CAN INDIA AFFORD PROTECTIONISM?
India’s recent efforts at Protectionism may not solve its trade concerns.
By Tarini
In his seminal 2017paper, “Protectionism: This Good Bad Word,” published by the European Scientific Journal, Gabriel Anibal Monzon, Technical Secretary of the Parliamentary Confederation of the Americas, University of Flores, Argentina, tries to trace the roots of economic Protectionism.
As per him, the controversy about the origin of economic Protectionism has been generalized since the emergence of the international trading system. Subsequently, this is with the advent of the concept of country. Also, it is closely linked to Mercantilism. As a main reference, it provoked the general and erroneous idea that the natural thing is Liberalism.
From the origin of the tribal economies, a concept of necessity and opportunity existed. Inside the tribe, the needs were solved in solidarity. When the absence of any element could be provided by another tribe, an exchange (barter) system based on Protectionism was generated. As a result, the tribes sought what they lacked and traded what was left over. That way, no one could think of putting aside what he needed to deliver for something he did not. When any "stranger" wishes to appropriate something necessary for him and not surplus on the other side, disputes tend to arise. Therefore, this has not changed beyond the years and forms.
The adherents to liberal economic thought state that there must be non-intervention of the State; any protectionist measure is unnatural and will only have harmful effects. As a result, they try to explain that Protectionism involves tax increases, loss of jobs, price increases, debt crisis, and transfer of income in the hands of a few.
Today, India confronts the same dilemma. While India’s recent tariff hikes aim to boost local production, they may not be the answer to trade concerns, and there may also be a fallout. India's Protectionism could cost it the chance to participate in important global supply chains such as those for smartphones and consumer electronics.
India’s Tariff Trajectory
Since its economic liberalization in the 1990s, India has increasingly integrated with the global market. India’sopenness to trade (measured as a trade-GDP ratio) increased from 14 per cent in 1991-2 to 41 per cent in 2017. India had been proceeding towards lower tariffs; the average tariff rate was reduced from 125 per cent in 1990-91 to 13 per cent in 2014-15. The export basket diversified from traditional primary and agricultural products to value-added products like engineering goods and pharmaceuticals.
Since 2014, there have been 3200 tariff increases, with the most significant increase in 2018. After 2018, India has consistently raised its tariffs. These tariff increases have reflected the government’s Aatmanirbhar Bharat or Self-reliant India approach. Between 2017-19, tariffs increased for 2319 items. The average tariff value increased from 13.5 per cent in 2017 to 17.3 per cent in 2019. This average tariff rate level is significantly higher than in other Asian countries like China, Vietnam, and Bangladesh. Today, India’s tariffs, at an average of 18 per cent, are amongst the highest in the world.
India also refused to join the Regional Comprehensive Economic Partnership (RCEP), a Free Trade Agreement (FTA) among Asia-Pacific countries signed in 2020.
The mobile phone industry presents a good example. Since 2018, New Delhi has departed from 20 years of trade openness and increased duties, notably on mobile phones and components like Printed Circuit Assembly Boards (PCBs) and display units. The smartphone manufacturing boom mostly featured assembling finished goods. Most value addition and crucial parts were built in China, South Korea, Japan, or Vietnam. Even with booming smartphone exports, India was importing more electronics. Making flexible PCBs in India is 8-10 per cent more expensive. The government subsidy on domestic production has not been sufficient to offset the cost gap between China and Vietnam. Meanwhile, China and Vietnam import electronic inputs duty-free. For India, a 10-15 per cent tariff is the norm.
Mobile phone manufacturers have criticized the high tariffs on parts like circuit boards and chargers. This discourages companies looking to de-risk supply chains away from China. Countries like Vietnam, Thailand, and Mexico are lowering tariffs on phone components as they vie to attract phone manufacturers.
In the recently unveiled Budget, the basic customs duty (BCD) on mobile phones, PCBs and mobile chargers has been reduced to 15 per cent from 20 per cent. This has been hailed as a positive step supporting growth and competitiveness. However, the BCD on PCBs for certain telecom equipment has increased from 10 to 15 per cent. The Budget has also provided exemptions from import duties for a range of input items, raw materials, and capital goods. The Budget further proposes to exempt 25 critical minerals from customs duties. Critical minerals like lithium, copper, cobalt, and rare earth elements are crucial for sectors like renewable energy, space, defence, telecom, and electronics. This will help India build processing and refining capacities and secure access to strategic and important sectors.
Tariffs Across Sectors
Tariffs have been increased across a range of industries. There has been a significant tariff hike on sewn products, footwear, and textiles, over which India has a comparative advantage. While tariffs can be justified on the grounds of protecting an infant industry, tariffs in labour-intensive sectors where India has a competitive advantage point to a protectionist policy.
Tariffs have also increased significantly for steel and transport equipment where there is a domestic production base.
Capital goods have witnessed an inverted duty structure, meaning that tariffs on imported finished goods are lower than on raw materials used to make capital goods. This makes importing capital goods into India cheaper than buying domestic goods. The domestic cost of production has gone up as tariffs target steel and electronic imports, mainly supplied by China. These goods are essential raw materials for the production of capital goods. China can produce them cheaper due to its economy of scale.
Are Tariffs the Solution?
The government justifies tariffs on the basis that they promote local manufacturing. However, in the long run, they can threaten the competitive strength of industries. Proponents of tariffs argue that they allow domestic industries to improve their exports. However, a tariff regime does not necessarily help; most imported goods are usedto make export products.
While India has faced disadvantages with FTAs and the trade deficit, FTAs may not be entirely responsible for skewed exports. In the years when India was a more open economy – 2004-2005 and 2009-2010, exports were growing faster than GDP. Between 1995 and 2018, export growth was witnessed at an average of 13.4 per cent annually, the third highest in the world.
True, India’s growing trade deficit with three FTA partners and China is a cause for concern. However, this is not just due to increased merchandise imports but also because India’s merchandise exports are unable to access global markets.
Moreover, the increasing tariffs did not cause overall imports to fall. Import growth rates fell in the period 2013-2016 but again grew by 24 per cent and 39 per cent in subsequent years. Further, this decade has witnessed 8 per cent export growth compared to 17.3 per cent in the previous decade.
RetaliatoryTariffs
While increased tariffs have good intentions – encouraging local manufacturing – they lead to retaliatory measures by major trade partners such as the U.S. and UAE.
Retaliation on tariffs usually targets products where demand is more elastic. Countries raise tariffs in sectors where they are concerned about external dependence. For India, manufacturing materials like electronic items and metals are usually targeted for tariff hikes. However, India’s trade partners raise tariffs in sectors where they face a trade deficit. For instance, the U.S. retaliated by raising tariffs on textiles, where it has a sizable trade deficit with India. Consequently, India’s textiles and clothing sector faced difficulties due to tariffs. Export growth fell due to retaliatory tariffs.
Seizing the Moment
The ongoing shift in global supply chains provides a rare opportunity as there is a stand-off between Beijing and Washington, and the pandemic disrupted traditional supply chains. India must seize the opportunity as businesses diversify away from China.
Restricting imports will cut India off from global supply chains and factory networks that require free movement of goods. A tariff regime hinders the free movement of goods and prevents industry from functioning smoothly.
High tariff barriers don’t just hurt producers and their exports but also hurt consumers by making goods more costly and encouraging inefficient domestic players. The protectionist policy may not work in the long run, given that a sizable lower-income class can’t afford higher-cost domestic goods.
It also increases business uncertainty and discourages investment, making it challenging for smaller companies to access finance.
Chinese imports have particularly been targeted due to border clashes and strained ties. This affects domestic producers because Chinese imports account for a substantial share of input items and capital goods. It reduces the competitive edge of goods in important sectors like electronics and pharmaceuticals.
Assessment
India's recent Protectionism has featured tariff raises across a range of industries, including those where it has a competitive advantage.
It could reduce access to global markets and supply chains, harm the competitiveness of exports, hurt consumers, discourage investment, and lead to retaliatory tariffs.
It could also prevent India from harnessing the opportunity to benefit from changing global supply chains.
India should encourage an open ecosystem to allow for global practices, technological exchange, and access to global markets. This will help it modernize its industry and overcome structural obstacles to growth, such as supply limitations and low productivity.
However, the recent Budget indicated a shift, which is a good sign.
