Correct course on tariffs

Union Budget must avoid failed strategy of protectionism

This year’s Union Budget will have to address both the immediate crisis in the economy, caused by the pandemic, lockdown, and social- distancing norms, as well as the longer-term headwinds caused by a revenue crunch and slowing growth momentum. The main focus of the Budget, therefore, should be on reform and competitiveness, alongside targeted relief to those sectors most directly affected by the pandemic. It is unfortunate therefore that, according to recent reports, the Budget will include tariff increases on 50 or more different items including electronics and chemicals. This would be another misguided step towards isolating India from the global economy, alongside other recent anti-trade moves. Further protectionism will neither help the economy recover swiftly nor raise India’s growth trajectory sustainably.

The government has, in recent years — in spite of pro-globalisation and pro-trade rhetoric from some officials and politicians — taken distinct steps to return India to its pre-1991 trade isolation. Bureaucrats have claimed this is just a way of minimising “non-essential” imports. But that claim is economically uninformed and ignores India’s history of such attempts by previous generations of bureaucrats. The fact is that the government is not capable of identifying those items that are “essential” and those that are “non-essential” from the point of view of growth and investment. This problem is even more acute in the 21st century than it was in the 20th, given the far more complex production systems in place today, and the enormously disaggregated and flexible nature of competitive value chains. The thought that policy set in New Delhi could somehow anticipate these decisions, based on commercial factors and technological innovation, in order to try and manage to on-shore manufacturing without significantly affecting investment or output, is ludicrous.

The Budget must display some humility and some understanding of history — recent history, if not that prior to 1991. The fact is that successive protectionist moves have not led to an explosion of domestic manufacturing. They have merely made prices higher for consumers, and thereby reduced welfare — the inevitable consequence of such attempts. Given the clearly apparent failures of previous rounds of tariff hikes and controls, the government should quietly retreat from this strategy. It is not wise to try and double down on strategies that have already been proved ineffective, in the hope of finding some magic mix of tariffs that would set off private investment in the domestic market. After all, those who have attempted to set up manufacturing in India care far more about questions of tax and policy stability.

This was also initially a priority area for the government, but it has lost ground in recent years to old-style import substitution. The latter creates the sense that something is being done, provides some immediate results and revenue, and satisfies domestic producers and lobby groups that might otherwise demand tax relief. But the fact is that only sustained reform can increase India’s share of manufacturing, raise competitiveness, and create employment. If the government cared about welfare — or basic economic logic — it would focus this Budget entirely on reform, and not increasing its reliance on mechanisms that have been clearly proven to not work for India.