Recipe for change

The next big disruption in India’s trade policy may happen by the end of the year if the 16 members of the proposed Regional Comprehensive Economic Partnership (RCEP) reach a final agreement. The potential of the world’s largest free trade area, which includes the world’s two most populous and fastest growing major economies, China and India, is tantalising. That this may happen when the West, led by the United States, is turning its back on openness is significant. Given trade’s close link with prosperity and indeed geo-strategic leadership, RCEP could well be the beginning of a decisive shift in economic power from the West to the East. And yet, at least in India, there is deep skepticism about what RCEP might lead to.

Leading the pessimists are wide sections of the manufacturing industry. Historically, India’s trade policies have never succeeded in creating a globally competitive industry. Before 1991, tariff and non-tariff barriers protected infant industries that never quite grew up, fleecing consumers while producing substandard products that would not have withstood any degree of international competition. Post-1991, the narrative of trade liberalisation took over but reductions in tariffs and non-tariff barriers have not sufficiently boosted manufacturing. The share of manufacturing in India’s GDP hasn’t budged much since 1991. In fact, in the last decade, the signing of ambitious free trade agreements with ASEAN, Japan and Korea, all manufacturing powerhouses, has caused industry further distress — imports have surged and exports have stagnated. With China, it hasn’t even taken a free trade area to see the balance of trade deteriorate from under $1 billion at the turn of the century to over $60 billion almost two decades later.

Historically speaking: India’s trade policies have never succeeded in creating a globally competitive industry

Given continued stress on the issue of creating better jobs for more people as well as periodic bouts of serious worry on the current account deficit, the consequences of signing on to one more free trade area are non-trivial. 

The government could argue, and does argue, that it is industry’s job to become more competitive rather than to ask for protection. In theory, it is possible to argue that trade liberalisation is one way to nudge greater competitiveness in the economy. The example of China is instructive. The doomsday prophets had forecast that Chinese manufacturing would collapse once the country acceded to the “free trade” World Trade Organization in 2001. On the contrary, China’s exports (and GDP growth) took off into the stratosphere precisely after it joined the WTO. Clearly, China gained from the additional market access it got and minimised losses from import competition. 

Of course, it is possible to argue that by the time China signed on to the WTO, it had already gone through two decades of internal reform (from 1978 to 2000). And so, its manufacturing industry was ready to compete. Arguably, Indian industry also had almost two decades between the start of trade liberalisation in 1991 and the signing of the first FTA in 2010. However, there is one big difference in the India and Chinese experience. In China, not only did firms become competitive, but so did the government. In fact, it was because the government got many of its policies right — building world-class infrastructure, cutting red tape, opening up to FDI, providing cheap and plentiful land, inexpensive power, flexible labour laws, low capital costs — that industry in turn became competitive.

In India, industry has had no option but to improve competitiveness in order to survive trade liberalisation. But it has been let down by the government’s failure to be “competitive” in the domain of policy. The reality is that if India has to have a globally competitive industry, the government must emulate China on creating the right ecosystem.

RCEP may actually provide an opportunity, if it provides a peg for every ministry of the government to set right policies in a time-bound manner. The commerce ministry’s negotiators will drive a bargain and commit to liberalisation in different categories across different time frames (immediate, 10 years, 15 years, 20 years). Industry will be directed to prepare. So should ministries, with time deadlines. The ministries of coal and power must sign on to a plan for cheaper tariffs; finance must commit to a structural reduction of capital costs; mines and steel must open the mining sector for raw materials which will enable steel and aluminium to compete. Agriculture must reveal its plan for internal market reform; industrial policy and promotion must tell us whether India will be in the top 10 in the world in the Ease of Doing Business by 2030. The list goes on.

If the performance of ministries is tied in with RCEP commitments, India may actually be able to create world beating industry. For real transformation, RCEP needs to disrupt policy, not industry.

The author is Chief Economist, Vedanta