More R&D, easier labour laws needed to counter Trump's tariffs, say experts

Providing more incentives to Indian industry to blunt the impact of the tariffs is unlikely to help, as will be any retaliatory measures; instead, lowering duties on intermediate goods will do more go

The key question from the Trump tariffs, with its seeming emphasis on re-industrializing America, seems to be whether India will be able to leverage the ensuing chaos to also push up domestic manufacturing? Large segments of the Indian industry have already begun to pitch the government for incentives instead of tariff protections. The latter is ruled out, since raising tariffs any more will invite further punitive tariffs from the US.

 

However, as a recent study from  New Delhi-based think-tank Centre for Social and Economic Progress (CSEP) shows, these incentives are unlikely to be of much help. Instead, simplifying labour laws — a project already begun by the central government - and making easy rules for labour to migrate to cities with high employment potential, concomitant urban planning - something states have to do - and a huge push for research and development are the greater need of the hour.

 

Many of these may sound intuitive, but are also in fact essential if India desires to compete with Asian powerhouses like Vietnam and Thailand, despite the higher differential tariffs those nations have been slapped with. In fact, just after the reciprocal tariffs were announced, US buyers have already begun asking their Indian suppliers, among others, to cut prices. In the absence of reforms, these cuts will be difficult for suppliers to offer or absorb.

 

The study 'Why is India struggling with Manufacturing Competitiveness?' by CSEP's  Prerna Prabhakar, Sanjay Kathuria, and TG Srinivasan could hardly have been more timely. The authors are, respectively, associate fellow at CSEP, visiting senior fellow in the Growth, Finance and Development vertical at CSEP, and former senior economist at the World Bank.

 

In the huge tariff walls President Donald Trump has erected around the US, India has a relatively easier face to scale. But the challenge is made stiffer by the often contradictory and inadequate government policy support that industry needs. So even though India has to factor in a reciprocal tariff of 26 per cent by the US, internal challenges add some a few more basis points to the number. One basis point is a hundredth of a percentage point. 

Credit: (Source: 'Impact Analysis of US Reciprocal Tariff on India' - Ficci)

 

One of those contradictory supports is the high tariffs on imports that India levies, and are the primary reason for Trump’s ire. The high import costs have hurt the competitiveness of manufacturers, since the inputs they need become costly. What manufacturers need, instead, are lower tariffs on the intermediate goods they have to import. The offset provided by the government through the Production-Linked Incentive (PLI) scheme does not help push up exports.

 

Yet in suggesting lower import tariffs, the authors strike a note of caution, saying that those will have to come down but not haphazardly. The downward move will need to be rationalised, which is interpreted as a “forward-looking vision prioritising overall industrial competitiveness rather than focusing on specific sectors”.

 

The paper, thus, argues that asking for government support the way industry has been so far, is not going to help, not any more, at least. A report released by industry chamber Ficci this week titled 'Impact Analysis of US Reciprocal Tariff on India' finds no significant advantage to exporters from the new tariff rates. Instead, it makes the case that the government should offer support to them. The report examines 20 sectors from marine products like shrimp to electronics to conclude that only electronics among the large exporters will gain some advantage. 

 

Against this position, the authors provide an example to push a different approach. In their segment on research and development, or R&D. they argue that to be a valuable part of the global supply chain, Indian companies need to step up their investment in this critical department. Yet, this cannot be done by asking for government incentives; indeed, the 10 per cent tax deduction on R&D for industry has had limited impact, they conclude. Rather, exposing companies to both domestic and global competition through trade liberalisation is better in terms of giving them a leg up on the global innovation chart.

 

Their point of view is supported by Saon Ray, professor and noted trade economist, now at the Indian Council for Research on International Economic Relations (Icrier). “Indian companies have been most reluctant to join the global value chain. Functional upgrading which involves the movement into more technologically sophisticated or more integrated aspects of a production process has been limited,” she points out.

 

Ray, who has been studying the role of global value chain (GVC) for decades to understand how these give a fillip to manufacturing, notes that “Import substitution can lead to greater reliance on domestically produced intermediates — thereby promoting indigenous manufacturing — but need not lead to greater GVC integration”.  

 

The CSEP report also makes the same point suggesting the Indian government should move quickly to develop an industrial policy which is much more than just import substitution.

 

Some hard decisions have become necessary, as a report by S&P Global Ratings points out. “These US tariffs, and possible responses by other economies, will likely lead to slower GDP growth globally (with) a potential for risk-off sentiment to take root, amplifying the economic effects through raising financing costs," it said. "With the imposition of these broader tariffs, the region's exporters will need to seek other markets for their goods, intensifying price competition and leading to margin squeeze.”

 

The S&P report also warns that while regional economies may adopt more protectionist measures as a response to Trump's tariffs to shield domestic industries, those will likely not help.