For a calibrated approach to reforms

KV Tirumala Moin Afaque | Updated on January 12, 2018 Published on June 08, 2017

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India did well not to embrace the conventional wisdom of the day, be it dispensing with capital controls or trade barriers

The inexplicable delays in policy formulation and implementation make it seem that the bureaucracy is the biggest stumbling block for policy-driven progress.

It is indeed tempting to suggest that policy makers should hit the reforms accelerator and watch the dust in the rear mirror. But the reality can be more complex. In hindsight, India’s calibrated, less hurried approach to opening up the economy in certain sectors might have seemed contrary to the conventional wisdom of the time, but it was validated later. A policy of circumspection can do no harm.

Do no harm

Prudent policy making should steer clear of groupthink about popular policy choices and evaluate them on the merits of the arguments. This may appear as delay mongering to some, but given that policymaking is both an art and a science, the policy maker should take it in her stride.

As economist Dani Rodrik argued “When knowledge is limited, the rule for policy makers should be, first, do no harm”. To put this thesis in context following are a few examples from the past.

In August 1991, India approached the IMF for loans to tide over its balance of payments crisis. With these loans came conditionalities wherein IMF called for liberalisation of India’s current and capital accounts. While India could move towards current account convertibility, convertibility on capital accounts was staggered.

At that time, it appeared to be against conventional wisdom to have a closed capital account when the current account was open, as an open current account could be used to bypass capital controls through mechanisms such as trade misinvoicing. While India was recovering from her 1991 financial crisis, another crisis was in the making in the East Asian Countries which had already embraced full capital account convertibility. The fixed exchange rate regimes in these countries coupled with heavy capital inflow led to an asset bubble that burst in July 1997, precipitating the crisis.

Post-crisis, there was new policy understanding about the difference between the theory and practice of capital account liberalisation and how free movement of short-term capital flows had destabilising effect on individual economies. On the other hand in India, Tarapore committee report proposed a staggered capital account liberalisation. Now post-crisis thinking also veered towards India’s approach of gradual lifting of capital controls.

Sub prime and Asian crisis

Again during the global recession of 2008, India was amongst the less affected countries. Till then RBI had not allowed Indian banks to invest in synthetic structured products like MBS, CDOs, and CDS. These products despite having sub-prime American housing loans as their underlying asset were rated as highly secure AAA investment products. US and European banks had invested heavily in subprime tranches. A conservative approach towards such instruments saved India from the direct contagion risk of the great recession. All along these years, the accepted wisdom was that free capital flows across borders would usher in higher investments and was a part of the standard dose for sick economies. However, in 2012 the IMF finally came around to the view that robust institution building should precede capital liberalisation and free capital flows, at times, might do more harm than good. India still lacks, institutional depth to handle free cross-border capital flows.

Trade liberalisation

When the course was uncertain, policy planners chose to ‘do no harm’ to start with. There is similar policy uncertainty when it comes to the question whether to provide infant industry protection. The infant industry argument calls for state support for new or sunrise industries by way of high import tariffs or domestic subsidies until the industries have matured and attained economies of scale. Industrialisation of USA and Germany took place behind the high import tariffs walls. Import tariffs in US till the end of World War II were one of the highest in the world. However, the conventional wisdom changed over time.

The era of high globalisation dawned with WTO agreement. We have two diametrically opposing examples from India where our policymakers took two opposing views and ended up with two different results which hold a lot of value. When India signed the Information Technology Agreement (ITA-I) in 1997 under WTO’s Singapore Ministerial Conference it removed tariff protection for IT hardware products covered in the agreement. This effectively made the electronic hardware imports cheap and Japanese, Korean and Chinese manufactured IT hardware poured in, stalling our nascent electronics manufacturing.

Japan, Korea and such signatories of ITA-I were operating at economies of scale that were built over preceding decades, while in India, the infant IT manufacturing industry was barely born. The effect is such that even today India is struggling to come up in this area. On the other hand, the auto and auto-ancillary sector in India was protected through high import duties and other conditions in terms of mandatory localisation provisions and investment restrictions during early and late nineties. This led to a healthy growth of auto sector in India and as India’s auto sector grew confident, India slowly withdrew most of the restrictions except high duties on fully assembled vehicles.

As a result a world class auto and auto parts sector grew here. The free-trade brigade which dominated discourse was ignored due to representations from the organised auto sector and planned policy making by the Government. India has been constantly critiqued as a slow liberaliser and high import tariff country.

Today, as the world turns back on low tariffs and talks about pains to domestic sector arising out of job losses due to factory Asia led by China, India finds itself well-padded in critical areas and sensitive sectors. These examples certainly don’t imply that we should go slow on policy reform. The point however is that, all too often simplistic models are imposed on complex societies without due consideration for the diverse developmental strategies possible.

It always helps to step back from currently accepted paradigm moulds and do a rethink and allow the files to move in the corridors till the lobby noises settle down. Till then, policy makers can abide by the adage to ‘do no harm’.

The writers are with the Indian Trade Service. The views are personal

Published on June 08, 2017
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