Bad examples of India abroad

Indian Express, 5 October 2004

Export-led growth is supposed to encourage efficient firms and kill off the inefficient ones. But massive export subsidies are draining the exchequer

Subsidies to promote exports have become a way of life in India. Exporters seem to behave as if they are doing the country a great service and should be mollycoddled. The Government also encourages this attitude. It sometimes appears as if the logic of why exports are good has been forgotten; all that is remembered is that we should have high export growth. It is time to stop confusing the means with the ends.

The literature on the subject has clear policy implications: export subsidies must go. The issue is not merely one of WTO compatibility. It is a much deeper one of India’s choice of growth strategy. High export growth is good for India’s growth. But if that export growth is artificially induced through subsidies, then exporting does not have the hoped-for beneficial impact upon growth.

The belief that exports must grow has been around for more than two decades now. But, it was not always like this. For many decades, export pessimists ruled the day, and India followed inward-looking policies: where imports were banned or curtailed, and foreign companies were prevented from operating in India.

Different people came to this position for different reasons. Some people believed that dependence on foreign markets would lead to greater dependence on the West Some believed that the West would not allow India to prosper. Others believed that the world markets were too small to support the scales at which India could produce. But most importantly, the anti-globalisers tended to be people who were deeply insecure about Indian competence and didn’t believe Indian goods could win in world markets.

Trade and development literature focused on import-substitution versus export-promotion. Among the first studies on India in this field was a D.Phil thesis at Oxford in 1962 by a young man named Manmohan Singh. His thesis was later published as a book titled Export trends and prospects for self-sustained growth, in which he questioned India’s inward-oriented export policy. By the early 1970s, the battle of ideas against inward-looking policies was won by Jagdish Bhagwati, T N Srinivasan and Anne Krueger.

The logic for export-led growth consisted of two steps. First, there was a rediscovery of the idea of ‘‘gains from trade’’ in economics, which demonstrates that trade is almost always beneficial, and that opportunities for trade are prolific even if Indian firms are weak and incompetent. More importantly, there was the issue of ‘‘dynamic gains from trade’’, which consisted of greater competition, inflows of new ideas along with trade, and innate pressures to break down bad domestic policies.

Bhagwati, Srinivasan and others demonstrated that there was no case for ‘‘export pessimism’’, that it was possible for India to win by exporting to world markets, and that there were deep benefits in terms of higher growth by switching from looking inwards to having an outward orientation. India did not learn from them, and watched idly as one after another, the countries of East Asia, including China, leaped ahead.

By the early 1980s, however, the pendulum swung the other way, and everyone started worshipping at the altar of exports. The policy community agreed that India had missed out on a gigantic expansion of world trade and that fast export growth could become the most channel for high economic growth.

Pretty soon, there was a Ministry of Commerce chasing an annual target for export growth, and a sustained government effort at ‘‘export promotion’’. At this point, something started going seriously wrong in terms of confusing means and ends.

Exporting is good because when India is open, and the exchange rate is free, then efficient firms will export, inefficient firms will die, and investment will take place in export-oriented firms where India has a comparative advantage. The basic logic of export-led growth is one where export orientation rewards efficient firms and kills off weak firms, and the country benefits and grows owing to efficient firms.

The ‘export promotion’ bandwagon turned this upside down and started thinking that ‘‘since our firms are inefficient, we should give them export subsidies so as to make them export’’. This was a major blunder, one that mixed up means and ends. What India needed was genuine exports, based on efficient firms and a sound exchange rate. Instead, what the Government system started pushing for was fiscal subsidies and manipulated exchange rates so as to produce fake exports.

But if firms are inefficient and manage to stay alive and export owing to export subsidies, this does nothing for Indian growth. Fake exports don’t increase competitiveness or GDP growth. An inefficient firm should die; it should not be kept alive using subsidies.

We now have an elaborate government machinery paying out export subsidies in various ways. These include duty drawback schemes, DEPB, explicit export subsidy programmes and tax incentives for exports. Instead of focusing on markets and efficiency, the companies of India are wasting time interacting with this government machinery to gather their subsidy cheques. Even the RBI jumped into the act, and thought that in the effort to produce higher exports, it could chip in by forcibly undervaluing the rupee. It purchased dollars whenever there was pressure on the rupee to appreciate. This led to a massive pile-up of reserves in a few years, which has given us a bit of an indigestion.

It is important to shake our heads clear of this confusion. India needs efficiency and India needs genuine exporting success. Fake exports are merely a drain on the exchequer and do not do anything for Indian growth. This is not to say that government and public goods are irrelevant for exports. There is clearly a case for sound economic policies which foster efficiency and thus exports. These include tax reforms, infrastructure, R&D and FDI. It is when these policies yield export growth that GDP will grow. There is nothing to be gained by faking it.

One of the major economic policy achievements of the NDA was cutting tariffs. The contribution of the UPA Government should be to eliminate export subsidies.

Ila Patnaik