There is both theoretical and empirical evidence in the economics literature that trade is beneficial for economic growth. India’s own economic history proves that infant industry arguments do not really work.
By Bornali Bhandari & Prerna Prabhakar
With the GDP growth rate falling to 5% in the Q1 of 2019-20, and forecasts suggesting a further fall in the Q2 of 2019-20, there is an urgent need to look at all the demand drivers of economic growth, because that is what is driving the current slowdown in the short run. One of the key channels of demand is the external one. In fact, the year-on-year growth rate of exports and imports of goods and services fell to 1.5% and (-)6.9% in the Q2 of 2019-20, versus 26.1% and 32.9% in the Q1 of 2018-19, respectively. Essentially, we ask two questions in this article. First, what may India do to increase its growth rates of exports and imports? Second, does India have mechanisms present for gainers from trade to compensate losers as it opens up externally?
The current state of affairs is worrisome, especially when we look at it in the context of Indian economic history. We find that the ongoing decade has seen a fall in the average growth rate of exports and imports, but their shares to GDP have risen. The average growth rate of exports in 2010s is lower than in the past two decades, and the average growth rate of imports is the same as in the 1980s. Of course, world trade has also slowed down in the current decade, especially after the 2008 recession. Steps such as demonetisation and the implementation of the goods and services tax (GST) in India took a toll on the Indian external sector. But then how does one explain the rise in the shares of exports and imports. This is a puzzle and clearly a problem for a low-middle income country. In 2017, the share of Indian merchandise exports in total world merchandise exports was 1.7%, and imports was 2.5% (World Trade Organisation, WTO). India ranked 20th in merchandise exports, and 11th in merchandise imports that year. The Indian share in total exports of commercial services was 3.5% in 2017, and for imports it was 3%.
There is both theoretical and empirical evidence in the economics literature that trade is beneficial for economic growth. India’s own economic history proves that infant industry arguments do not really work. Also, the presence of China cannot be held as an argument to hold back India from opening up, because internationally other countries like Bangladesh and Vietnam are benefiting from opening up their economies. However, there are always certain groups within a country that gain from international trade and others that don’t. Mechanisms may be found for gainers to compensate the losers.
One needs to look at the supply and demand sides of both exports and imports to answer the first question. Export supply and import demand are affected by Indian GDP, prices and exchange rates, etc. Export demand depends on rest of the world income, prices and exchange rates. Import supply is assumed to be perfectly elastic.
The recommendations to improve supply of exports have been articulated many a times—improve the competitiveness of Indian products in the global economy. That would involve steps like investing in physical and digital infrastructure, revamping labour laws, filling the skill gaps, facilitating the availability of land at market prices, limiting the administrative procedural delays with regard to various steps involved in setting up or expanding units.
Can India try and improve demand for its products in an environment of trade wars and rising protectionism? It can, by either developing new markets for its products or developing comparative advantage in products for which there is external demand, or being part of global value chains (GVCs). Doing the latter two takes time. As Saon Ray and Smita Miglani’s book ‘Global Value Chains and the Missing Links: Cases from Indian Industry’ points out, India’s engagement with GVCs has been limited, and India’s imports are dominated by intermediate imports. The World Development Report 2020 notes that “a 1% increase in GVC participation is estimated to boost per capita income by more than 1%, or much more than the 0.2% income gain from standard trade.”
The short-run solution is to find India new markets for its exports. In that context, not joining the Regional Comprehensive Economic Partnership (RCEP) may prove to be a costly mistake. Not being part of the RCEP essentially means that, in the short run, 20% of our weak external demand is further dampened. This argument is also supported in a general equilibrium framework in a paper submitted by the National Council of Applied Economic Research (NCAER) to the High-Level Advisory Group (HLAG) appointed by the government of India. Plus, the withering away of the WTO (The Economist, November 28, 2019) means that India is not a part of any significant multilateral trade block.
The second topic is that of exploring mechanisms to compensate groups that do not directly benefit from opening up of trade. Worldwide, there are two ways—either we give unemployment benefits and/or reskill them for different professions. India is in the process of developing fairly sophisticated systems for both. Here, identification of the beneficiaries would not pose a problem. Direct benefit transfers may be used as a mechanism to provide unemployment benefits for a particular period of time to people losing jobs from opening up of India’s external sector. This can be combined with subsidised upskilling and reskilling programmes.
Therefore, the answer to the first question is trying and finding out new markets in the short run, and in the medium run improve both export supply and demand conditions. In response to the second question, India is developing quite rapidly in both social security and skilling mechanisms.
Bhandari is senior fellow and Prabhakar is associate fellow, NCAER. Views are personal