#59 What Do We Talk About When We Talk About India Growth Story
Eking out 6 per cent growth, export incentives and environmental clearances
This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?
Welcome to the mid-week edition in which we write essays on a public policy theme. The usual public policy review comes out on weekends.
— Raghu Sanjaylal Jaitley
I like to read Anantha Nageswaran’s The Gold Standard blog. He reads a lot and offers fresh perspectives on issues. Also, he isn’t beholden to any dogma.
In his latest post, he makes three points that lead to an interesting, if contentious, conclusion:
Growth environment globally has turned unfavourable. Developed economies with huge national debts have overdrawn from their future. The popular opinion on immigration and free trade has soured. These economies can’t power the growth of export-oriented emerging markets anymore
There’s no reason to paint a doom and gloom scenario for India. We are resilient and our businesses are confident about our future. We haven’t used up all the arrows from our fiscal and monetary quiver. We have headroom to stimulate growth
There is an international leadership vacuum because of the uncertainty the US faces at this moment. Anantha argues if we can manage our economy well and offer a credible counterpoint to China, we could come out of this with our global reputation enhanced. He cautions against going back on tried and failed policies specifically calling out the dangers of pushing protectionism beyond a point where it will hurt the society
What surprised me was the conclusion he draws from these points. In his words:
“In this environment, eking out growth rates of around 6% (in inflation-adjusted terms) per annum for the next decade or two will be highly creditable. Aspiring for anything higher, given the above scenario, would induce policy errors and make the medium to long-term growth situation all the more irretrievable.”
We have a history of underachieving any targets we take for ourselves. Setting a low bar on growth will diminish any urgency for policy changes. The fear that a more aggressive target will induce policy errors doesn’t have any historical basis. Our policy errors have been largely on account of egregious state interventions and political ‘masterstrokes’ (bank nationalisation, demonetisation etc) that tend to be bad for the economy. As much as India has a way of confounding experts, we’d say the U.S. has a greater ability to do so. There will still be a global opportunity for growth and considering India’s relatively low share in global trade we shouldn’t be happy eking out 6 per cent kind of growth.
Production Linked Incentives And Lessons From Past
That leads me to the government’s announcement on Production Linked Incentives (PLI) for mobile phones and other specified electronic components. The Indian Express reports:
As a part of the National Policy on Electronics, the IT ministry had on April 1 notified a scheme which would give incentives of 4-6 per cent to electronics companies which manufacture mobile phones and other electronic components such as transistors, diodes, thyristors, resistors, capacitors and nano-electronic components such as micro electromechanical systems.
According to the scheme, companies that make mobile phones which sell for Rs 15,000 or more will get an incentive of up to 6 per cent on incremental sales of all such mobile phones made in India. In the same category, companies which are owned by Indian nationals and make such mobile phones, the incentive has been kept at Rs 200 crore for the next four years.
The government had another export promotion scheme called the Merchandise Exports of India Scheme (MEIS) that was running since 2015. How has MEIS fared? From the Business Standard
Senior government sources say public tax liability under the MEIS ballooned from Rs 20,232 crore in 2015-16 to Rs 43,500 crore in 2019-20, becoming unsustainable. However, exports remained stuck at $313 billion in 2019-20 against $310 billion in 2014-15.
The government is still debating the merits of MEIS or bringing it in another form. The problem with MEIS isn’t too hard to figure:
There’s no concept of supporting only those sectors where we have a comparative advantage. What this has meant is over time it covered 75 per cent of all traded goods. This is insane. We can’t be globally competitive in 75 per cent of what we export. The incentives don’t matter if the products made by our manufacturers aren’t competitive in the global marketplace.
The goal of the government department that’s running the scheme is to increase exports. As a lot of our manufacturers weren’t able to compete globally despite the incentive, they started demanding more incentives to make up for it. The department had no choice but to increase the incentive because they wanted exports to grow. As Business Standard reports:
“Gradually, the scope of the scheme got widened. The country differentiation was removed and MEIS rates were liberally increased. Over a period of time, MEIS was given at rates varying from 2-20 per cent.”
Lastly, the scheme ran afoul with WTO who in Nov 2019 ruled against India saying it was a case of providing direct export linked subsidy. India was asked to discontinue this within four months.
The PLI scheme announced by the government suggests we have learnt from this experience. So far, the intention is to restrict PLI to five sectors where we have a comparative advantage. The PLI also focuses on incremental sales (with the base year 2019-20) to link the incentives to avoid giving incentive for legacy business. Also, by linking incentives to sales and not directly to exports, it has ensured it won’t run into trouble with WTO guidelines. The threshold of Rs. 15,000 for the price of a mobile phone at which further incentives will be given is clever drafting considering such phones will mostly be exported. Indian mobile phone market is predominantly sub-15,000 market.
The government should avoid what Anantha calls ‘tried and failed’ policies in running the PLI schemes. First, it shouldn’t be tempted to increase the number of sectors where PLI will apply. Second, it must not increase tariffs on input raw materials or intermediates which go into the manufacture of the mobile phone. This is critical because there is a possibility we might be giving a manufacturing incentive while simultaneously increasing the raw material costs. Third, there are many examples of inverted duty structure in this sector where the finished product has a lower import duty than its intermediates. We must correct them. Also, there is a possibility that the Rs. 15,000 threshold for claiming an incentive could mean the companies at the margin increase their prices in collusion. This could increase the prices of phones in domestic market.
Finally, a PLI is not a panacea. The manufacturers will weigh the benefits of 4-6 per cent of incentives on incremental sales with the costs of doing business in India. The costs include our inadequate port and logistics infrastructure to export goods, dealing with the regulatory cholesterol of manufacturing in India, import tariffs and various labour laws. At this moment, these costs aren’t insignificant, and they will be the real determinants of success of any such scheme.
EIA Draft: Growth Vs Environment Trade-Off
The draft Environment Impact Assessment (EIA) notification was issued on March 12 this year. The draft was open for public feedback and comments till August 11. It received a record two million comments in five months. There are two contentious points in the draft notification that has evoked strong reactions.
First, the notification allows the government to grant environmental clearance to projects after they have started work without an official clearance so long as the violators work on remediation and resource augmentation plan. This plan should correspond to 1.5 - 2 times the ecological damage assessed and economic benefit derived. This how it reads:
“The Appraisal Committee shall stipulate the implementation of EMP, comprising remediation plan and natural and community resource augmentation plan corresponding to the 1.5 times the ecological damage assessed and economic benefit derived due to violation in case of the suo moto applications or two times the ecological damage assessed and economic benefit derived due to violation in cases reported by any Government Authority or found during the appraisal of Appraisal Committee or during the processing of application if any by the Regulatory Authority, as a condition of Environment Clearance.”
Further, it states violations can only be reported by the government or the sponsors of the project, not by citizens.
Second, there are about 40 types of industries that are exempted from environmental clearance including projects that the government might term ‘strategic’. There are other exemptions including road and pipeline projects in border areas (within 100 kms from LAC), construction project of up to 150,000 sq mts and inland waterways and highways work.
Development versus environment is a trade-off even if this idea doesn’t sit well with environmental activists. Taking an absolutists position on any side of this debate is impractical. We will come to two examples of why absolutist positions don’t work at the end of this post.
So, the question is how to think of this trade-off. We have four points to offer:
The way a $2000 per capita income country thinks about the environment can’t be like that of a $50,000 per capita income country. Our state capacity is smaller, we have limited resources and our people remaining poor doesn’t help the environment either. There is also a moral imperative of saving lives here and now while weighing the long-term impact of environmental damage. So, merely imitating or benchmarking with the global standards of environmental clearance is fraught with risks. We won’t help the environment because we won’t have the capacity to manage a sophisticated law that’s not meant for us. And we won’t help with the growth of economy either.
Considering our state capacity, it is impossible to assess every single project upfront and clear them. This is the equivalent of wanting to scrutinise every single individual tax return. It doesn’t make sense. It is useful to have high penalties for violations and have the ability to do a post-facto clearance. The debate can be on whether the penalties are stringent enough. So, this idea that post facto clearances are a complete anathema needs to be thought through. We have had the experience of clearances becoming either means to rent-seeking or being hostage to policy paralysis in the early part of last decade. It helps no one.
The more the exceptions in the law, the easier it is to be violated or abused. The number of industries exempted and the catch-all nature of the term ‘strategic’ should be debated. It has to be narrowed. Else, there will be a market for getting a project exempted which will negate the purpose of the law. A smaller list of exceptions is easier to monitor
The violations can be taken up in courts of law by individual citizens or environmental groups. To keep the door open for anyone to report a supposed violation which then needs to be investigated by a committee is impractical considering our state capacity
Finally, we should learn from two of our experiences in the past decade.
First, the environment clearances all but stopped during 2011-14 for various reasons. We aren’t sure of the environmental benefits we accrued as a society because of it. However, what it meant for our growth is clear and there is data to show this. Private investments fell, infrastructure development slowed, companies who had taken debt to fund these projects suffered, banks ran up large NPAs and growth faltered. A 1 per cent rise in our GDP per capita lifts about 3 million Indians out of poverty as pointed out by Shruti Rajagopalan in the Mint. Over a decade we might have lost the opportunity to lift over 50 million out of poverty. There were other reasons too but there’s no denying this contributed too in a large way.
Second, and we are admittedly stretching logic a bit here, the pandemic lockdown was good for the environment from an absolutist perspective but the humanitarian impact of it in a poor country like India is quite evident to all. Over 120 million Indians have been impacted with most losing better-paying jobs in urban Indian and forced to migrate back to their villages.
When we think of our trade-off between growth and environment, it is useful to keep these in mind.
HomeWork
Reading and listening recommendations on public policy matters
[Paper] A 1977 World Bank paper by Bela Balassa that has a comparative analysis of export incentive schemes of 11 developing countries and their impact on comparative export performance and economic development. Summary: “Economic growth has been the most rapid in countries such as Korea, Singapore, and Taiwan, which more nearly conform to the "ideal" system of incentives described in Section III of the paper. The three countries provided a free trade regime for exports and ensured stability in the incentive system over time. They also granted comparable incentives to exports and to import substitution in manufacturing while there was little discrimination in primary activities.”
[Podcast] Tyler Cowen in conversation with Charles Mann on environment, development and limits of growth.
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