Few things in the tech world are as eagerly anticipated as Apple’s annual new product announcements. Even diehard Android fans want to know what the folks in Cupertino have up their sleeves, and this year didn’t disappoint. With their unveiling, the iPhone 6 and iPhone 6 Plus made every previous i-iteration effectively obsolete. The pricier 6 Plus model sold out in a matter days, while eBay was flooded with older models selling at bargain-basement prices.
Economists call the phenomenon “creative destruction,” and it’s an integral piece of sustained economic growth. Without the constant churning that creates new products and industries at the expense of their predecessors, an economy stagnates. And that’s exactly an issue that India faces, argues Amit Khandelwal, the Gary Winnick & Martin Granoff Associate Professor of Business, Finance & Economics at Columbia Business School.
Overly stringent industrial regulations, poor infrastructure, and the lack of access to credit are working together to constrain creative destruction and dampen the country’s economic growth, he says. Chazen India Insights talked to Khandelwal about the role of creative destruction in the evolution of a developing economy and how India can build a culture of innovation to reignite its growth.
Chazen Global Insights: In your 2010 paper “Multi-product Firms and Product Turnover in the Developing World: Evidence from India” you focus on product churning. Why is this topic important to economists and policymakers?
Amit Khandelwal: Product churning, or replacing one product with another one through innovation, is a key measure of dynamic growth. In very general terms, you typically find that about 20 percent of the businesses in any country generate 80 percent of that country’s GDP, so it’s that handful of large companies that dictate economic activity. Analyzing the output of large multiproduct manufacturers gives us a good reading on the overall creative destruction activity within the broader economy.
What we found was that before trade liberalization in 1991, India’s economy was very closed. Firms couldn’t get access to the raw materials they needed to produce new goods and services. Within a few years of liberalization, though, manufacturers were developing a wide range of new products for the Indian market, which is a type of innovation, but interestingly, they weren’t getting rid of old products.
This suggests that product churning, or creative destruction, wasn’t happening in India during the 1990s, despite major trade and other structural reforms during the same period. Then during the middle of the past decade we saw stagnation in economic growth, and attempts to pass additional reforms to restart that growth have been stalled. For example, the country is still working under strict labor regulations that often make it difficult for manufacturers to eliminate a product line or shift production to something else. Another issue that isn’t talked about as much is land acquisition. It is very difficult to buy and rezone land in India. These types of constraints are barriers to innovation and growth.
CGI: But isn’t a slowdown after a period of fast growth a predictable phase in the evolution of a developing economy? Or is something fundamental missing in India’s corporate culture?
AK: Yes and no. Most developing countries experience start-and-stop growth. For every two steps forward they take a step back. But over the long run hopefully you see more steps forward. In India, though, there are several headwinds limiting its ability to move forward. One important factor is that international businesses and investors face uncertainty with the country’s economic policies.
Consider the Walmart example. Retail is one of India’s largest sectors, but it is a very inefficient segment of the economy. In other developing countries, including China and Mexico, Walmart has been allowed to come in, and through the process of disrupting the traditional retail system Walmart has helped those countries modernize their retail industry.
In India, though, small mom-and-pop shops account for the vast majority of retail. This creates a very inefficient system with few economies of scale, but a lot of people own these small shops — including several members of my own family — and with such a large voting bloc, politicians are hesitant to allow Walmart in.
India has tried to revise its FDI (foreign direct investment) policy for foreign retailers like Walmart. In 2006, the government passed legislation to allow foreign retailers to operate wholesaling businesses in India and to partner with Indian retail firms to sell to consumers. Walmart expected to enter the retail market soon thereafter and was encouraged by plans to allow multibrand FDI in retail. But shortly thereafter, the government abandoned the idea because of political opposition.
More recently, the government introduced local content provisions requiring foreign retailers to source 30 percent of its products from small- and medium-size businesses. While this may be feasible for agriculture products, which are produced locally, it is harder for manufactured goods in which India has a relatively smaller base. By the end of 2013, Walmart had announced it had indefinitely delayed its decision to expand wholesale outlets.
This is just a microcosm of what’s going on in the country. Many other large companies are hesitant to come into India because of this kind of uncertainty. The many political parties of India’s democracy mean that politicians must create alliances that are sometimes unstable. This can make it hard to pass the difficult reforms that are needed.
CGI: What will it take to ignite and instill that spirit of innovation in India?
AK: The puzzle in India today is that there are some sectors, such as information technology services, that are actually quite innovative. Entrepreneurs who started out in Silicon Valley decided to move back home, and they have been very successful. But this is a very small portion of the economy in terms of the number of people it employees.
India is very unusual in that its economy is dominated by agriculture and services. It is useful to break down an economy into three broad sectors: agriculture, manufacturing, and services. As countries begin to develop, innovation improves efficiencies in agriculture, and those displaced workers move to manufacturing. The service sector then develops to support the manufacturing industry. This was the pattern of development in the United States in the early 1900s and more recently in China.
But unlike China, where you have the big manufacturing firms with 200,000 employees, India doesn’t have a relatively large manufacturing base. So even if there were a way to improve agriculture, where would those workers go? India needs to focus on unleashing growth in the manufacturing sector, but how do we unlock it?
Some of that requires regulatory changes. But India also needs to invest heavily in its infrastructure. Today India’s best and brightest entrepreneurs are focusing on information technology because they don’t need to transport products across borders. Manufacturers need to ship and receive goods through efficient ports and across modern roads and railway systems, and they need plenty of reliable power. These are still concerns in India today.
CGI: Your paper “Trade Liberalization and New Imported Inputs” suggests that access to new inputs can expand product lines. Can they also spur innovation?
AK: Yes. Access to inputs is really fundamental for developing countries. When I would go visit relatives in India in the 1980s there were a handful of firms that made televisions, but these were very low-quality televisions in part because their components were sourced from Indian firms shielded from competition. When the manufacturers could import new inputs, quality improved.
When you start to source more expensive, high-quality components, you also need higher skilled workers who can use these components. The downside, of course, is that employment opportunities for the people who don’t have that skill set may be more limited. On the other hand, one thing that happens when you ramp up demand for skilled labor is that the educational system also improves to meet that demand. Those things tend to move simultaneously, and that is happening in India, but of course could move at a faster pace. Although the best universities in India are world renowned, quality remains an issue in middle-tier universities and schools.
CGI: What are the next steps for India?
AK: We know the ingredients necessary to unleash growth. A lot of things have changed, but not everything. There is still a lot of room for additional reforms. The question now is whether the politicians will be able to do that. The recent election shows that the country is ready to go in a new direction. It’s too soon to see if that will occur with the new government, but people are very optimistic that it will.