Why is India Struggling With Manufacturing Competitiveness?

Executive Summary

Many studies have highlighted the multitude of factors that hinder the competitiveness and exports of Indian manufacturing. These constraining factors include India’s onerous regulatory framework, high costs of essentials such as land, energy, quality-adjusted labour inputs, and infrastructure constraints. While there is some merit in these arguments, it is also true that there have been significant improvements in easing the regulatory burden, as reflected in India’s Ease of Doing Business ratings, massive enhancements in transport and logistics infrastructure, tax reforms, and a more responsive bureaucracy. Yet, India’s manufacturing competitiveness does not seem to improve.

Another set of studies has identified constraints on external economic interactions, including an overvalued exchange rate and rising domestic protection levels, which reduce export competitiveness, alongside increasing global protectionist tendencies that limit trade opportunities. How India can balance its priorities within this larger setting remains an open question. However, it is evident that studies have tended to identify numerous factors working simultaneously to create what appear to be insurmountable hurdles to the global competitiveness of Indian manufacturing.

Perhaps as a consequence, the latest government efforts are not only aimed at easing these hurdles but also at providing active support to industry. One underlying argument behind the Production-Linked Incentive (PLI) scheme, for instance, is that given the higher costs and greater difficulties of doing business in India, some government support is necessary to help industry achieve sufficient scale, where economies of scale can mitigate other hurdles.

India’s high tariffs and allied policies protection have come into increasing focus following US President Donald Trump’s tariff policies in his second term. This presents India with challenges, but also opportunities to expand its export market share—provided its competitiveness parameters are robust.

This paper examines the core issues that have prevented India from achieving manufacturing competitiveness and suggests policy priorities to overcome these challenges. We do so in a novel fashion by modifying the well-known Porter’s Diamond Model (PDM). Using this modified PDM, we compare multiple countries from Asia with India by constructing a Competitiveness Index (CI) for each country across a range of components aggregated within six pillars. The insights derived from this comparative analysis form the basis of in-depth qualitative discussions with industry stakeholders, providing us with a unique combination of a bird’s-eye view and an on-the-ground perspective, both quantitatively and qualitatively. The four distinct methodological contributions of this paper are listed here:

1. Modification of the PDM Framework: The PDM framework comprises six pillars that contribute to competitiveness at the country level: factor conditions, demand conditions, related and supporting industries, firm strategy, structure, and rivalry, government (regulatory quality), and chance. We replace the chance pillar with the global trade policy pillar. This pillar encompasses external policies such as import tariffs and membership in large multilateral Free Trade Agreements (FTAs) that influence how a country integrates into the global trading system.
2.  Use of PDM to Calculate the CI: By applying the PDM framework, the paper proposes a method to calculate the CI based solely on input factors, rather than combining both input and output factors as seen in other global competitiveness indices, such as the World Economic Forum’s Global Competitiveness Index (GCI). This approach offers predictive insights into a country’s future competitiveness.
3. Focus on Asian Competitors: Given that Asia contributes a significant share of global Gross Domestic Product (GDP) and hosts many Global Value Chains (GVCs), the paper selects specific Asian competitors for India as potential alternatives to China in its trade and manufacturing strategies. The comparator countries include Indonesia, Malaysia, Thailand, Vietnam, and India.
4. Industry Consultation to Align with CI Findings: The paper also compares the CI results with insights from industry consultations. The intention is to provide a clearer understanding of the main factors impacting competitiveness, ensuring the insights are more grounded in real-world industry perspectives.

Results

Our CI analysis finds that, among the countries studied, India and Indonesia are the two least competitive countries. The top three spots are occupied by Malaysia, Vietnam, and Thailand.

• Of the six pillars studied, India ranks poorly in two: firm strategy, structure, and rivalry; and global trade policy. India is among the lowest in three other pillars: “factor conditions”, “related and supporting industries” and “regulatory quality.”
• The only pillar where India is not among the lowest rankers among the five countries studied is “demand conditions.”
• In the factor conditions pillar, India performs poorly overall, with gaps evident in Research & Development (R&D), access to finance, and land.
• India’s better performance in the demand conditions pillar is largely due to its large domestic market, which is a crucial subcomponent of this pillar.
• In the related and supporting industries pillar, India’s low rank is attributable to high import tariffs on intermediate goods.
• India’s low rank in the firm strategy, structure, and rivalry pillar is primarily driven by a high degree of firm concentration in Indian industry.
• For the regulatory quality pillar, India’s low rank is due to issues with customs and trade regulations, and tax administration.
• India’s lowest rank in global trade policy is primarily due to its high Most Favoured Nation (MFN) tariffs and its absence from major trade agreements.

Industry Discussions

The findings from the above analysis were validated through discussions with stakeholders from four key sectors: apparel, pharmaceuticals, auto-components, and electronics. These sectors were selected based on their varying export performance. Pharmaceuticals constitute a strong export sector, electronics and auto-components are emerging sectors, and apparel is a sector where India lags substantially despite significant potential. The insights from discussion are analysed within the PDM framework.

Factor Conditions

We find that, while concerns have been raised about the availability of skilled labour, India’s overall supply of graduates and engineers suggests that labour, including skilled labour, is unlikely to be a constraint at the national level, at least in the near future. At the subnational level, high-growth regions require both skilled and unskilled labour from slower-growing regions. Thus, the south of the country attracts migrant labour from other states. However, there are underlying challenges in labour mobility, with high housing costs discouraging workers, particularly women, from migrating for better job opportunities. Addressing this issue could improve labour mobility, especially for women, and reduce perceived labour shortages.

There is general agreement on the need for greater investment in R&D and technology development. We argue that, although government support can offer short-term benefits, the private sector must ultimately take responsibility for investing in technological change. Government policies, for their part, should focus on facilitating foreign technology flows to promote innovation within the country.

Priority Areas: R&D investments; facilitating labour mobility across regions through better urbanisation policies.

Demand Conditions

Indian industry predominantly relies on domestic demand for growth, with exceptions such as pharmaceuticals and mobile phones in the electronics segment. The apparel sector exports a significant portion of its output; however, there is a mismatch between the evolving pattern of global demand for apparel products and Indian production. This suggests that Indian apparel exports could be much higher with better alignment with global demand.

Priority Areas: Address the factors that have prevented Indian firms from better aligning with global patterns, as discussed in the priority areas under other PDM pillars.

Related and Supporting Industries

Stakeholders across all sectors, except the pharmaceutical industry, emphasised the need to liberalise the import of key inputs to make finished goods more competitive. High tariffs on intermediate goods increase costs, rendering these goods less competitive in global markets. Additionally, stakeholders highlighted the importance of integrated industrial parks to streamline supply chains and improve cost efficiency. As many industrial parks do not function effectively and fail to provide basic facilities and services, it is necessary to examine the policies and institutions governing industrial parks in India.

Priority areas: Liberalise imports of intermediate goods; implement facilitative policies to ensure the clustering of various stages of the supply chain within a single location.

Firm Strategy, Structure, and Rivalry

While not directly discussed by sector players, the Micro, Small, and Medium Enterprises (MSME) sector expressed concerns about the lack of fair domestic competition, which could adversely affect pricing and competitiveness. Discussions revealed that pricing for key downstream products is largely controlled by one or two dominant firms. This has a cascading impact on the entire supply chain, significantly reducing the competitiveness of the Indian industry.

Priority areas: Encourage domestic competition by reducing bureaucratic barriers to the entry of new firms; foster foreign competition in key raw materials by reducing import tariffs.

Regulatory Quality

Industry stakeholders highlighted regulatory hurdles such as obtaining permits, securing land for manufacturing units, and navigating labour laws as key barriers to scaling up. MSME representatives emphasised that current labour laws create incentives for firms to remain small, thereby preventing the scaling of manufacturing operations. Other regulatory hurdles include those associated with the environment, effluent management, and various types of permits. Many of these issues can be addressed at the level of industrial parks through a cluster approach to industry.

Priority areas: Changes in firm size thresholds within labour laws and the development of a cluster-oriented policy where various forms of assistance are available to meet regulatory compliance requirements.

Global Trade Policy

As has been the policy direction in recent years, the Indian industry is generally open to FTAs. However, it favours selective engagement, particularly focusing on countries that supply essential intermediate goods. Within this context, India’s limited participation in major FTAs has hindered its competitiveness relative to countries like Vietnam.

Priority areas: Increase the number of FTAs and deepen engagements with major trade partners.

Conclusion

India must adopt a comprehensive strategy to enhance its manufacturing competitiveness. By dismantling protectionist policies, embracing deeper FTAs with key partners, enhancing internal labour mobility, investing in clusters and industrial parks, improving regulatory frameworks, and prioritising technological innovation, India can better compete in the global marketplace and leverage emerging opportunities. This is not the time to regress but to advance.