Paul Krugman?s Nobel award has refocused attention on determinants of international trade. Modern trade is not only guided by scale and efficiency, it is also shaped by incentive structures. Trade patterns of countries are often different from what their resource endowments and economic characteristics would typically suggest.
India is one of the best examples. Its oil dependency is well-known. It doesn?t produce enough crude oil and imports three-fourth of its requirements. Yet, petroleum products are India?s leading exports. In 2007-08, such exports stood at $28.4 billion. This was 17.4% of the country?s total exports. Petroleum products have overtaken gems and jewellary as India?s topmost exports. At the same time, India is also importing both crude and refined products. Petroleum imports are 31.7% of India?s total imports. They have overshot electronic items as India?s main imports.
Exports and imports include some common items. These are high speed diesel (HSD), aviation turbine fuel (ATF) and motor spirit. Other refined by-products like fuel oils also figure either way. So why does India import those oil products it exports?
Traditional theory suggests that exports are residuals. Whatever is left after meeting domestic demand is exported. Similarly imports are meant to bridge gaps between domestic production and consumption. But then why is India importing the same stuff it is exporting?
The paradox can be explained by market dynamics and incentive structures. Higher exports of refined petroleum products like HSD and ATF are linked to their higher outputs. With a large increase in India?s refining capacity, the domestic production of refined products has gone up sharply. But incentive structures have produced distortions splitting the output from public sector oil companies and private refineries in different directions. Only the HSD and ATF from public sector companies are reaching the domestic consumers.
Public sector companies have more than 80% share of the domestic petroleum market. They follow administered prices that do not change in line with global changes.Even if global crude prices rise, these companies do not pass on the rise to consumers. But private refiners have to pass on higher costs to consumers through higher prices, which makes them uncompetitive in the domestic market. Consumers don?t distinguish between ?public? and ?private? as long as the qualities are broadly similar. They would always opt for the cheaper variety. So what do private refiners do? Withdraw from the domestic market and look overseas. Practically the entire refined private output from India is being exported, with UAE and Singapore being the two main destinations.
Diversion of this output has created imbalances. India?s rapid growth in recent years has increased demand for refined petroleum products, with car sales, air travel and engineering industries being its main drivers. Thus India has been importing HSD, ATF and motor spirit also. Lower shipping costs and logistic advantages make Singapore an important source of these imports. Refined products sourced from several other countries are also being routed through Singapore as re-exports.
Krugman had underlined economies of scale and the resultant production efficiencies as main determinants of trade. India?s refining industry has achieved both. But these do not tell the whole story of India?s petroleum trade. Domestic market incentives play a key role here. If these incentives had been otherwise, then petroleum exports would have been much lower. Proponents of modern trade theory didn?t anticipate such opportunity costs. They are not to be blamed. It is difficult to conceive that economies of scale will co-exist with such counterproductive incentives.
But that?s how the oil market works in India. Till these incentives persist, the current trade pattern won?t change. India will keep importing what it exports. And will continue to confuse theorists in the process.
?The author is a visiting research fellow at the Institute of South Asian Studies at the National University of Singapore. These are his personal views