The government may be on the right track to increase industry’s share of GDP contribution. He just needs to become more flexible and daring.
The economic policies of the Narendra Modi government have been an interesting mix of orthodoxy and heterodoxy over the past seven years. When it comes to macroeconomic management, the government has erred on the side of fiscal conservatism, even in a once-in-a-century pandemic. As for industrial policy, it has shown itself to be more open to a more interventionist approach. This has led many critics to label him as protectionist. However, this is a bad characterization. In fact, the government may be on the right track in increasing the industry’s share of GDP contribution. He just needs to become more flexible and daring.
Even a cursory analysis of India’s most successful industries highlights the key role of government policy in their rise. Automobiles and auto components became India’s largest manufacturing sector thanks to “local content requirements” in the 1980s and 1990s, a policy that was banned under the WTO agreement on trade-related investment measures (TRIMs) in the 2000s. Pharmaceuticals, another success story, experienced rapid growth from the 1970s after India changed its patent regime from a product-based on a process-based diet. This policy was subsequently banned by the WTO TRIPS Agreement. However, by the time TRIMs and TRIPS were applied in international trade law, both industries had gained a lot of strength and momentum. Even in services, India’s most prosperous sector, information technology – which is often said to have developed without government support – has benefited enormously from government policy which has exempted export revenues from taxes for more than two decades. Now, under WTO laws, export subsidies of any kind are also illegal.
It is possible to argue that these were protectionist policies, but it would be more appropriate to classify them under another heading: facilitation. There is a difference between protection and facilitation. In the first case, some firms are sheltered from competition, regardless of their performance in terms of production and profit, the kind of thing that prevailed before 1991. In the latter case, firms are strategically encouraged to expand. their production and profits in the presence of competition, national and foreign. The experience of all successful industrialized countries is full of facilitation policies (West and East Asia). The history of countries that have failed to industrialize is linked either to blind protectionism (India before 1991) or to generalized free trade (Africa, Latin America, after the 1980s). The design and quality of the intervention are important.
Criticism of the Modi government’s industrial policies focuses on the intensive use of tariffs on most categories of goods. Indeed, by itself, the increase in tariffs does not ensure the development of a competitive industry. But when tariff increases are moderate (real rates lower than WTO bound rates), free trade agreements exist (with ASEAN, Japan, Korea) and complementary policies are in place to stimulate growth. industry, the result would be diametrically opposed to what critics say.
International trade agreements restrict the use of certain interventions. But they are silent about the others. The government-initiated 13-sector Production Incentive Program (PLI) is an authorized intervention and provides incentives for companies to increase production and scale up. Lack of scale is one of the reasons India’s industry is not competitive or not part of global and regional value chains. The plan only exists for a limited number of years – a maximum of five. If tariff increases also come with sunset clauses, then LIPs and time-limited tariffs can create several competitive industries and millions of jobs.
In terms of political economy, the LIP should not be seen as a “subsidy” regime, just as interventionist measures should not always be seen as protectionist. This is a government ‘investment’ that will produce big returns not only for the economy but for the public purse, as industries that grow will pay taxes, ancillary industries that grow alongside will pay taxes. and those who find a job will also pay taxes. .
It is possible to modify the PLI according to the target sector. In some sectors, which are still nascent or absent, and where the initial investment costs are extremely high, the appropriate intervention may be a capital grant or a Viability Gap Funding, in the start-up years rather than a LIP. Certain very strategic sectors such as semiconductors and other manufacturing, including display, may fall into this category.
The LIP should also be extended to sectors which continue to be heavily dependent on imports, such as oil and gas. In this sector, tariffs make little sense. Instead, what is needed are incentives to increase current and future production. Perhaps some of the heavy taxes levied in this sector could be reduced provided the relief is allocated to improving production and exploration. Again, this is a government investment in future production and higher income. In yet other sectors, for example in the technological space, government intervention can support R&D spending, which is at the heart of the success of companies in this space.
Now is the perfect time for a major push towards industry and to increase domestic production. The government must continue to “facilitate” and “invest” towards this goal.
Dhiraj Nayyar is Chief Economist, Vedanta.