Blast from the past

Blast from the past

India’s regression to protectionism marks revival of failed import substitution policy.

On Tuesday, US President Donald Trump directed yet another blast of criticism at India’s policy on import tariffs. This comes on the heels of the Union Budget where customs duty on a large number of goods, including newsprint, was hiked. This round of tariff increase is not an isolated development, but one more instance of a recent reversal of long-standing policy. After almost three decades, protectionism has re-emerged as a policy tool to promote domestic manufacturing – ignoring the elementary economic lesson that high import tariffs also act as a tax on exports, reducing the competitiveness of Indian exports.

For about two decades world trade has been dominated by global value chains (GVCs). In concrete terms, it meant that emerging markets such as India and Vietnam could become one among many destinations in the manufacture of a sophisticated product. More than two-third of world trade is on account of GVCs, and China is their biggest beneficiary.

Resurgence of protectionism is tantamount to rejection of an influential factor that lifted millions out of poverty. Protectionists overlook an intrinsic element of GVCs. Import intensity of economies will usually increase as production is spread across frontiers. A recent report put out by WTO, among others, showed that in almost all countries the share of domestic value added in exports has trended downwards on account of GVCs. Trade data doesn’t capture this adequately. For example, China’s domestic value content of ICT exports is only about half of the total value.

The Narendra Modi government’s tariff policy can result in lost opportunities. Japan’s Nintendo this week announced that it will shift a part of its production line out of China to Vietnam to hedge the risks arising from US-China trade friction. Vietnam has embraced greater integration and is one of the big beneficiaries of GVCs. India, on the other hand, is bringing back a policy which it had tried in the past, in the Nehruvian years before liberalisation, and which failed conclusively. Meanwhile, Washington is breathing down New Delhi’s neck and could punish it further after dropping India from its generalised system of preferences; other countries could retaliate against it too. Government must reverse tariff hikes and discard the idea of using them as a policy tool. Make in India will happen, and India get up to $5 trillion by 2024, only if the world comes knocking.