Ricardo would be turning in his grave

There are limits to building resilience over economic efficiency

Supply chain disruptions resulting from the Covid-19 pandemic and Russian invasion of Ukraine have scared the world and, in turn, given a big impetus to trade deglobalisation and increased protectionist behaviour amongst nations.

Most of the major economies have turned inward-looking, exploring new or alternative supply sources and aiming to become self-reliant to the extent possible. Increased costs have been often justified to achieve self-reliance in strategic sectors in these uncertain times.

Domestic industries thriving mainly on local clientele love protectionism. For them, it means going back to the old pre-free-trade times — reduced competition, less pressure to improve productivity or operational efficiency, no focus on quality, among others. Of course, it is an entirely different story from the consumers’ perspective.

Admittedly, the supply chain disruptions have proven to be non-transient and have persisted for quite some time now. Countries can’t simply ignore their lasting impact, including on inflation. They have to take corrective actions best suited to their economy. The moot question, of course, is: What should be such actions? Is it worth attempting to decouple from the world? More importantly, is it even sustainable?

Nineteenth century British economist David Ricardo propounded the theory of “comparative advantage”, attributing the cause and benefits of international trade to the differences in the relative opportunity costs of producing the same commodities among countries. Simply put, free international trade based on this concept, would lead to efficient allocation of resources and facilitate different economies to specialise in production of goods and services in which they have competitive advantage — a “win-win” outcome for everyone.

It is no one’s case that international trade in the real world is just based on the Ricardian principle. There are a whole lot of complex issues. This article isn’t about this subject. Suffice to say that the principle makes immense sense intuitively — neither is it logical for a country to try to produce everything itself nor is it sustainable. Also, the fact is that all countries, developed or developing, have benefited from free trade over the period. A country may have comparative advantage for a variety of reasons, viz natural resources endowment, competitive edge in different factors of production, locational advantage, etc. Many jurisdictions might have also benefited as first-movers — achieving over the period economies of scope and scale in certain industries, thereby gaining substantial comparative advantage.

Illustration: Binay Sinha

Take the example of the semiconductor/chip manufacturing industry — a hot topic of discussion worldwide. The Taiwanese semiconductor industry got its start way back in 1974. The Taiwan Semiconductor Manufacturing Company came out with the fabless-foundry model in 1987, changing the course of the global semiconductor industry. Due to its strong OEM wafer manufacturing capabilities, developed over decades, and comprehensive industrial supply chain, Taiwan has been able to differentiate itself from its competitors and dominate the global market; it has emerged as a trusted global supplier with a reputation for quality. Taiwan stays in the lead while rivals try to play catch-up.

Any attempt by a jurisdiction to aim at self-reliance in a sector, which goes against the comparative advantage principle, would be costly in the short term and likely to fail in the medium to long term, unless that sector meets the “infant industry” criteria — another economic concept with its origin in the 19th century.

Simply stated, “infant industries” are newly established industries that are at the developing stage and need protection so that their products can effectively compete with the products of long established international businesses. Note that any support to “infant industries” can only be for a limited period and it is presumed that they would thereafter grow and survive on their own merit.

How should a jurisdiction objectively choose such sectors and what should be the period of support are million dollar questions. The proponents of self-reliance ought to pause and analyse the costs involved and the feasibility of such an intervention in the medium to long term.

For a country dependent on import of certain goods, developing self-reliance may or may not be an option. Either way, it would be in its own interest to continuously look for diversification of suppliers across the globe and explore viable alternatives. Even with regard to monopoly supplies, in case of supply disruptions, de-monopolisation is likely to happen over a period with the next best jurisdictions (in terms of comparative advantage) catching up and occupying the vacated space. Instead of always focusing on building self-reliance, it might be a more practical and cost-effective approach to be on the lookout for such possible jurisdictions and engage in developing commercial relationships with them in advance.

Coming to the Indian scenario, “Atmanirbhar” is the buzzword. Production-linked incentive (PLI) scheme has emerged as the flagship government scheme — of course, not solely with the objective of self-reliance but to encourage manufacturing activities in general, and not to miss the opportunity of being a part of the global supply chain. The PLI scheme was first notified for large-scale electronics manufacturing in April 2020. The scheme has since been extended to 14 sectors. The government has announced an outlay of about Rs 2 trillion under the scheme. Reportedly, an investment of over Rs 40,000 crore has already been made and based on the approval of applications, another Rs 2.70 trillion is expected to be made.

It is not the intention here to critically examine the PLI scheme. However, a few observations may be in order. The criteria for selection of sectors ought to be robust, based on thorough dispassionate economic analysis — generic usage of terms like “strategic” or “security” shouldn’t overwhelm the decision-making. “Infant industry” principle should be strictly followed with the sun-set clause for providing support stated upfront for any sector. Past experience has shown that once such support is given to an industry, it becomes politically difficult to end it. Lastly, the pressure to include many sectors under the scheme must be resisted — there is no point in thinly spreading the fiscal resources.

Between geopolitics and economics, ultimately economics would prevail. One should also keep in mind the possibilities of global supply chains getting restored and the Chinese economy picking up earlier than expected. There are limits to preferring “building resilience” over economic efficiency. Any investment in an industry which prima-facie goes against the “comparative advantage” principle or whose survival on its own merit is doubtful in the medium term is avoidable, lest it becomes a non-performing asset (NPA) when sanity returns to the world. Recall that after the global financial crisis of 2008, excessive credit disbursed by banks, purportedly to boost the infrastructure sector investments in the country, was the main cause of the humongous bank NPAs. 

The writer is a retired IAS officer and former Sebi chairman