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Why is PLI Scheme Suboptimal? – IMPRI Impact and Policy Research Institute

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Why is PLI Scheme Suboptimal? - IMPRI Impact and Policy Research Institute

Arun Kumar

India’s Production Linked Incentive (PLI) scheme, launched in 2020 with high expectations, aimed to provide a subsidy of Rs 1.9 lakh crore over six years. However, as of March 2023, only Rs 3,400 crore in claims have been received and Rs 2,900 crore disbursed. The scheme had, therefore, experienced a significant shortfall.

Government officials have said that they would review the scheme to identify the deficiencies.

The PLI scheme, which aimed to provide an average subsidy of 5%, was expected to have a significant impact on production, projected to boost it by Rs 38 lakh crore. However, the current official figures indicate a much lower boost of around Rs 60,000 crore.

Amid the lower-than-expected performance of the PLI scheme, it is worth noting the success in attracting Apple to assemble mobile phones in India for both domestic sales and exports.

According to officials, incentives are being disbursed in eight sectors, however, in the remaining six sectors, there is hope for future progress.

They also added four sectors are experiencing a slow pick-up and two sectors are at “advanced stages”. The latter part on what “advanced stage” means would need further clarification from the officials.

Let’s understand this subject from a historical perspective.

Structural changes in the economy

India has faced challenges in increasing the share of the secondary sector, including manufacturing, in its GDP. Despite the introduction of pro-business reforms under the New Economic Policies in 1991, the growth has been limited. The share of the secondary sector in the GDP has only marginally increased from 24.7% in 1991-92 to 27.3% in 2019-20, just before the COVID-19 pandemic. The manufacturing sector has remained at around 17% of the GDP.

In the classical development pattern, observed in many rich countries, industries and services are the dominant sectors. However, India follows a different trajectory.

At the time of independence, agriculture was the dominant sector and the services sector was already larger than industry. Post 1947, the share of the services sector grew, and agriculture’s share declined. The industrial sector experienced rapid growth in the first 15 years, but then it eventually slowed down, and then hardly changed after 1980. In 1980, the services sector became the largest sector, surpassing the industrial sector.

A need to boost the manufacturing sector

Policymakers have recognised the need to boost the manufacturing sector to generate employment.

A National Manufacturing Competitiveness Council was set up in 2004 by the UPA government, but it was wound up in 2018. A National Manufacturing Policy was also set up in 2011, to boost the share of manufacturing in the GDP to 25% in a decade, and create 100 million jobs.

However, per a government report, by 2016, manufacturing contributed only 17% to India’s GDP, and only 4 million jobs were created in the sector since 2010.

A 2011 policy document highlighted the importance of the small and medium enterprises (SME) sector in boosting India’s manufacturing capacity as well as creating jobs.

“There are over 6,000 products, ranging from traditional to high-tech items, which are being manufactured by the SMEs in India. The MSME sector provides the maximum opportunities for both self-employment and jobs after agriculture sector,” the document noted.

Despite the available data, the focus of policies has primarily been on large-scale industries, neglecting the small and micro sectors.

The micro sector, which accounts for 97.5% of MSME employment, has been largely overlooked due to its small size, resulting in the stagnation of the manufacturing sector.

Value addition in the PLI scheme

The government in 2020 launched the PLI scheme for the large-scale industries by providing subsidies based on the value of additional production.

In March 2020, three industries were chosen, followed by the inclusion of ten more in November 2020. Later, the scheme included the drone industry. At present, 14 industries are covered under the PLI scheme.

The rationale behind the PLI scheme is to address the global disadvantages faced by the Indian industries and to encourage them to produce at scale. Therefore, the PLI scheme provided a subsidy of 4% to 6% on the value of the additional production the firms generate.

However, the value of the production includes inputs purchased from the outside. For instance, if a Rs 10,000 mobile phone assembled in India contains Rs 9,000 worth of purchased components, the production unit only adds Rs 1,000 in value, with a potential profit of Rs 200. However, under the PLI scheme, the company would receive a subsidy of 5% of Rs 10,000, which is Rs 500. This would increase the profit on additional production to Rs 700, raising the profit margin from 20% to 70%.

The incentive is indeed huge and should spur greater production of the items under the PLI scheme. However, officials have indicated that the response has been slow with only 733 applications received up to March 2023.

More production and employment

Is the PLI scheme an optimum policy to generate more production and employment?

Most of the industries under the PLI scheme are either large or medium-sized units, which tend to be mechanised and automated, and provide limited employment.

These large industries grow at the expense of the small and micro units, displacing jobs.

Officials talk about the creation of jobs, but they don’t mention the displacement of jobs, which suppresses demand and leads to a slowdown in investment and growth.

The MSME sector, as stated in the government’s 2011 note, was growing faster than the rest of the industrial sector. Providing incentives to this sector would have been a more effective use of subsidies, promoting additional output and employment.

The manufacturing sector accounts for 17% of the GDP, with more than half of it consisting of large-scale industries. The subsidy is limited to a only small portion of the economy (2-3% of the GDP). But why restrict the subsidies to such a small portion of the economy? This also raises questions about the PLI scheme’s impact and effectiveness.

Furthermore, production for local sales will reduce employment by displacing the unorganised sector, leading to increased unemployment and a decline in wages and demand. Note that the shortage of demand led a slowdown in the economy since demonetisation. That led to excess capacity in industry, low private investment and slow growth.

So, in spite of the PLI scheme leading to a rise in profits, growth will slow down.

Finally, the selection process for firms under the PLI scheme may be influenced by cronyism, leading to winners and losers and deteriorating the overall investment climate in the country.

Therefore, the PLI scheme’s focus on providing subsidies to selected large and medium-scale industries is a sub-optimal policy. Despite a promise of increased profits, it has not gained momentum due to shortage of demand. If one cannot sell more, the subsidy will also not accrue.

It would have been better to target subsidy towards the micro and small units, boosting output and employment. This approach would have created a positive-sum game, benefiting both the small-scale and large-scale industries through increased demand.

The article was first published in The Wire as PLI Scheme Shows Flaw in Govt’s Approach as Subsidies Fail to Address Demand Shortage on 16 June, 2023.

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