Manufacturing hub ambitions aren’t served by statist policies

The circuit board assembly, camera module, touch-screen display and glass cover account for three-fourths of the bill-of-materials cost of a smartphone. Vietnam, the world’s second-biggest exporter of handsets after China, gets these and most other components at zero tariffs from free-trade partners. But India, which has few such accords of its own but is still keen to be a manufacturing hub, has customs duties as high as 22%. The result? Making mobile phones in India now comes embedded with a cost disadvantage of 4%, says a study of tariffs by India Cellular & Electronics Association (ICEA).

This extra burden is something India has imposed on assemblers even as it began offering production-linked incentives (PLIs) that promise to pay firms 4-6% of their incremental sales. One way to see it as that India is damaging its competitiveness and then paying firms to set up factories in the country. Another perspective is that handouts are being “supported through indirect revenue from increased indirect taxes from the same sector,” as the ICEA report says. The PLI scheme, which kicked in for mobile phones in October 2020, is being touted as a success. Annual production has surged more than 60% to $42 billion. Of this, $11 billion is exported, compared with virtually nothing when Prime Minister Narendra Modi came to power in 2014. From being a net importer, India has become a net exporter of handsets.

Elsewhere in Asia, the contest is over semiconductors. From Thailand to Singapore and Malaysia, several countries are now in the fray to shift the locus of front-end chip manufacturing from East to Southeast and South Asia. India is trying to get in via packaging and testing. While those plans are yet to bear fruit, cheap labour has made the nation an upcoming rival to Vietnam in a low-value-added activity like assembling electronics parts.

The pandemic and China’s souring relations with the West have changed the thinking of multinationals. A Foxconn plant in Tamil Nadu is preparing to deliver iPhone 15s only weeks after they start shipping from factories in China. The likes of Apple are reluctant to rely too heavily on China to feed global demand. Their quest for a China+1 strategy has presented India with a chance to storm the supply chain. Vietnam’s phone exports last year were six times India’s, thanks to Samsung. It is this gap that New Delhi wants to close.

However, conflating correlation with causation could jeopardize this goal. Just because an apparent change in Indian fortunes has occurred despite a lurch toward protectionism, critics are being dismissed who dare to question the wisdom of the tariff-subsidy combo. The official view is that as long as exporters can claim back the duties on imported parts, they won’t grumble about India’s cost disadvantage against Vietnam. The Modi government in 2018 announced a “calibrated departure” from more than two decades of greater trade openness, and raised import duties on mobile phones to 20% from 15%. That project has continued unabated. In 2020, the duty on circuit board assembly and displays was raised by 11 percentage points.

This year’s government budget cut the duty on camera lenses to zero. That hasn’t made much difference. As the ICEA study shows, the accumulated increase from three years of changes still works out to nearly 5.6% of the bill of materials, or 3.6% of a phone’s total cost. Add the impact from the rupee’s 11% slide against the dollar since the start of last year—double the decline in the Vietnamese dong—and Indian-made phones would be uncompetitive by more than 4%, the ICEA says. This cost may not be showing up in export performance because it is being borne by consumers. Component makers have no incentive to be globally competitive if they can hawk whatever they make in their home market at an inflated price, shielded by tariffs.

Exporters have every reason to keep importing components—and claim duty drawbacks. Self-reliance, the slogan under which the programme is being marketed, may be an illusion. Raghuram Rajan, a former governor of the Indian central bank, has shown that after adding major parts that go into phones, the country may have become a bigger net importer than before. PLI incentives are on incremental production, but the tariffs are on total costs. When the handouts eventually end, the elevated duties would bite.

India’s own history is littered with cautionary tales of excessive state control. Erecting protectionist walls didn’t work in the past. High tariffs and a new licence requirement on imported computers, laptops and tablets— a measure that smacks of bureaucratic desperation, as my colleague Tim Culpan has written—may not help make India the next factory to the world even now. ©bloomberg