Will protectionism help govt’s ‘Make in India’ plan?

Nirmala Sitharaman made a clear embrace of protectionism in her maiden Union Budget. The list of items on which tariffs have been hiked or introduced is far longer than the list of tariff reductions. These tariff hikes, which are part of a broader push towards protectionism and promoting ‘Make in India’, will have important implications for Indian industry and the economy.

For a start, because of these tariffs, the government expects a net revenue gain of ₹25,000 crore in 2019-20. It also hopes to encourage domestic manufacturing in the process.

In total, Mint’s analysis of tariff proposals in the budget, suggests that around US$10.6 billion imports would face ‘protectionist’ tariff hikes. In other words, the items slapped with tariff hikes – excluding gold, silver and petroleum – accounted for US$10.6 billion dollars of imports in 2018-19.

Gold and silver are excluded from the analysis because unlike other items, duty hikes are primarily motivated by increasing the government’s revenue. Similarly, tariffs on the petroleum sector have more to do with bringing parity with domestic taxes rather than protectionism.

After all, imposing higher import duties on oil or gold cannot spur its domestic production as India lacks these resources

The budget’s tariff hikes have targeted select industries. Based on last year’s trade patterns, Mint’s analysis shows that the protectionist tariffs are mostly concentrated in five industries: electronics; chemicals, plastics and rubber; paper; automobile and steel. In terms of trade partners, China is likely to be the most impacted country as it accounts for one-fourth of the affected items by import value.

More importantly though, within these industries, around half of the items facing higher tariffs are industrial supplies. The government’s motivation is to encourage domestic production of these items but raising tariffs on such items, which are used as inputs by the domestic industry, can often backfire. For instance, the anti-dumping duty imposed on steel three years ago hurt many of India’s engineering and manufacturing firms. A protectionist policy and the associated uncertainty in tariff rates is likely to discourage foreign companies from establishing part of their manufacturing chains in India.

So is the government’s turn towards protectionism misplaced? The answer is not obvious.

While the effects of tariffs on GVC integration are clear, the effects of GVCs on India’s economy are less clear. After all, India is no stranger to GVCs. According to data from the Organisation for Economic Co-operation and Development (OECD), the share of foreign ‘value-added’ in India’s gross exports rose sharply from 9% in 1995 to 24% in 2011. However, despite the apparent rise in integration with the rest of the world, the share of manufacturing in India’s GDP has remained stagnant.

This apparent contradiction is often attributed to the fact that GVCs tend to trap poor countries into low-value add activities. GVCs apparently led to ‘hollowing out’ of India’s manufacturing sector, according to a 2014 Economic and Political Weekly article by Rashmi Banga, an economist with United Nations Centre for Trade and Development.

Against the backdrop of a global trade war, the Indian government appears to have embraced the view that globalization of production need not guarantee the development of domestic industry. And, consequently, it is pushing for domestic sourcing requirements in several industrial policies ranging from electric vehicles to retail to solar panels.

This type of protectionism and import-substitution was crucial for South Korea’s and Japan’s rapid industrialization. It remains to be seen whether India will replicate that success or will it simply lead to an inefficient domestic industry shielded by high tariffs.