Panagariya’s caution may not be correct.
By Chidambaran G Iyer
The author is Senior Fellow, Pahle India Foundation
Import duties can be counterproductive was the caution given by former V-C of NITI Aayog Arvind Panagariya, according to a recent news report in FE (https://goo.gl/3i2Pwe). He mentions India grew at a reasonable pace only after removing protective tariffs and shouldn’t go back to protectionism. There is enough statistical evidence for the point he makes and one cannot argue against it. But probably his opinion on import duty hikes may not be completely correct.
First, the last 20 years have been the golden years for globalisation and the only super power was, until recently, its strong proponent. It welcomed free trade, and India was also a benefactor of this policy. India capitalised strongly on the services side, and services exports from India helped us register the strong growth we had during this period. It is in this context that openness helped us. The political backlash against free trade in the US has tilted it towards protectionism and it has now adopted a tit-for-tat behaviour. Many countries are now taking a similar stance. This implies that a fundamental assumption in economics, namely ‘ceteris paribus’, is no longer applicable—that all the statistical evidence we had from openness in the previous two decades may no longer hold.
In these changed circumstances, India—among the largest markets—is being eyed by many countries for their slice of the pie. With the US closing doors and doing one-on-one trade deals with select countries, it is possible that the excess production slated for the US will find its way into an open India. This has a high chance of dampening our already subdued manufacturing sector. Supporters of free trade will argue that Indian firms need to be efficient to take on the world. This argument would have been valid had the firms been provided with world-class infrastructure at affordable costs, which is absent. Unsurprisingly, there are studies that documented declining productivity in Indian manufacturing during 1991-2001. It is plausible that this trend may have continued during 2001-11.
Second, global capital flows to finance us are slowing—UNCTAD finds that, as a percentage of global GDP, capital flow was 6.9% in 2017 compared to 21.4% in 2007. It also finds that though flows into developing economies rose, these were not in the form of FDI but debt-related flows, cross-border banking, and portfolio debt. In India, the financial system is dominated by banks, which provide capital both to infrastructure and organised sector. Given the huge NPAs of our banks, getting credit at lower costs has become difficult. In other words, local and global capital to finance our creaking cities, manufacturing hubs and organised firms has turned out to be more expensive, which will lead to lower productivity of our firms. This implies that products our firms churn out in an open India will not be able to compete with imports from our Asian peers.
That we have not been able to provide world-class infrastructure at required scale, quarter century after reforms, is a sad commentary on the state of affairs. But, given the aspirations of a demographically young India and a politically-competitive democracy, our policymakers have the unenviable task of creating policies that hopefully will generate enough jobs, and fast, for the 1 million per month addition to the labour force. The hike in import duty, now that countries have turned protectionist, fits the bill perfectly as an immediate response that seems to protect jobs as well as create the perception that the government is doing something.