7 min read.Updated: 16 Jul 2020, 08:16 AM ISTVijay Kelkar
R. A. Mashelkar
Embracing economic isolation at this point will be a strategic mistake. India must seize global opportunities
A confident India, which is already a lower middle-income country, and which needs to avoid the middle-income trap, should not be afraid to engage with the world
There is a whiff of protectionism in the air. The unprecedented economic dislocation across the world as a result of the coronavirus pandemic has resurrected demands that countries should cut down their interactions with the rest of the world. It would be a strategic mistake for India to accept such a course of action, just when it has rediscovered its ancient roots as a trading nation.
There have been varied responses by India to previous episodes of discontinuity. The impoverishment of the country during colonial rule meant that political freedom in 1947 came with an entrenched suspicion of foreign trade, from leaders across the political spectrum.
The initial development strategy was thus to expand the Indian economy with minimal trade with the rest of the world. After some initial success that helped India get strategic depth through a diversified industrial structure, the strategy of import substitution failed to meet its core goal of defeating mass poverty through rapid economic growth.
The strategy changed with the economic crisis of 1991, another episode of discontinuity. India decided to reintegrate with the world economy through deep reforms in industrial, trade, fiscal and financial policies. The emphasis was on economic openness rather than isolation.
Later, the commitment to an open economy was tested with the economic sanctions imposed on India after the nuclear tests in 1998. The government led by Atal Bihari Vajpayee wisely continued to deepen the engagement with the global economy rather than withdrawing into a protectionist shell. Millions have been lifted out of poverty as a result.
Here are the four reasons why we argue that India needs to remain a strong trading nation.
The risk and the reward
First, Indian economic growth is constrained by a limited home market, especially in terms of discretionary spending on industrial goods and modern services. The long journey since the 1991 economic reforms has lifted millions of Indians out of dire poverty. The economic expansion overseen by successive governments since 1991 has won global plaudits.
However, the $3-trillion domestic economy is still dwarfed by the $90-trillion global economy. A decision to focus on a slice rather than the entire pie will reduce the potential demand for goods and services produced in India.
Second, higher taxes on imports, in effect, work like taxes on exports. This is especially true in the modern global economy in which trade across national borders is dominated by intermediate goods rather than consumption goods.
The iconic iPhone may be designed in the US and assembled in China, but it is built with inputs sourced from other countries across Asia. India can become a hub for global supply chains only if intermediate goods or inputs can move with relative ease across our borders.
The government is quite correctly trying to draw global supply chains into India, especially with the rising global anger against China. Higher import tariffs will hinder this quest.
Third, there is a genuine concern that growing protectionist sentiment in many parts of the world could eventually lead to a reduction in global trade. However, decision makers should not focus on this risk alone. There is a huge opportunity as well—the reconfiguration of global supply chains away from China, partly because of rising wage costs in that country and partly because of the strategic concerns of the US and its allies. India should carefully weigh the relative impact of these two trends on its economy. We believe that the benefits of trade diversion from China will be more than the costs of trade destruction because of rising protectionism.
Fourth, India is an economy with surplus labour, with workers often trapped in agriculture or tiny informal enterprises. It is ideally placed to do well in labour-intensive, export-oriented industries. These industries have moved from Japan to East Asia to China in successive waves of development since 1950. Right now, countries such as Vietnam and Bangladesh have been early beneficiaries of the exit of such activity from China.
India no longer has a dominant foreign exchange constraint since it became an open economy in 1991, but it is important to remember that we have to earn dollars to fund imports, including natural resources such as petroleum and rare earths that India is not abundantly endowed with.
India experimented with a strategy to industrialize behind tariff walls, when foreign exchange to import capital goods was in short supply. The idea was to ration foreign exchange through a web of imports controls rather than earn more foreign exchange through export promotion.
In other words, the trade deficit was sought to be reduced through import compression rather than export promotion. These import controls were managed through equally complicated administrative rules. The experiment ended with the creation of an inefficient industrial structure, in terms of both costs and technology, in one of the most protected economies in the world.
Learnings from 1991 reforms
Just before the 1991 economic reforms, the highest tariff rate was 355%, the simple average of tariffs for 113% and the average tariff rate weighted by imports was 87%. India’s share of global trade fell from 2% at the time of independence to 0.5% in 1990.
One of the explicit goals of the economic reforms of the 1990s—pursued by three different political combinations— was to gradually bring Indian tariff rates down to East Asian levels. The Indian share of global trade went up in tandem with reductions in import tariffs. Further, an open trading regime created competitive pressure on domestic industry to use capital efficiently. The two most recent episodes of accelerating growth—in the mid-1990s and the mid-2000s—coincided with strong export growth that, in turn, helped sustain a splendid boom in domestic corporate investments.
However, Indian export growth has been particularly weak over the past decade. The global economy is less conducive to rapid export growth this decade than it was in the previous two decades. That said, there is still ample opportunity for India to boost its share of global trade.
In a classic paper published in 1963, Jagdish Bhagwati and V.K. Ramaswami showed that the best policy response to a domestic distortion is a subsidy rather than a tariff. Policymakers should focus their attention on the cause rather than the symptom of a particular distortion.
The correct policy response in the context of trade should thus be easing constraints on the domestic production of tradable goods, through lower transaction costs, better infrastructure, more flexible factor markets and a competitive exchange rate.
Trade policy is intimately linked to industrial policy. The two are not separate. In fact, they need to move in broadly the same direction. Higher export growth will boost domestic investment while higher domestic investment will drive exports in a world of supply chains. A more liberal policy for investment will necessarily have to be complemented with a more liberal trade policy.
Deepening economic ties with the rest of the world needs to be accompanied by building domestic technology capabilities, so that economic growth is resilient. Trade and investment links matter in this context as well—since they allow India to plug into robust global innovation networks. The most obvious manifestation of this is the outsourcing of some types of research to India by global multinationals. The knowledge spillovers from such research laboratories have been significant, thus helping the wider Indian innovation ecosystem. However, such techno-globalism should not matter for the provision of only goods for private consumption, but also for public goods.
Rise of techno-globalism
The world faces several profound challenges in the 21st century—public health, climate change, depletion of fossil fuels, a water crisis and protecting biodiversity, for example. The forces of techno-globalism should be used to create public goods that help humanity meet the emerging challenges.
India can play an important role in this quest if it remains open to the flow of knowledge and ideas, partly by participating in multilateral institutions and partly by being a centre of trade and investments. The world is unlikely to go all the way back to techno-nationalism. A more likely outcome is selective techno-globalism, with patterns of trade and technology favouring nations that are seen as trustworthy. For example, Britain has proposed recently a “D10 Alliance", which is a club of 10 democracies comprising G7 nations plus India, Australia and South Korea on 5G and emerging technologies. Such a shift will certainly favour India.
It is very likely that the global economy will be reconfigured in the aftermath of the ongoing pandemic. The need for resilience from shocks could mean “just-in-time" will be flanked by “just-in-case" as an organizing principle for global supply chains.
It is in our national interest to take advantage of this anticipated reset, by deepening our engagement with the rest of the world rather than sliding towards protectionism.
One way to think of the opportunities is in terms of the three Ts—talent, technology and trust. India is well placed in terms of talent and technology. It needs more trust, not just in others but also in itself; or more self-confidence. The goal of atmanirbharta (self-reliance) will be meaningfully met if it is complemented with atmavishwas (self-confidence).
A confident India, which is already a lower middle-income country, and which needs to avoid the middle-income trap, should not be afraid to engage with the world, for trade, for investment, for ideas, for innovation. Embracing economic isolation at this turning point in the global system will be a strategic mistake.
Vijay Kelkar and R.A. Mashelkar are, respectively, vice-president and president of the Pune International Centre. Niranjan Rajadhyaksha is a member of the academic advisory board of the Meghnad Desai Academy of Economics.