Working Papers In Trade And Development
Working Papers inTrade and DevelopmentFrom Import Substitution to Integration into GlobalProduction Networks: The Case of IndianAutomobile IndustryPrema-chandra AthukoralaandC. VeeramaniJune 2018Working Paper No. 2018/14Arndt-Corden Department of EconomicsCrawford School of Public PolicyANU College of Asia and the Pacific
From Import Substitution to Integration into Global ProductionNetworks: The Case of Indian Automobile IndustryPrema-chandra AthukoralaAustralian National UniversityandC. VeeramaniIndira Gandhi Institute of Development ResearchAbstractThis paper examines the growth trajectory and the current state of Indian automotive industry, payingattention to factors that underpinned its transition from the import-substitution phase to export orientationthrough integration into global production networks.Following the liberalisation reforms, India hasemerged as a significant producer of compact cars within global automobile production networks.Interestingly there are no significant differences in prices of compact cars sold in the domestic and foreignmarkets. This suggest that cost competitiveness of Indian cars sold in foreign markets is not rooted solelyin the prevailing high tariffs on imported cars in India. Market confirming policies implemented over thepast two decades, which marked a clear departure from the protectionist past, have been instrumental intransforming the Indian automobile industry in line with ongoing structural changes in the world automobileindustry. Capacity development propelled by the entry of global carmakers and parts and componentsproducers to set up production bases in the country and leaning through competition in foreign marketshave been the key factors behind India’s emergence as a production base within global automobileproduction networks.Key words: India, automobile industry, global production networks, trade policy, foreign direct investment.JEL Codes: F13, F14, L92, L98.
From Import Substitution to Integration into Global Production Networks:The Case of Indian Automobile Industry1. IntroductionThe automobile industry is one of the first targets of industrial development through importsubstitution in many developing countries. It is seen as a driver of broad-based growth throughtechnological innovations and as a source of dynamic externalities to other industries via backwardand forward linkages. However, only a handful of developing countries have managed to develop aninternationally competitive automotive industry. In many developing countries, automobileproduction has turned out to be a high cost activity, which depended heavily on government supportthrough tariff protection, tax concessions, and other preferential treatments. Consequently, there hasbeen a growing emphasis in these countries in recent years on restructuring the industry with a greaterexport orientation to reap gains from ever increasing globalization of the industry.Until about the mid-1980s, auto firms were predominantly engaged in multi-market operationsby setting up production bases in individual countries to serve those markets. Since then theautomobile industry has become increasingly globally integrated in the sense that manufacturing,sourcing and marketing has become increasingly cross-national (Shapiro 1994, Humphrey 2003), Klierand Rubestein 2008). Production standards have become increasingly universal, accompanied by apalpable shift in production process from generic to modular technology. Consequently parts andcomponents production has grown rapidly to cater for multiple assemblers. In this context, intensecompetition among carmakers has transformed the geographic spread of the automobile industrybeyond the mature industrialized countries. Car assemblers now have to decide which models toproduce at what locations, at what prices and quality standards, and for which markets. The search forlow-cost production sites have led to new waves of setting up production plants by automotive MNEsin peripheral countries. This massive transformation in the structure, conduct and performance ofworld auto industry over the past three decades or so, has opened up opportunities for countries inthe periphery to join the global automotive production network. However, an important unresolvedquestion is whether the government in these countries should follow the conventional ‘carrot andstick’ (activist) approach to promote export orientation of ‘indigenous’ industry with significant
domestic value addition or ‘market-conforming’ approach in which multinational enterprises(MNEs) play the leading role in integrating domestic industry into global production networks (GPN).The purpose of this paper is to contribute to this policy debate by examining the emergenceof India as a significant production hub within the global automobile networks against the backdropof a longstanding import substitution phase, focussing on passenger cars and commercial vehiclesegments of the industry. Indian automobile industry is an ideal case study of this subject given itslong protectionist history and the significant structural changes following the liberalization reformsinitiated in the early 1990s gathered momentum from about 2000. For over a half a century from thelate 1940s, the Indian automobile industry remained a canonical example of a high-cost industryevolved and survived heavy trade protection. However, over the past two decades, the industry hasshown promising signs of gaining significant capabilities and global competitiveness throughintegration into global automobile production networks. Between 1999 and 2016, India’s share inglobal passenger car production (in terms of number) increased from 1.3% to 5.1% 1. Between thesetwo years, India’s ranking among the producing countries increased from sixteenth to sixth. Most ofthe world’s leading auto companies now have well-established production bases in India.A study of automobile industry is also relevant for the policy debate in India given itscontrasting growth experience compared to other major manufacturing industries in the country. Astylized fact is that India’s economic growth has been primarily driven by the service sector whilemanufacturing growth has been sluggish. Manufacturing output accounts for only about 17% ofIndia’s GDP as compared to about 30% for China. As far as the participation in GPNs is concerned,India’s manufacturing sector remains generally cut off from global production sharing activities(Athukorala, 2014, Krueger 2010). The automobile industry, however, is an exception in that it hasbeen recording impressive growth and export expansion with an increasing participation in globalautomobile production networks. In order to illustrate this contrast, the paper provides a comparativeprofiling of India’s automobile industry with that of electronics industry that has been the majordriver of export growth in China and other dynamic East Asian countries.1These figures are based on OICA database; /.
To preview the key findings, the analysis suggests that just granting trade protection, in theabsence of enabling conditions for foreign technology transfer, is not an effective strategy to build aglobally competitive automotive industry. Learning and capacity development through foreign marketparticipation and entry of parts and components producers to set up production bases has been thekey factor behind India’s emergence as a production base within automobile global productionnetworks. Market confirming policies in automobile sector over the past two decades (opening thesector for private sector and MNE participation), which constituted a notable departure from theprotectionist past, have played a key role in transforming the Indian automobile industry. Interestingly,there are no significant differences in prices of cars sold in the domestic market and foreign markets.This suggests that cost competitiveness of Indian cars sold in foreign markets is not rooted solely inthe prevailing high tariffs on completely built-up (CBU) cars in India. An important question in thepresent context of globalisation of the industry is, therefore, whether trade protection outlived itspurpose. This question is relevant given that Indian cars have become highly price competitive in theinternational market, the economies of scale enjoyed by carmakers in the large domestic market andthe bulky nature of the product (unlike most electronics goods), which would continue to providesome degree of natural protection for the industry from imports.The remainder of the paper is organized as follows. Section 2 and Section 3 sets thebackground by providing a survey of the evolution of Indian policy regime relating to the automotiveindustry and by describing the entry of the main players in the Industry. The growth and compositionof automobile production is examined in Section 4, with emphasis on the experience following thepolicy transition from import substitution to global integration since the early 2000s. Section 5 analysesthe extent of India’s engagement in GPN in terms of the involvement of MNEs in the domesticindustry, export expansion from the host country (India), and international sourcing of components.Section 6 provides a comparative perspective on automotive and electronics industries with a view tohighlight the importance of differences in the underlying policy regimes and industry characteristicsas possible explanations for India’s contrasting performance in these industries. Finally, Section 7summarises the main findings and provides the policy implications.
2. Policy ContextThe automobile industry has figured prominently in India’s industrialisation strategy sinceindependence in 1947. In terms of the nature of the policy regime relating to the automobile industry,the post-independence period can be grouped into four distinct phases: the period from late 1940s tomid-1970s was characterised by progressive regulation, protection and indigenisation; the period fromlate 1970s into 1990 witnessed some easing of restrictions and a drive towards technological upgradationthrough foreign collaboration and a relatively liberal import policy for capital goods and components;the period from 1991 to 2000 saw partial liberalization as part of a process of structural adjustmentprogram for the economy; and finally there have been major liberalisation and global integrationinitiatives from 2000.2.1. Late 1940s to mid-1970s: progressive regulation, protection and indigenizationIn 1948, automobiles and tractors were included in the list of industries that were subjected to “centralregulation and control”. Subsequently, the customs duties on certain components were raised, importsof completely built-up (CBU) vehicles were banned, and local manufacturing was encouraged. From1953, only companies with a plan for progressive manufacture of components and complete vehicleswere allowed to operate while mere assemblers of imported CKD were asked to terminate operationsin three years. Later, the Tariff Commission of 1956 recommended that the automobile industry(including ancillaries) should be granted protection for a period of ten years ending December 31,1967 (Tariff Commission 1957, Kathuria 1987).Starting with the early phase of import substitution, the government encouraged theparticipation of private sector in the automotive sector. As per the 1956 Industrial Policy Resolution,the automobile industry was included in Schedule C, which means that its future development was leftto the initiative and enterprise of the private sector subjected to state control through a system ofindustrial licensing. In this respect, the treatment meted out to the automobile industry was clearlydifferent from other capital-intensive industries (such as iron and steel, machinery and electronics)where the prime responsibilities for capability development rested with the public sector firms 2.Establishment of regular institutional support for the industry began with the setting up of theOther capital-intensive industries were included either in Appendix A (exclusively for the public sector) and AppendixB (progressively state owned industries where the private sector would just supplement the effort of the state).2
Development council by the government in 1959 to periodically review the problems faced by theindustry 3.Some new regulations were put in place during the first half of the 1970s. First, with theestablishment of MRTP commission in 1970, it became mandatory that all expansion plans have tobe approved by this body. Second, a gradual but mandatory increase in local content termed ‘phasedmanufacturing program’ (PMP) was started since the 1970s. Third, the Foreign Exchange RegulationsAct of 1973 stipulated that foreign holdings in Indian companies could not exceed 40 per cent.2.2. Late 1970s to 1990: easing of restrictions and a drive towards technological upgradation.The period from late 1970s to 1990 witnessed a major drive towards technological upgradationthrough foreign collaboration and a relatively liberal import policy for capital goods and components(D’ Costa, 1995). The state loosened its tight grip in favour of increased competition at home andgreater participation of foreign capital. In January 1985, the facility of broad-banding was extendedto motorized four-wheelers, so that companies were allowed to adjust the product mix and produce arange of related products instead of one kind as decreed by the industrial license. Further, the normsrelating to capacity expansion were eased and ancillary industry was delicensed though some of theautomotive components were reserved for exclusive production by the small-scale sectors.2.3. 1991 to 2000: period of partial liberalisationAs part of the overall structural adjustment program, a number of reforms were undertaken in India’smanufacturing sector since the early 1990s. First, de-licensing was announced for commercial vehiclesand auto-component production in 1991 and in the passenger vehicle segment in 1993 along with theelimination of the need for MRTP clearances. Second, automatic approval for foreign holding of upto 51% of equity was announced in a number of sectors including automobiles in 1991. The phasedmanufacturing program was abolished in 1991 for the new units and in 1994 for the existing units.Since 1997, import of capital goods and auto-components were placed under Open General License,and permitted free import. The import tariff rates for completely knocked down (CKD) units andThis period also witnessed the setting up of industry associations such as Automotive Component ManufacturersAssociation of India (established in 1959) and Association of Indian Automobile Manufacturers (established in 1960).Later, in 1966, Automotive Research Association of India was set up.3
parts and components have been gradually brought down from 65% in 1992 to 35% in 2000-01 (seeTable 1).Despite the above changes, the liberalization initiatives during in the 1990s were at best partialas some of the trade restrictions continued and certain new restrictions were introduced. Import ofautomotive vehicles in Completely Built-up (CBU) form was classified as “restricted” items in theNegative List, which meant that, for all practical purposes, import of cars were banned during the1990s (Pursell, 2001).After its abolition for a brief period, indigenization requirements were reintroduced in 1995making it compulsory for all new joint ventures to indigenise their production up to 70-75 percentover a period of 5 to 7 years. With effect from December 1997, the indigenization requirements weremodified and each joint venture firm was required to sign a Memorandum of Understanding (MOU),which stipulated, among other things, that (i) import of ckd or skd kits for "mere assembly" wouldnot t be allowed, (ii) indigenisation of components of at least 50 percent must be reached by the thirdyear of production and 70 percent by the fifth year of production, (iii) exports of cars and/or autocomponents are required to balance the cif value of imported ckd/skd/components during the MOUperiod, starting in the third year of production. Manufactures of commercial vehicles were notsubjected to these restrictions (Pursell, 2001).2.4. Post 2000: major liberalization and global integration initiativesThe early 2000s witnessed some major policy initiatives which were instrumental for the integrationof India’s automotive industry in global production networks. First, in 2001, as part of commitmentsunder the membership of the World Trade Organisation (WTO), all quantitative import restrictions(QRs) on used vehicles and new completely built units (CBUs) were removed while imposing hightariffs (Table 1), and the local content requirement for automobile production were removed. Second,100 per cent foreign ownership was permitted for firms in both the automobile and the componentproduction sectors, enabling several MNEs to enter the industry by setting up wholly-ownedsubsidiaries. Third, the customs duties on commercial vehicles, CKD and components have beenprogressively reduced, from 35% in 2001-02 to about 10% by the end of the decade. Since 2011-12,CKD in pre-assembled form attracted a higher duty of 30% while those not in pre-assembled formattracted lower rate of tariff at 10%.
In addition to these liberalisation measures, the government announced specific policies toexploit India’s potential in the sector, which includes “Auto Policy-2002” (aiming at making India aninternational hub for manufacturing of small cars), Automotive Mission Plan 2006–16 (aiming atstrengthening technological competencies) and National Automotive Testing and R&D InfrastructureProject (aiming to achieve global performance standards).The excise duties on cars were progressively reduced from 40% during the 1990s to 32% in2001-02 and 25% in 2003-04 (see Figure 1). The excise duty on smaller cars was reduced further to17% in 2006-07 while bigger cars attracted higher rates of 25%. During the period 2008-09 to 201516, excise duties for small cars remained in the range of 9%-13.5% while higher rates in the range of21%-28% were imposed on bigger cars. Further, additional fixed levies in the range of Rs 15000 – Rs20000 were imposed on bigger cars. Clearly, the tax structure shows a bias in favour of small cars.3. Entry of the Main PlayersTable 2 summarizes details on the timing and mode of entry of multinational enterprises (MNEs) inthe passenger vehicle and commercial vehicle segments of India automobile industry. The whollyowned subsidiaries of General Motors and Ford Motor Company of Canada started assembly ofCKD trucks and cars in India during the late 1920s. Later, during the first half of the 1940s, HindustanMotors and Premier Automobiles entered the market under license agreements with Morris andChrysler, respectively. Ashok Motors (later changed to Ashok-Leyland) started manufacturing ofAustin cars and Leyland commercial vehicles in 1948. General Motors and Ford withdrew from Indiaas a result of tightening of regulations, particularly the government decision to refuse permission toassemble imported vehicles without increasing local content. Tata Engineering and Locomotive Co(TELCO) started manufacturing of commercial vehicles in 1954 in collaboration with Daimler-Benz.Mahindra and Mahindra, another important player in commercial vehicles segment started productionof Willys jeep in 1955. Bajaj Tempo began producing light commercial vehicles in 1958 under licensefrom Vidal and Sohn Tempo-Work of Germany.Until the mid-1980s, the auto industry remained a low-volume, high-cost industry with a fewprominent private players. There were only two key firms in the passenger car segment (HindustanMotors and Premier Automobiles) while other firms manufactured commercial vehicles (Tata Motors,
Ashok-Leyland, Mahindra and Mahindra and Bajaj). The various measure
ANU College of Asia and the Pacific : From Import Substitution to Integration into Global Production Networks: The Case of Indian Automobile Industry : Prema-chandra Athukorala : Australian National University : and . C. Veeramani : Indira Gandhi Institute of Development Research . Abstract This paper examines the growth trajectory and the current state of Indian automotive industry, paying .
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