Clipped from: https://www.business-standard.com/opinion/columns/perspectives-on-industrial-policy-123082301031_1.html
Balancing financial incentives with trade liberalisation is crucial for making India’s manufacturing sector globally competitive
Illustration: Binay Sinha
Earlier this month, the Directorate General of Foreign Trade of India notified licensing requirements for imports of electronic goods, such as laptops, tablets, and certain computers. These restrictions are in addition to the already high tariffs, which are the highest among competing economies (Business Standard, July 6, 2023), on imported inputs in the electronics sector. A gradual upward movement has also been evident in recent years in the average most-favoured nation (MFN) tariffs on non-agricultural/ manufactured goods, with more than a four-fold increase in the number of tariff lines in the 15 per cent-plus tariff category since 2010 (See my “India in the GVC diversification Strategy: A reality check”, Business Standard, January 4, 2023). Some non-tariff measures in the form of Quality Control Orders for imports have also been introduced, and more may be in the offing.
Complemented by financial incentives under the Production-Linked Incentive (PLI) scheme, these import restrictions are being bundled as necessary industrial policy measures to allow domestic manufacturing, particularly the electronics sector, to thrive. The re-emergence of industrial policy elsewhere in the world, most prominently in the developed economies of the US and EU, is often cited as providing context and rationale. However, it may be important to highlight the differences and reflect on alternative perspectives.
First, it is important to recognise the difference between selective protectionism in the strategically designed subsidy programmes of the developed economies and the more generalised protectionist environment for industry in India. In the case of the US, a combination of factors like the economic after-effects of the pandemic, the challenge of climate change, geopolitical ramifications of the Ukraine war and the perceived economic and technological threat from “Made in China 2025” have contributed to the adoption of industrial policy measures, most prominently, the CHIPS and Science Act and the Inflation Reduction Act in 2022. Both are billion-dollar state funding initiatives to give a boost to domestic research and manufacturing in primarily semi-conductors and electric vehicles. Aimed at “strategic autonomy”, which is understood to imply reduced single-source dependence in critical inputs, both laws include specific “guardrail” provisions against the use of funding for transaction or production capacity expansion, with “countries of concern” clearly identified to include China and Russia. Simultaneously, it may be noted, the legislations incentivise deeper regional economic integration within North America and preferential imports originating from their free trade agreement (FTA) partners. Regional trade is further reinforced through the upgraded US-Mexico-Canada Agreement (USMCA) that has been in force since July 2020.
Similarly, the EU Green Deal Industrial Plan subsidy programme, aimed at achieving carbon neutrality by 2050, is also selectively protectionist. Its major implementation tool, the Carbon Border Adjustment Mechanism (CBAM) / carbon border tax, will initially apply to EU imports in five carbon-intensive sectors, for which China and Russia happen to be major exporters. The CBAM imposes no limitations on movement of goods in these select sectors within the European Union or with countries using a carbon pricing mechanism linked with the EUs Emissions Trading System. It may help to note, in this context, that intra-regional merchandise trade in the EU continues to be the highest among major regions of the world (WTO, 2023).
In India, however, financial incentives under PLI are spread across 14 sectors, many of which (such as textiles, white goods, automobiles and food processing) are hard to view as being driven by strategic motivation. Automobiles have been among the most protected sectors in all of India’s FTAs, so far. The progressive increase in tariffs in the manufacturing sector, in recent years, further reinforces the fact that protectionist policies in India are not strategically selective but constitute a more generalised, overarching means to boost manufacturing as a whole. India’s FTA drive, while having picked up pace, is yet to show conclusive outcomes. The FTAs with the UK and EU have seen successive postponement of their deadlines, while those with regional economies like Asean and Korea have been long under review.
Second, the electronics sector, the focus of the most recent import restrictions, is characterised by a rapid pace of technological advancement that makes import substitution a difficult task to accomplish. Furthermore, the sector has high potential for global value chains (GVCs) and trade. Its inherent architecture of “modularity” allows for interoperability of parts and components and hence scope for fragmentation of production across different locations. The high value-to-weight ratio makes transportation of intermediates and final goods across long distances cost effective. Notably, the list of world’s top 10 exporters in the electronics sector overlaps almost completely with the top 10 importers. So, in the electronics industry, typically characterised by a high degree of value chain activity and trade dynamism, the advantage lies in integrating with GVCs by having more open trade policies and easy cross-border movements.
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Third, the experience of Asian economies evolving as the hub of regional electronics value chain provides helpful insights for a supportive trade policy. Over the last two decades, GVCs in the electronics and communications equipment industry have not just pivoted away from traditional centres like the UK and Japan towards Asia, but within Asia too, the centrality of GVCs has moved first from Japan to China and some Asean economies, now being most evident in Vietnam. In the case of China, the primary driver of the electronics GVC activity within the shifting dynamics in Asia, a dual trade regime, whereby apart from normal trade, parts and components trade received duty-free entry into the Chinese economy, was followed. After being assembled, final goods were exported from China. Preferential tariff policy for processing trade was followed by other Asean economies to successfully integrate with the electronics value chain and may be a useful guideline for India too.
Finally, going further back into history, even in the case of South Korea, an example often cited in support of building complete supply chains within a country, the dynamic evolution of its comparative advantage happened after it abandoned the import-substitution policies and reoriented the economy towards export expansion by virtually eliminating tariffs on imported intermediate inputs used in export production, broad tariff reduction, and not shielding domestic industry from import competition.
It is important, therefore, that India design financial incentives for manufacturing in combination with trade liberalisation. Exposing domestic producers to competition will not just promote efficiency-enhancing specialisation, but also incentivise innovation, both being necessary to making India’s manufacturing sector globally competitive.
The writer is professor of economics, School of International Studies, JNU, and author of India’s Trade Policy in the 21st Century, Routledge: London, 2022. The views are personal
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