Industrial licensing

Also called: Licence system · Topic: Industrial Policy, Public Sector, MSMEs and Disinvestment · NCERT: Class 11, Ch 2 "Indian Economy 1950-1990"; Class 11, Ch 3 "Liberalisation, Privatisation and Globalisation: An Appraisal"

Meaning

Industrial licensing is a system in which a firm needs government permission before it can start, expand, diversify or close an industrial unit. In India its legal base is the Industries (Development and Regulation) Act, 1951 (IDR Act) [2].

• Why it matters: from the 1950s to 1991, licensing let the state, not the market, decide how much of each good was made.
• It grew into the "permit licence raj", with few firms, little competition and little innovation.
• The New Industrial Policy, 1991 abolished licensing for all but a few hazardous or strategic products. Only four industries still need a compulsory licence [4].

Explanation

How the licence system worked

• Legal base: the IDR Act, 1951 (Act No. 65 of 1951). Under Section 11, only the Central Government could set up a new industrial undertaking without a licence. Everyone else needed a licence from the Central Government [2].

• The procedure was set out in the Registration and Licensing of Industrial Undertakings Rules, 1952 [2].

• Licensing reached the private sector too. Under the Industrial Policy Resolution 1956, Schedule C industries were open to private firms. Even these firms needed a licence to:

• start a new unit;
• expand output (make more of the same good);

• diversify (make a new variety of goods).

• The idea behind it: output should not go above what the planners thought "the economy required".

• A firm got a licence to expand only if the government agreed that more output was needed.
• So planners, not market demand, decided how much of each good was produced.

Licensing as a tool for regional equality

• Easier licences for backward areas: units in backward regions got licences more easily. They also got tax benefits and cheaper electricity.

• The aim was to spread industry across India, not let it crowd into a few cities.

• Freight equalisation policy (1952-1993) worked against this aim. Under it, the government subsidised the transport of minerals such as coal and iron ore, so a factory anywhere in India paid the same price for them.

• Worked example (illustrative numbers): coal costs ₹1,000 a tonne at the mine and ₹400 a tonne to carry to a distant city.
  • Without the policy: the factory near the mine pays ₹1,000. The distant factory pays ₹1,400.
  • With the policy: both pay about the same, so there is no longer any reason to build near the mine.
• Result: firms set up near ports and markets, mostly in the west and south. The mineral-rich eastern states (Bihar/Jharkhand, Odisha, West Bengal) lost their cost advantage and industrialised slowly.

The wider control web and its misuse

• Licensing sat inside a larger system of controls:

Control	Year	What it did
Monopolies Inquiry Commission	1964-65	Found that economic power was concentrated in a few business houses
Hazari report	1967	Found that big houses were pre-empting licences
Dutt Committee (Industrial Licensing Policy Inquiry Committee)	1969	Confirmed that the licensing system was being misused
MRTP Act	1969	Firms above set asset limits needed extra approval to expand
FERA	1973	Strict controls on foreign exchange and on foreign firms
Price and distribution controls	1950s-80s	The government fixed prices and supply of cement, steel, sugar and other goods

• Pre-emption of licences: a big business takes a licence it does not plan to use, only so that no rival can get it.
• Rent-seeking: firms spent time and money lobbying ministries for permits instead of improving their products. NCERT calls this the "permit licence raj".
• NCERT's chain of cause and effect:
• strict permits → few firms;
• few firms → little competition;
• little competition → little innovation, poor quality and high prices.

Step-by-step loosening before 1991

• 1973: the joint sector, where the government and private firms own a unit together.
• 1977: District Industries Centres (DICs), which served small industry at district level.
• 1980 and 1985: broad-banding, where one licence covered a group of related products, so a firm could shift output between them without a new licence. There was also partial delicensing.

In India

• The law still in force: the IDR Act, 1951. Section 11 still requires a Central Government licence where licensing applies [2].

• Today's compulsory licence list: under Notification S.O. 477(E) of 25 July 1991, only four industries need a licence [4]: 1. Cigars and cigarettes of tobacco and manufactured tobacco substitutes; 2. Electronic aerospace and defence equipment; 3. Industrial explosives; 4. Hazardous chemicals.

• Defence licensing made easier:

• DPIIT Press Note 1 (2019 Series), dated 01.01.2019, replaced Press Note 3 (2014 Series), dated 26.06.2014. It cut down the list of defence items that need a licence under the IDR Act and the Arms Act, 1959 [3].

• Parts and accessories used in defence do not need an industrial or arms licence unless they are named in the list [3][7].

• Online filing: applications for an Industrial Licence under the IDR Act and Arms Act can be made on an online portal run by DPIIT (Department for Promotion of Industry and Internal Trade) [7].

• Locational rules remain: the 1991 policy kept some rules on where units may be set up. These apply alongside the licences still needed under the IDR Act [6].
• From MRTP to competition law:
• The MRTP Act was repealed. The Competition Act, 2002 was passed in the Winter Session ending 20 December 2002 and notified as Act No. 12 of 2003 [6].

• Policy moved from limiting firm size to punishing unfair conduct [6].

• Cronyism after the licence raj:

• Discretionary allocation means officials choose who gets a resource, without an open auction.
• The courts cancelled 2G spectrum licences in 2012 and coal blocks in 2014. Both judgments pushed allocation towards auctions.
• The Economic Survey 2019-20, Chapter 3, links India's $5 trillion economy goal to "pro-business" policy and to moving away from "pro-crony" policy that favours powerful incumbents (firms already established in the market) [5].

Don't confuse with

• Industrial licensing vs MRTP approval: a licence was needed by any firm to start, expand or diversify under the IDR Act, 1951. MRTP approval (1969) was an extra approval needed only by large firms above set asset limits.
• Industrial licensing vs locational policy: a licence decides whether a unit may produce an item. Locational rules decide where a unit may be set up. Locational rules survived 1991 alongside the remaining licences [6].
• MRTP Act vs Competition Act, 2002: MRTP limited firm size and was built for the pre-reform economy. The Competition Act punishes unfair conduct and is built for the post-reform economy [6].
• "Pro-business" (Economic Survey 2019-20) vs "pro-business" (Rajan-Zingales): in the Survey, "pro-business" is the good, pro-competition option and "pro-crony" is the bad one [5]. In Rajan-Zingales, "pro-market" is good and "pro-business" (favours to incumbent firms) is bad.

Prelims Hooks

• IDR Act, 1951 (Act No. 65 of 1951) is the legal base of industrial licensing. Section 11 requires a Central Government licence for any new industrial undertaking [2].
• Only four industries need a compulsory licence today: tobacco cigars and cigarettes, electronic aerospace and defence equipment, industrial explosives, and hazardous chemicals. The basis is Notification S.O. 477(E), 25 July 1991 [4].
• Trap: before 1991, even Schedule C firms needed a licence to expand or diversify, not only to start a unit.
• Match the committee to its finding: Monopolies Inquiry Commission (1964-65) → concentration of economic power; Hazari (1967) → pre-emption of licences; Dutt Committee (1969) → confirmed misuse.
• Freight equalisation policy (1952-1993) hurt the mineral-rich eastern states. It did not help them.
• Dates of the loosening steps: joint sector = 1973; District Industries Centres = 1977; broad-banding = 1980s (one licence covering related products).

Mains Points

• Licensing as government failure:
• It was meant to steer scarce resources and spread industry evenly.
• Instead it led to pre-emption of licences, rent-seeking and little innovation. Freight equalisation made regional imbalance worse.

• This is a useful case study for GS-III answers on liberalisation.

• From licence-permit state to regulatory state:

• Controlling firm size gave way to regulating firm conduct (MRTP → Competition Act, 2002, with the CCI as regulator) [6].
• Licensing now survives only where there is a clear safety or security reason, such as explosives, hazardous chemicals and defence [4][3].

• Easier defence licensing and online filing [3][7] support Make in India and Atmanirbhar Bharat in defence manufacturing.

• Cronyism outlived the licence raj:

• The discretionary allocation behind the 2G (2012) and coal (2014) cases repeated the old licence-raj problem.
• The fixes are auctions, transparent rules and a strong competition regulator.
• The Economic Survey 2019-20 argues that the churn of creative destruction (new, better firms replacing old, weaker ones) creates more wealth than a static pro-crony system. It cites a World Bank study on Ukraine, which found growth would be 1 to 2 per cent faster if all political connections were removed [5].

Related concepts

• Licence Raj
• Licensing for regional equality
• Freight equalisation policy
• Crony capitalism
• Pro-market versus pro-business policy

Read more

• Industrial licensing and the permit-licence raj