Subir Gokarn: Policy inter-linkages

The practice of an annual trade policy derives from a context that doesn't exist now

The annual ritual of announcing an export-import policy was gone through last week. The announcement took place in a scenario of substantial buoyancy in merchandise trade, which grew by 24 per cent during 2004-05.

Imports grew even faster at 34 per cent, which, even after accounting for higher oil prices, reflect a rapidly growing appetite for capital and intermediate inputs by domestic producers. The ministry of commerce and industry had set a target for doubling India's share of world merchandise trade by 2009. Sustaining this rate of growth will more than accomplish that.

This year's policy announcement persisted with the tradition of a bottom-up, sector-based approach to export promotion. Virtually every major incentive scheme administered by the ministry was re-structured in some way, with either the entitlements to exporters being increased, or their obligations for a given level of entitlement being relaxed.

Administrative simplification was also attempted, with the total number of forms to be filled by exporters being reduced from 120 to 50; of course, only in India would we consider a process, which required 50 forms to be filled out, "simple"!

Going by media reports, the policy measures have been, by and large, welcomed by the exporting community. Representatives of some sectors obviously believed that more could have been done for their activities, but that is par for the course in any policy announcement. The ministry is obviously seized of its goals and the steps that it can take to accomplish them.

However, amidst the debate and discussion on specific aspects of the policy it may be worth taking a step back and looking at the whole issue of export promotion and performance in a contemporary context of economic growth and development.

Over the last four decades or so, there have been two distinct approaches to export promotion, both embedded in specific growth strategies. The "export-led" growth strategies pursued by the East Asian countries starting in the late 1950s put exports at the centre of the growth process. Simply put, all economic policies were evaluated in terms of their contribution to export performance.

While different countries compromised with this commitment at various times to promote other objectives, they never completely abandoned it. From a policy perspective, therefore, exports were the responsibility of the whole government, not just the commerce or trade ministry.

The "import-substituting" strategies preferred by the Latin Americans and India, on the other hand, saw exports as an adjunct to their emphasis on developing domestic capabilities for a wide range of activities.

This development would require some imports of either goods or technologies for periods of time and foreign exchange was needed to finance these. Exports were necessary to bring in foreign exchange.

However, the elaborate structure of domestic policy instruments could not be sacrificed for export performance. The compromise was, therefore, to provide incentives to exports, which would neutralise the disadvantages they faced in the prevailing policy environment.

Over the last decade, the distinction between these alternative paths has virtually disappeared. From both the central and the peripheral roles that exports played, they have moved to one of complementarity with various other drivers of growth.

In the export-led growth countries, rising levels of affluence have driven domestic demand; the dependence on external markets is no longer so high.

In the import-substituting economies, liberalised capital markets have created opportunities for foreign exchange inflows that are not dependent on export performance. Large economies, like India, in which domestic demand is always going to play a dominant role, must take these new realities into account while designing their policies.

This brings me to the main point of this article. The prevailing practice of an annual (or longer-horizon) export-import policy derives from a context and an environment that simply doesn't exist any more.

The underlying philosophy for this year's policy and all its predecessors is still rooted in the need to offset domestic distortions to provide exporters with a degree of competitiveness.

The problem is that the number and complexities of these distortions have reduced significantly over the reform period. Those that are left are huge and simply cannot be neutralised by any instruments that the ministry of commerce and industry has within its control.

The two specific distortions that directly impact on export performance are small-scale reservation and job security regulations in manufacturing. The close relationship between scales of production and export competitiveness is a significant lesson to be learned from the East Asian experience.

There are, of course, some exceptions and Indian exporters have benefited from them. But, they are exceptions. Even if explicit restrictions on scales of production were removed, as they gradually are, the incentive to grow to larger scales is constrained by the web of labour regulations that would apply.

Beyond these, there is the familiar story of infrastructure constraints and, moving to the macroeconomic plane, the issue of the exchange rate. Progress is visible, but worrisomely slow on the first.

On the second, there is the very fundamental question of whether export competitiveness should be a primary, or parallel, objective of exchange rate policy, which itself has many inter-linkages to other variables and outcomes.

So, one might ask: should we bother with export promotion at all? This is not a frivolous question. There will always be some level of exports based on intrinsic competitiveness. But, do we need to go that extra mile, scrutinising and monitoring all the claims and exemptions embedded in those 50 forms, if the pay-off is going to be marginal?

There may be good reasons for doing this. However, it has to be done with the full recognition that, in the long run, performance will depend on how the issues mentioned are sorted out.

The main justification for preserving an incentive system for exports is that they are more labour-intensive than the country's production basket as a whole. The risk of lost jobs from a sudden fall in exports is high, and one that no government can afford to take.

A significant change in the export promotion regime could have rather disruptive consequences in the short run. It is important to keep the wheels turning, without necessarily expanding the scope of entitlements. Recent policies have, broadly speaking, tried to do this, though succumbing to the temptation to be expansive once in a while.

In India's current situation, the focus has to shift from differentiating between export and domestic markets to an integrated perspective of their common problems. What is imperative for accelerating economic growth is also imperative for achieving ambitious export targets. The era of neutralisation and offsets is long gone.

The author is chief economist, Crisil. The views here are personal.