Influence of government policies on industry development: The case of India's automotive industry

Project Report 2009 96 Pages

Business economics - Economic Policy


Table of Contents

List of Figures

List of Tables

List of Abbreviations


2.Current overview of India’s automotive industry
2.1. Domestic sales
2.2. Exports
2.3. Research and development

3.Present configuration of the industry
3.1. Industry structure
3.2. Industry clusters

4.Industry development and the role of government: A discussion
4.1. Government’s role in the development of an industry
4.2. Policies as the means for government interventions

5.Evolution of India’s automotive industry under State interventions
5.1. Protection, indigenisation and regulation: 1947 to 1965
5.2. Increased regulation and disparate segmental growths: 1966 to 1979
5.3. Limited liberalisation and foreign collaborations: 1980 to 1990
5.4. Liberalisation and ensuing globalisation: 1991 onwards

6.Influence of government policies on the development of India’sautomotive industry
6.1. Influence of key policy decisions in the regulatory phases
6.2. Influence of key policy decisions in the limited-liberalisation phase
6.3. Influence of key policy decisions in the liberalisation phase


Appendix A: Production of vehicles in India (1951 to 2007
Appendix B: Detailed automotive vehicle classification in India
Appendix C: SIAM/ACMA members with DST-recognised R&D units
Appendix D: Some foreign auto firms with R&D units in India
Appendix E: List of automobile manufacturers in India
Appendix F: Some of the top auto-component manufacturers in India
Appendix G: A study of plant locations of major auto players in India
Appendix H: Some useful websites


List of Figures

Figure 1: Domestic sales trend for different vehicle types

Figure 2: Size of Indian auto-component market (2003-04 to 2007-08)

Figure 3: Export trend for different vehicle types

Figure 4: Export trend for auto-components

Figure 5: FDI trend in Indian automotive industry

Figure 6: Market shares of key players in the Indian automobile market

Figure 7: Distribution of automobile plants across Indian states

Figure 8: Timeline of key policy decisions and events in the regulatory phases

Figure 9: Timeline of key policy decisions and events in the deregulation phase

Figure 10: Timeline of key policy decisions and events in the liberalisation phase

List of Tables

Table 1: General classification of automotive vehicles in India

Table 2: Growth drivers of the Indian automobile market

Table 3: District-wise distribution of major auto players’ plants in leading auto states

List of Abbreviations

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1. Introduction

The automotive industry in India has come a long way from its nascent state in the early 1940s to its present day dynamic form. As compared to a mere production of 4,000 vehicles in 1950, the production of the industry crossed the historic landmark of 10 million vehicles in 2006. Today, the industry produces a wide range of automobiles and auto-components catering to both the domestic as well as foreign markets. The development of the industry has been shaped by the demand on one hand and the government interventions on the other, the influence of the latter being considerable.

The automotive industry in India was heavily regulated until the 1970s. The automotive firms were obliged to obtain licenses from the Indian government for various firm activities. The 1980s witnessed some relaxation in the regulations and the entry of Japanese firms. In the early 1990s, India undertook historic economic reforms under which the automotive industry was liberalised. Various government interventions in the form of policies, existing at various points of time, have influenced the development of India’s automotive industry over these phases.

This work makes a modest attempt at identifying these policies that have influenced or are influencing the industry’s development and at understanding their influences on the same. It is also of interest to understand the considerations made on the part of the Indian government that underlie such policies and to explore the role played by the government in the development of the industry. For this purpose, the work is organised in the following way:

Chapter 2 provides the current overview of India’s automotive industry,

Chapter 3 describes the present industry structure and industry clusters,

Chapter 4 makes a general discussion about the role ought to be played by the government in different stages of industry’s competitive development,

Chapter 5 discusses the evolution of India’s automotive industry under the influence of various government interventions providing background on considerations made, Chapter 6 analyzes the influence of important policies identified in Chapter 5 on the development of the automotive industry. It also discusses the role played by the Indian government in each of the developmental phase of the industry,

Chapter 7 provides a summary of the work and the conclusions made.

2. Current overview of India’s automotive industry

The automotive industry in India has been witnessing an impressive growth since the country’s economic liberalisation in the early 1990s. In contrast to the 1.5 million units produced in the year 1993-94, the production of vehicles in the country crossed a historic landmark of 10 million units in the year 2006-07 (refer Appendix A). Rising demand owing to the strong growth of Indian economy post liberalisation and the changing landscape in the global automotive industry have fuelled such a growth. India is currently the world’s second largest market for 2-wheelers (IBEF 2008, p. 2) and is considered to be one of the fastest growing passenger car markets (GOI 2006a, p. v). In the year 2007, India ranked 8th in the production of commercial vehicles and 9th in the production of passenger cars worldwide, moving up from a rank of 13th and 15th respectively in the year 2000 (OICA 2008a).1 India is also home to the world’s largest 2-wheeler manufacturer and the 11th largest commercial vehicle manufacturer (Hero Honda 2008 and OICA 2008b).

Indian automotive industry, which comprises of the automobile and the auto-component industries, is one of the largest industries in India.2 In the year 2005-06, the turnover of the Indian automobile industry was United States Dollar (USD) 28 billion and that of the Indian auto-component industry was USD 10 billion (GOI 2006a, p. v). The automotive industry with its deep backward and forward linkages in the economy has been identified by the Government of India as an important industry with a high potential to increase the share of manufacturing in gross domestic product, exports and employment (GOI 2006b, p. 3). As a result, the Indian government has paid special attention to the investment and growth within the industry. Favourable investment conditions and the changing scenario of global competition have attracted world’s major auto manufacturers into India. Be it market-seeking or low-cost sourcing firms, India has emerged as an attractive automotive location to offer them strategic advantages.

Increased competition on the home turf as well as the growing acceptance of their products in the foreign markets have encouraged the Indian auto manufacturers to upgrade their technological capabilities, either through in-house research and development (R&D) efforts or through other means of technology acquisition. The industrious efforts of Indian auto manufacturers are earning acclaim worldwide. For example, the world’s cheapest car recently unveiled by the Indian 4-wheeler manufacturer Tata Motors received attention of auto manufacturers around the world (Time 2008). The Indian automotive industry with its large number of domestic and foreign players is operating in terms of the dynamics of an open market. The growing installed capacity of the industry reached a figure of 2.24 million 4-wheelers and 12.69 million 2-/3-wheelers in the year 2006-07 (SIAM 2008a). The competitive conditions within the industry have substantially benefited the Indian consumers, who now have access to a wide variety of vehicles with affordable price tags.

The subsequent sections in this chapter elaborate upon some of the important aspects of the Indian automotive industry like domestic sales, exports and R&D.

2.1. Domestic sales

Indian consumers have at their disposal a broad array of automobile models to choose from. The well-developed Indian automobile industry produces nearly all kinds of vehicles, which are broadly categorised as shown in Table 1 below. For a detailed classification of automotive vehicles in India, please refer to Appendix B.

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Table 1: General classification of automotive vehicles in India3

The Indian automobile market provides a strong demand base for the growth of the automotive industry. Figure 1 below shows the domestic sales trend for different vehicle types from the year 2003-04 to 2007-08.

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Figure 1: Domestic sales trend for different vehicle types4

As seen in Figure 1, the sales of 2-wheelers dominate the Indian automobile market. This can be attributed to the country’s poor mass transport system and the need for cheaper and efficient means of individual mobility (BajajAuto 2007, p. 3). Another striking characteristic of the market is the rapidly growing demand for passenger vehicles and CVs. These segments grew at a compound annual growth rate (CAGR) of 14% and 17% respectively in contrast to 6% for 3-wheelers and 8% for 2-wheelers for the period 2003-04 to 2007-08. In value terms, the market for passenger vehicles and CVs exceeds that of the 2-wheelers (GOI 2006a, p. 7). Further, a look into the sub-segment-wise demand of each of the above vehicle segments gives an idea about the preferences of Indian consumers. For instance, in the 2-wheelers category, the sales of motorcycles currently exceed that of any other sub-segment. Similarly, in the passenger vehicles category, the sales of small cars (mini & compact) dominate over other sub-segments; see for instance SIAM 2008b. Such a nature of demand specific to the Indian consumers is explained by the country’s demographic (e.g. highest number of people below the age of 35 years) and socioeconomic (e.g. rising middle class) factors.

Further, as indicated by Figure 1, the Indian automobile market has been registering a positive growth annually. The average annual growth rate of the market calculated for the years 2004-05 to 2007-08 has been 9%. A low ownership of 8 vehicles per 1000 persons (ACMA 2008a, p. 10) and the presence of strong demand drivers have identified India as an attractive automobile market. The commonly cited growth drivers of the market and their direct influence on different vehicle segments are summarised in Table 2 below.

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Table 2: Growth drivers of the Indian automobile market5

The import of automobiles in completely-built unit (CBU) form generally attracts high custom duties in India. Even though the import duties have been progressively reduced, they are still high enough to discourage a significant market for imported CBUs. For example, the total value of imported CBUs in the year 2005-06 was mere USD 130 million when compared to the USD 28 billion of production within the country.6 Thus, several foreign automobile manufacturers attracted by the growth prospects of the Indian market have resorted setting up production facilities in the country. The resulting increase in industry competition and the availability of world-class technology products have further stimulated the domestic demand.

The market for auto-components in India has grown along the lines of the automobile market. The domestic sales and imports of auto-components serve the rising demands of both the original equipment manufacturers (OEM) and the replacement market. Increasing number of vehicle models being introduced in the country combined with shorter product life-cycles have meant growing Indian auto-component market not only in size, but also in terms of product diversity. Figure 2 below shows the size of the Indian auto-component market over the years 2003-04 to 2007-08.

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Figure 2: Size of Indian auto-component market (2003-04 to 2007-08)7

As could be seen in the above figure, the Indian auto-component market has witnessed a steep growth. It expanded at an impressive CAGR of 29% over the period 2003-04 to 2007-08. This growth was constituted by increase in both the domestic sales (27% CAGR) as well as the imports (36% CAGR) of auto-components. While growth in domestic sales of auto-components could be understood by the general trends in the Indian automobile industry, that in the imports could possibly be explained by a) progressive reduction of import tariffs on auto-components and semi-knocked down (SKD)/ completely-knocked down (CKD) kits of automobiles, and b) newly established foreign automobile manufacturers commencing their operations by assembling SKD/CKD kits.

2.2. Exports

Indian automotive industry has been registering a healthy growth in terms of its exports as well. The industry crossed an exports turnover of USD 8 billion in the year 2005-06, with the share of exports in industry turnover being around 24% (GOI 2006b, p. 3). India exports both automobiles as well as auto-components to markets around the world. The key destinations include SAARC countries, European Union (Germany, UK, Belgium, The Netherlands and Italy), Middle East and North America (GOI 2006a, p. 8). Increasing pressure in the global competition to source from low-cost countries combined with the skills and quality advantages of India, is the commonly cited explanation for the growth in India’s automotive exports; see for instance Singh (2004) and GOI (2006a). Additionally, supporting policy measures of the Indian government such as export-linked fiscal incentives, establishment of export-processing zones, bilateral or multilateral trade agreements with other countries, etc. have furthered this growth.

Figure 3 below shows the export trend of different vehicle types within the Indian automobile industry over the years 2003-04 to 2007-08.

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Figure 3: Export trend for different vehicle types8

As observed in the above figure, the Indian automobile industry is witnessing rising exports in all vehicle types. The exports grew at a CAGR of 14% for passenger vehicles, 36% for CVs, 20% for 3-wheelers and 33% for 2-wheelers for the period 2003-04 to 2007-08. Both domestic as well as foreign automobile manufacturers have been instrumental in such a growth, by making either direct or indirect exports.9 The domestic manufacturers are forging partnerships with foreign players or are making outward foreign investments for developing and strengthening their sales overseas. On the other hand, several foreign manufacturers have made India the manufacturing base for some of their products meant for regional or global exports; see for instance IBEF (2005, p. 13). In value terms, the exports of the Indian automobile industry crossed USD 2 billion in the year 2005-06 (GOI 2006a, p. 8). All this testifies to the fact that the ‘Made in India’ brand is gaining increasing acceptance in the global export markets.

With regard to the Indian auto-component industry, the export performance has been even better. Figure 4 below shows the export trend of auto-components from India over the years 2003-04 to 2007-08.

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Figure 4: Export trend for auto-components10

As seen in the above figure, the exports of the Indian auto-component industry grew at an impressive CAGR of 30% (value-wise) over the period 2003-04 to 2007-08. The improvement in export performance is also reflected in the shift in composition of customer base for exports made by the industry. In the year 2007, India shipped 75% of its auto-component exports to global OEMs/Tier-1 suppliers and 25% to the aftermarket, in contrast to 65% to aftermarket and 35% to global OEMs/Tier-1 suppliers in 1990s (ACMA 2008a, p. 29). Such a shift has manifested itself in several foreign OEMs and Tier-1 suppliers establishing their purchasing offices or subsidiaries in India for the purpose of component sourcing.11 Also, foreign OEMs and suppliers are increasingly integrating the Indian auto-component manufacturers into their global sourcing strategies. All this attest to the fact that the Indian auto-component industry has been able to establish a cost-competitive and quality-conscious image in the global auto industry. With the continuing trend of global outsourcing, the exports of Indian auto-component industry are estimated to reach USD 25 billion by 2015 (ACMA 2008a, p. 39).

2.3. Research and development

According to OECD (2002, p. 30), the term R&D encompasses basic research, applied research and experimental development. It covers both formal R&D in R&D units and informal or occasional R&D in other units. In India’s automotive industry, both domestic as well as foreign automotive firms undertake some or other form of R&D either in their formal or informal R&D units.12 Most of the R&D efforts of the domestic automotive firms are directed towards value engineering or tweaking the designs to improve performance (Knowledge@Wharton 2005, p. 1). The domestic automotive firms have primarily been relying upon the foreign partners for product and process technologies, with R&D efforts mainly employed to adapt the designs for in-house production and local demand conditions. However, the threats and opportunities brought about by globalisation (wherein foreign collaborator becomes competitor and exports become necessary to sustain growth) have encouraged the domestic auto firms to develop core R&D skills (Knowledge@Wharton 2005, p. 2).

The domestic automobile firms are increasing their R&D spending on in-house product design and development. This is evident from the indigenous product development efforts undertaken by the domestic firms. Tata Motors launched India’s first indigenously developed car ‘Indica’ in the year 1999, an important milestone in the history of India’s automotive industry. Subsequently, commercially successful models such as Tata Indigo, Mahindra Scorpio, TVS Scooty, Bajaj Pulsar and Tata Ace have been indigenously developed and introduced by the domestic firms (ACMA 2008a, p. 33). The success met with the indigenously developed products has led to higher confidence in the domestic firms with regard to the development of core R&D capabilities. Nevertheless, the domestic automotive firms still spend a relatively low amount on R&D as percentage of sales as compared to that of the global auto majors (Knowledge@Wharton 2005, p. 1).

The investments made by foreign automotive firms in India have primarily been market-seeking (Singh 2004, p. 18). Accordingly, the R&D efforts undertaken by foreign automotive firms in India have mainly been directed to adapt the proprietary designs to Indian market conditions. However, the foreign firms are gradually realising the attractiveness of India for carrying out their offshore R&D activities. Low-cost scientific talent, growing IT skills with sound automotive domain knowledge and strong base for prototyping, testing and validating of auto-components are some of the factors that are furthering such a trend (ACMA 2007, p. 30). Moreover, the characteristic demand of Indian consumers for low-cost and fuel-efficient means of transport, especially small cars, is compelling the global auto majors to undertake product development in India for the purpose of acquiring new set of capabilities. Such a consideration is driven by the global trend in shift from big cars to small cars due to recessionary trends and rising fuel costs.

The policies and programmes of Indian government have also played an important role in stimulating the R&D efforts of the industry. Apart from providing fiscal and monetary incentives for firm-level R&D activities, the government is playing an active role in the development of common R&D infrastructure. In the year 2005, the government along with industry players launched a unique initiative for the establishment of world-class testing, homologation and certification facilities, along with nine R&D centres under the National Automotive Testing and R&D Infrastructure Development Project (NATRiP) (GOI 2006a, p. x).

3. Present configuration of the industry

3.1. Industry structure

The competition in India’s automotive industry has become more intense with the growing number of domestic and foreign firms operating in its automobile and auto-component sectors. The liberalisation of automotive industry in early 1990s in tandem with country’s favourable macroeconomic trends has contributed to such a development. The entry of foreign firms into the industry has been further encouraged by the advancements in India’s foreign investment and trade policies. The rising trend of foreign direct investment (FDI) in India’s automotive industry depicted in Figure 5 below testifies for this fact.13

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Figure 5: FDI trend in Indian automotive industry14

The automobile industry in India comprises a good balance of domestic as well as foreign players. Appendix E provides a list of domestic and foreign automobile manufacturers currently operating in India. As could be observed in the list, most of the domestic firms were established in the pre-liberalisation period and are currently operational in more than one vehicle segments. In case of foreign firms, the entries into the Indian market were mainly observed after the year 1993. Firms like Suzuki and Yamaha who had established joint ventures with Indian partners in the pre-liberalisation period, acquired majority stake in their ventures subsequently. Among different vehicle segments, the foreign players are predominantly concentrated in the passenger car and CV segments. Thus, a good mix of seasoned domestic players and renowned foreign players has rendered healthy competition in the Indian automobile industry. The automobile models produced by the industry fill up nearly all the price points addressing varied consumer preferences, and thereby further stimulating the industry growth.

The market shares of key players in different segments of the Indian automobile market for the year 2006-07 are presented in Figure 6 below.

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Figure 6: Market shares of key players in the Indian automobile market15

The Indian auto-component industry comprises of around 500 firms in the organised sector and more than 10,000 firms in the unorganised sector (GOI 2006a, p. 17). The diverse firms produce a comprehensive range of auto-components, which include engine parts, drive transmission & steering parts, body & chassis parts, suspension & braking parts, equipments and electrical parts amongst others (ACMA 2008a, p. 25). In line with the global trend, the auto-component industry in India has also undergone tierisation, with Tier-1 suppliers at the apex and unorganised players at the base of the supply pyramid.16 For meeting the present day challenges of lean and responsive supply, the auto-component manufacturers in India work in close cooperation with their customers both at home and abroad. The rising level of technological and management capabilities among the Indian auto-component manufacturers have made such collaboration possible.

As in the case of automobile industry, the structure of Indian auto-component industry also exhibits a good mix of domestic and foreign players. Appendix F provides a list of some of the top domestic and foreign auto-component manufacturers in India. As could be observed in the list, the prominent domestic players in the industry exist in the form of group companies. Some of these auto-component powerhouses are promoted by Indian OEMs themselves. In general, most of the domestic players in the industry have some form of technological collaboration with the foreign counterparts. Further, the entries of foreign OEMs into India have been accompanied by the entries of their requisite suppliers, which entered into JVs with Indian partners and/or established subsidiaries. On the other hand, several foreign auto-component firms have voluntarily entered the subcontinent to cater to the growing demand of the Indian automobile industry.

The growing potential for exports is making the auto-component companies in India to increase their production capacities (ACMA 2008a, p. 39). As a result, the investment in the industry has risen from USD 3.1 billion in 2003-04 to USD 7.2 billion in 2007-08, growing at a CAGR of around 23% over the period (ACMA 2008a, p. 23).

3.2. Industry clusters

The Indian automotive industry has been noticed to have grown in clusters, which are evident in and around Manesar in North, Pune in West, Chennai in South, Jamshedpur-Kolkata in East and Indore in Central India (GOI 2006a, p. xiv). ACMA (2008a, p. 18) describes such a pattern of investments in the country as ‘regionally balanced’. Figure 7 below indicates the distribution of manufacturing plants of major automobile players across different states and union territories in India.

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Figure 7: Distribution of automobile plants across Indian states17

The manufacturing plants of auto-component players in India are usually located near their OEM customers. Figure 7 therefore also indicates the major auto clusters in India. As could be observed in the figure, the automotive clusters in India span across different states, with a certain state having the lead in attracting auto investments. Locational advantages such as infrastructure, access to pool of educated workforce and supportive state government policies are some of the factors that help explain such a difference between the states within a cluster. Table 4 below provides a district-wise distribution of manufacturing plants of major automobile and auto-component players across the three leading auto states in India.18

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Table 3: District-wise distribution of major auto players’ plants in leading auto states19

4. Industry development and the role of government: A discussion

4.1. Government’s role in the development of an industry

The role the government should play in the development of a nation’s industries has been a topic of much discussion; see for instance Porter (1990) and Lall (2003). With economic liberalisation and globalisation gaining pace in present day times, the development progress of a nation’s industry is increasingly gauged by its ability to endure and excel against international competition – at the home turf as well as in the export markets. The competitiveness of an industry has become synonymous to its international competitiveness, and the mere comparison among industries within the same nation is no longer sufficient. In his comprehensive work reasoning the international competitive success of industries in certain nations, Porter (1990) identifies government as an important variable that influences the competitive advantage of an industry by influencing the national environment in which it operates. The national environment, which is explained by the country’s characteristic demand, basic and advanced factors of production, industry structure and related and supporting industries, could be influenced both positively as well as negatively by various government decisions.

Based on his findings, Porter (1990, p. 671, 672) suggests a varying role for the government as an industry progresses through consecutive stages of competitive development. In early investment- and factor-driven stages, the government could play a more direct role by providing capital, subsidies or temporary protection to help stimulate the investment and create factors such as infrastructure and basic technological base. However, as the industry progresses to a more innovation-driven stage, the firms themselves must become the source of advancement. The role of government should then be just an indirect one, continuously challenging and pushing the firms to upgrade and innovate by raising demand standards. Thus, along with progressive reduction of interventions, the role of government ought to shift from actor and decision maker to that of a facilitator. While the direct role of government articulated above has been in the context of relatively advanced nations, that for the developing nations in early stages of economic development could be more intense.

The principal economic goal for any nation ought to be high and rising standard of living for its citizens (Porter 1990, p. 6). Further, it has been factually accepted that there is a strong and positive relation between the standard of living of a country and the extent of its industrialisation (Chettri 2002, p. 1). Thus, these premises suggest that a developing nation in its early stages of economic development should strive for rapid industrialisation. The underlying principle in the gains in economic prosperity through industrialisation is the increase in national productivity, and thereby the increase in national per capita income. In their drive for industrialisation, the governments in the developing countries are posed with the question as to whether build the economy largely by indigenous companies or by wide-spread foreign investments (Porter 1990, p. 678). While the latter has obvious attractions of swift and easier economic development, the sustainability of such economic growth and national advantage over a longer period is uncertain. On the other hand, economic development based largely on indigenous companies is a slow and riskier process, but rewarding in the long-term if it succeeds. Indigenous companies consider the nation as a home base and invigorate the creation of advanced and specialised factors of production as they progress (Porter 1990, p. 679). When competitive at international level, a largely indigenous industry could help the developing nation move beyond factor driven advantage to the innovation-driven advantage involving higher productivity.

However, the path to competitive indigenous industries for a developing nation is not an easy one. To start with, the nation must decide the industries that need to be focused upon. With scarce resources available at its disposal, the developing nation needs to be highly selective with the industries that it intends to foster. Porter (1990, p. 677) recommends the use of principle of clustering for setting the development priorities. He notes that the development of competitive industries in a country occurs in industry clusters and therefore recommends the government to aim for building entire clusters. According to the principle, as a starting point the government should identify industries in which the country has some competitive advantage today owing to factor conditions, and also the fertile underlying national circumstances like favourable demand conditions are present. Such industries, especially the ones with extensive backward and forward linkages to rest of the economy, should become the centres of development. Subsequently, the government should accelerate the efforts for upgrading the advantages in these industries beyond the basic factor ones. The objective then would be to develop upstream, downstream or related industries in which the advantages are less factor-sensitive. In parallel, the government should concentrate its investments in education, research and infrastructure over these clusters. Eventually, the government should encourage the indigenous firms to explore export options.

In yet another consideration, most of the developing nations in their early stages of economic development lack even a basic industrial base. The fragile and often fleeting ability to export of such nations is derived from primary industries relying on factor endowments such as abundant natural resources, cheap labour, locational factors, etc. (Porter 1990, p. 675). Considerable foreign currency spending on diverse and growing demands of the developing economy combined with inadequate exports maintains a continuous pressure on the foreign exchange reserves of such countries. As a remedy, some developing nations adopt the industrial strategy of import substitution during the initial phases. This involves establishment of core industries like steel, cement, communications, etc. in the country. The underlying justification is that making the country self-sufficient in goods of mass consumption could help to reduce the imports, and thereby free up substantial foreign exchange (Chettri 2002, p. 5). The freed up foreign exchange could then be utilised for advanced purchases. Another belief that supports the adoption of import substitution strategy is the political ideology of self-reliance for the purpose of national sovereignty. Porter (1990, p. 677) here cautions that obsession of import substitution could drive a nation into industries that are unattractive with regard to their future competitiveness and that the government must make sound decisions with its selection of the target industries. Further, while import substitution can help in saving upon the foreign exchange, the government must eventually aim at fostering advanced industries that compete in international markets and earn back home foreign currency.

Thus, the challenges involved in indigenous industry development warrant a more direct role from the governments in developing nations. Government interventions that control or influence the economy as opposed to the free market outcomes might be necessary to offset the disadvantages faced by such nations. Interventions in the form of protection, regulation or direct State support are common tools available at the disposal of government. Infant industry theory developed by Friedrich List, a leading German economist of the 19th century, has been the pervasive theoretical ideology among the developing nations around the world for protecting and nurturing their immature industries.20 Porter (1990, p. 665) asserts that the infant industry argument, which advocates restrictions on free foreign trade and foreign investment, is legitimate only in developing nations lacking a basic industrial base. The nascent indigenous firms in such nations are at a disadvantage to the mature foreign firms possessing better technology, higher quality and lower price offerings. A time-bound protection and encouragement from the government could provide the indigenous firms with sufficient breathing space for attaining competitive capabilities.

Porter (1990, p. 665, 666) suggests that protection bestowed upon the indigenous industry works only under the following three conditions: a) presence of effective domestic rivalry that substitutes for international competitive pressure, b) presence of favourable home demand that promises international competitive position in the future and c) that the protection should be limited in duration. Apart from protection measures such as tariff barriers, import quotas or foreign investment regulation, the governments in developing countries sometimes opt for regulating the domestic rivalry. The rationale usually employed behind such a regulation of the industry structure is the perceived need to ensure sufficient demand for each indigenous firm in order for it to achieve economies of scale, and therefore maintain the prices within an acceptable level. However, an absence of strong domestic rivalry and assurance of sustained profits could make the indigenous firms to underinvest in upgrading their capabilities. Porter (1990, p. 665) thus cautions that without effective domestic rivalry the protected industry shall never emerge at all to become internationally successful. Also, it is important that the duration of protection is set and communicated to the local firms in advance, so that more time is spent by them in developing competitive capabilities instead of lobbying for extending the protection.

Another important aspect of industry development is technological progress (Kathuria 2000, p. 2). Therefore, despite the concern of national sovereignty, the government might need to allow adequate inflow of foreign technology into the nascent indigenous industry. Indigenous firms could be allowed to enter into licensing agreements and financial-cum-technical collaborations for technology acquisition, the latter being more enticing for the foreign collaborator. Moreover, the government could encourage independent R&D efforts as the indigenous industry progresses, since the future competitive advantage would be more technology- rather than factor-driven. Eventually, the government must reduce its interventions substantially and leave decision making to the commercial judgment of the firms. Additionally, the government might also allow investment by foreign companies to inject new vigour into the industry competition. Porter (1990, p. 672) suggests that such a move by the government might be required as part of the reciprocal behaviour for gaining access to foreign markets. Nevertheless, the reduction in interventions should be gradual and not abrupt, so as to allow adequate time for the indigenous firms to adapt to the changing competitive conditions. Ultimately, the role of government during the innovation-driven stage should be to maintain an environment in which firms are and continue to be innovative and dynamic (Porter 1990, p. 672).

4.2. Policies as the means for government interventions

Government intentions for intervening in industry development are usually articulated in some policy forms such as industrial policy, trade policy, fiscal policy, etc. Torjman (2005) defines policy as “a deliberate and (usually) careful decision that provides guidance for addressing selected [..] concerns (p. 4)”.Policy development is therefore a decision making process, which generally involves identifying the objective and determining pathway to the objective based on criteria such as effectiveness, costs, resources required for implementation and political context (Torjman 2005, p. 4, 8). The outcome of policy development is usually a policy statement that outlines the objectives of the policy and the measures to realise the same. Further, the measures for implementation of the policy may necessitate new legislation, amendment to existing legislation, modification of institutional context or design of specific programme initiatives (Torjman 2005, p. 8). Additionally, depending upon the form of government in a nation (for instance, the federal form of government) the policy formulation might also take place separately at the regional or local level, apart from that at the national level.

The objectives that government seek to achieve are usually complex and therefore involve several ministerial departments. As a result, the pathway to the objective is reflected in various policies from different departments. The policies are generally interlinked and the choices made in one policy area have effects on the other. For instance, an R&D policy decision to promote in-house R&D might be reflected in fiscal policy as tax-break to firms for their expenditure on R&D. There also exists a sort of hierarchical relationship between policies that collectively address a particular concern. With regard to industry development, an industrial policy forms the core of the policy framework. Other policies such as trade policy, foreign investment policy, monetary policy, fiscal policy, education policy and infrastructure policy basically support the decisions made in industrial policy within their respective policy areas. Nevertheless, the policies interact in a complex integrated manner and a policy could both influence and be influenced by other policies. For example, shortage of foreign exchange might require a nation to liberalise its foreign investment policy, which in turn has implications on the industrial policy.

Thus, so far the chapter discussed the role government ought to play in the development of an industry, both for developed as well as developing nations (with more emphasis laid on the latter). Based primarily upon the authoritative work of Porter (1990) on the subject matter, the chapter discussed a changing role for the government through successive stages of industry development – from a more direct one in the factor-driven to an indirect or partial one in the innovation-driven stage. Further, policies as the means for orchestrating government interventions on industry development were explained. While the whole discussion made was to an extent idealistic and therefore prescriptive in nature, the role that government actually plays in the evolution of an industry might be a differing one. The difference is basically explained by the political and social pressures under which a government operates. For example, the political pressure on the government to save jobs in the short-run might result in a policy decision that extends the duration of protection given to an industry, thereby compromising on its long-term competitiveness. Moreover, a sound government policy might not be able to generate the desired outcomes, if the institutional structure like the bureaucratic apparatus is not in sync with the policy objectives.


1 Ranking in terms of the number of units produced.

2 Indian tyre industry with a turnover of USD 4.4 billion and exports of USD 0.6 billion in the year 2007-08, is also a part of the Indian automotive industry (ATMA 2008). For the purpose of this work, the discussion shall be limited to the Indian automobile and auto-component industries.

3 Source: Self-construction based on SIAM (2008b).

4 Source: SIAM (2008c).

5 Source: Self-construction based on GOI (2006a, p. 8), ACMA (2007, p. 11) and IBEF (2008, pp. 4­8).

6 Import value obtained from the Export Import Data Bank (Tariff item no.: 8703 and 8711) of the Directorate General of Foreign Trade (DGFT), Government of India. Website: www.dgft.delhi.nic.in.

7 Source: Calculated from ACMA (2008a, p. 23).

8 Source: SIAM (2008d).

9 Indirect exports imply that the vehicles exported by the automobile manufacturer are sold in the target market under a different brand name, probably that of the foreign collaborator.

10 Source: ACMA (2008b).

11 Some foreign players have established exclusive export-oriented units (EOU) in India for this purpose. For example, the global Tier-1 supplier Visteon has a 100% EOU near Chennai in India.

12 Appendix C provides a list of domestic automotive firms with R&D units formally recognised by Department of Science and Technology (DST), Government of India. Appendix D provides a list of foreign automotive firms whose investment in India’s R&D sector was studied by TIFAC (2006).

13 Foreign investment in a country can take place in the form of either portfolio or direct investment. India adopts the ’10% rule’ to classify foreign investment into portfolio or direct, wherein ownership of 10% or more of the ordinary shares (or equivalent for the unincorporated enterprises) by a foreign investor is recognised as FDI (OECD 1996, pp. 7-10 and RBI 2002, p. XV).

14 Source: GOI (2008a).

15 Source: IBEF (2008, pp. 10, 13, 5, 15).

16 Tier-1 suppliers are understood as the ones who make direct supplies to the OEMs or in other words directly invoice the OEMs.

17 Source: Self-construction based on author’s own study of the location of manufacturing plants of major automobile and auto-component players in India. Refer Appendix G for further details.

18 Major automobile and auto-component players in India are members of the Society of Indian Automobile Manufacturers (SIAM) and Automotive Components Manufacturers’ Association (ACMA) respectively.

19 Source: Self-construction based on author’s own study of the location of manufacturing plants of major automobile and auto-component players in India. Refer Appendix G for further details.

20 The infant industry theory could be found described and discussed in Friedrich List’s book ‘The National System of Political Economy (1841)’ available online at http://www.econlib.org/library/YPDBooks/List/lstNPECover.html.


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Influence India



Title: Influence of government policies on industry development: The case of India's automotive industry