Wrong lessons

Wrong lessons

Import substitution will undo the economy’s gains over the last two decades.

Protectionism is contagious. India, one of globalisation’s biggest beneficiaries, has for over a year experimented with an import tariff policy inspired by its autarkic and poverty-stricken past. It isn’t an aberration. A government taskforce has been set up to recommend policies which will promote import substitution. This swing back to the 1970s mindset is mystifying because the economic structure which underpins the global economy has changed fundamentally since then. Romancing a bad idea from the past will undo India’s gains brought about by tighter global integration.

Two intertwined developments changed the nature of global trade over the last three decades. First, advances in information and communications technology, and innovations in logistics allowed multinational companies to slice production processes and locate them in different countries. This showed up in the form of a surge in intra-firm global trade and intermediate exports. Second, lowering of trade barriers through multilateral and bilateral agreements helped the value chains spread across countries. In other words, there is no longer any benefit in clustering within national borders.

The semiconductor industry provides an example. US headquartered companies accounted for half the global sales in the last two decades but the value chain spread out. Between 1980 and 2015, global semiconductor fabrication capacity within US declined from 42% to 13% even though US remains the leader in semiconductors. It is against this economic current that India’s current trade policy is headed. The danger from this approach is that manufacturing related foreign investments may not take place, as a policy to keep pushing up tariffs will undermine India’s attractiveness.

Parts of the world may have succumbed to the false promise of mercantilism. But India should not follow suit because it will hurt economic growth and attendant job creation. The right way to go ahead is to relentlessly remove impediments which get in the way of economic activity and India’s overall competitiveness. For example, reducing the time taken by GST system to refund exporters will do a lot more for durable job creation than coming up with a new import substitution policy. If the last 25 years in India have been its best period in terms of economic growth and poverty reduction, openness has had an important role to play. The Narendra Modi government must avoid learning the wrong lessons from economic history.