Arvind Panagariya wants India to have a more liberal trade regime

It would be a mistake to downplay the damage that creeping import substitution can do to India’s growth and jobs ambitions, cautioned Arvind Panagariya, former Vice-Chairman of Niti Aayog.

Referring to the tariff increases that have been applied selectively precisely where they have the greatest bite, he said: “The explicitly stated objective being import substitution, tariffs have been raised on precisely those products in which substantial imports exist and domestic industry is failing to compete.”

Panagariya emphasised that when high protection applies to products accounting for a large proportion of imports and low protection to products that the country hardly imports, the effect of a given average tariff is more pernicious than when the opposite is the case.

Anti-dumping (AD) duties by India have complemented these tariff increases, Panagariya, who is now Professor of Indian Political Economy, Columbia University, said at the Export-Import Bank of India’s 36th Commencement Day Annual Lecture.

Import substitution: deleterious effect

According to the Professor, of particular relevance is the deleterious effect that this creeping import substitution policy can have on growth in labour-intensive manufactures and associated expansion of well-paid jobs for India’s vast workforce that has at best limited skills.

“When industries are promoted on the crutches of protection, they rarely become world-class.

“India’s own successful industries such as information technology, pharmaceuticals and petroleum refining have succeeded on the back of global markets,” he said.

In contrast, auto industry, which has had 70 years of autarky-level protection, is yet to acquire even 1 per cent share in the world automobile market despite being fully open to foreign direct investment (FDI).

Citing the example of India embracing import-substitution industrialisation in the electronics industry beginning in 2014, Panagariya said: “What has this policy achieved in the six years since then?

“Imports of electronic goods shot up from $32.4 billion in 2013-14 to $55.6 billion in 2018-19, while exports inched up from $7.6 billion to $8.9 billion over the same period.”

The professor noted that predictably, protected and subsidised, several mobile phone assembly firms have come up during these years but they have not added up to a vibrant electronics industry.

Locally-owned firms are small

Nearly all locally-owned firms are small by global standards, with none that is about to turn into a powerhouse of exports, he added.

“The reason for this lack of success is not difficult to see: by its very nature, protection attracts firms that principally want to make quick profits by selling the product in the protected domestic market,” Panagariya said.

He elaborated that with foreign suppliers disadvantaged by tariffs, locally-owned firms typically enter business to exploit an assured, almost risk-free domestic market.

Lacking global ambition, they also choose to operate on a scale much smaller than their counterparts in the global economy.

“A critical lesson from our own economic history has been that capital is a highly scarce resource in a developing country.

“...import substitution channels this resource into high-cost, capital-intensive import competing sectors while depriving low-cost labour-intensive export sectors of it,” explained Panagariya.

The unintended consequence of the policy is a reduction in exports alongside the reduction in imports. The economy thus disengages with the world markets, he said.

Increase engagement with world markets

The professor underscored that India needs to increase, not reduce, its engagement with the world markets.

“The simple fact we must keep in mind is that when we expand imports in the wake of trade liberalisation, we also expand exports to pay for the extra imports.

“As the process of import and export expansion proceeds, we replace low-paid jobs in small import-competing firms by better-paid jobs in export-oriented firms,” he said.

Panagariya underscored there is no doubt that given the reforms already in place and those proposed, India can count on growing at 8 per cent rate annually in the two post Covid-19 decades.

A more liberal trade regime carries the promise of pushing this growth rate into double-digit range, he added.

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