Last month, the Government of India raised import duties on several electronics items, using its emergency powers under the customs laws. Duties on imported mobile phones, DVD players, TVs, digital cameras, video cameras and electricity meters were raised from 10 to 15 per cent, while duties were doubled from 10 to 20 per cent on imports of microwave ovens, LED lamps, lamps and light fittings, set-top boxes, water heaters, hair-dressing instruments etc.
Additionally, import duty exemptions on LCD, LED and OLED panels for the domestic manufacture of TVs were withdrawn and a duty of 7.5 per cent has been imposed. These tariff hikes are being viewed by many as an attempt to boost domestic manufacturing, job creation and government revenues. However, in my view, this policy change is a wrong-headed approach to achieving the desired objectives.
First, I view these tariff hikes as a partial reversal of the trade reforms started in 1991. But once initiated, such reform reversals gather momentum. The argument is based on what is called “logrolling” in American politics, which is applicable to any democracy. In the context of international trade, logrolling refers to one politician supporting protection from imports for manufacturers in another politician’s constituency in exchange for the same kind of reciprocal support for manufacturers in his own constituency.
This leads to a snowballing of import protection. It is, therefore, not too early to be sounding alarm bells, given India’s own past experience with import protection. This experience, based on the attempt to substitute imported products with domestically produced ones (often called “import substitution”) produced an annual growth rate often below 2 per cent, making today’s growth rates of 6-8 per cent a very distant dream. In addition, over 60 per cent of the population was below the poverty line.
Importantly, trade policy in India after Independence took the form of “infant-industry” protection, that, by definition, is temporary. Through such protection, India’s manufacturing sector was expected to grow out of its infancy into adulthood to compete with the world’s manufacturing powerhouses.
But we all know what happened. India’s import substitution phase lasted over four decades — that can hardly be called “temporary”. Even after those four decades, Indian industry could not come close to producing manufactures of high enough quality and at low enough costs to compete with imports. Not surprisingly, most Indians continued craving imported goods. After roughly another three decades today, it seems many have forgotten that import protection does not work.
Now the main question to be addressed is whether import protection today will, as is being claimed, expand manufacturing, create more jobs and generate revenues for the government. Based on India’s labour abundance, its natural comparative advantage lies in the production of labour-intensive products. Freer trade should push India towards its natural comparative advantage, into specialising in such products, thereby creating more jobs.
Any barriers to trade should move India away from such production to less labour-intensive products and fewer jobs. The impediments to specialising in labour-intensive production under trade, however, are things that make labour artificially more expensive (not reflective of its abundance), such as India’s onerous labour regulations. Thus, in place of raising import duties, these distortionary domestic conditions need to be tackled.
Notwithstanding the fact that India is a country with a large potential market for manufactures, the domestic market size still will be a binding constraint for the expansion of jobs. If India decides to produce all the manufactures it consumes, it will produce a little bit of everything, as opposed to a lot of each of a relatively limited number of products it specialises in under free trade. In turn, it will not be able to exploit any benefits of large-scale production.
Additionally, lack of foreign competition will enable domestic producers to exploit Indian consumers through high prices and low quality. There will be no pressure on the government to reform regulations on labour, in turn leading to the use of more capital relative to labour, with few manufacturing jobs being created. This was indeed the story of the first four decades of post-independent India.
A tried and tested way of creating jobs in any country with a large pool of low-skill workers is processing of imported inputs and their assembly. For example, China benefited from its processing exports, for the viability of which it fully exempts imported inputs from customs duties. India’s withdrawal of import duty exemptions on LCD, LED and OLED displays goes in the opposite direction and makes manufacture of TVs in India less profitable. Therefore, this is clearly a job-destroying step.
As regards revenue generation, analysis of data across countries over a number of years by several researchers shows that the average import duty rate in a country falls with increases in per capita income. The reason is that at low income levels, the government’s income tax machinery is not advanced enough, resulting in substantial tax evasion. Customs duties then are a relatively cost-effective and easy way of raising revenues. But with growth in incomes, there is a real benefit to the government from investing in a better income tax department that ensures tax compliance. Potential revenue benefits through tariffs then become relatively negligible. Thus, after two decades of 6-10 per cent growth in India, the idea of now using import duties to generate government revenue, to put it mildly, seems absurd.
It seems that Make in India is being captured by protectionists for their own benefit. The dismantling of India’s protectionist regime, starting in 1991, led to a prolonged period of high growth. Reversing trade reforms will also reverse India’s growth trajectory.
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