Context

Recent escalation of protectionist steps between US and China has raised questions about India’s policy response.

About

• After independence in 1947, India spent decades trying to survive without international trade.
• While this protection succeeded in creating a large and highly diversified industrial base, it also led to inefficiency in the use of resources.
• India ditched its model of local production for local consumption following a currency crisis in early 1990s. It open up to foreign investment and removed trade barriers in exchange of help from
• Since 1991, the tariff policy of India has led to a systemic reduction in India’s weighted effective average tariff.
• Decline in average tariff has coincided with a sharp rise in GDP and higher growth rate. Lower tariffs offered following few benefits:
  • Rise in exports and reduction in poverty at the fastest pace in India’s history.
  • India emerged as a leader in exports of IT services, and is now a key player in
  • It also helped India run a trade surplus - whereby it sells more than it buys - in goods and services with US.
  • Trade liberalization fostered an atmosphere of intense competition, leading to better use of inputs and innovation, driving productivity growth.
• Current Scenario: Recent trade experience has been mixed.
  • Export growth is slow paced.
  • The current economic slowdown has led to a drop in the value of imports, thus shrinking the current account deficit.

“Infant industry" argument Protecting ‘infant’ domestic industries: The argument in favour of high tariffs or import substitution is that in developing countries, industries are yet to develop and, therefore, need to be protected from international trade. Import substitution policy: Government uses trade tariffs as a policy instrument to encourage domestic industry, the idea being to substitute imports with domestic goods. The “infant industry" argument was often cited to justify the policy of tariffs, licences and quotas that predated the 1991 reforms.

India a “tariff King” and growing protectionism

• A few months back, President Donald Trump described India as “the tariff king", accusing it of imposing “tremendously high" tariffs on American products.
• When higher tariffs are supplemented by higher current account deficit and fall in rupee, they reinforce a growing trend of protectionism.
• India is among the most heavily protected economies in the world:
  • Among members of BRICS grouping—Brazil, Russia, India, China, South Africa—India has the highest effective tariff rates on food items, automobiles and industrial inputs.
  • Data from the Global Trade Alert (GTA) database shows that India and the US introduced the most trade restrictions in 2018.
  • Number of harmful interventions implemented by India has increased in last decade.
  • A recent World Bank report accused India of increasingly resorting to trade remedy measures such as anti-dumping and safeguard actions.
  • In its latest report on global trade barriers, the US trade department singled out India as having the highest tariffs "of any major world economy" - averaging 13.8%.
• While import tariffs may provide the economy with short-term relief, growing protectionism can have long term adverse consequences.

Case against growing protectionism

• At a time when other economies are also raising trade barriers, it is easy to fall into the protectionist trap.
• Will undo trade liberalisation benefits: India’s trend to protectionism threatens to undo more than two decades of trade liberalization measures that have powered India’s growth over the past quarter century, boosting incomes and helping cut poverty levels.
• Will be hardest hit: A recent OECD report warned that India, Australia and China would be the biggest losers in terms of per-capita income growth if the current wave of trade protectionism escalates and slows down global growth.

Higher tariffs do not aid Make in India

• Disincentive competition: There is adequate empirical evidence, including India’s experience, that suggests protectionism and tariff barriers act as a disincentive for domestic industries to become competitive.
• Higher input cost: A higher tariff on imported inputs result in higher input costs for manufacturers, which could otherwise be competitive if they could import cheaper inputs.
• Hence, a comprehensive view of the supply chain must be taken while making any changes to tariff policies.
• High-level advisory group suggestions: Amidst US-China trade war, it is possible that higher tariffs might be imposed by other countries on Indian goods and services. It would be beneficial for India does not retaliate with tariffs.
• Any move to raise tariffs must consider the integrated supply chains and the fact that Indian imports are largely for domestic consumption.

Suggested policy response

• As production takes place through supply chains, India should integrate with global markets to ensure adequate labour-intensive manufacturing jobs.
• As India has a natural comparative advantage in labour-intensive economic activities, such activities should benefit from provision of adequate infrastructure for manufacturing and the elimination or reform of crippling anti-business labour laws.
• Tariffs can be part of a revenue-raising strategy, but it is better to have a small, uniform (same for all goods) tariff, rather than large tariffs in seemingly arbitrary sectors.
• This would help avoid the problem of “effective" rate of protection deviating from the nominal rate, and the possible worsening of the problem of tariff inversion.

Effective rate of protection (ERP):  In economics, ERP is a measure of total effect of the entire tariff structure on the value added per unit of output in each industry, when both intermediate and final goods are imported. Nominal rate of protection (NRP): NRP is the percentage tariff imposed on a product as it enters the country. Tariff inversion: It is a case where tariffs on intermediate inputs are higher than tariffs on final goods, making domestic production inefficient.