How to import-save efficiently

It is feasible for India to correct its chronic current account deficit without compromising on efficiency. It desperately needs to be competitive, at the policy and firm level

Long before ISI became a dreaded acronym courtesy the notorious Inter-Services Intelligence of Pakistan, it was associated with a (failed) economic strategy practiced by India and several other developing countries: Import Substitution Industrialisation. Now, as India faces a large current account deficit and struggling exports, import saving (a politically correct alternative for ISI) is in vogue again. Can it work?

The fact is that no country can live off imports alone. Even the theory of free trade proposes the notion of comparative advantage, not absolute advantage, as the basis of trade and efficiency. Nations must produce things and export them along with buying from abroad. The point of contention is whether any protection (in the form of trade or investment barriers) should be granted to domestic industry/agriculture/services in order for them to become competitive with rivals who already have scale and market share in the first instance. The trouble with granting protection to “infant industries” is they may never grow up to become competitive adults saddling the economy with inefficiencies in the process. Think India before 1991.

Import substitution usually involves protecting the domestic industry from imports using tariffs or some other form of trade protection. But what if it can be achieved through domestic structural reform? Evidence suggests, whenever India has signed free trade agreements (whether with ASEAN, Japan or Korea), the rise in imports has outpaced the rise in exports. In China’s case, even without a free trade area, the rise in imports has greatly outpaced any rise in exports over the last two decades. The question to ask in light of the evidence is whether Indian industry has a competitiveness problem (at the firm level) or whether India does (at the policy level).

There is no substitute for the government addressing the fundamental structural problems that continue to linger | Illustration by Binay Sinha

There are sufficient reasons to believe that India has significant competitiveness problems induced by the policy environment. Most of these reasons are well known. The cost of logistics is high. The cost of power is dictated by the philosophy of charging more to industry while cross subsiding agriculture and households. In most competitor countries, particularly China, industry gets cheaper tariffs. The same principle also drives the pricing of freight on the Railways to the detriment of efficiency. The government has made enormous strides in the ease of doing business but the fact is that key sectors that are weighing heavily on the import bill (such as oil, minerals and defence equipment) are mired in restrictive, controlling policy frameworks which deprive India of even a modicum of competitiveness. The coal sector is perhaps the best example where India has an abundance of the resources but an inefficient market structure — effectively a public monopoly — means that expensive coal is imported. There are problems with the land acquisition law which have made acquiring land for industry not only expensive but almost impossible. The list goes on.

There is a real challenge for industry to compete on a level playing field with these constraints. Unsurprisingly, the government has responded in some sectors (but not all) by raising tariffs. That angers competitor nations and reformists. 

There is no substitute for the government addressing the fundamental structural problems that continue to linger. While it does so, it can help create a level playing field for domestic industry without compromising the cause of efficiency if it follows some thumb rules. The tariff protection it affords industry should be reasonably low (not more than a 10-15 per cent range) and in compliance with the World Trade Organization norms. Preferably, the protection should be uniform across the board but this is hard to achieve. Importantly, there should be no inverted duty structures where final products are levied with lower duties than intermediates – currently this is not uncommon. Quantitative restrictions should be avoided. The government must ensure that the domestic industry structure is competitive. In cases where it is monopolistic or oligopolistic, that is, where select firms may have market power because of limited competition, import competition should be encouraged not discouraged. The government must review bilateral free-trade agreements, as per the terms of the treaties, to see where the design can be improved to provide industry with a level playing field.

The attempt to foster “Make in India” by offering a level playing field should not come at the cost of exports. This was one of the big errors of India’s pre-1991 strategy. As long as domestic manufacturers are outward oriented, Making in India for not just India but the world, they will strive towards efficiency and competiveness at the firm level. The policy narrative on exports needs two fundamental changes. First, policy become completely agnostic about what the country exports, whether primary goods, manufactured goods or services. Second, it must not be tempted to restrict or heavily tax exports for any reason.  

It is feasible for India to correct its chronic current account deficit without compromising on efficiency. Once the government has taken care of the policy-induced competitive disadvantage then domestic firms have nowhere to hide. Firm-level efficiency then has to be on a par with the world’s best to survive. India desperately needs to be competitive, at the policy and firm level.

The author is chief economist, Vedanta