Trade Protectionism — How it won’t solve India’s long term Problems
The latest GDP quarterly numbers are in and they look ugly. Many had expected the economy would contract due to the stringent lock-down which was imposed in the months of April and May. Having said that, a -23.9% GDP growth rate certainly leaves a lot to be desired. The next quarters also don’t seem to look too bright either and If Mr Pronab Sen’s (Former Chief Statistician of India) predictions are correct, the economy can contract by 14% this financial year. However, one key aspect of the government’s economic strategy which has implications for India’s long term economic prospects needs further analysis viz Trade Protectionism and Import Substitution, which is a serious retrogression to India’s policies before liberalization.
Looking at the quarterly GDP growth figures for FY19–20, the economy grew at 5.24% in Q1, 4.42% in Q2, 4.08% in Q3 and was down to 3.08% in Q4 (Jan’20-March’20) . Thus, a slowing economy had been a problem even before the onset of the Coronavirus and while this has been happening, India has been becoming more protectionist with increasing tariffs on imports and effectively looking at a policy of Import substitution.
Tariffs on imports were raised for a list of 37 items for FY21 by the Finance Minister in the budget and over the last few months there is a further push for a tariff increase for another list 300 items. Not to forget, there is now a slogan to champion this cause as well, which is “Atmanirbharta”.
Statistically we can prove that import duties lead to dead weight losses and inefficiencies in the market, not to mention that it even goes against the law of comparative advantage. However, it has not stopped nations from taking on protectionist measures. Let’s look at it the from the consumers’ perspective and even at a macro level from the economic perspective.
Why does the consumer suffer?
Since there are high tariffs on imports, consumers are forced to look for local alternatives, these local alternatives will cost more and may not even match the quality of the imports. Thus consumers pay more in the end. Now, we must remember that consumers also don’t have infinite funds. They also operate under a fixed budget. So, if I’m forced to pay more for a particular product, then I will obviously have to spend less somewhere else.
Why does the economy suffer?
Import substitution does create a system of sub optimality, where consumers end up paying more. And in order to pay more they will have to cut down on expenses elsewhere. This leads to drop in consumption and demand which are never good for any economy. So, if I’m forced to pay more for a smartphone, I will either delay or in some cases abandon the plans to buy a new pair of shoes due to budgetary constraints.
Export Lead Growth
Also, there is talk from the government about having an export lead growth. However you can almost never boost exports while also at the same time practicing import substitution and restricting imports. In most cases exports and imports will always go hand in hand. The example that is often quoted is that of China and its exports. Even looking at World Bank data from 2017, China had a total exports of US$2.1 Trillion but its imports were also a very high US$1.73 Trillion. The difference between the imports and exports is the revenue they are earning for the value addition they have done. Ergo, to have high exports, a country will have to import in large numbers as well and hope that it can climb up the Global Value Chain with experience and thus earn higher margins on the value addition being carried out.
So much so that in a recent interview to the Print, Mr Arvind Panagariya (Former Vice Chairman of NITI Aayog) said that “Import substitution will shave off almost 2% from India’s growth rate year on year”. Now, that should be a cause for concern.
Make in India
If India wishes to “Make in India” for world consumption and boost exports, it certainly cannot achieve it without serious Land and Labor reforms as has been pointed out by many in the past.
If we look at the 2 main factors of production, which are Labor and Capital. Indian doesn’t have much of the later but it certainly has a lot of labor. That is where India’s comparative advantage lies. So ideally, India should dominate the world market in Labor intensive goods like textiles etc. However, that is not the case. India has been struggling to even beat Vietnam and Bangladesh whereas China does almost 10 times in textile exports than India. This is where Labor reforms are needed. As per the Industrial Disputes Act, 1947, any firm employing 100 or more workers is required to seek permission from the Labor Department with jurisdiction over the firm, before layoffs or retrenchment. Now due to this inflexibility in firing people, small industries choose to stay small and don’t expand. Now, if you are in the business of making labor intensive products, it’s imperative to also achieve economies of scale without which you will struggle to complete in the global markets.
Import substitution and protectionism may give short term gains like boosting local employment but not necessarily the desired long term benefits India would want as an economy. Surely, there is an understandable threat from China and a need to curb India’s long term dependence on them, but the answer to all that lies in genuine land and labor reforms, better access to credit at affordable rates and seeking new alliances by going in for Free Trade agreements with other countries like the US or even the EU. The future does look bleak but prudent policy measures can certainly pull India out the current predicament it finds itself in.