Make In India Is Not An Excuse For Protectionism

To ensure the Make in India campaign’s success, the government must resist pressures from domestic industry lobbies wanting to reap undue gains from protectionist policies at the cost of consumers and other industry players.

Prime Minister Narendra Modi’s Make in India campaign is founded on noble intentions. If local manufacturing is encouraged, it could not only help India gain significant mileage in terms of economic growth, but also make that growth inclusive through adding millions of jobs and raising the general standard of living.

To realize this end, the government could follow two economic pathways, both of which are markedly distinct from one another:

1. Heeding the demands of some local manufacturers whose businesses have recently been facing the heat of surging imports, the government could raise customs duties on certain foreign products. This would benefit a select few producers by shielding them from external rivals, but harm domestic consumers who would now have to shell out a higher price for the same products. It would also damage the prospects for a sustained, higher growth in the long run as the higher costs of “protected” products percolate into various other sectors and distort their market prices.
2. Instead of restricting foreign competition, the government could simply move out of the way and throw open most sectors to foreign direct investment (even if in a gradual, considered manner), while also allowing free imports of goods and services. It could focus its limited resources, including time, on removing existing political and administrative barriers that impede local innovation and entrepreneurship within India.

For instance, it could remove red tape and bureaucratic hurdles to enable faster clearances. It could greatly enhance access to clean and sufficient energy (power, gas, etc.) to companies so as to make their manufacturing processes efficient. It could also enforce property rights and rule of law more effectively so as to reinforce the confidence of investors—both domestic and foreign—as well as foreign companies that may be considering setting up manufacturing plants in India.

Several industry lobbies have recently been clamouring for the government to choose the first pathway. The tyre industry body, for example, has raised concerns over the increasing imports of truck and bus radial tyres. These imports account for 20 per cent of the domestic market.

India’s steel industry body, Indian Stainless Steel Development Association (ISSDA), too has asked the government to enact similar measures to curb imports. Let’s look at the economics of steel imports and its deeper long-term ramifications to get an idea of why imports are good for the economy and, therefore, are best left unrestricted.

With the share of Chinese flat stainless steel imports in the country having risen to a staggering 30 per cent, ISSDA has demanded that the customs duty on steel be raised to 12.5 per cent from the present 7.5 per cent. It used to be 5 per cent prior to this year’s budget. To be sure, China charges a higher customs duty (10 per cent) on its steel imports.

The argument advanced by the industry body is that Chinese firms, emboldened by various forms of direct and indirect subsidies doled out by their government, engage in dumping and other unfair trade practices to assume undue advantages over foreign rivals.

In 2013, these subsidies accounted for 47 per cent of total profits of China’s steel mills. In the first half of 2014, nearly 80 per cent or four-fifths of total profits owed themselves to subsidies. Given the overwhelming support provided by Chinese government to its steel mills, one would be tempted to support the case for protectionist policies for India’s own steel firms. But any such policies would be divorced from sound economic underpinnings, just as China’s case demonstrates.

In the aftermath of the global financial crisis of 2008, China aggressively boosted its steel production to support the development of national infrastructure such as bridges, high-speed rails, and buildings. This production was dictated not by genuine consumer demand, but by State-imposed central planning. This trajectory paid off for a few years, until loose credit policies and rapid approvals for industrial projects resulted in steel firms adding capacity severely disproportionate to domestic demand.

The excess supply put downward pressure on China’s steel prices, thereby helping boost its exports to countries like India. Yet, despite massive subsidies and trade barriers provided to protect its steel mills, China’s steel sector halved its profit margin to just 0.3 per cent in the first half of 2014.

If China’s goal was to achieve an even greater share of the world’s total steel production through dumping (selling below cost), then that prospect looks patently bleak as the country wrestles with a massive slowdown in overall economic growth. It cannot afford to continue misallocating crucial national resources by subsidizing one inefficient industry at the expense of other efficient ones.

Ideally, cheaper steel imports should be welcome by India. The economic gains from lower steel prices could translate into lower prices of products that use steel as an input. Ironically, even as ISSDA demands a higher customs duty on steel imports, it has proposed the removal of 2.5 per cent customs duty on raw materials such as scrap nickel and ferro nickel so as to benefit from reduced input costs.

In effect, it wants lower input costs for its own industry but demands the introduction of higher input costs (in the form of customs duty) for industries that otherwise use cheaper, imported steel as a raw material.

The fallacy of protectionism lies in forgetting the fundamental fact that all economic activity is justified only insofar as it satisfies genuine consumer demand. This is not to mean that producer interests are to be sacrificed or even ignored. Far from it! Adam Smith, the author of The Wealth of Nations, explained it best when he wrote, “Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer.”

If one thinks otherwise, it may help to imagine what would happen if the waiter at a restaurant demands that we order at least five items from the menu so as to protect the interests of the producers—the farmer as well as the owner of the restaurant. Surely one would never entertain any such policy. Then how does it make sense to employ similar, producer-oriented policies in the steel industry?

China’s policy of subsidizing its steel industry comes at the cost of higher taxes on its citizens. In effect, we could say that China subsidizes our consumption of cheaper steel at the expense of its own taxpayers. To this, our response should be (in the words of the noted Austrian economist Murray Rothbard), “Come on, China. Subsidize us even more!” But instead, we choose to enact competing trade barriers that make Indian consumers poorer, since they now have to purchase finished stainless steel products at a higher domestic price.

The government has vowed to improve the ease with which India’s entrepreneurs establish and run businesses. To this end, it has rightly begun focusing on cutting red tape and other bureaucratic hurdles. It must, however, ensure that the Make in India campaign, well intentioned as it may be, is built on sound and robust economic principles. To ensure the campaign’s success, Modi must resist pressures from domestic industry lobbies wanting to reap undue gains from protectionist policies at the cost of consumers and other industry players.