TeaTwo standard criticisms have been made by market-oriented commentators that the Narendra Modi government made a grave mistake in abstaining from a regional free trade arrangement, and that production-linked incentives (PLIs) to encourage domestic manufacturing activity behind protective tariff walls ) The plan is fundamentally wrong. ,
There is merit in both criticisms. India could be locked out of regional production and supply chains if it is not part of the trade facilitation regime, and a subsidy- and tariff-driven manufacturing policy risks again creating an uncompetitive manufacturing sector.
What’s more, the macroeconomic consequences are potentially dire as no economy can achieve rapid economic growth without a strong and growing export sector. And a manufacturing sector that flourishes only under protection, with the help of subsidies, is not just what the doctor ordered for healthy, long-term growth of industrial activity.
The message is clear: India must join those regional trade regimes, and bring about the necessary changes to benefit from being part of international supply chains.
But while the criticisms are valid, they miss a point about the emerging situation: exports of goods (which have been mostly about Asia’s regional trade agreements) are no longer the primary driver of India’s export growth. That role has been taken over by exports of services, which have grown more rapidly. This was 42 per cent of the total export earnings last year.
If current trends continue, this figure could climb to 50 per cent in a few years and then overtake merchandise exports. When looking for export success, critics look in the wrong places and miss the wood for the trees.
They compound that error by seeking to replicate the East Asian model of export-led development that focuses on low-value, low-margin, labor-intensive exports of products such as clothing. This is a fantasy, as the operating conditions in India are different from East Asia, and are difficult to change.
There are still countries today where labor is cheaper and/or more productive. If labour-intensive exports succeed to India, as they well may, it is more likely to be with the assembly of products where labor costs are a small part of the product’s price, and/or where The domestic market provides an incentive. For localization – as is the case with mobile phones and to a lesser extent other electronic goods.
The rest of the manufactured goods exports will be mostly capital- or knowledge-intensive: refined petroleum products, engineering goods, pharmaceuticals and chemicals.
It is most unusual for a country at this stage of development to lead the export of services. But it is now well established that the country’s greatest comparative advantage lies in its educated, low-cost, white-collar workforce, not its blue-collar military.
In fact, the more the services sector generates a trade surplus, the stronger the rupee, and therefore the more difficult it is for East Asian-style low-margin, labor-intensive goods exports to succeed. This is not a new revelation. Economists have known this for years, but they fail to work it into their trade and industrial policy prescriptions.
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TeaThat second point is about PLI. Once again, the criticisms are valid, but the point that has been missed is that there is very little damage if a PLI fails. In the macro-economic context, the proposed incentives are meagre.
Total PLI payments are to come down to around Rs 2 trillion over five years – perhaps one-tenth of 1 per cent of gross domestic product (GDP) expected over that period. This is completely affordable, assuming PLI doesn’t become a permanent boon.
And what if the PLI is successful? The government claims that this will result in an investment of about Rs 3 lakh crore. That five-year total is just 1 percent of the current year’s GDP – virtually nothing when compared to the roughly 30 percent of GDP annual investment in fixed assets accounts for. But it is expected to increase the share of manufacturing in total capital expenditure, achieve substantial import substitution, boost exports and create six million jobs (one-tenth of the current total in manufacturing).
Be by all means skeptical of such claims, but if an affordable financial incentive is all that it achieves, then more power to the PLI! For this it goes: you win heads, you lose less tails.
By special arrangement with Business Standard.
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