invested. According to SIAM's suggestions, the deduction should be 200% for those investing upto 1% of turnover in R&D. The figure should be higher at 300% for those investing between 1% to 2% and 400% for those investing more than 2%.

While the incentive from the government is only part of the input required to create an environment that fosters research and development, the real push will come from the private sector working whole-heartedly towards the area, instead of merely 'showing' expenditure towards R&D to get tax breaks. Telco has shown the path, others need to follow.

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