The effort to invigorate Make-in-India by increasing customs duties on a range of imported electronic items, including smartphones, is nothing but import substitution for encouraging local production. Will it work?
India is not new to import substitution. The strategy was first introduced in the 1960s, in the second decade of India’s economic planning. The objectives were to save foreign exchange by reducing non-essential (read consumer goods) imports and encourage greater domestic production of imports for achieving self-reliance. The long-term effects of the policy were to make the Indian economy abstain from imports for almost three decades. The extent of self-reliance achieved by the strategy is debatable. But given that India is hardly anywhere close to being a major industrial powerhouse in the modern world is probably evidence of import substitution failing to achieve its objective.
The situation and context of today is vastly different from the 1960s. The biggest difference is in the wider macroeconomic policies. Compared with the 1960s, the Indian economy is now heavily receptive to foreign investment. Indeed, there are hardly any sectors of the economy where foreign investment is not allowed, including sensitive sectors like defence production. In this respect, increase in customs duties should encourage foreign producers to look at the Indian economy as a location for investing and manufacturing locally. This is exactly what the government wants. If household items like LED lamps, microwave ovens, set-top boxes, television sets, VCRs and DVDs are able to attract tariff-induced domestic market-oriented foreign investment, then Make-in-India would get a firm push.
The counterfactual is that in spite of liberal policies and high tariffs, the possibility of getting investments in these sectors might be limited. India’s quintessential drawbacks of difficult business conditions at local levels, particularly long delays in starting business, obtaining permits and transporting goods within the country, makes cost calculations significant from the perspective of potential investors. There are dedicated efforts by the government to bring down these costs, but it will be years before India becomes as cost-competitive as middle and lower-middle income economies like Thailand, Vietnam and Mexico that are centres for producing consumer durables.
The assumption behind the hike in customs duty seems that as imported electronic items become expensive, consumers would shift to buying more from local producers. The obvious fallacy in this logic is ignoring the consumer. It has been established time and time again that consumers don’t mind paying more for better items. The challenge for Indian industry then is to manufacture products that are as good in quality as their imported counterparts and yet sell them at competitive prices. This is a tall ask by all yardsticks since Indian producers would continue facing adverse conditions leading to higher production costs. The further, and greatly irrational, assumption is that notwithstanding inability of Indian producers to manufacture consumer goods of same quality as imports at competitive prices, the fact that they are Made-in-India would make Indian consumers buy them nonetheless. The problem is nationalism, notwithstanding its emotional appeal, doesn’t influence economic decisions, particularly in buying TVs, cameras and mobile phones. Indeed, for Indian consumers who, for more than two decades now, have been experiencing the best of what the world makes in electronics through imports, the expectation level on quality is as high as consumers anywhere else in the world. Local producers would find it tough to match these expectations.
While boosting Make-in-India is the ostensible logic behind the hikes in customs duties, what appears to be a bigger motivator is the compulsion of garnering revenues. The implementation of GST has, at least for the time being, put the government on the back-foot on revenues given its commitment to compensate state governments for revenue shortfalls. The challenge has expanded given that the GST Council has sharply slashed the number of goods and services figuring in the top-most 28% GST tax slab. Expectations of volume compensating value are unlikely to materialise as industrial production is progressing at a sluggish pace. The only option is to mobilise revenues from alternative sources. Higher customs duties on electronic items are good choices in this regard, as an economy driven by consumption is unlikely to stop buying smartphones and cameras even if they become expensive. Ironically, revenues would boost if Indian consumers—on quality and preference grounds—keep buying imported stuff without worrying too much about what that means for prospects of Make-in-India!
Increasing local output of smartphones and electronic appliances looks unlikely given consumer preferences. That would then defeat the objective of promoting Make-in-India through import substitution. The government though, wouldn’t be unhappy, as revenues would keep flowing. So, even if Make-in-India doesn’t get to enhance local production, it remains a convincing ground for raising tariff walls for fetching revenues. After all, the government also has a right to be self-reliant!