McKinsey Quarterly discusses how other industries need to replicate the success of India’s outsourcing and automotive industries:
India has clearly benefited from closer integration into the global economy in industries such as automotive, business-process outsourcing, and IT. To build on that success, the government must now lower trade and foreign-investment barriers still further.
First, tariff levels should be cut to an average of 10 percent, matching those of Indias neighbors in the Association of South East Asian Nations (ASEAN). Although progress has been made on tariffs, the Indian government still prohibits imports of many goods and protects inefficient companies from foreign competition. To give those companies a chance to improve their operations, the government might first lower duties on capital goods and inputs. Then, over several years, it could reduce them on finished goods.
Foreign-ownership restrictions should be lifted throughout the economy as well, except in strategic areas, notably defense. At present, foreign ownership is not only prohibited altogether in industries such as agriculture, real estate, and retailing but also limited to minority stakes in many others, such as banking, insurance, and telecommunications.
Indias government should also reconsider the expensive but often ineffective incentives it offers foreign companies to attract foreign investment, for these resources would be put to better use improving the countrys roads, telecom infrastructure, power supply, and logistics. Whats more, MGI research found that the government often gives away substantial sums of money for investments that would have been made anyway.3 (To give one example, it has waived the 35 percent tax on corporate profits for foreign companies that move business-process operations to India, even though the country dominates the global industry.) Moreover, state governments often conduct unproductive bidding wars with one another and give away an assortment of tax holidays, import duty exemptions, and subsidized land and power. Yet MGI surveys show that foreign executives place relatively little value on these incentives and would rather see the government invest resources in the countrys poor infrastructure.
Finally, interviews with foreign executives showed us that Indias labor laws deter foreign investment in some industries. It is no coincidence that software and business-outsourcing companies are exempt from many labor regulations, such as those regarding hours and overtime. Executives tell us that without these exemptions, it would be impossible to perform back-office operations in India. To attract foreign investment in labor-intensive industries, the government should therefore consider making labor laws more flexible.
Some Indian policy makers might argue that the reforms proposed here would undermine long-held social objectives, such as creating employment. But the evidence shows that regulations on foreign investment, foreign trade, and labor have actually slowed economic growth and lowered the standard of living. A decade ago, Indias per capita income was nearly the same as Chinas; today, Chinas is almost twice as high.
Indias economy has made real progress, but further liberalization will be needed to sustain its growth. The country now has 40 million people looking for work, and an additional 35 million will join the labor force over the next three years. Creating jobs for all these Indians will require more dynamic and competitive industries across the economy. Opening up to foreign competition, not hiding from it, is the answer.