India Has A Lot to Gain From Further Trade Liberalisation

At the Advancing Asia summit organized by the International Monetary Fund and the Ministry of Finance over the weekend, chief economic adviser Arvind Subramaniam suggested that India needs to work on an export-led economic growth model, only to be strongly countered by Martin Wolf, chief economics commentator at the Financial Times, who is widely acknowledged as an authoritative commentator. In this interview with Swarajya, Wolf talks about how he views India and how it can build on its strengths. Excerpts:

IMF’s Christine Lagarde said India faces an unprecedented opportunity for transformation. Is this a view you share?

I think it is reasonable to say that India has substantial opportunities. It’s large enough to have a relatively diversified economy, relatively strong domestic sources of demand and relatively strong domestic skills even in a country with a lot of illiteracy and poor people. It has reasonable political stability, has achieved a fair amount of pretty fast growth in the last generation and has a well-developed corporate sector. And it is still relatively poor and has relatively low productivity - on average, output per head in India at international prices is about 10 per cent of leading economies - and that indicates a tremendous potential for catch up. It has a relatively youthful population and a growing population. So, unlike other places, it suffers no demographic issues in the medium term.

So these are tremendous sources of potential. One would tend to think that it should be able to grow fast and achieve substantial improvements in the standard of living of the people over a sustained period of time, transforming itself ultimately to an advanced country. This would take two generations, but it would not be an unreasonable ambition.

What would it take to achieve that?

You could divide these things into short term, medium term and long term. There are things you can’t change in the short term – your existing labour stock/education can only be changed over decades. But there are things you can do in the short run. Obviously unproductive regulation needs to be eliminated, everybody knows where the main areas are – labour, land, the inefficiency of the power system, inefficiency of the bureaucracy, of the legal system.

There is clearly a necessity to maintain fiscal and monetary stability without paralysing the economy. There is a great need to raise the rate of investment, particularly in infrastructure across the board. There needs to be further liberalisation of trade in order to exploit opportunities for becoming part of global value chains, including in manufacturing – that’s a big potential source of growth which India has never exploited effectively. The service sector dynamic is, worryingly, slowing. And my impression is that even the very strong IT sector is not as dynamic as it used to be.

Other short to medium term issues are cleaning up the banking sector, reorganising the finances of the corporate sector, but not doing this as a one-off but actually reforming it so that it doesn’t happen again, so you have a better financial sector in future.

It seems to be reasonably clear that the government, broadly speaking, understands these objectives; it talks about improving the business environment. This is incredibly important. The other thing that is terribly important is improving the efficiency of spending. Indian public spending has been historically very inefficient, wasteful. The biggest challenge of all is to provide the people with the requisite level of education so that everyone can participate fully in a more advanced economy.

My own dissection is that China has done much better in this regard. And in the long run, that’s possibly the single biggest drag. A lot of the middle income countries that have failed to keep up momentum have failed because they did not upgrade the quality of labour, of education, and if that happens the growth that India is experiencing will just stop.

This government has started to do a lot of these things.

I have a lot of friends who think they should have done much, much more. Other friends think what they have done is realistic. I am more sympathetic to the view that since there is no economic crisis, it is very difficult to do a huge big bang reform in India. Secondly, there are a lot of things at the state level and they have to go along with that. Some things they are being blocked on, like the GST which is very important. Maybe they haven’t done very well as they should have in getting cooperation from the opposition.

Some people feel that the government has wasted the opportunity to be transformative, and I sort of understand that frustration. Some people feel the government has got too attached to the big, showy projects like the high speed train, rather than focussing on the rail network. I think that is probably right. The orientation towards showy projects is a dangerous one, that’s not the answer.

My broad answer would be I am sure they could have done more, it is always possible to do more, and clearly the reforms that are happening are not as profound as those happening in the early nineties. But if they keep up with what they are doing and keep up what they are saying and keep up the pressure for reform in the states, for improving regulation, for eliminating or reducing corruption, making the thing work better, improving incentives, then cumulatively, it could make a very, very big difference.

So I would not be in a position to say they have failed. But on the other hand it would be quite wrong, from what I see, to say they’ve succeeded either. They have to be concerned about whether they are going to exploit the opportunities they have.

You disagree with Arvind Subramaniam on India needing to become an exports-led economy on the grounds that the global situation is tougher. But you also say India should engage more actively with world trade.

I think that it is going to be more difficult. If India does need its exports to grow in line with GDP, not more, and since GDP growth should be relatively fast, that means your exports should grow relatively fast. So you have to exploit all the opportunities that you can. Part of that is making your economy as competitive as possible. There are many things you can do to improve competitiveness that do not even require changes in trade policy. So things that benefit the domestic economy will also benefit your international competitiveness.

Furthermore, India should probably be lowering protectionist barriers. That will make the economy more competitive, but that will also pull India into global supply chains and that is another big opportunity. And now that China has become higher cost, there is a real opportunity for India in some parts of the global value chain. Why should it just go to Bangladesh and Vietnam?

Finally, if you are not engaging in trade negotiations at all, there is going to be discrimination against you and that is going to be even more difficult for trade. I know there are big problems for India in getting involved in things like the Trans Pacific Partnership, but there are costs and I think that India can offer an increasingly attractive domestic market.

There is a feeling that the burden of liberalising is always falling on the developing countries and that the West is getting more protectionist.

I see the argument. But right now in the West, it is more bark than bite. I would argue that one of the ways that you reduce protectionism in the West is by making clear that they have large markets to lose. And India has large markets. You have an influence which is important.

I do agree that because you have higher barriers than, say the US, you would be liberalising more than the US. But there is the argument that you would get the benefit of lower barriers to your own trade. And remember when you lowered trade barriers unilaterally in the 1990s, your own exports and imports grew. You will gain from liberalisation too.

All I am saying at this point is, yes, you have more to give up that is true, but I think you still have a lot to gain from further liberalisation, and if there are deals with you, other countries will find it more difficult to be protective. Countries won’t want to protect against a rising power like India.

If exports can’t be a growth driver, then domestic demand will have to step in. But that is also not picking up and now we are having this debate about using fiscal policy as a demand booster.

This is a very difficult question. You have a lot of margin of manoeuvre on monetary policy. Interest rates are still relatively high, way above zero. So I don’t see why monetary policy shouldn’t be used to support demand. This being so, I would be inclined to not focus fiscal policy on short term demand management, but rather focus it on quality of spending, quality of revenue. I wouldn’t worry about the deficit, I think India can support a deficit perfectly comfortably; it is not unmanageable in any way.

I would focus, in spending, on investment. It seems to be me that there must be a lot of high quality investment, India clearly needs more infrastructure and I don’t see why it should all be done through PPPs. There is a strong case for direct public investment, provided you can set up systems to manage it and implement it well. India is capital starved and since the investment rate in the private sector is still relatively low, the case for pump priming investment through the public sector seems to me to be quite strong. But I would look at this not as a demand tool, but as a supply tool. It is about enhancing the growth of potential supply, removing bottlenecks and crowding in the private sector.

In the short term, demand is going to be a bit of a problem. But in the end, the monetary policy tool is the right demand tool in India and I wouldn’t use fiscal policy for that. It’s different if you have zero rates. Then fiscal policy becomes more important.

India’s tax-GDP ratio is considered low, though you feel it is high. But can’t that be raised by just bringing more people into the tax net?

A GST would do that.

What about direct taxes?

In an economy like yours, with such a large informal sector. . . most countries have found that taxing the informal sector is very, very hard. Now, maybe with your new personal identification system, you could perhaps do it, but you do have to be careful, because in India there are a lot of people who are not above subsistence level. You can’t tax them. There are parts of the middle and upper middle class you can probably tax and probably raise a little more revenue from them. But the general experience around the world is that it is very difficult to make direct taxes work across the economy until most of it is formal.

But indirect taxes hit the poor as well, more than direct taxes.

Well, that is why you have to do the indirect tax along with targeted benefits to the poor. But operating an income tax for people who don’t keep accounts is quite difficult. So the need is to get the economy to become more formal. Even in Italy, they find it difficult thing to do. In Brazil, they have very high tax ratios but the tax mostly falls on the formal sector and so it doesn’t grow. Maybe with all this digital stuff it will be easier to tax the informal sector but I suspect if you try it, everything would go underground.