Self-reliance and supply chains

India needs to focus on manufacturing competitiveness, rather than building domestic supply chains in their entirety

As India redefines national priorities in the face of the Covid pandemic, it has, in the economic context, sought to invoke the objective of self-reliance. The aim is to evolve local supply chains, reduce import dependence and instead emphasise import substitution while simultaneously seeking export competitiveness. These goals may prove elusive. Let us understand why. 

Building a competitive industrial base through import substitution is a long process, possibly spanning decades, as it requires specialisation and scale in all components of the supply chain. Characterised by proximate production and development of necessary sectoral competencies, such “lumpy” industrialisation was predominant prior to the information and communication technology (ICT) revolution. With the ICT revolution, however, fragmentation of production across borders became possible. Large corporations from developed economies found it cost-effective to locate production in countries with abundant cheap labour and close to large markets. The host economies, often developing countries, benefitted in this process as they acquired manufacturing specialisation in the off-shored production stages over a much shorter period of time. They were no longer required to go through decades-long learning process — as, for example, South Korea underwent successfully in the 1970s, but that many developing countries, including India, could not accomplish till the mid-1980s. 
 

“Factory Asia” centered around China was a key outcome of this process of production fragmentation. The regional value chain (RVC) process that intensified in the 2000s was further facilitated by widespread unilateral tariff liberalisation and enabling business environments in the host economies in the 1990s. 

Inherent in this phase of globalisation and manufacturing specialisation was “technology lending” or transfer of know-how. To secure this, large corporations in developed economies looked for facilitating investment and trade rules vis-a-vis host developing countries. New age deeper free-trade agreements (FTAs) went beyond just tariff liberalisation to include disciplines like intellectual property and investor protection. Since the multilateral system at the World Trade Organization was enmeshed in the Doha Development Agenda deadlock, it led to a proliferation of such deep FTAs. Over time, as RVCs increased in complexity, FTAs graduated to mega-regional trade agreements. Comprehensive and Progressive Trans-Pacific Partnership (CPTPP) and Regional Comprehensive Economic Partnership (RCEP) are two such mega-regionals in Asia. 

Illustration: Ajay Mohanty

India’s participation in this process of manufacturing specialisation through global value chains (GVCs) has been low relative to developing countries as a whole and much lower than Asean countries (See Table). In its lead export sectors, textiles and automotives, India has experienced a decline in its backward linkages (value of imported intermediates in gross exports) with GVCs since 2012-2013. In electronics and computing, the sector that has led global value chain development, India’s backward linkages in 2015 are almost half the level of Vietnam. India has not been able to take advantage of its proximity to the dynamic GVC hub of Factory Asia. Hence, its value chain linkages with the region remain weak. (see “India’s Exports and Factory Asia” Business Standard, September 3, 2019). Moreover, as pointed out, import substitution through increases in input tariffs in recent years, as in the case for textiles and automotives, will further depress India’s prospects for value chain integration. 

Recent experience clearly shows that India has not been an attractive destination for supply chains. In the wake of the economic slowdown since the global financial crisis and more so since 2018 owing to the US-China trade war induced uncertainty, there has been some “re-shoring” back to home economies and relocation of supply chains from China to other Southeast Asian economies. Also, as China moved up the value chain over the last decade, the lower end value chains have relocated to other nearby Southeast Asian economies, mainly to Vietnam, but also to Cambodia. A favourable wage ratio vis-a-vis China and domestic trade and investment reforms, which were largely a consequence of its active pursuit of FTAs including with the EU and the CPTPP, have strongly favoured Vietnam. 

 

India, in contrast, continues to struggle with its FTAs, as reflected most recently in its withdrawal from the RCEP negotiations at the concluding stage. In this context, the oft-repeated argument, that other than China, we have FTAs with nearly all RCEP member nations — Asean, Japan and South Korea— is weak. A large corporation located in Vietnam will have seamless preferential access to the larger collective market, including China, Australia, New Zealand and the Asean, unlike when it is based in a country with FTAs with individual countries, as is true for India. 

In recent years, import tariff reductions have not been the most critical element of FTA negotiations since these are already very low for most participating economies. It is the supply chain facilitative “behind the border” regulatory issues and investor-friendly provisions that drive FTA negotiations. The opportunity now available in the review of FTAs with Asean (announced) and South Korea (underway), should not be frittered away on reversing tariff concessions already granted under the pretext of import substitution. This would be counter -productive. Instead, India should seriously re-work its FTAs strategy to focus on regulatory issues and investment-inducing provisions. 

The RCEP negotiations are still open for India to join. It is important to understand that the RCEP is an Asean-centric process, not a China-led one. East Asia may well be the first to see economic revival post the pandemic. None of the Asean countries, not even China, is among the top 20 worst-affected countries in terms of total confirmed cases of Covid-19. (John Hopkins Coronavirus Resource Centre, June 29, 2020). The re-shoring or near-shoring processes, already underway in the region, are likely to consolidate further owing to the pandemic, even though large scale supply chain shifts will depend on the nature and timing of China’s economic recovery, given its centrality in the dense regional production networks. 

Therefore, rather than building domestic supply chains in their entirety, India’s focus, now, should be on increasing its manufacturing competitive advantage through possible opportunities that the pandemic may offer. Focusing on necessary domestic regulatory and investment climate reforms as a means to GVC participation may be far more effective in the present context. 

The writer is professor, School of International Studies, Jawaharlal Nehru University. Views are personal.