India has increased import duty on 19 products such as diamonds, shoes, ACs, and refrigerators. Even as these products cover $12 billion or close to 2.6 per cent of India’s annual imports, the argument has begun on whether countries should regulate free flow of goods across national boundaries.
More specifically, should countries regulate or restrict imports for specific products by imposing import duty or other barriers? Economists are at loggerheads with government policy-makers on the issue. The US-China trade war has increased the wedge. Many countries, including India, are actively considering such measures.
Economists argue that governments should refrain from regulating trade flows. Free imports allow a growing economy to expand production quickly. They boost the purchasing power of consumers by allowing them to buy high-quality goods at low price. If trade flow is unhindered, they argue, the law of comparative advantage takes over, forcing countries to specialise and trade in few products in which they have some competitive advantage.
This benefits consumers and producers of both exporting and importing countries. But the real world is messy, say government policy-makers.
China has repeatedly proved that comparative advantage, in most cases, can be developed in a short period through a sprinkling of incentives. In the 1980s, China had no domestic electronics and computer industry and imported everything for meeting local needs. China had no skill-set, no R&D and not enough capital too. Yet, it chose to ignore experts — who said the country had no comparative advantage in the sector — and implemented a shrewd production strategy.
It could attract MNCs to set final assembly units in China by offering them low-cost land, power, water, labour, tax exemptions, and an efficient customs administration. MNCs were allowed to import all inputs through the ‘global value chain’ model of shared production.
Raw materials and low-end components came from ASEAN and components requiring advance manufacturing came from Japan, Korea and Taiwan. This model saw China becoming the leading exporter of electrical machinery, electronic items and telecom equipment by 2005. China reached this position through import substitution of final product tied to a large-scale import of inputs. In the next phase of growth, it reduced dependence on the GVC model by manufacturing everything needed in-house. So initially, while China imported most parts for the assembly of an Apple from many countries, now almost everything is produced in China.
About 30 dedicated suppliers based in China are part of Apple’s ecosystem. China applied a similar strategy for organic chemicals and electrical machinery to emerge a world leader.
Import duties
Economists also consider import duty as an evil — lower the better, but zero the best, they aver. But the real world disagrees. The WTO and FTA negotiations are, after all, about forcing other countries to lower the duties.
While average duties are low for many developed countries, the devil lurks in the details. The US, the EU and most other developed countries charge high import duty on products of interest to developing countries and grant calibrated access only. The EU and the US charge 10-20 per cent import duty on Indian apparel and shoes. Japan charges 300 per cent duty on rice. Many European countries charge seasonal import duties on agriculture products.
Total import duty on some types of steel in the US and EU now exceeds 100 per cent. South Korea is an excellent example of export-led development, but in most sectors it imposes high import duties and non-tariff barriers.
The trade war is all about increasing import duties. The US is fast approaching a point where it would impose extra 25 per cent import duty on all goods coming from China. And, China is mechanically retaliating by doing the same.
India follows an open trade policy where most products can be imported without prior permission on payment of import duty. But consider two of India’s two post-1991 success stories — automobiles and pharmaceuticals. Currently, India is the world’s small-car hub mainly because the country imposed over 60 per cent import duties on automobiles and allowed the import of auto component at a much lower 5-15 per cent.
Also, India could reduce its dependence on imported medicine and emerge as the world’s leading generics supplier because of not recognising product patents for a few years. Today, low priced and high-quality cars and medicines from India find a ready market the world over.
While no case can be made for protecting an inefficient industry, action may be needed to reduce over-reliance on a country on products related to health, food or national security. Pharmaceuticals could be a good example. We import over 90 per cent of our requirement of Active Pharmaceutical Ingredients (APIs) from China. APIs are the raw materials for the industry. Realising its monopoly position, China has sharply increased prices in the past two years. We need an urgent strategy for import substitution.
Also, consider the massive import of day-to-day use items. China accounts for more than 95 per cent of imports of India for these items: blankets, bed linen, artificial flowers, kitchenware, baby carriages, clock movements, tricycles, festival items, combs, vacuum flasks, candles, etc.
Our dependence on China for these products was less than 10 per cent in 2005. These are low technology, labour-intensive products that can be manufactured locally.
Innovation matters
But import substitution is no substitute to innovation. A driver-less car can take shape only in a country with in-depth institutional knowledge of precision fabrication, electronics, robotics, design, IT and many more streams.
No firm, howsoever smart, can hope to develop this in Brazil or India or China. It can take shape in Germany, Japan or the US as they have meticulously invested in advanced manufacturing techniques. Quick comparative advantage cannot be developed in a short period for such products through import substitution.
Trade should largely be free from regulation. But in critical areas, countries take active measures to substitute imports. China’s example shows how comparative advantage on most products can be acquired with sufficient focus. Import regulation remains an area of disconnect between what economists argue and what most countries do.
The writer is from Indian Trade Service. Views are personal.