Why alarmists must not derail policy direction if they want a better India

Governments in almost all market economy countries intervene to a greater or a smaller degree in their industries. India, finally, might be on the same path

India’s Budget 2018, which raised customs duties on many imported manufactures, finally suggests that the government recognises the need for (a) an industrial policy; and (b) a trade policy that complements the first. However, mainstream economists/journalists are a a-flutter as they believe India is abandoning economic reforms (Panagariya, 12 February 2018, “Return of protectionism”). This is strange, to say the least.

Governments in almost all market economy countries intervene to a greater or a smaller degree in their industries. The US government intervenes in industry through anti trust laws, industrial standards, pollution regulations, and labor laws. However, no one would contend the US has an “industrial policy”, but Japan did and East Asian countries do. What makes interventions by East Asian (Japan, South Korea, Taiwan)/other South-East Asian countries into an “industrial policy” is that their interventions were generally coordinated and viewed as a coherent whole. India, finally, might be on the same path.

Equally, in all East/SE Asian countries, industrial policy was executed as part of five year or longer-term plans. In fact, it was precisely because these countries had planning institutions — which went hand in hand with industrial policy — that they managed to steer policies through good and turbulent times in the global economy, sustaining growth. They did not, unlike much of Latin America (LAC) or Sub-Saharan Africa (SSA), experience “lost decades” in the 1980s-90s. 
 

By contrast, in LAC and SSA two decades of potential economic growth were lost, hence per capita income barely rose, just when their populations were rising. This was not the case in East/SE Asia, which grew rapidly but also transformed their structure of output/employment, ensuring major achievements in human development. The important identifier of these East/SE Asian countries were their planning structures, backed by effective industrial policy, implemented by 

learning bureaucracies.

However, many were sceptical that industrial policy could be practiced in other developing countries, since they have weaker bureaucracies and that, the international community today is unlikely to accept interventionist industrial and trade policies. So dominant was this mode of thinking when India launched economic reforms, that Indian policy-makers seem to have fallen prey to it as well. While the 1991 economic reforms were exactly the right response to the irrational and distortionary dirigisme prevailing until the early 1980s, it took two decades (2011) before a National Manufacturing Policy was announced (which never got to implementation stage); the National Electronics Design & Manufacturing, 2012, remained confined to paper. 

Since 1991 the implicit policy seems to have been: reduce high tariffs, deregulate domestic markets, end industrial licencing and market forces will ensure that manufacturing investment will thrive. However, the share of manufacturing in neither output nor employment increased grew since in 1991; it was and is 16 per cent of GDP and under 12 per cent of employment. Manufacturing has in 25 years not been the lead sector. Services have driven growth. Unfortunately India saw premature growth of services, without accompanying manufacturing growth, that was the well-established Kuznets pattern. Services, especially traditional ones (for example, wholesale/retail trade, transport, domestic services) became the receptacle for absorbing surplus labour from rural areas.

However, time is more than ripe now for this policy path dependence to change. India still does not have an industrial policy (that DIPP began consultations towards one is a good beginning, and a recognition that we don’t have one). Improving ease of doing business is an integral element of one, but it is only an element. Recognising that logistics is a especially difficult Indian constraint on all sectors, not just manufacturing, and hence creating a new unit for logistics in the DIPP is a good idea; but this is also only just another element. Every government has invested in better infrastructure, which is a critical element of better logistics support.

However, industrial policy should have several components (on which more later). But first, recognising that India’s ballooning trade deficit with China is accounted for by exports of manufactures to India is critical to policy corrections. Also, policy should note import-intensity of Indian manufacturing production has systematically risen. This partly contributed to rising exports of manufactures, which had imported inputs. However, within manufacturing the average trade-ratio has risen sharply over 20 years. Moreover, capital-intensity of manufactures rose. Also, the capital- and skill-intensity of exports rose. The result: jobs in manufacturing fell between 2005 and 2010, and although they rose till 2012, they have since fallen in absolute terms again.

Yet Panagariya has no hesitation in sounding the alarm (on the Budget slightly raising tariffs on manufactures): “For those of us old enough to remember the India of the 1960s to the 1980s, this is déjà vu. Thanks to ultra-high protection and tight internal regulation, India was condemned to per capita growth of less than 2 per cent during 1950 and 1990”. What  alarmists forget is that tariffs in 1990 stood at an average rate of 150 per cent. Reduction from 1991 to 1998 was precipitous, to an average of 40 per cent by 1999, and to 10 per cent in 2007-8. Indian manufacturers unreasonably protected till 1990 were too quickly exposed to competition. A slower reduction would have enabled  them to adjust to import competition and upgrade technology. All that Budget 2018 does is to raise rates to 20-25 per cent at best in a limited number of manufactures. A more comprehensive re-examination is now necessary.

Even the limited reversal of inverted duty structures in electronics since 2014 has resulted in domestic inputs into electronics rising, even though all integrated circuits still come from China. We also know that within the last decade the Indian auto sector output has risen sharply, making automobiles’ share in manufacturing value added as high as 49 per cent. This sector did not suffer from an inverted duty structure.
 

Alarmists must not be allowed to derail the policy direction.

The author is a professor of economics, JNU, and Chair of the Centre for Labour. santoshmeh@gmail.com