A Passage for India
A DEVELOPMENT PATH FOR A NEW ERALawrence Burns, Investment Manager. Fourth Quarter 2016
Since the industrial revolution, developing countries have been following the same manufacturing-orientated path to economic growth. How else might one generate employment for the masses, bring them into the formal economy, and so lay the foundations for a domestic consumer economy in the years to come? This model is now under threat. On the back of greater factory automation, cheap labour may no longer be the spur to development it once was. This poses a dilemma for India. In order to grow, it must branch out in a new direction.
In this respect, technology will be both India’s biggest challenge and potentially its greatest opportunity, with the emergence of mobile platforms providing alternative avenues for economic development.
That Was the Way It Was but This is Now
Advances in transport and communications infrastructure have facilitated an explosion in global trade during the last 50 years. By enabling production to be co-ordinated across vast distances, and goods moved quickly and easily across the planet, companies no longer had to go through the arduous process of building out whole supply chains. Manufacturing activities were therefore rapidly outsourced en masse to low-cost exporters. Another spur was containerisation. In isolation, the advent of standardised inter-modal containers boosted bilateral trade by 790% in the first 20 years following their introduction. By plugging into global supply chains in this way, countries such as China, South Korea and Taiwan developed at a speed not previously seen.
But times are changing. China’s meteoric rise was facilitated by technological progress in transport and communication, yet India’s may be hampered by progress in automation. Those countries wishing to play the cheap labour card must navigate the growing challenge from robotics. India’s abundant supply of low-cost labour, where factory costs are 40% lower than in China, is no longer a game changer. Where once an importer would have kept costs down by seeking out the cheapest source of labour, they now also have the option of replacing workers with machines.
The word ‘automation’ used to conjure up images of slick factories in Japan, but this is an outdated assumption. Factories around the world are employing fewer staff. For example, the world’s largest contract electronics manufacturer recently announced it will replace 60,000 workers with robots in China. And in Germany, Europe’s largest sportswear manufacturer is to produce its running shoes in a factory operated largely by robots. Even Indian companies are doing the same – Rajasthan is now home to a factory operated by a skeleton crew using robotic arms, where automated storage and retrieval systems do most of the work. And these changes may only be the beginning. 3D printing is in its infancy, but will revolutionise manufacturing processes.
Long-term trends in value and volume of merchandise exports
1950 – 2010 (Index numbers, 2000=100)
Source: UNCTAD secretariat calculations, based on UNCTADstat and CPB Netherlands Bureau of Economic Policy Analysis, World trade database.From Development and Globailization, Facts and Figures 2012, by United Nations Conference on Trade and Development, © 2012 United Nations. Reprinted with the permission of the United Nations.
The word ‘automation’ used to conjure up images of slick factories in Japan, but this is an outdated assumption. Factories around the world are employing fewer staff.
Manufacturing will employ fewer people
The Nobel-Prize winning economist Joseph Stiglitz is absolutely clear on this point; productivity increases will continue and fewer people will be employed in manufacturing in the coming decades:
[the] observation is uncontroversial… global employment in manufacturing is going down because productivity increases are exceeding increases in demand for manufactured products by a significant amount.
India’s Chief Economic Adviser Arvind Subramanian agrees. His work has highlighted that all countries, regardless of their income level, are less reliant on manufacturing, both in terms of output and employment, than they once were. But the downward trend goes further. It is not just the number of people employed within the industry that is declining; the level of income per person at which a country’s reliance on manufacturing peaks is also in decline. As illustrated in the graph opposite, when South Korea reached its manufacturing peak in 1988, the average annual income for a worker was just over $10,000 (in Purchasing Power Parity (PPP)-adjusted 2015 dollars) per person; less than a decade later, Indonesia peaked at close to $6,000; by the time India peaked around a decade after, its manufacturing high saw an average income of only $3,000. Manufacturing then, gets you ever shorter distances along the development path.
How can India expect to compete, given that its scale puts further pressure on the factory-led development model? Between 2005 and 2012, India’s workforce expanded by 51 million, whereas manufacturing jobs increased by only 6 million. This is not enough. For manufacturing to have a meaningful impact on the formal economy it needs to generate tens of millions if not hundreds of millions of jobs. When up against the forces of China and automation, this is a tall order.
At a Crossroads – Where Do We Go From Here?
So if India cannot manufacture its way from rags to riches, where does its hope lie? Is it with the outsourcing sector? This alone will not solve the development puzzle. For the same reasons that technological progress itself will not provide the whole answer. While new communication technologies have enabled IT services to become exportable and Indian companies have taken advantage, its impact is also limited by the sheer scale of jobs that would be required to drag the economy as a whole along the developmental highway.
And in terms of creating mass employment, there are a number of factors limiting India’s ability to step up its level of IT recruitment. It is easy to overlook the fact that only 10% of the population speak English, but this is often a requisite skill within the IT outsourcing industry. And while Indian tertiary education is good, the general lack of secondary education makes tech-related jobs a select rather than mainstream employment opportunity. And just as low-skilled manufacturing workers are feeling the brunt of automation’s rise, so too are those employed in the lower-end of the IT industry. India’s two largest companies in the industry are investing in automation platforms that enable software bots to perform commoditised IT jobs at a fraction of the cost and time that it would take a human engineer. Demand for IT services is being hit by companies, that would previously have outsourced to Indian datacentres, opting instead for cloud-based solutions with off-the-shelf software. As a result, the Indian IT outsourcer industry is growing at its slowest rate in five years.
Times are Changing
Technology has always had something of a bad press. A pinnacle of historical irony was surely the American politician who wrote to President Hoover in the 1930s expressing his fears that technology was “Frankenstein’s monster” that would “devour civilisation” – he was the mayor of Palo Alto (now the heart of Silicon Valley)! Just as the mayor’s fears were unfounded, so too is the current hyperbole surrounding automation often overdone. Data produced by statistician Professor Hans Rosling has demonstrated that, by applying new technologies alongside our accrued knowledge, countries are now able to achieve higher levels of social development with lower levels of GDP than was previously possible. This is supportive of economic growth in the long term.
Increasing automation may, at first glance, seem to hamper developing countries’ attempts to formalise their economies, because it restricts their ability to employ large swathes of people via the traditional manufacturing route. Yet the flip side of technology should be new opportunities for growth and job creation. I am not suggesting that this will be a panacea to cure all of India’s woes; the automation of low-skilled factory work will be a heavy blow. But technology will provide new avenues for Indian entrepreneurs to explore.
E-Commerce leaders have spoken of the need to be open-minded to new company formats in the wake of technology. The mobile internet offers a new way to structure businesses that blend the efficiency and scale advantages of large firms with the nimbleness of entrepreneurs.
Image: © Bloomberg/Getty Images.
India – Imagining the Future
The overriding characteristic of India today is its lack of formalisation. Around 90% of all employment is in the informal sector; 60% of Indians do not have a bank account; only 3% pay income tax; and 90% of retail is unorganised, consisting of cramped shops and roadside vendors. The section of society that pays its taxes, takes out loans and saves is a thin layer on top of an invisible, but vast, self-organised economy.
What if by combining India’s large self-organised sector and the mobile internet, the country could produce an alternative development path for itself that would bypass the need for big, formal companies to accelerate economic growth, but rely instead on network-based companies to drive the economy?
India has already taken tentative steps in this direction. An Indian taxi-hailing smartphone app has already attracted hundreds of thousands of self-employed drivers on its mobile platform. For the drivers, the benefits of large-scale aggregation come not just from operating under the umbrella of a relatively trusted brand, but also from the ability to access big data analytics and the scale it gives in areas such as payment. It should also bring them into the formal economy. The network provides an audit trail – including both verified income levels and customers’ reviews – which the drivers can then use to apply for personal or business loans. For even greater security, lenders can become part of the network and so take loan instalments directly from a driver’s revenue. The government benefits too, because it both becomes harder for the drivers to avoid paying tax and easier for them to pay it.
Separately, India’s largest e-commerce marketplace, which was started by two Indian entrepreneurs in 2007, now offers 40 million products across 80+ categories. Through its network, 85,000 sellers reach an audience of 75 million registered users. In addition to accessing its traffic, the small merchants benefit from hosting, big analytics and logistics capabilities.
Fortunately for India, not only are these networks potentially a more efficient form of organising labour, but they can also be created far more easily and rapidly than scaling up a company in the traditional way. The advent of business models based on the ‘sharing economy’ provides a template. In the US, the leading online accommodation-sharing company now has more rooms available than some of the world’s largest traditional hotel groups but has only 800 direct employees. The same could hold true for Indian companies and we have already seen one Indian-based accommodation-sharing business establish a network of more than 6,000 properties in just three years.
These companies are also notable for the fact that they are not listed. Capital light business models, network effects and rapid growth rates have allowed these and other online companies to achieve significant scale while remaining in private hands. It may be some time before they come to the public market but, in the meantime, it is important to continue tracking their rise, not only as possible future investment opportunities, but also in recognition that they are re-shaping their respective industries, which has knock-on implications for investing in companies
ConclusionThis is not intended as a Luddite note. But investors expecting India to repeat China’s most recent leap forward may be disappointed. The possibilities that automation brings to reshape and reduce the workforce means that manufacturing cannot spur development to the same degree that it once did. India’s development path will have to adapt to reflect this. Our challenge is to imagine the route this path will take and focus our investment research accordingly. Companies that leverage mobile platforms will play a key role in shaping India’s journey, all the more so because of their ability to scale their business quickly. We will continue to monitor the development of India and its mobile platform companies, and indeed those companies that are actively backing this sector.
Important Information and Risk Factors
The views expressed in this article are those of Lawrence Burns and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.
This communication was produced and approved on the stated date and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.
Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA). Baillie Gifford Life Limited is authorised by the Prudential Regulation Authority (PRA) and regulated by the FCA and the PRA. Baillie Gifford & Co Limited is a unit trust management company and the OEICs’ Authorised Corporate Director.
Baillie Gifford Overseas Limited provides investment management and advisory services to non-UK Professional/Institutional clients only. Baillie Gifford Overseas Limited is wholly owned by Baillie Gifford & Co. Baillie Gifford & Co and Baillie Gifford Overseas Limited are authorised and regulated by the FCA in the UK.
Persons resident or domiciled outwith the UK should consult with their professional advisers as to whether they require any governmental or other consents in order to enable them to invest, and with their tax advisers for advice relevant to their own particular circumstances.
Important Information Hong Kong
Baillie Gifford Asia (Hong Kong) Limited 百利亞洲(香港)有限公司 is wholly owned by Baillie Gifford Overseas Limited and holds a Type 1 licence from the Securities & Futures Commission of Hong Kong to market and distribute Baillie Gifford’s range of UCITS funds to professional investors in Hong Kong. Baillie Gifford Asia (Hong Kong) Limited 百利亞洲(香港)有限公司 can be contacted at 30/F, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong, Telephone +852 3756 5700.
Important Information South Korea
Baillie Gifford Overseas Limited is licensed with the Financial Services Commission in South Korea as a cross border Discretionary Investment Manager and Non-discretionary Investment Adviser.
Important Information Japan
Mitsubishi UFJ Baillie Gifford Asset Management Limited (‘MUBGAM’) is a joint venture company between Mitsubishi UFJ Trust & Banking Corporation and Baillie Gifford Overseas Limited. MUBGAM is authorised and regulated by the Financial Conduct Authority.
Important Information Australia
This material is provided on the basis that you are a wholesale client as defined within s761G of the Corporations Act 2001 (Cth). Baillie Gifford Overseas Limited (ARBN 118 567 178) is registered as a foreign company under the Corporations Act 2001 (Cth). It is exempt from the requirement to hold an Australian Financial Services License under the Corporations Act 2001 (Cth) in respect of these financial services provided to Australian wholesale clients. Baillie Gifford Overseas Limited is authorised and regulated by the Financial Conduct Authority under UK laws which differ from those applicable in Australia.
Important Information South Africa
Baillie Gifford Overseas is registered as a Foreign Financial Services Provider with the Financial Sector Conduct Authority in South Africa.
Important Information North America
Baillie Gifford International LLC is wholly owned by Baillie Gifford Overseas Limited; it was formed in Delaware in 2005. It is the legal entity through which Baillie Gifford Overseas Limited provides client service and marketing functions in America as well as some marketing functions in Canada. Baillie Gifford Overseas Limited is registered as an Investment Adviser with the Securities & Exchange Commission in the United States of America.
Potential for Profit and Loss
All investment strategies have the potential for profit and loss.
Any stock examples and images used in this article are not intended to represent recommendations to buy or sell, neither is it implied that they will prove profitable in the future. It is not known whether they will feature in any future portfolio produced by us. Any individual examples will represent only a small part of the overall portfolio and are inserted purely to help illustrate our investment style.
This document contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research and Baillie Gifford and its staff may have dealt in the investments concerned.
All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.
The images used in this document are for illustrative purposes.
Lawrence Burns Investment ManagerLawrence graduated BA in Geography from the University of Cambridge in 2009. He joined Baillie Gifford in the same year and has spent time working in both the Emerging Markets and UK Equity departments. Lawrence is an Investment Manager in our EAFE Alpha Research Team. He became a member of the EAFE Alpha Portfolio Construction Group in October 2012.
YOU MAY ALSO LIKEInsights.Visit Baillie Gifford's Insights page.Investing in Climate Solutions.How do we save a planet? Paulina Sliwinska invests in the companies tackling climate change.Stock stories: ClimeworksClimeworks, the company using innovative technology to capture and store CO2 underground safely, measurably and permanently.The Hunt For European Tenbaggers.Investment managers Moritz Sitte and Stephen Paice dispel the negative perceptions of the European market by discussing an exciting company which exemplifies the growth potential in Europe, and their investment strategy which aims to seek out European tenbaggers.