Narendra Modi's Rise in Import Tariffs Will Hurt India's Economy

February 19, 2018
Photo Credit: 
REUTERS/Denis Balibouse

During the past quarter of a century, India has made impressive strides in reforming and opening up its economy, and raising its growth rate. But in recent weeks, Prime Minister Narendra Modi appears to have set a new priority: protecting his country from a perceived Chinese threat to Indian industry. Unfortunately, this approach is self-defeating.

Mr. Modi's latest financial plans call for substantial import duty increases aimed squarely at the world's export superpower. By targeting China, India runs the risk of prematurely decoupling itself from the supply chains it seeks to enter. These new tariffs are all the more worrying because they contribute to the retreat from globalization arguably already under way in the United States, in Britain, and in China itself.

By targeting China, India runs the risk of prematurely decoupling itself from the supply chains it seeks to enter.

By reducing its tariffs from an average of almost 81 percent in 1990 to about 13 percent today, India has progressively opened its market to foreign competition. Since taking office in 2014, the Modi government has promoted the Make in India campaign, a drive to build the country's manufacturing capacity by cutting barriers to foreign investment and introducing regulatory reforms.

These steps clearly followed the Chinese playbook for leveraging trade and investment, which makes sense—like China, India has a growing young labor force with rising expectations.

But India now seems to have lost faith in this course, as it reverts to its old habit of import substitution. Rather than take further lessons from Chinese success, the new budget implicitly blames China for India's slow manufacturing take-off. Indeed, the higher import duties the budget imposes build a wall against Chinese imports, thereby running the risk of locking out foreign investors and locking in the world's largest workforce.

The budget raises duties, typically to 20 percent, on two broad groups of products that India imports mainly from China. The first group is an assortment of labor-intensive activities. The government is doubling duties on beauty aids, watches, toys, furniture, and footwear. That India needs protection in these entry-level industries after 25 years of domestic reforms is astounding. Indeed, the new tariffs suggest that Indian companies are not competitive in the production of kites and candles!

The second group of sectors in which tariffs are being doubled comprises electronics and communications devices, including mobile phones, televisions, and associated parts and components. Here again the competition is mainly imports from China.

These steps could yield short-term results that might appeal to voters. But as a development strategy the policy will fail because it does more to reduce export competitiveness than to build it. The experience of China, Brazil, Indonesia, Turkey, and India itself shows that easier access to imported products boosts productivity and enhances domestic value added. By doubling taxes on imported components such as LCD/LED displays for televisions, India risks harming its own import-using producers.

In this age of global production networks, higher tariffs on components make India a less desirable location for export processing. The role of multinational enterprises in mediating flows of labor-intensive goods, as well as computer and communications devices, is hard to overestimate. India might do well to observe Vietnam's success in developing a growing footwear sector, with foreign companies accounting for 81 percent of Vietnam's footwear orders.

An international outcry against India's policy reversal is hardly likely. If anything, the United States, Britain, and other countries are moving in a similarly self-defeating direction. It is a shame that Mr. Modi, who has promised reform, seems to have decided to follow suit.

Mary E. Lovely is professor of economics at Syracuse University and a fellow of the Peterson Institute for International Economics. Follow @melovely_max on Twitter. Devashish Mitra contributed to this article.