Why Higher Import Tariffs Cannot Be A Standalone Measure For Make In India

The budget decision to raise import tariffs on a wide range of items has been roundly criticised by many economists as “protectionist” and counter-productive in the long-run. Among the critics are former NITI Aayog vice-chairman Arvind Panagariya, his successor Rajiv Kumar, Vivek Dehejia, and a part-time member of the Prime Minister’s Economic Advisory Council, Surjit Bhalla, among others.

In his budget speech, Finance Minister Arun Jaitley said he was “making a calibrated departure from the underlying policy in the last two decades, wherein the trend largely was to reduce the customs duty. There is substantial potential for domestic value addition in certain sectors, like food processing, electronics, auto components, footwear and furniture. To further incentivise domestic value addition and Make in India in some such sectors, I propose to increase customs duty on certain items.”

The critics have rightly pointed out that import-substitution policies have usually failed, and that any artificial curbs on imports often impact exports as well.

It is possible that the tariff increases are a short-term revenue measure, but in this case an across-the-board small increase would have been better. The focus on specific sectors like mobile phones, high-end TVs, fruit juices, leather and furniture suggests that revenue is not the main consideration here.

Actually, there is a slightly different way of looking at this issue. The legitimacy or otherwise of higher import tariffs depends on obtaining answers to three other questions: how long the higher tariffs will remain; what are the accompanying steps that will enable domestic industry to use this breather to improve its competition position once the tariff protection is tapered down; and whether the tariffs will be used as a lever to obtain higher market access to some of the countries targeted (like China in mobile phones). Without answers to these questions, it is a bit premature to lambast the government on this move.

Logically, the following should be the gameplan that can justify the selective tariff hikes for a limited period.

First, there must be an announced tariff reduction plan so that domestic industry knows that the protection is not forever. It can grab window of opportunity to invest and lower costs to global levels by building scale.

Second, in the areas earmarked for Make in India, specific steps to improve competitiveness – from lowering duties on raw materials to offering cheaper credit – need to be forthcoming. Make in India needs to be cost-competitive to succeed over the long-term. Purely as an import-substitution method it cannot work.

Third, reform of the factor markets – especially labour – is vital. The Narendra Modi government has moved in a small way to ease things, by amending the Apprentices Act. It is also extending the job-creating benefits of fixed-term employment contracts to sectors beyond apparel and leather. But we need more sweeping reforms of land and labour laws that are permanent in nature, and that is nowhere on the horizon.

Fourth, the long-term alternative to higher tariffs is a managed depreciation of the rupee. The Indian rupee is overvalued largely due to high capital inflows into Indian debt, and the RBI’s failure to cut rates when inflation was ruling low. A lower exchange rate is key to pushing up exports in the short run.

Fifth, our real trade problem is China, where our annual trade deficits are now in excess of $50 billion. At some point, this huge source of income for Chinese firms needs to be used as leverage to either move some of its manufacturing or assembly jobs to India’s export zones, or the trade should be converted partly to local currency, where the rupee surpluses of China can be used for infrastructure investment in India. Given that China is also a threat to India’s security, we cannot delink trade measures against China from the budget’s recent tariff actions. But tariffs are about short-term breather, and do not amount to a credible strategy that will ultimately benefit India.