An Indian security guard pulls down the shutters of a state bank's ATM branch during a nationwide bank strike in Agartala, the capital of the northeastern state of Tripura, on February 28, 2017. / AFP PHOTO / Arindam DEY
An Indian security guard pulls down the shutters of a state bank's ATM branch in Agartala, the capital of the northeastern state of Tripura, on February 28, 2017. Photo: AFP/Arindam Dey

India won its independence from the British on August 15, 1947. So it has been 71 years since the British left. During much of those 71 years that India has been independent, the country followed protectionism and an inward-looking import-substitution strategy – in fact, for nearly the first four and a half decades.

The Indian economy remained closed to outsiders, and the idea was that domestic companies would produce for the domestic market. The belief in import substitution as an economic strategy also came from the fact that India was coming out of a long period of British rule and so wanted to be self-sufficient.

This is a point that becomes clear from a paragraph in Jawaharlal Nehru’s book The Discovery of India: “The objective for the country as a whole was the attainment, as far as possible, of national self-sufficiency.… The first charge on the country’s produce should be to meet the domestic needs of food, raw materials, and manufactured products.”

The trouble is that this inward-looking strategy has cost India quite a lot over the years. The countries of Southeast Asia also started with import substitution (or producing only for the domestic markets), but quickly shifted their focus toward exports, given that their domestic markets were small (unlike the Indian case). India continued to favor import substitution for much longer, given its large domestic market, and this has had repercussions over the decades.

When companies produce for the global market, they need to compete with the best in the world. This automatically leads to a situation where the products a company produces need to be globally competitive.

On the other hand, when import substitution is the norm and companies need to produce just for the internal market, almost anything goes. This explains why some countries in Southeast Asia, and other countries such as South Korea, are export powerhouses, which India is not.

What did not help was that the “license raj” (license regime) unleashed by Indira Gandhi in essence ensured that there was next to no competition in many product markets.

Automobiles are an excellent example. For a very long time, Indian consumers had access to only two brands – the Ambassador, manufactured by the Birlas at Uttarpara near Kolkata, and the Premier Padmini, by the Walchand group at Kurla in Mumbai.

Other than a lack of choice for the consumer, the closed economy also led to slow economic growth. Between the financial years 1950-51 and 1990-91, a period of four decades, the Indian economy grew at the rate of 4.1% per year. Between 1991-92 and 2013-14, a period of a little over two decades, the economy grew at a significantly higher rate of 6.6% per year.

The rate of economic growth has been calculated here only until 2013-14 for a certain reason. The GDP series that is in use currently, and which is used to calculate economic growth, has data starting from only 2011-12 onward. Hence one cannot carry out historical comparisons using this GDP series. The previous GDP series has data from 1950-51 up to 2013-14, and so that GDP series has been used to make the comparisons in this article.

This jump in economic growth happened primarily because India started initiating major economic reforms in the early to mid-1980s and big-bang economic reforms were initiated in the budget of 1991, when India was on the brink of a foreign-exchange crisis. This budget was presented by the finance minister at the time, Dr Manmohan Singh.

The economic reforms opened up the Indian economy, and the results can be clearly seen in the economic growth that followed. In 1991, the government decided to do away with import licensing on raw materials as well as machinery. Import tariffs were also gradually reduced over the years.

In 2001, import licensing on consumer goods came to an end. If one considers the economic growth between 2001-02 and 2013-14, it was at an even higher 7.2%. This helped pull millions of Indians out of poverty. All this is reasonably well documented.

But in the recent past, things have started to change.

In the annual budget presented this February, then-finance minister Arun Jaitley said: “In this budget, I am making a calibrated departure from the underlying policy in the last two decades, wherein the trend largely was to reduce the customs duty.”

While budget speeches in India are more a case of showmanship than a serious policy document, that cannot be said in this case. A recent news report in The Indian Express suggests that over the last 24 months the government has increased customs duty on more than 400 products. This includes everything from solar panels to mobile-phone parts to apples.

The idea, as is the case with any tariff, is to encourage domestic manufacturers by making imports expensive. Now only if things were as easy as that. There are several points that need to be made here:

  1. One of the big talking points in India is the huge trade deficit that it runs with China, that is, we import much more from them than we export to them. Hence the idea that Indian industries should be protected against Chinese imports by imposing tariffs. The basic problem with this argument is that no one is forcing the Indian customer to buy Chinese products (or products imported from other countries). Indians are doing it out of their own free will, given that they see more value in buying these products.
  2. Hence any tariff goes against the basic democratic choice that consumers of any country exercise while buying an imported product. Also, a tariff tries to protect domestic manufacturers at the cost of domestic consumers, who are much greater in number. The trouble is that unlike the domestic manufacturers, the domestic consumers aren’t really organized. Hence manufacturers can lobby, but consumers cannot.
  3. The hope while imposing any tariff is that the imported item will become expensive and consumers will buy the same item produced domestically. There is a slight problem with this argument. If the consumer buys the domestic product, he will end up paying more for it. There is only a certain amount of money that he can spend and if he pays more for one product, he will have to cut down on expenditure somewhere else. So if he buys one domestic product, he may not buy another. Hence, net-net, a tariff may not make any difference.
  4. Also, those advocating protectionism forget that global trade at the end of the day is a zero-sum game. In simple terms this means that global exports equal global imports. It further means that only if countries are able to export will they be able to pay for imports.

When India imposes tariffs, it discourages countries that export goods and services to India. When this happens, these countries do not earn enough dollars to be able to pay for goods and services they import out of India.

The point is that if a country makes imports difficult, it will ultimately start to impact its exports.

Once these factors are taken into account, it is easy to see that a return to a pre-1991 kind of economy simply doesn’t make any sense. It is to be hoped that Indian policy planners realize this sooner rather than later.

Tariffs and protectionism hurt. And Prime Minister Narendra Modi should not make the same mistakes that Jawaharlal Nehru and Indira Gandhi did.

Vivek Kaul

Vivek Kaul writes on the economy and finance. He is the author of the "Easy Money" trilogy and India's Big Government. He tweets as @kaul_vivek

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