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To embrace atmanirbharta is to choose to condemn Indian economy to mediocrity

India does not have the luxury of abandoning export orientation, the alternatives are limited. Resisting the misleading allure of the domestic market, India should zealously boost export performance and deploy all means to achieve that.

Written by Shoumitro Chatterjee , Arvind Subramanian |
Updated: October 15, 2020 9:17:57 am
Buyers shop for consumer goods at a store in Pune. (Express photo by Ashish Kale)

If India’s inward turn is misconceived, then what about the effectiveness of the twin prescriptions: Domestic demand over exports and protectionism over freer trade?

The debate in India has focused on domestic-demand led growth not just as a short-run response to COVID-19, but as a medium-term growth strategy. All the evidence across the world and in India has shown that rapid and sustained economic growth requires export dynamism. India’s GDP growth of over 6 per cent after 1991 was associated with real export growth of about 11 per cent. Pre-1991, a 3.5 per cent growth rate was associated with export growth of about 4.5 per cent. There is no known model of domestic demand/consumption-led growth, anywhere or at any time, that has delivered quick, sustained, and high (say 6 plus) rates of economic growth for developing countries. But even leaving aside the desirability of exports over domestic demand led growth, how feasible is the latter today? Policies that could achieve this are: More public spending, tax cuts to boost private consumption and private investment, and/or financial sector reform to boost private investment.

Against the current backdrop of bleeding public, financial, and household and private sector balance sheets, these policies look difficult. Only growth can rehabilitate balance sheets; stressing balance sheets further cannot realistically revive growth. Consumption growth will be limited by the fact that household debt has grown rapidly in the last few years. Consumption now can grow only if incomes grow.

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Government spending could be a short run option, but COVID has limited that possibility. Post-COVID, India’s debt is expected to rise from about 70 per cent of GDP to about 85-90 per cent and deficits are likely to be in the double-digit range. The fiscal space for spending will be severely limited both because of high levels of deficits and indebtedness and because debt dynamics will be adverse unless growth picks up substantially.

India should be cautious about succumbing to intellectual mimicry of advanced countries on fiscal policy. India’s interest rates are not at zero and are unlikely to be so because of persistent inflation. India’s borrowing is still considered risky, reflected in ratings that are hovering perilously close to being classified as sub-par. The favourable interest rate-growth differential that supports expansionary policy in the advanced countries is absent in India. India may well have scope for expansionary fiscal policy in the short run but not as a medium run growth strategy.

India’s financial system was badly impaired even heading into the COVID crisis and will come out more seriously damaged. Given the limited progress in fixing the financial system, prospects for investment remain weak. In short, in India’s current circumstances, India does not have the luxury of abandoning export orientation because the alternatives are so limited.

Opinion | India’s export opportunities could be significant even in a post-COVID world

If exports are critical, can the recent recourse to protectionist policies deliver? As argued in our last column, India’s market is too small to sustain any kind of serious import substitution strategy or even as a way of offering investors the domestic market as bait and incentivising them to export.

India’s big, unexploited opportunities are in unskilled labour exports, highlighted in the figure. It shows, on the y-axis, a country’s share of low-skilled exports of all developing countries (non-HIC), and on the x-axis, its share of the unskilled labour force for these countries. We expect that countries should line up roughly along the 45 degree line so that outcomes (exports) match endowments (unskilled labour force).

China and India are stark outliers but in the opposite direction. China is vastly over-exporting. India is vastly under-exporting relative to its labour force. We estimate that India is producing and exporting about $60-$140 billion (2-5 per cent of GDP) less of low-skilled activity annually than it should be. There are, of course, two ways to look at this finding. On the one hand, it is an indictment of past performance. On the other, it is also an indicator of potential future opportunity if the underlying problems are addressed.

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In recent years, because China’s wages are rising as it has become richer, it has vacated about $140 billion in exports in unskilled-labour intensive sectors, including apparel, clothing, leather and footwear. Post-COVID, the move of investors away from China will probably accelerate as they seek to hedge against supply chain disruptions because of trade actions against China. India did not take advantage of the first China opportunity. Now, a second opportunity stemming from geo-politics has been created and that is India’s big prize waiting to be seized.

Importantly, exploiting this opportunity in unskilled exports requires more not less openness. Consider clothing. To be internationally competitive, many parts and components have to be imported from so many different sources that openness is an existential necessity not a luxury. One indicator is the foreign or import contribution to exports. Comparing China and Vietnam at roughly the time of their export boom in textiles and clothing suggests that exports were highly dependent on imports (between 40 and 45 per cent). In contrast, India’s import share is about 16 per cent. Achieving Chinese and Vietnamese levels of success will therefore require greater imports and openness.

In the case of clothing, a key policy change in India will be to eliminate tariffs on all inputs. Especially the long-standing tariff on man-made yarn because man-made fibre-based exports (not cotton-based apparel) are the most dynamic segment of world exports. It will also require signing free trade agreements with Europe that still impose high duties on India’s clothing exports of close to 10 per cent which disadvantages India relative to Bangladeshi and Vietnamese exports which enjoy preferential access to world markets. But Europe will only be willing to sign such an agreement if India is willing to open its other markets (for example, automotives). Export success will also require genuine easing of costs of trading and doing business in India.

Editorial | Quest for ‘self-reliance’ must not lead to failed policy of import substitution. It did not work in the past, won’t work even now

As India contemplates atmanirbharta, two deeper advantages of export orientation are always worth remembering. First, foreign demand will always be bigger than domestic demand for any country. Second, there is also a fundamental asymmetry: If domestic producers are competitive internationally, they will be competitive domestically and domestic consumers and firms will also benefit. The reverse is not true: Being competitive only domestically is no guarantee of efficiency and low cost.

In sum, resisting the misleading allure of the domestic market, India should zealously boost export performance and deploy all means to achieve that. Pursuing rapid export growth in manufacturing and services should be an obsession with self-evident justification. Abandoning export orientation will amount to killing the goose that lays the golden eggs and indeed killing the only goose laying the eggs. Alas, to embrace atmanirbharta is to choose to condemn the Indian economy to mediocrity.

This article first appeared in the print edition on October 15, 2020 under the title ‘The domestic market mirage’. Chatterjee is assistant professor of economics at the Pennsylvania State University. Subramanian is professor of economics at Ashoka University and former chief economic adviser to the government of India

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