India's economy, now with muscle

Long considered a dead end for manufacturing, India's economy is now headed to the factory floor.

For a decade, India's economy has played the same hit song, stuck on repeat: The service sector – anchored by information technology – generates 50 percent of the nation's wealth. Meanwhile, manufacturing has been dismissed with a snort. India was too inefficient, too bureaucratic, too underdeveloped.

Now, that is changing.

Boosted by the country's growing appetite for global goods, companies ranging from Honda to Hewlett-Packard are bringing new assembly lines to India. Manufacturing grew 11.3 percent in the first quarter of this fiscal year, spurring the country's highest first- quarter growth this decade: 8.9 percent.

The old problems persist, and India is nowhere near ready to displace China as the world's factory floor. But in a nation where 250 million people live on less than $1 a day, it offers a hope that high tech cannot: that India may begin to spread its newfound prosperity beyond a small, urban middle class.

Here outside Chennai, amid a thicket of thatched-roof huts, two factories – one for Nokia and the other for Korean automaker Hyundai – suggest what is possible, even in a country short on power, pitted by potholes, and still under the economic sway of Karl Marx.

"Can manufacturing work in India?" asks Jukka Lehtelä, director of Nokia's India operations, as the footsteps of arriving workers rattle ceiling light fixtures. "Anyone who could see behind these walls would not ask that question."

While the scene outside is timeless India, with workers filing by wearing saris so bright they could be plugged into a light socket, behind these walls is something new: the whirring and clicking of clockwork cellphone construction. By design, the factory floor is organized with the same Scandinavian orderliness that characterizes every Nokia plant – from its domestic factory in Finland to others in China, Texas, and beyond.

It is at least a start. While manufacturing is 55 percent of China's gross domestic product, it is only about 17 percent of India's – so it has often been overlooked. "In the 1990s, we lost sight of manufacturing as a sector," says Ramesh Mangaleswaran of the Mumbai (Bombay) office of McKinsey & Co., an international consulting firm.

For one, the brightness of the service sector eclipsed manufacturing. But there was also a lack of will to put in the work needed to make manufacturing viable in India.

Indian-made goods were expensive because of high taxation – the legacy of India's bygone socialist era.

Likewise, the country undercut its advantage of low-cost labor with strict labor policies – such as one law that requires companies with more than 100 employees to get permission from the state government before laying off workers.

Lastly, India's roads and power grids were ill-equipped to handle the strain of a manufacturing economy, with its sorties of multiton trucks and a thirst for uninterrupted electricity.

By and large, the problems remain. There is progress, as the government amends the tax code and establishes special industrial zones with better infrastructure, tax breaks, and – in some cases – more flexible labor laws. But Chinese goods are still 30 percent cheaper, and China still has seven times the highway miles, by some calculations.

The great incentive nowadays is the Indian market itself. Domestic demand, not exports, is the real engine behind India's growth.

It is the world's fastest-growing cellphone market, with more than 1 million phones sold every week. By 2016, auto sales here could more than quadruple, to $145 billion, the government estimates. And Indians will buy 5.6 million computers this fiscal year – 1 million more than last fiscal year, according to Dell Computers.

So it is no mystery why Samsung and Motorola, Dell, and Hewlett-Packard are setting up Indian factories. For its part, Nokia considered building a plant here in 1995 and again in 2001. But the time wasn't right until 2004.

"It's like a hockey stick," says the Finn, Mr. Lehtelä, casting his mind back to things more familiar than cows and curry. "[The market] was very, very low for many years, and now it starts to go up."

Yet it is the growth of a domestic Indian auto market that most clearly presages India's manufacturing potential. In the past few weeks, automakers have piled into India like clowns into a Volkswagen.

• Honda announced its intention to triple its car sales to 150,000 by 2010, and it is in talks to build a second India plant near New Delhi.

• Toyota and Daihatsu will invest $86 million in a Bangalore plant to build 100,000 cars annually, ramping up to 200,000 by 2010.

• General Motors has decided to spend $300 million for a second plant that would raise its Indian capacity to 140,000 cars a year, from 60,000.

• German automakers Volkswagen and BMW are building their first factories in India.

In each case – except with luxury carmaker BMW – the primary goal is a better share of India's small-car market, which makes up 70 percent of auto sales here. Each major car company now needs to have an "India plan" – and in many ways, Hyundai is the foreign carmaker furthest down that road.

Trial and error for Hyundai

When it opened its plant in 1998, Hyundai was one of the first foreign brands to commit to India. Along the way to building up an 18.5 percent market share – good enough to be India's No. 2 brand – Hyundai has had to deal with all the frustrations that India has to offer.

The roads and congestion are so bad that it takes seven days for trucks to get Hyundai cars from here to New Delhi – roughly the same distance as Miami to Boston. It takes three to four hours just to get to the port 20 miles away. The state government promised to build a highway between Sriperumbudur and the port 10 years ago, but it is still not finished.

While Hyundai has a special power line from the government that promises uninterrupted electricity, at least one nearby supplier relies 100 percent on its own generators.

"We have experienced trial and error," says Heung Soo Lheem, managing director of Hyundai's India operations.

For example, he sees a large number of malnourished workers, meaning that they are weaker than workers in other plants. Moreover, there are unusually high absentee rates, and not just due to illness. "People will travel two or three days by train to go to a marriage," says Mr. Lheem.

Yet the bottom line is good: "The efficiency is not as good as in Korea, but it still has competitiveness," says Lheem, noting India's lower wages. "Our Indian operation is very much successful at this point."

Then he adds pointedly: "Even more so than our Chinese operations."

Indeed, the factory at Sriperumbudur is a plot of perfect Korean efficiency transplanted to the scrub of the south Indian plains – right down to the kimchi in the executive cafeteria. The factory's 9,000 employees, contractors, and apprentices split three eight-hour shifts – the only plant in Hyundai's worldwide network to be online 24 hours a day. In addition, the workers handle different car models on the same assembly line, shifting seamlessly between Santros, Sonatas, and the other four models Hyundai makes here.

Proving the cars meet high standards

At first, Hyundai had difficulty persuading outsiders that its India operations weren't substandard. European dealers wanted a discount on cars made in India. Surely, they reasoned, the cars would be shoddy, and it was only fair to trim the price for Europe's more discerning consumers.

Then, at Hyundai's bidding, they came to take a look at the plant. No one asked for a discount again.

In fact, the plant has been so successful that Hyundai recently decided to make India its "export hub for small cars to the rest of the world," says Lheem. The facility is adding a second factory on the campus to double its capacity to 600,000 cars a year – half for India, and half for export.

Nearby, 16 Korean suppliers have sprung up to support Hyundai's operations – providing everything from brake pedals to wheel axles. Fifteen more will arrive when the second factory opens.

This is the "halo effect," with supporting industries establishing satellite factories near a main plant. "It's one of the biggest influences in the economy, and it's one reason countries like the motor-car industry so much," says Garel Rhys, an auto-industry expert at Cardiff Business School in Wales.

The 'Detroit of India'

It's also one reason that Chennai has come to call itself the "Detroit of India" with an affection for the Motor City that only a Tigers fan would know. In addition to hosting Hyundai, Ford, and BMW factories, Chennai has become the hub for an Indian auto-parts industry forecast to grow to $25 billion in 2015 from $10 billion in production this year.

Each of these halo companies offers more jobs, as is evident in the Hwashin factory nearby, where Indian workers weld fenders and hoods amid showers of sparks.

In contrast to the climate- controlled coolness of the Hyundai production floor, where a white- fingered glove could swab the floor without complaint, Hwashin is a riot of activity and a cacophony of crashing steel.

It is the sound and sweat of industry, and these are 885 jobs that India needs. More than half of India's 1.2 billion people are age 25 or under, and in order to keep up with the demographic wave to come, India needs to add as many as 8 million jobs a year.

India's youth is both a blessing and a challenge. The young demographic contrasts with China's, where the one-child policy has yielded an older work force less attractive to foreign investors.

Yet the employment pressures it creates cannot be solved by IT alone. By leaping straight from a premodern agrarian economy to a white- collar service economy, India essentially skipped an economic step: It never built a blue-collar industrial base. Today, 70 percent of Indians are still employed in agriculture.

So when the economy grew by 6 percent from 1995 to 2005, the growth passed them over. During this time, poverty in India fell by only 0.8 percent, according to a study by the National Sample Survey Organization here.

Manufacturing is the only sector that can begin to fill the gap, adding about 4 million jobs a year, says Mr. Mangaleswaran of McKinsey. "You can't take [people] off a farm and put them in a call center," he says. "But you can put them in a factory."

Ready pools of workers

At Hyundai, they come from as many as 30 miles away, filing off buses that line up nose-to-tail like expectant schoolchildren. With its low-cost work force and abundant natural resources, India has much good to recommend it to manufacturers along with the problems of infrastructure and access.

But the government appears to be placing its greatest faith in the small-car industry, reducing the excise tax on small cars to 16 percent from 24 percent earlier this year.

"With 1 billion people to feed, you cannot depend on services," says Sugato Sen, director of the Society of Indian Automobile Manufacturers in New Delhi.

"You need manufacturing, which the government realizes," he says, "and the auto industry is one industry that can really make a contribution."

Nokia calling? Yes, we'll answer.

When Nokia decided it was time to build a factory in India, a curious thing happened: Many of its calls to explore investment went unanswered.

In many parts of the world, the prospect of securing the world's largest cellphone maker would turn local politicians into game-show hosts, offering ever-sweeter deals in hopes of winning the economic sweepstakes.

Here, it often didn't warrant a call back. From states that did respond, Nokia execs were confronted with India's intense desire to have every single document stamped – and in triplicate.

Then Nokia called the offices of the southern Indian state of Tamil Nadu. Government officials called back immediately and set up a meeting. Not long after, Nokia signed on the dotted line, and their plant opened faster than any in the company's history.

As a globalizing India attempts to unwind itself from a bureaucracy bestowed by the British and then allowed to run amok for decades, Tamil Nadu has become a model.

India still has more red tape than any country in South Asia, according to the International Finance Corp., and it is in the bottom quarter of that organization's list of easiest places to do business. But Tamil Nadu is top among a handful of states here that are taking the boldest steps to become business-friendly, executives and experts say.

"These states have learned the tricks now," says T.S.R. Subramanian, a former adviser at the International Trade Center in Geneva.

The tricks are not that revolutionary. The state has stayed ahead of the nation's electricity crunch, meaning it can supply relatively reliable power – unlike northern states. It has built highways and modernized its port. And it has attacked red tape with industrial-size scissors.

Typically, foreign firms need clearance from about 70 offices and authorities to even open their business. This can take three months or more. Like several other states, Tamil Nadu has instituted so-called single-window clearances – a one-stop shop for every business-licensing need.

These are some of the reasons that Indian automaker Mahindra chose Tamil Nadu when it wanted to set up an industrial park with special tax breaks and better infrastructure. The venture has attracted BMW, as well as Indian high-tech giant Infosys, which built the world's largest software-development campus here.

"Projects of this nature require the support of the state governments to enhance credibility and also ensure smooth, hassle-free operations," writes Anita Arjundas, chief operating officer of Mahindra World City outside Chennai, in an e-mail.

Another measure of Tamil Nadu's success is a new stretch of highway that unspools from Chennai to the Nokia plant in Sriperumbudur. The marvel is not the road itself, but the scenery. The 30-minute drive takes travelers past no less than 10 engineering colleges – one of which looks curiously like the Taj Mahal. A landmark decision a decade ago to begin privatizing education has led to 660 industrial-training institutes, 250 engineering colleges, and 234 polytechnic schools.

"The caliber of the talent pool" was a primary reason that Dell decided to build its first India factory here, says Rajan Anandan, vice president of Dell India.

Yet it was Tamil Nadu's responsiveness that clinched the deal. When Dell voiced concerns that its land parcel was too small for partner firms – which supply keyboards, monitors, and more – officials "allocated a chunk of land," says Mr. Anandan.

The government hasn't always been so take-charge. "We're focused on going after investors now," says K. Rajaraman, a state secretary for industry, "not just waiting for them to come to us." Which means when Nokia calls, Tamil Nadu listens. To be sure, says Jukka Lehtelä, Nokia's Indian operations manager, he could have set up shop elsewhere. "But how well?" he asks. "That is the question: how much you want to hit your head against the wall."

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