Macroeconomics

Protectionism and Statism, once again

  • Blog Post Date 25 June, 2020
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Ajit Karnik

Middlesex University, Dubai

a.karnik@mdx.ac.ae

In this post, Ajit Karnik argues that, at a broad strategic level, the Indian government has displayed a disconcerting shift towards protectionism and Statism over the last few months. While discussing India’s experience with an inward-looking policy in the past – the negative consequences of which had kept it shackled in a low rate of growth for decades – he presents a critique of the economic vision of the current government.

 

The victory of the Bharatiya Janata Party (BJP) in May 2014, and especially the prospect of Mr. Narendra Modi as Prime Minister, was greeted with joy in the Indian stock market. The monthly average of the Sensex index for the 12 months following the victory was 29% higher than the monthly average for the year prior to the victory. Clearly, the market was hoping for strong market-oriented reforms from someone who had been lauded for the ‘Gujarat Model’. Six years later, at least some of those hopes have been dashed. There is a feeling that while the government may have been pro-business, it has certainly not been pro-market. I say this despite some recent changes in labour laws, ostensibly to remove rigidities in the labour market. While some have welcomed these changes, others (not necessarily of the leftist variety) have expressed strong reservations especially considering the timing of the changes when the Covid pandemic is causing unprecedented unemployment.

At a broad strategic level, the Modi government has displayed a disconcerting shift towards protectionism and Statism over the last few months. It is this shift that I focus on in this post. In 1997, I had written an article entitled “Look Back in Anguish” (Karnik 1997), which was a lament for the development strategy that was initiated under India’s first Prime Minister Jawaharlal Nehru and continued for about 35 years. The adverse consequences of that development strategy would keep India shackled for decades to the ‘Hindu rate of growth’ as it was derisively labelled. Many had hoped that we had bid permanent farewell to that inward-looking, autarkic, government-dominated management of the economy. Little did I imagine that, almost 25 years later, I would have to dust the pages of that article to critique the economic vision of the current government.

India’s experience with the inward-looking policy

The Nehru-Mahalanobis approach to the Second Five Year Plan (1956-61) was based on two important tenets:

  1. Export pessimism: It was felt that India, with its limited production capabilities, would not be able to compete in the world export market.
  2. Autarky: It was felt that the industrial world of the late 1940s and 1950s was dominated by large businesses, and that nations were separated by protectionism. Apprehensions about India’s position in such a milieu, led to import substituting industrialisation (ISI) within an autarkic economy.

The reforms of 1991 began a process that brought about significant changes to the policies that had been followed over the previous three decades. In brief, these changes opened Indian industry to international competition, abolished licensing of industries, liberalised FDI (foreign direct investment), substantially reduced peak import tariffs, and increased the use of market forces in place of rigid bureaucratic controls. Kotwal et al. (2011) aver that, “The reforms that began in 1991 completely changed the direction of economic policies… India moved away from a State-led closed economy framework in favor of greater integration with the world economy, lesser controls on private business activity…”. Of course, none of these changes were easily accomplished. Criticism of India’s languorous process has been defended on grounds that with India being a democracy, reforms needed to be carried out by consensus, compromise, and dilution. Political opposition to the economic reforms often emanated from within the Congress party. Sitapati (2016) describes how Prime Minister Rao “shrouded [reforms] in the ritual invocation of the Nehru-Indira-Rajiv vision” in order to convince uneasy party workers.

At the other end of the political spectrum, the BJP has also faced resistance to reforms from its own right-wing nationalist ideologues, especially to the opening of the economy to the world. The views and philosophy of swadeshi as expressed by the Swadeshi Jargan Manch (SJM) is revealing. For example, the swadeshi approach is to limit the size of the market (without making it clear what this entails), coupled with a significant and powerful role for the State. It is opposed to globalisation and foreign trade agreements. While the Congress party, however haltingly, was able to push the economic reforms agenda forward, there is fear that the power wielded by the swadeshi lobby could derail this process completely.

That the power of the swadeshi lobby has blunted the reforms process is visible in the dramatic turn inwards that the Prime Minister announced in his December 2019 Mann Ki Baat radio talk. He appealed to the citizens to “…pledge, that by 2022, when we achieve 75 years of independence we insist and remain steadfast at least, for about two-three years on buying local products? Products made in India, made by the hands of our citizens, carrying the fragrance of the sweat of our countrymen, can’t we resolve to buy such things?” The cadence of Modi’s words (one needs to hear this in Hindi), and the underlying strong nationalist flavour does not hide the fact that this is a call for import substitution. The policy of import substitution was inappropriate even in the late 1950s when independent India was barely a decade old and the economy was very fragile. The policy is most definitely wrong-headed 60 years later when India has acquired much greater economic strength and resilience.

The ‘Make in India’ programme designed to attract investments to India has so far failed to light the spark of Indian industrialisation effort. It was badly in a need of revival, and it came on the wings of a hike in customs duties in the 2020-21 Budget. This was a major reversal of the trend towards reduced customs duties that started in 1991. Import duties on finished product and parts have been hiked in order to reduce competition faced by domestically manufactured goods. The similarity of this approach to that followed by India in the decades after independence, should be obvious. The absence of competition will fulfill the swadeshi requirement but will compel Indians to consume shoddy products as they did in the past.

Additional protectionist measures were introduced in the Atmanirbhar Bharat Abhiyan package, wherein it was announced that global tenders will not be permitted to bid in government procurements up to Rs. 2 billion. This, it is expected, will protect Indian bidders from foreign competition, and divert business towards Indian companies. Most such measures sound eminently reasonable, especially when couched in terms of protecting Indian manufacturers from foreign (read Chinese) companies, which might be subsidised by their governments. One should remember that infant-industry protection of the Nehruvian variety had the same objective, namely, protecting fledgling Indian industry from imports from abroad. The problem is that these ‘infant industries’ cannot be weaned away from the protection given to them.

Has it become necessary now to protect Indian interests?

It has been argued that globalisation and, in particular, China have been responsible for the poor state of Indian manufacturing. Hence, it has become necessary to protect Indian interests. Secondly, it has also been argued that nationalistic sentiments have been increasing across the world, and hence, withdrawing from world markets seems inevitable. Finally, it has also been suggested that the disruption of global supply chains due to the Covid crisis has meant that there is no option but to turn inwards. Do these arguments justify the inward-looking policies that have been initiated in the recent past?

Protection of Indian industry from Chinese competition is no different from the arguments for infant-industry protection. India has had a long and unfortunate experience with this policy, as I have discussed above. Such protection, apart from making the industry dependent on protection, also opens the door to lobbying and rent-seeking, both of which India has suffered from, for decades. It is indeed true that globalisation has been on the retreat over the last few years, as has been argued by Rodrik (2020). However, this does not mean that India needs to cater exclusively to the domestic market. The decision on whether to cater to external or domestic markets can be left to individual producers, forgoing any of the compulsions that trade barriers necessarily entail. The disruption of global supply chains has affected a large number of countries including India. How the future will unfold is still not clear, but it seems likely that supply chains might become shorter. This does not have to mean that India’s supply chains need be limited by its national boundaries. These are decisions that will be taken in response to market signals and careful evaluation of risks by producers, without necessarily being forced to look inwards by means of protectionist policies. The danger that we must recognise is that the heavy hand of regulation that protectionist policies inevitably involve will likely reverse much of the progress that India has made since the economic reforms of 1991.

There is no doubt that the Covid pandemic represents a massive challenge to the Indian economy. The important question is whether India should retreat behind a wall of trade barriers and pursue inward-looking policies to meet this challenge. It is a sad commentary on Indian policymaking that, with this sharp turn inwards, we are about the repeat the same mistakes that had been committed decades ago. It is indeed ironic that the present government, which has blamed India’s first Prime Minister for all imaginable ills, should have chosen to borrow from his playbook, precisely those ideas it should not have   namely, protectionism, import-substitution, and infant-industry protection.

Further Reading

  • Karnik, Ajit (1997), “Look Back in Anguish: A Review Article”, Journal of the Indian School of Political Economy, January-March 1997.
  • Kotwal, Ashok, Bharat Ramaswami and Willima Wadhwa (2011), “Economic Liberalization and Indian Economic Growth: What’s the Evidence?”, Journal of Economic Literature, 49(4):1152-1199.
  • Sitapati, V (2016), Half Lion: How P.V. Narasimha Rao Transformed India, Penguin Books India.
  • Rodrik, D (2020), ‘Future of globalization after the COVID crisis, The economic implications of COVID-19’, A webinar series from the Princeton Bendheim Center for Finance.
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1 Comment:

By: CHANDRahas DESHPANDE

...Well-articulated. In fact, there is a need to enable Indian Industry and (even) SMEs to join the Global Value Chains, GVCs and to capture global markets as and when the world opens up again for business. This requires an integration of FDI, Industrial and Trade Policy...

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