A subsidy-tariff-permit raj?

If each PLI scheme is to be run by different ministries it's easy to envisage a hydra-headed bureaucracy

Over the past three years, our import tariffs have been increased in stages to protect and support a large number of our manufacturing sub-sectors, thus reversing over 25 years of trade liberalisation undertaken by successive governments. Now, there is a new game in policy town. It’s called production-linked incentive (PLI) schemes. The avowed goal is to boost manufacturing production in chosen sectors, both for domestic and export markets. The scheme got its big launch in April 2020 in the sub-sectors of mobile handsets and specified electronic components, as well as medical devices and active pharmaceutical ingredients. But, it had been “cooking” over the previous 12-18 months, including preparatory policy measures such as increases in Customs duties on mobile handsets. Early signs of success led, earlier this month, to the Cabinet decisions favouring extension of the PLI scheme to 10 new sectors, including automobiles and auto components, advanced electrical batteries, pharmaceutical products, personal computers and laptops, air conditioners, telecom equipment and specified processed food products.

The essence of a PLI scheme, such as the one for mobile handsets, is to offer government subsidies for a limited period (5 years for mobile handsets) at rates starting from 6 per cent and declining to 4 per cent on incremental sales over a specified base year level, provided minimum qualifying criteria of incremental investment and sales are met. Each PLI scheme is tailor-made and administered by the concerned ministry (Ministry of Electronic and Information Technology, or MEITY, in the case of mobiles) and its designated project management agency (PMA). The subsidy amount is capped: It was Rs 40,000 crore over five years for mobiles and specified electronic components; and is stated to be about Rs 145,000 crore for the 10 new sub-sectors, with autos and their components accounting over a third of the total. The details of the 10 new schemes are not yet known.

As a tool for promoting particular manufacturing sub-sectors, PLI subsidies would seem to have some advantages over tariffs. First, they are transparently borne by the government, as compared to tariffs where the “subsidy” cost is borne by consumers and user industries and, more generally, potential exports which get disfavoured compared to import-substitution. Second, PLI subsidies are performance-linked — they only get paid when the incremental sales occur. Third, the subsidies do not discriminate between production for import substitution versus exports. Fourth, the fiscal cost can be capped, at least in principle. Fifth, the subsidies are for limited periods for each beneficiary enterprise — at least that’s what is currently planned.

However, that does not mean PLI schemes are free of problems. First, the fiscal cost is not trivial, especially in a context of extreme fiscal stress. The “capping” is not easy if the number of qualifying firms and incremental production is substantial in a particular sub-sector. Second, as in the case of sector-specific tariffs, PLIs also beg the basic question: Why does the government want to play favourites with particular sub-sectors? What superior knowledge do civil servants have compared to risk-taking businessmen in competitive markets? Third, how accurately can incremental production or sales be gauged? Conversely, how easy or difficult is it for firms to “game” the system, especially if the production is occurring in existing firms and their “brownfield” plants? Fourth, the implementation of the scheme requires an application/permission system allowing for significant discretionary elements. Fifth, if each PLI scheme is going to be run by different ministries and their PMAs it is easy to envisage a growing and hydra-headed bureaucracy, sprouting different qualifying criteria, incentive structures and their quality of implementation. Each PLI scheme could, over time, degenerate into its own little licence-permit raj, or, more accurately, subsidy-permit raj.

Illustration: Binay Sinha

More fundamentally, in the real world context of proliferating and increasing Customs tariffs, which vary across sub-sectors, it could be quite common for a particular sub-sector (such as mobiles) to be the beneficiary of both relatively transparent PLI subsidies and more opaque Customs duty benefits, especially when one factors in effective rates of protection arising from differing tariffs on inputs and outputs. In such a situation, it becomes virtually impossible for a government agency to gauge and assess the total amount of benefit being conferred by the multiplicity of sub-sector promoting interventions. In actual practice, it will mostly be unknown, as it used to be in the bad old license permit raj of the pre-1991 years. Then, too, an individual firm and its promoters benefitted from hard-to-quantify values of their industrial licences, various categories of import licences as well as a high and varied protective, Customs tariff structure. It was actually a licence-permit-tariffs jungle, which defied quantification of the financial benefits being conferred on the beneficiary sub-sectors, other than the general presumption that those businessmen who got the licences were extremely fortunate and favoured.

As we all know, that system bred inefficiency, low productivity and corruption. That is why the reforms of the early 1990s dispensed with industrial licensing and import licensing (for consumer goods, over time) and set in motion a quarter century of Customs tariff reductions. It is bad enough that the trajectory of declining import tariffs has been reversed in the last three years. Layering a new scheme of sector-specific PLIs on top is unlikely to increase the long-term productivity and competitiveness of India’s faltering manufacturing sector. It will certainly make it harder for India to enter regional free trade arrangements such as the Regional Comprehensive Economic Partnership (RCEP) that we passed up, unfortunately, a year ago and which was signed a fortnight back by 15 participating Asian countries accounting for about 30 per cent of world output and trade.

Anyway, PLI schemes in 13 sub-sectors are here to stay for now. My hope is that they will not proliferate, at least until such time that the recent trend of rising import tariffs is decisively reversed. Furthermore, it would be desirable for the government to ensure maximum feasible transparency, automaticity, uniformity and accountability in the design and implementation of these schemes across the various ministries and PMAs. It would be sad if the murky, discretionary taint of the old licence-permit raj was to infect these new schemes.

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The author is Honorary Professor at ICRIER and former Chief Economic Adviser to the Government of India. 

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