View: Will India's self-reliance stance prove to be a costly mistake?

Shortly before the 2014 election that made him prime minister, Narendra Modi came up with the idea that India’s young population, constitutional checks on arbitrary political power and large domestic market would bring prosperity over a decade. He even coined a slogan, calling it the nation’s 3D advantage — demographics, democracy and demand.

India’s democratic institutions, such as the judiciary and a free press, have frayed under Modi. With just over 40% of the labor force engaged in the economy — among the worst rates of worker participation anywhere in the world — the youth-bulge narrative has also lost its sheen. What remains of the 2014 mantra is demand. But how big an advantage is the domestic Indian economy? Can an inward-looking growth strategy create enough jobs and attract the capital that’s fleeing China?

In a Foreign Affairs article, economist Arvind Subramanian, an adviser to the Modi administration until 2018, and Josh Felman, a former International Monetary Fund representative in New Delhi, have attempted to answer these questions. Team Modi has done a decent job providing physical and digital infrastructure as well as basic services like cheap housing, electricity, water, cooking gas and bank accounts; but this boosting of the “hardware” of the economy, the authors argue, has been accompanied by a weakening of its “software,” including the centerpiece of the government’s growth framework — its industrial policy.

The chest-thumping nationalism of the last eight years has led to a repudiation of the gradual opening up of the previous three decades. More than 3,000 tariff increases have affected 70% of imports. India entered 11 trade agreements in the 10 years under previous Prime Minister Manmohan Singh. On Modi’s watch, it hasn't signed even one. Although the country is starting negotiations with post-Brexit Britain and Australia, and claims to be close to a pact with the United Arab Emirates, bilateral deals won’t compensate for the Regional Comprehensive Economic Partnership, a free-trade accord linking Asia’s exporting powerhouses. New Delhi turned its back on RCEP in 2019.

This protectionist drift springs from the belief that an economy of 1.4 billion consumers is large enough to be powered by internal demand. But, as Subramanian’s previous work with Pennsylvania State University economist Shoumitro Chatterjee has shown, even before Covid-19, no more than 1%-to-2% of the population could be described as middle class, compared with 25% in China. Such a tiny font of purchasing power could at best drive $500 billion in spending. World trade, meanwhile, is a $28 trillion opportunity, with much smaller countries like Vietnam making a determined play to win market share.

Will self-reliant India work? Subramanian and Felman are skeptical. “India has seen this movie before,” they say. Indeed, the current leitmotif is reminiscent of the pre-1991 “license raj,” in which the state controlled capacity in the private sector, but shielded it from global competition by erecting high tariff walls.

The lynchpin of the new system is subsidies, with New Delhi promising 2 trillion rupees ($27 billion) to investors for making their widgets in India. The idea is to dangle fiscal sops in front of a company like Tesla Inc. and win a large electric-vehicle factory. (Elon Musk, however, is proving to be a hard catch.)

India is parched for capital expenditure, and its trade deficits are ballooning, particularly with China. Every new investment is a victory of sorts for policymakers. Still, a “subsidy raj” carries all the risks of the old license regime: “It is hard to enforce, is driven by arbitrary decision-making, and creates a system of entitlements from which it will be difficult to exit,” according to Subramanian and Felman.

It’s impossible to become a factory to the world by coaxing firms to substitute imports with domestic production. Take mobile phones. Two years of tariff increases on camera modules, display and touch panels, printed circuit boards, and parts used in chargers have pushed up the cost of assembly in India by 8%. That’s about 6% of a phone’s ex-factory price and fully negates the 5% subsidy on offer, according to a study by the country’s Cellular & Electronics Association. The net benefit for Make in India is zero.

Contrast this with Vietnam, which is copying the winning formula of East Asian Tiger economies: free and frictionless trade. Out of 120 tariff lines of relevance to the handset industry, 59 are duty-free in Vietnam, compared with only 32 in India. And while India imposes import duties of 15% or more on 28 items, Vietnam’s tariffs are that high only for 16 components. These, too, are mostly sourced from countries with which Vietnam has free-trade deals. So they’re effectively zero-duty imports as well.

India’s inward turn has coincided with a rise in economic concentration. Just two conglomerates, led by billionaire tycoons Mukesh Ambani and Gautam Adani, have amassed vast influence across sectors. The danger of depending on a small coterie of national champions is that it won’t build widespread public support for market-based reforms. “In fact, it already has turned many Indians against them,” Subramanian and Felman say, citing the yearlong farmers’ protests that forced Modi to drop his plan of a market-oriented makeover of agriculture.

The pandemic has hollowed out India’s middle class by destroying 10 million manufacturing jobs. Industrial output in November was slightly lower than two years ago. And yet, by skipping out on large free-trade areas and putting up protectionist obstacles, New Delhi is crimping the country’s chances in labor-intensive industries like textiles and footwear — just as China is vacating the space because it has run out of cheap labor. For a second time in India’s history, self-reliance might prove to be a costly mistake.


(Disclaimer: Views expressed are author's own)