Protectionism and Import-Substitution Redux

Introduction

The victory of the BJP in May 2014 and especially the prospect of Mr. Narendra Modi as Prime Minister was greeted with joy in the 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 so-called “Gujarat Model”. Many others, in their eagerness to see liberal economic policies being implemented, were willing to overlook the communalism that was unleashed in Gujarat under his watch.[i] These hopes have been disappointed over the last few years. While the government may have been pro-business, it has certainly not been pro-market.[ii] 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. Amirapu and Soundarajan[iii] in their carefully researched article point out that removal of laws related to employment protection will be welfare improving (via increased employment) only if redundant and retrenched workers are provided with adequate social security.

At a broad strategic level, the Modi government has displayed a disconcerting shift towards protectionism and statism over the last few months discarding even the fig-leaf cover of being reformist. It is this shift that I focus on in this note. In 1997, I had written an article entitled “Look Back in Anguish”[iv], 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 shacked for decades to, what was derisively called, the “Hindu rate of growth”.[v] The situation worsened under the cynical rule of Indira Gandhi leading to the emasculation of many of India’s institutions such as the Reserve Bank of India, the Planning Commission and the Supreme Court. The article was written after India had initiated the economic reforms of 1991 and had decisively moved away from the license-permit raj that had hitherto characterized government functioning. I and many others had hoped that we had bid permanent farewell to the inward-looking, autarkic, government-dominated management of the economy. Little did I imagine that, almost twenty-five years later, I would have to dust the pages of that 1997 article to critique the economic vision of a government that many had believed would aggressively pursue economic reforms.

Critique of the Nehru-Mahalanobis Strategy

What were the elements of the Nehruvian planning strategy that I had critiqued? The following were some important elements:

• Export Pessimism: This was one of the basic premises of the Mahalanobis model which underlay the Second Five Year Plan. It was felt that India, with its limited production capabilities, would not be able to compete in the world export market. But, as Bhagwati and Srinivasan[vi] had pointed out, India’s export volumes in dollar terms rose almost continually over the First Five Year Plan period and that the balance of payments position over this Plan was comfortable. Hence, there was no obvious justification for this export pessimism. India, in a sense, had shut its doors to the rest of the world just as countries in East Asia were opening theirs to world markets.
• Autarky: It was felt that the industrial world of the late 1940s and 1950s was dominated by economies of scale, that the world market was deeply segmented and that nations were separated by protectionism. Given this international milieu what role could a densely populated poor economy like India play? Import substituting industrialisation (ISI) within an autarkic economy thus became the model that came to be adopted in the Second Five Year Plan. India's choice of ISI with emphasis on autarky meant that India was cut off from the rest of world: cut off from international competition as well as from technological progress outside India. Such an autarkic approach was borrowed from the communist regimes in the Soviet Union and China which believed themselves to be surrounded by “enemies of communism”. Both Nehru and Mahalanobis who were greatly impressed by the development strategy of the Soviet Union chose to emulate that strategy for India. As Bhagwati and Chakravarty[vii] (p.11)  note: "...it appears quite plausible to argue that Mahalanobis.....was impressed with Soviet thinking on industrialisation, with its emphasis on the building up of the capital goods base…". It can argued that the approach of the Second Plan was fashioned by a view of the world which was already changing. It seems more the case that due to reasons of ideology as well as due to an out-of-date and misunderstood view of the world, the Second Plan deliberately chose a development strategy that would set India on a path that was quite at variance with that followed by the more successful Asian economies.

Break from the Nehru-Mahalanobis Strategy

            The reforms of 1991 began a process that brought about significant changes to the policies that had been followed over the previous three decades. To put it succinctly, these changes were: [viii] [ix]

• Indian industry was increasingly exposed to competition from abroad and licensing of industries was abolished but a for a few industries
• Foreign Direct Investment was substantially liberalised
• Peak Import tariffs were reduced from 150% in 1991-92 to 10% in 2007-08

By and large, there was increasing reliance on market forces rather than bureaucratic controls even though major areas still remain where these winds of change have not yet made their presence felt, e.g. labour markets (despite what is being touted as labour market reforms in some states in the last few weeks[x]), and agriculture markets (where too some changes are being proposed[xi]). The benefits of these changes in the Indian economy have been discussed often and the reader is directed to numerous studies which have done that (apart from Ahluwalia, see Aiyer[xii]).

None of these changes have been easily accomplished. This has often led to frustration and those impatient for changes have looked longingly at China which has forged ahead of India. India’s slow, gradualist process has been defended on grounds that, with India being a democracy, reforms needed to be carried out by consensus even though Ahluwalia thinks it was reforms by compromise and dilution: “The [economic]  process  can  be  aptly  described  as  creating  a  strong consensus for weak reforms”.[xiii] Despite this, Kotwal and others assert 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  especially  in  manufacturing,  and  substantially  lower entry barriers to prospective entrants, whether domestic or foreign”.[xiv]

The difficulty in carrying out reforms in India is not only due to the democratic process and the contest that takes place among its numerous political parties, but also due to ideological differences within the political parties. Chapter 8 of Vinay Sitapita’s biography of Prime Minister P.V. Narasimha Rao[xv] provides a fascinating account of how Rao managed to push through reforms in the face of resistance from within the Congress Party. At the 69^th session of the Congress party at Tirupati in 1992, reforms had to be “shrouded in the ritual invocation of the Nehru-Indira-Rajiv vision” in order to convince uneasy party workers.

Return to the Nehru-Mahalanobis vision?

At the other end of the political spectrum, the Bhartiya Janata Party has faced resistance to reforms, especially to the opening of the economy to the world, from its own right-wing nationalist ideologues. 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.[xvi] It is opposed to globalization 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.

    The clout that the SJM wields can be seen in the following episodes:

• its opposition to the Walmart-Flipkart deal[xvii]
• Its opposition to the RCEP deal[xviii]
• The treatment of Amazon chief when he visited India[xix]

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 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?”[xx] The cadence of Modi’s words (one needs to hear this in Hindi) and the underlying strong nationalist flavor does not hide the fact that this is a call for import-substitution. The policy of Import-substitution was wrong even in the late 1950s when independent India was barely a decade old and the economy was very fragile. The policy is most definitely incongruous sixty years later when India has acquired much more economic clout.

The moribund Make in India programme also needed a revival and it came on the wings of a hike in customs duties in the 2020-21 Budget.[xxi] This was a major reversal of the trend towards reduced customs duties that started in 1991.[xxii] Import duties on finished product and parts have been hiked in order to reduce competition for domestically manufactured goods.[xxiii] This, it is expected, will create incentives for indigenous production while at the same time reducing choice for Indian buyers. 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. The socialist planning of yesteryears and likewise the current push towards swadeshi protects the interests of the producers while compromising the welfare of consumers.

The Atmanirbhar package announced recently to combat the COVID pandemic has added to the protectionist measures as well. For instance, as a means of encouraging MSMEs, global tenders will not be permitted to bid in government procurements up to Rs. 200 crores. 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 that might be subsidized by their governments. One should remember that infant industry protection of the Nehruvian variety had the same objective, namely, protecting the fledgling Indian industry from exports from abroad. The problem is that these “infant industries” cannot be weaned from the protection given to them. It is, indeed, amazing how Swadeshi and socialist arguments can coincide. Consider also the unintended consequences of the measure: government orders, in order to evade this ban, may inflate their orders to above Rs. 200 crores.[xxiv] To plug the loophole the government might need to carry out regular inspections mimicking once again a relic of Indian planning: the inspector raj.

Conclusion

It’s a crying shame that a government that was endorsed by one of the strongest votaries of globalization, Jagadish Bhagwati, and one who defended the government through thick and thin,[xxv] should have turned inwards. It is as if no one in the government has heard of his critique of the Nehru-Mahalanobis approach which dominated Indian policy making for decades. It is indeed ironic that the present government, which has blamed India’s first Prime Minister for all imaginable ills that India faces should have chosen to borrow from Nehru’s playbook of protectionism, import-substitution and infant-industry protection. India would be so much better off if this government had left protectionism and import-substitution in the dustbin of failed and outdated ideas and had, instead, borrowed from Nehru’s democratic and secular vision for India.

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[i] Praveen Dhonthi (2019) The Liberals Who loved Modi, Caravan, 16 May 2019, https://caravanmagazine.in/politics/the-liberals-who-loved-modi (accessed 14 June 2020)

[ii] Ashoka Mody, Anusha Nath and Michael Walton (2011) Indian growth: Pro-business or pro-market?, https://voxeu.org/article/indian-growth-pro-business-or-pro-market (accessed 14 June 2020)

[iii] Amrit Amirapu and Vidhya Soundararajan (2020) Disentangling the labour law debate: What does the evidence really say?, Hindustan Times, May 25, 2020, https://www.hindustantimes.com/analysis/disentangling-the-labour-law-debate-what-does-the-evidence-really-say/story-Lef1TrckiCSkJGzje5dMBJ.html (accessed 14 June 2020)

[iv] Karnik, A. (1997) Look Back in Anguish: A Review Article”. Journal of the Indian School of Political Economy, January-March, Vol. 9(1)

[v] Salil Tripathi (2006) Escaping the 'Hindu rate of growth', The Guardian, June 13, 2020, https://www.theguardian.com/commentisfree/2006/jun/13/escapingthehindurateofgro (accessed 14 June 2020)

[vi] Bhagwati J. and T.N. Srinivasan (1976) Foreign Trade Regime a and Economic Development: India, Macmillan, Delhi.

[vii] Bhagwati J. and S. Chakravarty (1971) Contributions to Indian economic analysis; a survey, Lalvani Publishing House, Bombay.

[viii] Montek Singh Ahluwalia (2002) Economic Reforms in India Since 1991: Has Gradualism Worked?, Journal of Economic Perpectives, Volume 16, Number 3, Pages 67–88, https://www.aeaweb.org/articles?id=10.1257/089533002760278721 (accessed 14 June 2020)

[ix] Montek Singh Ahluwalia (2019) India’s Economic Reforms: Achievements and Next Steps, Asian Economic Policy Review, Vol. 14, 46–62, https://onlinelibrary.wiley.com/doi/abs/10.1111/aepr.12239 (accessed 14 June 2020)

[x] Bhanu Pratap Mehta (2020) Ordinances by states to change labour laws are a travesty, The Indian Express, 12 May 2020, https://indianexpress.com/article/opinion/columns/industrial-relations-code-india-labour-law-amendment-pratap-bhanu-mehta-6405265/ (accessed 14 June 2020)

[xi] Roshan Kishore (2020) Will farmers get a better deal after recent reforms?, Hindustan Times, May 18, 2020, https://www.hindustantimes.com/india-news/will-farmers-get-a-better-deal-after-recent-reforms/story-8wrOzXKTL7J94cuInodOmK.html (accesses 14 June 2020)

[xii] Swaminathan S. Anklesaria Aiyar(2016) Twenty-Five Years of Indian Economic Reform, Policy Analysis, No. 803, https://www.cato.org/publications/policy-analysis/twenty-five-years-indian-economic-reform (accessed 14 June 2020)

[xiii] Ahluwalia (2002)

[xiv] Ashok Kotwal, Bharat Ramaswami, and Wilima Wadhwa (2011) Economic Liberalization and Indian Economic Growth: What’s the Evidence?, Journal of Economic Literature, Vol. 49 (4), pp. 1152–1199, https://www.aeaweb.org/articles?id=10.1257/jel.49.4.1152 (accessed 14 June 2020)

[xv] Vinay Satpati (2016) Half-Lion: How P.V. Narasimha Rao Transformed India, Penguin Books India, Gurgaon

[xvi] Swadeshi Jargan Manch (undated) Philosophy, https://swadeshionline.in/page/philosophy (accessed 14 June 2020)

[xvii] Anonymous (2020) Flipkart, Amazon circumventing laws, says RSS affiliate Swadeshi Jagran Manch, The Hindu, January 22, 2019, https://www.thehindu.com/news/national/flipkart-amazon-circumventing-laws-says-rss-affiliate-swadeshi-jagran-manch/article26061012.ece (accessed 14 June 2020)

[xviii] Gyan Varma (2019) RSS affiliate Swadeshi Jagran Manch starts 10-day nationwide protest against RCEP, Livemint, October 10, 2019, https://www.livemint.com/news/india/rss-affiliate-swadeshi-jagran-manch-starts-10-day-nationwide-protest-against-rcep-11570705535646.html (accessed 14 June 2020)

[xix] Paran Balakrishnan (2020) A throwback to protectionism?, The Hindu Business Line, January 22, 2020 https://www.thehindubusinessline.com/opinion/a-throwback-to-protectionism/article30618392.ece (accessed 14 June 2020)

[xx] Narendra Modi (2019) Mann ki Baat, https://www.narendramodi.in/mann-ki-baat#0 (in the audio recording of this talk listen especially from 12.20 to 15.30) (accessed 14 June 2020)

[xxi] ET Bureau (2020) Budget 2020: Custom of duty hikes makes a grand return, The Economic Times, February 2, 2020, https://economictimes.indiatimes.com/news/economy/policy/budget-2020-customs-duty-on-imported-footwear-furniture-hiked/articleshow/73837994.cms?from=mdr (accessed 14 June 2020)

[xxii] Vivek Kaul (2020) The dangers of India’s rising tariff walls, Livemint, February 13, 2020, https://www.livemint.com/news/india/the-dangers-of-india-s-rising-tariff-walls-11581521558549.html (accessed 14 June 2020)

[xxiii] Puneet Bansal and Sneha Ghosh (2020) The Great Indian Trade Wall: A Case Of Measured Protectionism - Analysis Of International Trade Measures In Budget 2020,  https://www.mondaq.com/india/international-trade-investment/915520/the-great-indian-trade-wall-a-case-of-measured-protectionism--analysis-of-international-trade-measures-in-budget-2020 (accessed 14 June 2020)

[xxiv] Anonymous (2020) Tender loving self-care, Livemint, 14 May 2020, https://www.livemint.com/opinion/quick-edit/tender-loving-self-care-11589438309553.html (accessed 14 June 2020)

[xxv] Lavina Melwani (2019) The PM must wake up..., The Week, 21 September 2019, https://www.theweek.in/theweek/specials/2019/09/20/the-pm-must-wake-up.html (accessed 14 June 2020)