(From the archives) The Trade Policy Ensemble
No Exports Without Imports
Programming Note: We’re on a short summer break. This edition is a compilation of some old posts that can help make sense of some current debates. Normal services resume on 30th April.
On 31st March, the Ministry of Commerce & Industry launched a Foreign Trade Policy 2023. By all accounts, it is meh. The government believes that increasing exports doesn’t require any significant changes in the tariff structure. Some more export incentives, a one-time amnesty scheme, and some duty exemptions are all that India needs to increase exports.
We hope the government is right. We fear it isn’t. Increasing exports also requires embracing most imports. The government doesn’t seem to acknowledge this connection yet. So here’re a few posts where we have written about this linkage.
India Policy Watch: Cheeni Kum? (from Edition #40)
Insights on burning policy issues in India
— RSJ and Pranay Kotasthane
Ban Chinese goods; teach them a lesson.
There is a momentum to this idea in public discourse these days. There are two camps here. The first runs on emotions. China is a mortal threat to India. They are the aggressor at LAC now. They are duplicitous; they lied to the world about the coronavirus, and now they are profiting from it. In any case, ‘China ka maal’ is a shorthand for poor quality. We must teach them a lesson by boycotting their products. This is our national duty.
The other camp is more nuanced. We must develop our manufacturing base. China isn’t a free market paragon. Far from it. It is a centrally controlled economy with limited market price mechanism. They control their currency, and they have used duties and tariffs to become the world’s factory. We have let Chinese products flood our markets for long. We are in the midst of a crisis now. There have been historic job losses. Why import now? This is the time to support our companies and our people. We must substitute Chinese imports for domestic goods. This is our moral duty.
Sonam Wangchuk’s now-viral video series straddles both these camps. Not buying Chinese goods is a moral duty that we owe to the Indian nation, he claims.
Economics and Morality
Both are flawed economic arguments. When I say this, I’m often told there are things that go beyond economic reasoning. Virtue, nation, friendship and love; to name a few. Economics must not overstep its bounds. That free individuals pursuing their self-interest will lead to socially beneficial outcomes can only be true for the economic domain. Not for others. I get these counters, but I don’t agree with them.
First, sound economic reasoning is based on what’s good for the individual, the society and the nation. Good is subjective and, often, relative. Economics tackles this by identifying all choices and their trade-offs. The trade-offs (economic, social or political) are quantified and then compared to reach the most optimal decision. If all dimensions of trade-offs are included, the resultant is, in fact, moral.
Second, economics, as Alfred Marshall wrote, is the study of people in the everyday business of life. You can try and keep economics out of other domains, but those domains will infringe on economics since they deal with people. Economics and morality aren’t engaged in mortal combat. They are the same.
In The Theory of Moral Sentiments, possibly, the greatest work of philosophy during the Enlightenment, Adam Smith wrestled with this dichotomy and concluded with clarity:
“The respect which we feel to wisdom and virtue is no doubt different from that which we conceive for wealth and greatness. It requires no very nice discernment to distinguish the difference. But notwithstanding these differences, those sentiments bear a considerable resemblance to one another. In some particular features, they are no doubt different, but in the general air of the countenance, they seem to be so very nearly the same that inattentive observers are very apt to mistake the one for the other.”
To wit, sound economics is moral.
More to Lose
How should we look at the India-China trade relationship? A simple way is to look at the share of each country in the exports and imports of the other. India imported $75 billion worth of goods from China in 2019. This is just 3 per cent of China’s total exports. But for India, this is 16 per cent of its imports. This share is higher if we exclude oil and defence imports where China isn’t a producer (oil), or we have a policy not to buy from them (defence). So boycotting Chinese goods to teach the CCP a lesson would be as effective as getting Virat Kohli to bowl out Steve Smith.
(Source: WITS)
Now on the other side, India exported about $18 billion worth of goods to China. This is 5.3 per cent of its exports. For China, this is only 0.9 per cent of its total imports.
You can see how the dependence is skewed. Also, what do we import from China? In the popular imagination, it is cheap toys, plastic goods, mobile phone knock-offs, firecrackers and diyas. In reality, it is electrical machinery, nuclear plant equipment, chemicals, jewellery and plastic goods.
(Image and data source: OEC)
But gross trade is a crude measure in a world where the global value chains (GVCs) are inter-meshed. Open up a Chinese phone; you will find it barely Chinese. Conversely, the inside of a Japanese TV could be all from China. Almost anything we use in everyday life is likely to have a Chinese part within it, regardless of its provenance. In this world, ‘what you make’ is more important than ‘what you sell’. The integration of a country with the GVCs and its position higher up the value chain are important measures of economic performance.
It is not gross trade in finished goods but trade in value-added (TIVA) that reveals the true nature of economic interdependence between countries. One metric of TIVA is the foreign value-added (FVA) content of gross exports. Simply put, the role of imports in export performance. Both India and China have about 17 per cent of FVA content in their gross exports.
There is an important detail within it. China is the single biggest contributor to FVA in India’s exports, at 34 per cent. What does this mean? About $16 billion out of the $75 billion we import from China goes into our exports (* an earlier version had this at $27 billion. A sharp reader, Lakhan Dhingra, pointed out the error). India’s share in the FVA of China’s exports, in contrast, is a mere 2.4 per cent. So, China is important because we depend on its intermediate products to export our finished goods. (data source here)
So, who has the most to lose from cutting off trade ties with China? Don’t answer; it’s a rhetorical question.
Boycott or Learn?
Let’s pause here for a moment. One question that jumps looking at these figures is why we have become so dependent on China. Shouldn’t we decouple from it? The answer is no one forced us. China worked for over two decades to develop its manufacturing base. It did so not by boycotting products or raising import tariffs. Instead, it did the opposite. It integrated itself with global trade networks and value chains by making it easy for others to do business with China. It started from low-end products and over time, innovated and went up the value chain. It became an indispensable trade partner for most large economies. We don’t have to boycott China; we need to learn from its manufacturing success.
The Trade Deficit Problem
Another reason commonly used to justify the ban on Chinese goods is India’s trade deficit with respect to China. Now, despite the rap that the term gets, a trade deficit is not inherently bad. It just reflects macroeconomic factors such as trade competitiveness. For more on this, read this excellent short article on WEF.
Regardless, one can argue that India’s trade deficit with respect to China also has a geopolitical dimension because of the nature of the Chinese State and its arrogant displays of coercive power. This is a fair point. But here again, tariffs and bans won’t help. Niranjan Rajadhyaksha has tackled this problem here in Mint:
Bilateral tariff wars are not the solution because Indian consumers will merely buy from other countries, or China can channel its exports into India through third countries such as Hong Kong.
(Instead, India needs to) rein in its domestic macroeconomic imbalances on one hand and build competitive industrial capabilities on the other.
(Also), large global investment projects will be the key. The larger lesson is that such industrial projects should help India plug into global supply chains, and use them as conveyer belts for exports of manufactured goods.
The Wrong Time
The other question is if we have to indeed decouple from China, is this the best time? China is the first major economy which is back to a degree of normalcy post-Covid. Over the last five years, it is transitioning from an export-led to a domestic consumption-driven economy. India has seen its demand collapse during the lockdown. The supply chains are still dislocated, and migrant labour will take time to come back. There is a real possibility of inflation over the next year. Boycotting Chinese goods in these times will increase prices and deepen the demand shock. It will also make our exports in many areas non-competitive exactly when we are looking for newer markets.
Also, a tit-for-tat response from China may see our exporters being shunted out of the growing domestic market in China. This will be a lost opportunity for industries like pharmaceuticals, chemicals, IT and agriculture produce where we have a comparative advantage.
We might face-off with the PLA at Ladakh, but that shouldn’t mean an economic war with China. This is a complex, interconnected problem. It has no single, easy emotional solution. We can’t teach China a lesson using tariffs and bans without falling on our own sword (to mix metaphors a bit).
This Business of Boycotting Foreign Goods
India has a storied history of boycotting foreign products. Following the partition of Bengal in 1905, the Swadeshi movement took off as a way to hurt Britain economically. Cheap clothes, sugar and other goods made in the factories of Manchester and Birmingham had begun flooding Indian markets. The Congress-led public bonfires where people volunteered to burn their made-in-Britain goods. Gandhi drew inspiration from this and made Swadeshi a national cause. The charkha (spinning wheel) became the symbol of self-reliance and of shunning foreign goods.
How did the Swadeshi movement fare? It had limited political success but charkha and khadi found emotional resonance among people. Its impact on the economy of Britain doesn’t register at all in the records. And it certainly didn’t help the Indian industry because it wasn’t just British goods but the idea of industrialisation that India boycotted. In fact, you could argue the Swadeshi movement set India back on its road to industrialisation. As Gandhi put it,
Machinery in the past has made us dependent on England, and the only way we can rid ourselves of the dependence is to boycott all goods made by machinery. This is why we have made it the patriotic duty of every Indian to spin his own cotton and weave his own cloth.
Tagore, who led the protest against the partition of Bengal and supported the swadeshi brigade initially soon backed out of it. Tagore had seen first-hand in Bengal how the Swadeshi movement hurt the poor and the marginalised. The British factory-made goods were cheaper, better and readily available. Many among the marginalised worked in factories or farms that exported raw or semi-finished material to Britain. There were hawkers and shopkeepers whose businesses depended on foreign goods. These people suffered. In his famous work, Ghare Baire (1916), Tagore explores multiple dichotomies – a woman’s place at home and in the world, tradition and modernity, western and oriental values and, interestingly, swadeshi and videshi goods. In it, he lays bare the moral duplicity and hollowness of the Swadeshi leaders. The Swadeshi movement, according to Tagore, had turned xenophobic and chauvinistic with no spiritual or moral centre. He wrote scathingly about this in his 1908 essay, Shodupaye (The Right Way):
“A few days ago, a letter arrived from the provinces saying that in a large market, traders had received a notice stating if they do not comply with the Boycott of foreign goods, their stalls will be set on fire. In some places such notices have been followed by arson. …. It is indeed sad that for some of our educated men this kind of oppression is not wrong. They have decided that such terror tactics are necessary for the good of the country. It is useless to talk of justice to such men. They claim that what is done for the sake of the country cannot ever be unjust, an ‘adharma.’ But even to a perverse mind we should repeatedly reiterate that injustice cannot be good for a land and for its people…” (contd)
“This is the reason why I say that the greatest curse upon the country is not foreign cloth but this quarrel within it. Nothing is worse than one section of the populace enslaving the opinions of another through force and against their will…”
Tagore was no economist. He saw the boycott as a moral issue, and he opposed it. He reached the same conclusion as Adam Smith – economics and morality are the same.
There’s a moral and economic lesson for us today as we seek to boycott Chinese goods.
India Policy Watch: The Problem with Protectionism (from Edition #155)
Insights on burning policy issues in India
— Pranay Kotasthane
Policy success, like beauty, lies in the eyes of the beholder. One such policy success that’s been talked about a lot of late is the increase in mobile phone production in India. The narrative underlying the success is that through a prudent mix of protectionism and industrial policy instruments, India has been able to reduce its mobile phone dependence on other countries, particularly China.
This deemed policy success is now being seen as the playbook for many other manufacturing sectors such as electric vehicles and pharmaceuticals. For instance, see this excerpt from Nilesh Shah and Pankaj Tibrewal’s article titled The mobile phone sector has lessons for India’s economy:
“We were one of the largest consumers of mobile phones in 2014. In 2014-15, our mobile phone imports exceeded $8 billion. Our electronics imports were threatening to exceed our oil imports. The government took many steps like 100 per cent automatic FDI, levy of import duties to protect local manufacturers, the Phased Manufacturing Plan (PMP), manufacturing clusters (EMC 2.0) and the Production Linked Incentive (PLI) scheme. Despite some execution challenges on the ground, these steps have developed our mobile phone manufacturing base. They have attracted investments, created lakhs of jobs, and have moved us from being a net importer to a net exporter.
Our mobile phone manufacturing value has jumped more than eight times from Rs 0.27 trillion in 2013-14 to Rs 2.2 trillion in 2020-21. Samsung runs the world’s single-largest location mobile handset manufacturing plant in Uttar Pradesh. We have surpassed the US and South Korea to become the second-largest manufacturer globally.” [Indian Express, Jan 20]
Impressive, isn’t it?
By now, you already know there’s going to be a “but” somewhere. So here it is.
Judging a policy based only on the benefits it brings is possibly the most common mistake in policy discussions. To understand the complete picture, we also need to analyse the costs.
What about the Costs?
Of the policy instruments used, allowing 100 per cent FDI through the automatic route is an unequivocally positive step. And we have dealt at length with the promise and perils of the mushrooming PLI schemes in editions 86, 118, and 153.
In this edition, we will limit the discussion to the third instrument in the armour: increasing import tariffs.
The modus operandi seems to be somewhat like this. Through the Phased Manufacturing Program (PMP), the government increases import duties on final consumer products such as mobiles, chargers etc. This leads to import substitution because products assembled in India (even with imported parts) start to become cost-comparable to duty-levied imports. Every year, the government keeps adding new products to this PMP list, with the objective of increasing the number of final goods that are assembled in India. The final aim and hope are that these assembly units will become the nuclei for a complete manufacturing ecosystem over time.
No, the costs of this strategy are being borne by two sets of Indians.
The first losers are all consumers. Higher import duties mean that mobile phone prices have been increasing. The absolute increase isn’t alarming at first sight, to be frank. But electronics prices commonly fall sharply with improving technology, and that has certainly not happened for phones over the last five years. Vivek Kaul has explained the cascading effect of this price rise here:
When an individual spends more on something, she cuts down on expenditure in some other area. Given this, if one business benefits due to protectionism, another business or other businesses, lose out in the process. It’s just that this is not so obvious in the first place and hence, is the unseen effect of protectionism.
Second, the Indian manufacturers themselves have been under the pump because of rising tariffs for mobile phone parts. The lure of protectionism is such that it quickly spreads from final products to intermediate inputs. Soon, it was felt that not just mobile phone makers but domestic manufacturers of camera modules and connectors should also be ‘protected’. The result — not surprisingly — the import duties are now negating all the benefits provided under the PLI schemes. Manufacturers are still unable to compete in export markets because the parts they import have become costlier. A recent comparative study analysing import tariff regimes of India, Thailand, Vietnam, China, and Mexico puts this well.
The main difference in their policy approach is the tariff policy of India compared to others. India has relied heavily on higher tariffs whereas other countries have not done so. Higher tariffs orient the approach of investors and domestic producers away from global markets and towards the domestic market. Notably the exports for India compared with others have remained low as has been examined in this report.
This is a crucial point. While the various incentives and protectionism has been successful to the extent that imports of phones have reduced, we are still far away from becoming a competitive exporter. Have a look at this chart I made from government data on mobile exports.
As you can see, India’s mobile phone exports fell sharply from FY15 to FY18 with increasing tariffs. Though exports in absolute terms have picked up in the last three years, mobile phones as a share of India’s total exports is still below what was achieved way back in FY09!
Going ahead, India’s domestic market alone (projected to be 8.8% of the global market in FY26) is insufficient to attract more manufacturing here. The ability to export competitively will be a key determinant of policy success going ahead. And for exports to rise, import tariffs must be brought down.
In sum, before copying the mobile phone policy success playbook in other sectors, we must remember that the consumers bear the burden of protectionist policies and, eventually, the manufacturers, both. Protectionism can play spoilsport in India’s hopes of exporting its electric vehicles and mobile phones to the world.
Not(PolicyWTF): No Exports Without Imports (from Edition #185)
This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?
- Pranay Kotasthane
If one were to make a word cloud of our editions, the term “import substitution” would appear right in the centre, in angry red colour. On many occasions, we have highlighted that high import tariffs and Production Linked incentives (PLIs) are at cross purposes. The tariffs end up increasing input costs to such an extent that it negates the monetary benefits of PLI schemes. The result is that manufacturing in India remains as uncompetitive as it was earlier, despite the government providing significant financial incentives.
Given our abhorrence for higher tariff barriers, it was a welcome surprise that the Minister of State for Electronics and Information Technology released an excellent report on August 29th, which has empirical evidence on the importance of trade for creating a domestic electronics industry.
The report, titled Globalise to Localise: Exporting at Scale and Deepening the Ecosystem are Vital to Higher Domestic Value Addition in Electronics, is written by trade economists from Indian Council for Research on International Economic Relations (ICRIER). It makes a crucial point that should interest anyone interested in Indian public policy: India must first globalise and only then localise if it aspires to be a global production and export hub for electronics. I guess this recommendation would hold to a large extent in other sectors as well.
But let’s get back to electronics. The report highlights that both Viet Nam and India exported the same value of electronics items in 2010. But by 2020, Viet Nam’s electronics exports had become seven times that of India’s. What just happened?
The report argues that the reason could be the difference in trade strategies followed by Viet Nam and China on the one hand and by India on the other. The difference is this. Indian governments have pursued a strategy of simultaneously increasing electronics exports and boosting domestic value addition per unit of total demand. To increase exports, governments used tax rebates and built special economic zones. To boost domestic value addition, governments deployed higher custom duties for components and local sourcing norms for public procurement.
In contrast, both Viet Nam and China focused on growing their exports at scale first. At first, this led to a decrease in the domestic value added per unit of demand. This is because companies preferred to import components, assemble, and then export them. Only after electronics exports had achieved global scale did the two countries target local content addition. That too, through instruments such as sourcing fairs and technology upgradation programmes, instead of erecting trade barriers. Over time, not only did the exports continue growing, but also a competitive components industry mushroomed.
Hence the report suggests that India, too, should first globalise and then localise. The comparative analysis in the paper is illuminating. I’ll leave you with the recommendations chart, which has specific ideas for putting this strategy into effect.
From a political economy viewpoint, it’s interesting that the electronics ministry unveiled this report. I hope that it suggests that the government is willing to reconsider its strategy of high customs duties for domestic value addition. To become a global manufacturing hub, we need to internalise that import substitution is self-defeating.
PS: This report’s analysis also makes for an excellent public policy teaching resource.
HomeWork
Reading and listening recommendations on public policy matters
[Podcast] A Puliyabaazi on a surge hiring strategy to increase India’s state capacity on foreign policy issues.
[Book] Founding Mothers of the Indian Republic: Gender Politics of the Framing of the Constitution by Achyut Chetan. The title speaks for itself.