Determinants of Machine Tool Output in India's Market Driven Open Economy: An Empirical Analysis, 1980–2020

Early development theory prioritised the machine tools sector as it was critical in transforming savings into investment in an export constrained economy. Creating an articulated industrial structure, through a complement of capital and consumer goods, without foregoing the advantages of international trade, has been an integral part of economic development in large developing economies. The following paper builds a simple model to investigate the determinants of machine tool demand between 1980 and 2020. It uses the 'Bounds Test' in an ARDL model to econometrically establish a long run relation between machine tool output, the rate of profit and specific elements of gross fixed capital formation (an instrument for expected profitability) in the periods preceding and following economic liberalisation in India in 1991. In its linear single equation error correction form, our ARDL model also elaborates on the dynamics that follow a deviation from equilibrium in the short run. Despite the three series being cointegrated, a somewhat finer grained analysis reveals that indigenous technological change, following the liberalisation of 1991, has been a somewhat arduous journey for India. India was somewhat hesitant in joining the liberalisation bandwagon unlike China; the eighties witnessed the lifting of quantitative import restrictions and somewhat limited foreign investment, confined to the automobile and computer sectors. The machine tool sector, propped hitherto by public investment in railways and defence got a new lease of life through the automobile sector. Further, the sector was witness to radical technological change in the form of computer numerically controlled (CNC) machine tools. However, the import penetration in capital goods, particularly machine tools, remained high despite rising demand. This can be attributed to three reasons: rising inequalities have led to a demand for high 'quality' consumer durables (including automobiles) and following that, a 'derived demand' for niche capital goods; an inability of Indian capital goods manufacturers to export and move into higher quality production; finally, averting a potential balance of payments crisis due to high import intensity of consumption were inflows due to 'invisibles' and the inflow of portfolio capital in the periods preceding and following the 'Great Recession' of 2008. India confronts two options: to either let the domestic currency appreciate (and stifle export growth) or let there be a growth of domestic credit, commensurate with its absorption of foreign currency, that sustains import intensive consumption demand without technological change.