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India’s Lurch Towards Protectionism

09 Mar 2018

Swaminathan S. Anklesaria Aiyar

At a Global Business Summit in New Delhi late last month, Indian
Prime Minister Narendra Modi aimed to enthuse foreign investors by
declaring that “India is open for business.” Yet India
has taken several protectionist steps over the last four months,
raising fears that the populist job pressures driving Trump in the
U.S. are beginning to animate Modi, too, now that he’s
entering his final year before the 2019 general election.

Optimists hope this is just a blip in the reform process that
will go away after the voting is over. But no government that
tom-toms protectionism as a job-creating blessing can easily
reverse it later.

Liberalization
revolutionized India’s economy. But under Narendra Modi, that may
be about to change.

Before liberalizing its economy in 1991, India had hundreds of
import duties on different items, some above 300 percent. High
tariffs aimed to accelerate industrialization, while widely
dispersed tariff rates across sectors reflected lobbying (and
kickbacks). The wide variation in tariffs on different items led to
false invoicing, tax evasion, and corruption. The results were slow
growth, uncompetitive industry, and empty government coffers when
oil prices exploded in 1990.

By contrast, liberalization led to steadily falling import
tariffs, with only occasional hiccups. In 1997, then-finance
minister Palaniappan Chidambaram declared that India would
gradually cut its tariffs to the levels of its Asian neighbors,
many of which had become miracle economies. In subsequent years,
different parties came to power, but all followed the same
approach. By 2007, India’s peak non-agricultural tariffs were
down to 10 percent, a smidgeon above those in other Asian
countries. The wide variation in duties ended.

The result: GDP growth accelerated to 8 percent per year after
2004, and India became a global export hub for small cars,
two-wheelers, and pharmaceuticals. Encouraged, Finance Minister
Ashok Jaitley pledged in 2015 to cut corporate tax rates to the
level of India’s Asian competitors, hoping to replicate their
path to success.

Now that paradigm is being upended. Last October, duties were raised on synthetic fabrics. Then
in December, import duties were raised to 20 percent on electronic items
ranging from mobile phones and TVs to digital cameras and microwave
ovens. Optimists felt this was a temporary aberration, and were
comforted when Modi went to Davos, sang the praises of
globalization, and slammed President Trump for “America
First” protectionism.

February’s budget shattered those hopes. Import duties
were raised on around 40 items “to provide adequate
protection to domestic industry,” and “promote creation
of more jobs.” Duties went up to 15 to 20 percent on items as
varied as auto parts, candles, kites, sunglasses, lamps, cigarette
lighters, toiletries, toys, watches, footwear, and furniture. The
duty on fruit juices and miscellaneous processed foods went up to
50 percent.

Revenue Secretary Hasmukh Adhia did not even offer the fig leaf
of claiming that these duties are designed to protect fledgling
industries. He baldly stated that the aim was to protect small and
medium enterprises.

The new policy also returns to the bad old variation in tariff
rates, with all its scope for lobbying, corruption, and false
invoicing. Many more industries will now demand similar additional
protections, and Modi will be tempted to give in as the next
general election nears in May 2019.

Modi had promised to create 100 million jobs in manufacturing
through a “Make in India” scheme, but manufacturing
growth is estimated at just 4.9 percent this fiscal year,
compared to 7.9 percent the year before. For Modi this is an
existential political issue-tepid growth and limited employment
remains a major problem, especially for youths with useless degrees
from useless colleges. Dominant rural castes (with much political
clout) have agitated for quotas in government jobs, even though
such quotas are supposed to be for socially and educationally
backward classes.

The new protectionism aims to create more jobs. But it ignores
past experience.

Meanwhile farm distress is widespread because of two recent
droughts and falling world prices. To combat this, agricultural
import duties have been raised sharply in recent months, the
highest rate being 100 percent on sugar. The volte-face on
industrial and farm tariffs suggests political panic on job
creation and farm distress as the next election approaches.

Indian businessmen are instinctively protectionist, and India is
among the biggest users of anti-dumping duties. Businessmen ascribe
China’s success to protection and manipulation. Some say
India should copy China’s policy of creating large industries
behind tariff walls, attaining huge scale economies and then
swamping the world with cheap exports. They say this “new
protectionism” will be outward looking and hence different
from the “old protectionism” of India’s socialist
era.

Alas, the outcome is unlikely to be better. Not even the finest
business orator can credibly argue that raising import duties to 20
percent will make India a China-style champion in exporting
candles, furniture, or toiletries. As President Trump brings the
protectionist playbook to the U.S., India should be differentiating
itself by sticking with the polices that have made it a success
story in recent years. It takes political courage to stand against
the rising tide of populism, but the economic results are worth
it.

Swaminathan
S. Anklesaria Aiyar
is a research fellow at the Cato Institute.

Click here to view the full article which appeared in CATO Journal