The siren calls for protectionism can be heard once again in some parts of Indian industry. In interviews to the Business Standard newspaper last week, several business leaders, such as Rahul Bajaj, Anil Agarwal, Sajjan Jindal, Harsh Goenka, and Harsh Pati Singhania, have called for policies that would, in effect, roll back the trade reforms that integrated India into the world economy after 1991. The Narendra Modi government must not heed such advice.
The current buzz brings backs memories of the Bombay Club that criticized the economic reforms unleashed by the P.V. Narasimha Rao government, arguing that the rapid opening up of the Indian economy would hurt domestic industry since it suffered from poor infrastructure, high domestic taxes, and expensive loans. Internal reforms should precede external reforms. There were also fears that making it easier for foreign companies to invest in India would lead to acquisitions rather than new industrial capacity.
The escalating trade war sparked off by the brinkmanship of US President Donald Trump is the primary reason why domestic protectionist sentiment has reared its head again. Many Indian businessmen argue that India also has to face unfair competition from Chinese imports, a valid concern given how China uses trade policy as an arm of strategic expansion. However, issues such as Chinese dumping should be sorted out at the World Trade Organisation rather than through unilateral action such as higher taxes on imports.
The economics of protectionism is all wrong. Most economists across the ideological spectrum agree that free trade increases human welfare. A prosperous autarky is a contradiction in terms—the real world is not like Wakanda, the fictitious country in the recent Black Panther movie, that magically manages to have prosperity as well as advanced technology despite having no trade with the rest of the world.
Production in our times is done through global supply chains that move intermediate goods (or inputs) across national borders with immense ease. This is radically different from the earlier variants of global trade where trade in finished goods dominated. The strategic necessity right now is to figure out how India can plug into these global supply chains rather than losing out further through higher tariff walls.
There is no doubt that India runs a large trade deficit with the rest of the world. However, it is a misconception that this deficit can be reduced by raising trade barriers. The English economist Abba P. Lerner had shown several decades ago that an import tax, in effect, is a tax on exports—as India painfully learnt during its several decades of autarky after independence. High import taxes led to an inefficient industrial structure that was not capable of exporting to a booming world economy. In fact, the large Indian trade deficit is better explained by the excess of domestic investment over domestic savings.
Two other popular misconceptions also need to be answered. First, India is now an active trading nation that will get hurt in case there is an escalating sequence of retaliatory tariffs. Its ratio of trade to gross domestic product is even higher than that of China. Second, India needs to sell to the rest of the world to maintain demand for what its factories produce. The global economy is expected to grow by $5 trillion in 2018, while the economic expansion in India is expected to add $176 billion to output.
There will continue to be specific cases where protectionism can be justified for reasons of national interest. The case of technology platforms with network effects is an issue that policy thinkers across the world are still trying to grapple with. These should be treated as exceptions rather than as a reason for a wider retreat into the cocoon. Retaliation may seem impressive on paper, but economic history tells us that tit-for-tat protectionist strategies not only hurt every country in the 1930s but also led the way to World War II. As the brilliant Joan Robinson—a caustic critic of most mainstream economics—put it, you should not throw rocks into your harbour just because your trading partner has thrown rocks into his harbour.
India has been one of the clear beneficiaries of the second wave of globalization—average incomes have increased, millions have emerged out of poverty and the country has acquired global economic heft. There are still immense challenges that need rapid economic growth as well as employment generation in the next three decades, and internal reforms to make domestic industry more competitive should be the preferred response. Protectionism is not the way to achieve core national goals.
In other words, India does not need a version 2.0 of the Bombay Club.
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