#254 The Great Splintering

India against digital trade tariff moratorium. US for tariffs on China.

May 12, 2024

PolicyWTF: India’s Counterproductive Stance on Digital Trade and Transfers

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

— Sridhar Krishna & Pranay Kotasthane

(An edited version of this article first appeared in Hindustan Times on 9th May)

India has been at loggerheads with the developed nations and China during the World Trade Organisation’s (WTO) 13^th Ministerial Conference (MC-13) at Abu Dhabi earlier this year. India’s resistance to extending the moratorium on tariffs for digital trade was one point of divergence. We argue that India’s stance is counterproductive, and likely to hurt its most promising economic sector.

The Moratorium

During the WTO Ministerial Conference (MC-2) in 1998, a moratorium on tariffs for electronic transmission was introduced for the first time, and this has nurtured the burgeoning digital trade sector. As a result of this, for example, when a design team in a US chip design house transfers design files electronically to their large team in India for the next level of design, there are no tariffs applicable. When the Indian team transfers the updated design files to a foundry in Taiwan for manufacturing the chip, Taiwan imposes no tariffs on the Indian company. This enabled the chip design to flow seamlessly across borders without additional costs.

Two-thirds of global GDP is in services, yet trade in services accounts for only 23% of world trade. Historically, services were executed and consumed within the same geographical boundaries. However, the advent of digital technologies has disrupted this paradigm. As the world becomes increasingly interconnected, the boundaries between goods and services blur, creating new challenges and opportunities. Trade in digital services globally is at $4.25 trillion and growing faster than any other sector of trade.

Today, a plethora of services can be delivered digitally, transcending borders including software services, customer and sales support through call centres, financial services including insurance, banking and financial consulting, professional services like accounting and management consulting, R&D activities like chip design, online education and training, and even online healthcare like telemedicine.

At MC-13, India’s posture was at odds with digital trade stalwarts like the United States and the European Union member states. They for once were aligned with China in seeking an extension of the moratorium and even suggesting this tariff free trade in digital services be made permanent. It would not be wrong to say that India was isolated in its opposition among the large economies. India’s stance was supported by Indonesia and South Africa.

India’s opposition to free trade in digital services is not completely new. In 2020, India introduced the “equalisation levy” targeting e-commerce giants like Amazon and Facebook. While this move aimed to ensure fair taxation, it also underscores the complexities of taxing digital transactions across borders.

Assessing the Reasons

One stated reason for India’s opposition is that the developed countries today including China dominate the export of digital services and the poorer countries are net importers of digital services. However, India is not a net importer of digital services and hence its stance is even more puzzling. India is the fourth largest exporter of digitally delivered services at $257 billion and it does not seem logical for India to oppose extension of the moratorium of tariff free digital trade. India’s digital exports grew last year at 17% and faster than Germany and China which grew at only 5%. The lesser the barriers for trade, the faster India will grow.

Second, with the distinction between goods and services, fast diminishing, India sought clarity on what falls within the scope of digital trade. As a member of the global south, it claimed it deserved some flexibility. India wanted the option to impose tariffs if necessary. It worried about issues like 3D printing and asked if 3D printing falls under electronic transmission. India was not comfortable with extending the moratorium without clarity on what constitutes electronic transmission and what does not. This position would make sense if India was a net importer of digital services. India’s exports have benefited from the rise of trade in digital services and worrying about insignificant items like 3D printing or e-books or video streaming is meaningless.

Third, India claims that it is losing critical customs revenue and that it needs to protect its domestic companies from unfair competition. By exempting electronic transmissions from duties, India foregoes potential revenue it claimed. Behind the rhetoric, there is unconvincing data. The worst-case estimate of losses to India in potential customs tariff on account of the moratorium is around $1.5 billion according to a research paper by South Centre, an intergovernmental organisation of developing countries, but this is not significant for a country whose digital exports are nearly 166 times that number. A paper was brought out with detailed statistics by Andrea Andrenelli and Javier Lopez-Gonzalez from the OECD Trade and Agriculture Directorate in October 2023 to demonstrate that lifting the moratorium was not in anyone’s interest and especially not in the interest of low income countries. This report shows that the potential fiscal revenue implications of not lifting the moratorium are on average 1.09% of total customs revenue or 0.2% of total government revenue for lower middle income countries like India.

Fourth, some reports conjecture that it is a negotiation tactic. Was India using this as a stick to combat the EU’s CBAM or carbon border adjustment mechanism? If this is more than just a negotiation tactic, India will need to rethink its position. The developed nations support a permanent moratorium claiming it ensures a predictable environment for digital trade. India is already a significant player in digital services and has the potential to grow even further in the future. Instituting protectionist tariffs will not help make its domestic industry competitive. On the other hand, it will reduce incentives for building globally competitive businesses. It will make the cost of consuming digital services more expensive for Indian consumers. It will increase friction in trade in digital services and the diplomatic impact on creating tariff barriers will far outweigh the insignificant increase in revenue from customs duties.

Fifth, and perhaps most important, this move hobbles India’s attempts to integrate itself in global supply chains. Recently a global consortium of semiconductor industry groups petitioned the Indian government to not impose tariffs on data transfer. They said this will impede the flow of chip design data across countries, raise costs, and create shortages. Chip design takes place as a collaborative effort between teams located in different countries and taxation will lead to inefficiencies in the supply chain. This move is at odds with India’s ambitions to play a key role in the semiconductor supply chain.

Despite India's opposition during MC-13, it finally supported the extension of the moratorium on customs duties for electronic transmissions for two more years with the understanding that it would expire after those two years. As we navigate digital trade, let us remember that every tariff decision shapes our economic destiny. The path forward lies in informed policies and data-driven assessments with a commitment to both prosperity, sustainability, and well-reasoned geopolitics. India’s current stance does not hold up to these tests.

Global Policy Watch: The Last (Byte)Dance

Global policy issues relevant to India

— RSJ

While Xi Jinping was doing his best to charm the EU this week, the US administration was busy clamping down on Chinese business interests on American soil. Earlier in the week, President Biden signed into law a legislation that gives Tiktok’s parent, Bytedance, till January 2025 to sell its U.S. operations to a government-approved buyer or face a ban. This legislation found rare bipartisan support among lawmakers in the Congress as classified hearings from various intelligence agencies gave them the ammunition to conclude Tiktok in its current avatar is a national security risk. The concerns seem to be two-fold. One, the sensitive information collected by the app about American citizens is not secure and can easily be demanded for by the Chinese government who have a stranglehold over any Chinese company including Bytedance. The way the Chinese government emasculated Jack Ma and changed the fortunes of Alibaba, one of the biggest success stories to come out of China in the last two decades, is a case in point. How comfortable should any US administration be with the data of their citizens likely to be in hands of a government which wants to challenge the US led global order? Two, there is also the threat of the Chinese party machinery abusing Tiktok’s content recommendation algorithm to spread misinformation and propaganda that foments further political separation in a nation already deeply divided on key issues. The Tiktok algorithm has been called into question in recent days because of the surfeit of anti-Semitic content it seemed to be pushing to the youth in America which many believe is one of the reasons for the student unrest seen across universities.

And soon after this came the news of the Biden administration planning to announce a raise in tariffs on electric vehicles from China from the current level of 25 percent to 100 percent. As the NY Times reports:

“The move comes amid growing concern within the administration that Mr. Biden’s efforts to jump-start domestic manufacturing of clean energy products could be undercut by China, which has been flooding global markets with cheap solar panels, batteries, electric vehicles and other products.
Mr. Biden has previously raised concerns about Chinese electric vehicles, saying that internet-connected Chinese cars and trucks posed risks to national security because their operating systems could send sensitive information to Beijing. He took steps earlier this year to try to block those vehicles from entering the United States. Mr. Biden said last month that he was asking the trade representative, as part of the review, to also raise tariffs on imported steel and aluminum products from China. The president and his aides have accused the Chinese of selling heavy metals at artificially low prices worldwide in order to gobble up market share, to the detriment of American producers.
The fate of the China tariffs has been the subject of intense debate within the White House since Mr. Biden took office, with economic and political advisers often clashing over how to proceed. But this year China has begun ramping up production of the same products — electric vehicles, lithium batteries and solar panels — that the Biden administration has been investing billions of dollars to start producing in the United States. Beijing’s move has re-inflamed trade tensions between the two countries, compelling Mr. Biden to press ahead with more aggressive trade restrictions.”

And if these skirmishes weren’t enough, the US Commerce Department revoked export licenses that allowed chip makers like Intel and Qualcomm to ship advanced chips to Chinese telecom equipment manufacturer, Huawei Technologies. Here’s the Reuters reporting:

“The move comes after the release last month of Huawei's first AI-enabled laptop, the MateBook X Pro powered by Intel's new Core Ultra 9 processor. The laptop launch drew fire from Republican lawmakers, who said it suggested to them that the Commerce Department had given the green light to Intel to sell the chip to Huawei.
Huawei was placed on a U.S. trade restriction list in 2019 amid fears it could spy on Americans, part of a broader effort to handicap China's ability to bolster its military. Being added to the list means the company's suppliers have to seek a special, difficult-to-obtain license before shipping. Even so, suppliers to Huawei have received licenses worth billions of dollars to sell Huawei goods and technology, including one particularly controversial authorization, issued by the Trump administration, which has allowed Intel to ship central processors to Huawei for use in its laptops since 2020.
Qualcomm has sold older 4G chips to handsets since receiving a license from U.S. officials in 2020. In regulatory filing earlier this month, Qualcomm had said it did not expect to receive more chip revenue from Huawei beyond this year. However, Qualcomm still licenses its portfolio of 5G technologies to Huawei, which last year began using a 5G chip designed by its HiSilicon unit that most analysts believe is manufactured in violation of U.S. sanctions.
Critics argue such licenses have contributed to the company's resurgence. Huawei shocked industry last August with a new phone powered by a sophisticated chip manufactured by Chinese chipmaker SMIC, despite U.S. export restrictions on both companies. The phone helped Huawei smartphone sales spike 64% year on year in the first six weeks of 2024, according to research firm Counterpoint. Its smart car component business has also contributed to Huawei's resurgence, with the company notching its fastest revenue growth in four years in 2023.”

So much for all the positives that emerged from a telephone call between Biden and Xi last month which both parties described as ‘candid and constructive’ and the follow-up visit by Treasury Secretary Yellen. The attempts to stabilise the relationship between the two using trade was one big hope among the optimists. Because on politics, given Xi’s stance on Russia, Taiwan and his antipathy to any US role in the Pacific, there wasn’t much to hope for in terms of a convergence of interests. All these measures from the Biden administration in quick succession will have repercussions going beyond the presidential elections and the US economy. There are four issues to consider here.

First, as was expected, Tiktok’s parent, Bytedance, has sued in the US federal court seeking to block the law passed by Biden, arguing that it violates the First Amendment free speech protections. The irony of watching a Chinese company seeking protection using free speech as its argument is beautiful to behold. Anyway, this isn’t a surprise because there’s no way Tiktok is going to find a buyer in 9 months who can stump over US$ 120 billion for the outright purchase while getting an assurance from Bytedance that the underlying algorithm will be passed on to them. Afterall, the app is the algorithm. But there’s no way, the Chinese government is going to allow Bytedance to sell the algorithm even if in some way it was technologically feasible to do so. And if that were to happen in the remotest of possibilities, any existing US company (mostly one among the Big Tech) who can afford to buy a company that’s still making huge losses, will face intense antitrust scrutiny from a regulator who is already breathing down their neck. It is clear to Bytedance that Tiktok will just have to shut down in January 2025. So, they have nothing to lose and will prefer to go down fighting. But the core questions that will come up as part of their lawsuit will have longer term repercussions for the social media space. Afterall, how convinced can the US government be that the data that’s collected by the private US social media companies is safe and not falling into the wrong hands? Or, the algorithm used by them is not biased for or against a political party which can then influence policy and government in future? What’s to stop a future US administration from imposing a similar ban on any US based social media company? Or, asking them to un-encrypt data to hand over to the government or seek approval on the recommendation algorithm to be used? This is all a slippery slope.

Two, if the US sets this precedent then it cannot argue against other countries, like India, persecuting or even banning a US company on the grounds of abuse of data of Indian citizens or manipulating the algorithm against India’s national interests. There are multiple US companies that run data networks, financial systems or media platforms handling huge amounts of data of people around the world. I don’t think any US administration can give an assurance that they will never ask these companies to share their data with them. In fact, much of the regulatory action on Big Tech is to eventually have some kind of governmental oversight on these issues. How comfortable should other countries be with the US government meddling with their data as against the Chinese government doing the same?

Three, eventually all businesses now are gathering data, selling connected devices and ecosystems and using chips to embed themselves deeply within the customer lifecycle. If it all comes down to data and who eventually controls it or the chip and who owns the semiconductor ecosystem, we will see similar actions replicating themselves in various other industries. Everything can be deemed to be a risk in national interest if you think of it hard enough. That’s where this is headed.

Lastly, China has focused on diverting its capital from its beleaguered property markets into green and alternative energy space in a big way since the pandemic. That coupled with lower labour costs, scale efficiencies and all kinds of government support and subsidies have meant that China is leading the world in multiple green energy sectors at a cost of production that’s a quarter of what can be done in the western developed markets. This overcapacity and subsequent overproduction leading to cheap prices won’t be easy for other economies, including in the EU, to shrug off. China will do its best to sign bilateral trade deals and weaken the existing groupings like the EU or NATO. That’s what they are betting on at this moment.

Whichever way you look at it, there’s going to be a continuous splintering of the global value chains and the world wide web. It is difficult to see how to put it back all together.

HomeWork

Reading and listening recommendations on public policy matters

[Podcast] Check out our Puliyabaazi on Building Standards that hinder industrial growth in India
[Essay] This essay by a labour economist, David Autor, on the impact of AI on jobs is worth reading