By Satyajit Mohanan
The global economy is currently facing two major risks. First, the pandemic, which has disrupted countries world-wide and one which has visible medium-term effects on the economy. Second, the return of protectionism, which would potentially disrupt countries in the future and one which has long-term effects on the economy. Unfortunately, India has fallen prey to both these risks. But India, like many other countries, would eventually fight the pandemic and return to normalcy. However, the results of a protectionist India would be felt for a long time.
In 2018, Prime Minister Narendra Modi at the Economic forum at Davos slammed rising trade protectionism. He warned that “the forces of protectionism are emerging” and stated that the “new types of tariffs and non-tariff barriers” are a result of the existence of such forces. Two years later, PM Modi’s policies and his economic vision seem to be consistent with that of the ‘forces of protectionism’.
India’s path towards protectionism:
On May 12th, PM Modi announced his vision for an ‘Atmanirbhar Bharat’, or in other words, a ‘Self-Reliant India’. India is yet to produce a coherent white paper on this new vision.While the government maintains that self-reliance does not amount to protectionism, its policy initiatives reflect an inward-looking trend. It appears that the government is convinced that they would achieve their self-reliant vision by adopting a host of anti-import policies. For instance, India recently announced that it plans to put an import embargo on 101 defense items. In June this year, India’s retaliation to its border dispute with China included an economic boycott, whereby the Indian government banned 59 Chinese apps and pledged to substitute imports of Chinese products worth $13 billion by local ones by 2021.
Shades of protectionism in India’s trade policy emerged over the last two years, way before PM Modi’s self-reliant vision and India’s dispute with China. India has increased import tariffs to curb cheap imports and help domestic industries. The annual budgets over the last two years has raised tariffs of some essential and many non-essential imports. The 2020-21 budget witnessed an increase in import tariffs to 20% on items such as kitchenware, fans and electrical appliances. A tax of 5% would be imposed on imported medical devices to fund health infrastructure. Reports suggest that import tariffs were levied with an aim to discourage imports and spook foreign firms. India also introduced stringent amendments to the Customs Act of 1962, which gives power to the government to ban the import or export of any good to prevent injury to the economy. This non-tariff barrier also gives sweeping powers to the customs officials to suspend preferential treatment or reject benefit claims.
India has also not signed any worthwhile free trade agreement in the last six years as it opted out of the Asia’s Regional Comprehensive Economic Partnership (RCEP) last year. Its recent increase in tariffs and non-tariff barrier and its recent ‘Self-Reliant’ vision coupled with certain anti-import policies reflects India’s protectionist turn. This trade environment hampered trade negotiations with the EU last month; EU officials stated that India’s latest policy of a self- reliant economy added a sense of uncertainty towards the direction of its trade policy.
India, by enacting trade barriers and discouraging imports, cannot be self-reliant. India’s economic experience of its first four decades after independence and a textbook analysis of trade theory reflect the ill-effects of a flawed and oversimplified economic theory, such as protectionism.
The Costs of Tariffs and Non-Tariff Barriers: A textbook Analysis:
In the Wealth of Nations, Adam Smith developed a persuasive argument for free-trade and made a compelling case against mercantilist policies. Smith rightly pointed out that in a mercantilist system, the interests of the producers are equated with the interests of the nation. He argued that the mercantilist approach often sacrificed the interest of the consumer to that of the produced. They confused the means with end; they considered production and not consumption as the ultimate end.
India following asmercantilist approach has adopted various anti-import policies. They argue that this policy of discouraging imports and being ‘vocal about local’ would boost domestic industry and help achieve economic prosperity. PM Modi lauded that this new vision would enable India to ‘Make for the world’. In his August 15th Independence day Speech, PM Modi states that India would strive to bring down its import bill and Indians would consume more locally manufactured products. In the political context, these claims were welcomed by the Indian electorate and domestic business groups. The media houses hailed this as ‘historic’ and a ‘game changer’ for India. But, little do they realize, that the opposite would be achieved.
A trade policy which is protectionist in nature would reduce the competitiveness of the domestic industry, distort prices and harm exports.
The protectionist measures do not prepare domestic firms for global competition. Firms become inefficient and its products expensive. Prior to 1991, India’s import-substitution policies resulted in the its economy becoming a high-cost one owing to its inefficiencies in production, which then hampered its exports. Critics of free trade argue that import liberalization would kill domestic industries as they would not be able to compete with cheap foreign products. While this is partially true, the solution is in enacting reforms to increase the firm’s competitiveness and not raising tariffs. India has a natural comparative advantage in labor-intensive activities, the government instead of enacting barriers to trade, should reform its industrial policy. India needs a comprehensive reform agenda that addresses lack of credit, poor infrastructure, low productivity, its complex labor laws and its tax regime. Addressing such factors would certainly improve India’s overall competitiveness.
Trade barriers also increase the prices of products thereby benefiting certain domestic producers while harming the others including the consumers. Restrictions on imports of a product leads to scarcity of that particular product which then drives up its price. The distortion of prices then lead to a problem knows as a deadweight loss. It is a measure of efficiency lost as a result of trade restrictions. It is calculated by deducting the overall costs to consumers (costs from purchase of expensive imported goods and domestic products) and the income transferred to domestic producers and government. For instance, a protectionist sugar policy in the US benefited producers of sugar to the tune of $1 billion and its costs on consumers were about $1.9 billion. The deadweight loss to the economy was about 900 million. Trade restrictions also raises the price of intermediate goods which then affects downstream industries. Import restrictions on certain intermediate goods such as oil and gas drives -up its prices which then result in higher costs of production. Hence, protectionist policies which benefit a particular industry always ends up harming another industry.
Import barriers also harm exports of a country. The Lerner symmetry theorem in trade theory argues that a tax on imports is equivalent to a tax on exports. Douglas Irwin in his book “Free Trade Under Fire” argues that exports are essential to generate the earnings to pay for imports and that they are the flip side of the same coin. He also argues that import restrictions affect employment in export industries. In America, the Smoot- Hawley Tariff of 1930 reduced imports but failed to generate employment as exports fell almost ‘one-for-one’ with imports. Trade theory also predicts that If a country raises trade barriers and restricts imports; it would face a similar retaliation on its exports from the affected countries. Hence, it would be foolish for countries to buy goods ‘Made in India’ when the Indian government closes its markets to foreign products,
India’s export picture has been grim for a decade now. Exports have been stagnating at around $300 billion for the last ten years. Countries such as Bangladesh and Vietnam have outsmarted India’s export potential. The current export stagnation, driven by lack of competitiveness in Indian exporters and sticky labor laws, could be aggravated by these protectionist measures.
The Politics of Protectionism:
Ideologically, this faulty economic thinking in India has its roots in the Hindutva ideology of the ruling party. The ideologues of India’s ruling party, V.D Sarvarkar , Upadhyay and Dattopant Thengadi were poster boys of ‘swadeshi economics’ which was protectionist in nature and viewed liberal economics with disdain. They view international economic institutions and international trade with suspicion.
Therefore, if protectionism was so costly and flawed, then what justifies its attractiveness and popularity? Protectionism as a political idea provides plenty of benefits. It has a nationalistic aura to it which makes it popular among the people. Slogans such as “Make in India” and “Self-Reliant India” sound patriotic and attractive. Moreover, certain powerful domestic businesses which have sufficient political influence stand to benefit from these policy actions. These domestic firms then offset this favor through campaign contributions. Interest groups from various sectors that lobby for these policies provide monetary and electoral benefits towards policy makers. However, at the end the Indian economy and its people stand to lose from this faulty economic thinking.
Thus, India’s recent protectionist turn can best be seen as a move with short-term political benefits but long-term economic costs.