India’s average tariff during the past decade of 8-11 per cent, as against the US’ 2-3 per cent, has prompted President Trump to initiate retaliatory action. Many economists have decried India’s use of high tariffs as being protectionist, raising manufacturing costs, constraining supply chain integration and harming the Indian economy. It should, therefore, not be surprising that these experts have taken the present tumult in international trade to argue that it would be in India’s own interest to cut its tariffs unilaterally.
How does the outright condemnation of India’s high tariffs square up with India’s experience of using tariffs over the last few years? While India’s average tariffs are high, the government appears to have used this policy instrument strategically by keeping customs duties on inputs substantially lower than those on final goods, auto sector being a good example. It also varied the duties to respond to both consumer and producer interests, and this was prominently evident in the edible oil sector. These have often been ignored by trade analysts. Further, three specific episodes on tariffs go against the grain of logic of the eminent economists.
First, the automobile sector has emerged as the most important segment of India’s manufacturing. According to the Press Information Bureau, almost half of India’s total manufacturing value-added arises from this sector. It is no secret that during 1990s and 2000s India succeeded in creating this vibrant sector on the back of 60-125 per cent tariffs on automobiles. If the government had followed the prescription of maintaining low tariffs in this sector, foreign players would have preferred to export automobiles to India rather than investing in creating manufacturing facilities in the country. Further, moderate tariffs on auto parts and components, coupled with local sourcing requirements for components, helped create a robust upstream industry of these inputs.
Second, in the last 2-3 years, the mobile handset sector has emerged as a star performer in manufacturing. With tariffs on smartphones being zero till 2017, most foreign investors showed little interest in establishing manufacturing/assembly facilities in India. However, after imposing a tariff of 10 per cent in 2017, foreign players found it profitable to assemble smartphones in India.
Of course, flanking policies, such as subsidies under the PLI scheme would also have attracted them. No doubt Nokia had established its manufacturing facility in India during the days when tariff on mobile phones was zero. However, what we are witnessing today, even at 10-20 per cent tariffs, is manufacturing at a significantly larger scale.
What happened when India removed tariffs in a particular sector over a span of 5-7 years? This brings us to the third illustration. After joining the Information Technology Agreement at the WTO, during 1997-2005 India eliminated tariffs on about 200 products in the IT hardware sector. This had a devastating impact on domestic hardware producers, whose share in domestic demand plunged from around 70 per cent in early 1990s to 35-40 per cent within a few years after India eliminated tariffs in this sector. This is what the website of the Department of Commerce continues to say till today: “India’s experience with the ITA has been most discouraging, which almost wiped out the IT industry from India”. Unfortunately, the failure of the Indian domestic industry to face import competition in the IT hardware sector under the zero-duty regime appears to have been almost forgotten.
Alternatives to tariffs
Some economists have suggested two alternatives to tariffs for according protection to India’s domestic producers. First, protect producers by depreciating the currency, thereby making imports costlier. From multiple perspectives, this suggestion is problematic. Unlike tariffs, which can be fixed at different levels depending on the sensitivity of the domestic industry, currency depreciation would be a blunt instrument that would impede imports of all products. Further, currency depreciation would impact other economic variables, such as repayment of foreign borrowings. It would also make the country vulnerable to the charge of being a currency manipulator — an issue firmly in Trump’s cross-hairs. Clearly, this suggestion appears flawed and of limited utility.
The second suggestion centres around using sanitary and phyto-sanitary (SPS) measures — standards on food safety and animal and plant health — to restrict imports of agricultural products. From two perspectives this is an impractical and half-baked idea. Based on past experience, there’s a big question mark on India’s ability to meet the technical requirements of scientific justification or appropriate assessment of risks prior to putting in place a stringent SPS measure that goes beyond international norms. Further, given the high compliance costs, most domestic producers, especially the smaller ones, are unlikely to be able to meet the stringent SPS norms. Consequently, they would be prevented from even selling in the domestic market. Thus, we would be shooting ourselves in the foot, if we try to use SPS measures to reduce imports with the objective of protecting our domestic producers.
Based mainly on theoretical considerations, many economists have used a broad brush to condemn India’s high tariffs. However, based on India’s experience in the past in specific sectors, a more nuanced approach to this policy instrument is warranted. It is not the case that high tariffs alone will create a vibrant domestic industry. But it is also true that on account of handicaps such as infrastructure deficiencies, logistics costs, high cost of capital, subsidised agricultural imports, etc., without tariff protection many segments of our domestic producers will not be able to face import competition. Till the time these handicaps are addressed, India may have little option than use a mix of high, moderate and low tariffs strategically on different products not only to protect and promote the interests of its domestic producers but also balance it with consumer welfare.
The writer is an international trade expert and author of ‘Strategies in GATT and WTO Negotiations’. Views expressed are personal