Patnaik is a senior economist at National Council of Applied
Economic Research. |
How much protection is enough protection?
Everyone is aware that the Indian government has
mollycoddled its domestic industry with protectionist barriers
for four decades now. It then continued doggedly along the
same track even after reforms were initiated in 1991 - by not
pushing Indian companies hard enough to become more
competitive. Now that the damage is well underway, the
government is desperately seeking ways to hide all the
different inefficiencies that abound in the Indian economy as
a result of its protectionist methods.
inefficiencies were well known, though usually discussed only
in a select circle of businessmen, bureaucrats and economists.
But the imminent removal of Quantitive Restrictions (next
April) and the current scare of cheap imports have brought the
high costs of Indian production into sharper public focus.
Exactly the same thing had happened in the US during the 1980s
with cheap Japanese imports flooding the markets. But while US
producers had the excuse of costly labour - and, therefore, a
comparative disadvantage in the production of labour intensive
goods - Indian producers have high infrastructure costs and
government policy to blame. Transport delays, expensive and
erratic power supply and poor telecommunications lead to
inefficiencies and push up their production costs, they
complain and not without reason.
India's closed economy floundered in a free
This mattered little when India functioned in a
virtually closed economy regime. But now that it has to face
up to the pressures of an open economy, these higher costs
will make domestic industry uncompetitive. Abroad, Indian
exports face threats from products from more efficient
economies. At home, the domestic industry faces price
competition from cheap imports. Last year, China exported
plastic products worth US$8b; in contrast, the US$4.4b Indian
plastic processing industry could export goods worth only
Plastic manufacturers attribute the Chinese
performance to the easy availability of labour, higher
productivity, better government policies and excellent
infrastructure facilities. The same story is replicated across
scores of industries. No wonder, then, that there is such a
strong case being made for greater protectionism. So QRs are
being replaced by anti-dumping duties and BIS standards. The
Budget may even introduce higher tariffs on imports.
Is there room for Mr Nice Guy anymore?
What this will do is buy some time, but what
happens when imports meet Indian standards and when the
anti-dumping cases fructify, one way or the other? How will
the government protect the industry then?
In the long
term, the government has to undertake the reform of various
policies in various areas of the economy - labour, exit,
financial markets, company law - that are holding back Indian
industry growth. But to the extent that the long term is made
up of a series of short terms, it will probably want to hide
the inefficiencies of Indian industry behind the protection
bush, explicit or implicit.
Explicit protection or the
use of tariffs and subsidies is one available option. Duties
can be raised to make imports more expensive while export
subsidies can be provided to make exports cheaper. Such
measures, though, may create difficulties under the new WTO
regime. Other countries could complain about India's policies
to the Disputes Panel and then India would be hard pressed to
defend itself. Once duties reach bound rates and subsidies
lead to anti-dumping measures against India, this no longer
remains a viable option.
Currency depreciation: taking the back door
This leaves the implicit protection way, the use
of the exchange rate, that achieves the same objective albeit
in a way that no one can call explicitly protectionist.
Depreciation of currency makes exports cheaper and imports
more expensive. Indeed, South- and East Asian economists have
followed aggressive depreciation as a strategy to push
exports. This, indeed, is the most important lesson of the
1990s: opening up has meant a permanent pressure to shift from
the first set of policies to the second, namely, the exchange
While the trademark of the 1970s and 1980s was
protection and subsidies, the 1990s saw a reduction in
explicit protection and a move to a "market determined"
exchange rate. To some extent, India has followed the strategy
of pushing exports through the exchange rate strategy, though
not very aggressively. For example, the RBI resists all
pressures on the nominal exchange rate to appreciate in order
to keep exports competitive. And, if the real exchange rate
appreciates due to inflation differentials, RBI's policy has
been to prevent this as well. The Tarapore Committee, for
instance, recommended that the real exchange rate should be
allowed to move only within a five-percent band.
has, in the past, often prevented the rupee from becoming
stronger even when in the market there was a pressure on it to
do so. This was quite clear, for instance, in the period when
foreign portfolio investment first entered India in 1994. The
RBI did not allow the rupee to appreciate and kept buying
dollars for over a period of a year and a half in order to
prevent the rupee from rising. Now that there will be much
greater pressure to open up in terms of removal of
constraints, the temptation to hide our inefficiencies behind
a weaker rupee will be much stronger.
Time for some good old-fashioned
The question is really whether the government
will still take the more myopic path and continue to shield
industry by hiding its inefficiencies behind a weaker rupee,
just because it is easier to do so. Or will it give the Indian
industry the shock treatment by letting the rupee remain
strong and force it to cut costs and improve efficiency? Of
course, this will have to be accompanied by necessary changes
in policy and improvements in infrastructure. But it will do
so if it no longer wants to spare the rod and spoil the child.
For next year, we'll be keeping our ears peeled for
the government's answer to this sawal sau crore ka!
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