Make in India: the smartphone challenge
History shows that manufacturing follows trade. In 1914, India was the world’s largest importer, not of British textiles, but of British textile machinery. That is, India was becoming a major textile manufacturer. This happened because merchants of British textile had developed mature markets in India and had themselves started manufacturing. The case with smartphones would be no different if things were that simple. Unfortunately, complications abound.
Morgan Stanley expects India to overtake the US as the second-largest smartphone market in 2018, with an expected compound annual growth rate (CAGR) of 23%. India will grow nearly five times faster than the world’s largest smartphone market China, where growth has decelerated. Morgan Stanley estimated that there are only 225 million smartphone subscribers in the country, accounting for 18% of the total population. Therefore, there is tremendous untapped potential for growth.
India has also shown impressive growth in manufacturing smartphones, almost tripling the value of output from Rs18,900 crore in 2015-16 to Rs54,000 crore in 2016-17. This is expected to increase to Rs94,000 crore in 2016-17. But all these “Made In India” smartphones, including those from home-grown companies like Micromax and Karbonn, are only assembled in India. Smartphone companies import semi-knocked down (SKD) units, in which all the key high-value components are already soldered. The value addition happening in India was only 6.1% of the smartphone’s value in 2016.
There are tangible reasons why smartphones are only assembled in India. In the 2015-16 Union budget, the government increased the differential excise duty structure for mobile phones from the earlier 5% to 11%, which gave domestic manufacturers a benefit over imported phones. This move has managed to flip the share of imported mobile phones from 69% in 2015 to 33% in 2016.
This is problematic for many reasons. First, tariffs get entrenched in the system and are difficult to revoke. Because protected industries benefit from tariffs, they lobby tooth and nail to keep them in place, often resorting to politically palatable reasoning like potential job losses and the health of the economy. This is precisely what the government did in August 2013 when it increased the import duty on flat-screen televisions to 36% on the pretext of a rising current account deficit (CAD). The CAD has since fallen to manageable levels, but the tariff is still 36%.
Second, tariffs enrich a particular industry at the expense of millions of consumers. The point of production is to be able to consume goods that we like, whether Italian shoes or Japanese cars. By differentially taxing foreign-manufactured electronics, the government makes it more expensive for Indian consumers to purchase high-end smartphones and laptops, just to support inefficient local manufacturers.
Third, a special privilege for one industry inadvertently comes at the cost of another industry. If importers of smartphone components don’t have to pay import duties, then the commensurate loss to the exchequer has to be financed by taxing another economic activity. If the policy is revenue-neutral, that means the consumers bear the full burden of the inefficiency of the favoured industry and have to pay extra for their purchases—money that could have been spent to buy something else, perhaps from an efficient business in India. What is seen is that jobs are created in one industry, but the job losses due to the higher taxes in another industry are not seen.
It must be underlined that the increase in mobile phone “manufacturing” is only a shift towards assembling smartphones owing to the tax benefits provided by the government. While this has succeeded in creating jobs in the country, the step forward from assembling to manufacturing of components is not guaranteed. The government launched a Phased Manufacturing Programme (PMP) in May 2017 to increase local value addition from 6% in 2016. Starting with the battery, charger and headphones in 2016-17, the plan is to increase the share of local value addition to the camera and touchscreen in order to boost the overall local value addition to more than 25% in 2019. Under the PMP, this is going to be achieved by slashing excise duties for the components—starting with the charger, batteries and headphones—to 2% (instead of 12.5%) in 2016-17.
This strategy of giving preferential treatment to domestic producers is unlikely to be successful in the absence of broad-based reforms in the economy. While India has good market potential owing to its growing middle class and data usage, legacy problems continue to haunt its manufacturing sector. These are well-known: too much regulation and associated paperwork, arcane procedures for land acquisition and environmental clearances, unfavourable labour laws and poor infrastructure.
As Pradeep S. Mehta recently argued in this paper, an effective industrial policy cannot be merely a collection of sectoral policies. If India has to increase its manufacturing output and employment, it needs to focus on improving its competitiveness. The Ease of Doing Business rankings have consistently ranked India to be worse than 130 other countries in the world, while China is ranked 78th in 2017. Bridging this gap is the key to becoming a manufacturing hub. Preferential taxes for domestic products are not going to take us very far.
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