View: How India can return to its past as a great trading power

Economy


By Ajay Srivastava


In his Independence Day speech, Prime Minister Narendra Modi repositioned the Make in India agenda as ‘Make in India for the world’. This signifies India’s aspiration to be a powerful trading nation on the back of quality products, competitive manufacturing, and integration into the world economy.

A robust trading nation is in a better position to set the agenda and influence narratives. Let us understand why trade is good and how we can be a powerful trading nation.

Almost everyone now agrees that trade is good for countries. We owe this understanding to David Ricardo, who in 1817 provided the foolproof argument in support of trade. His theory of comparative advantage says all countries gain from trade even when one country’s workers are more efficient at producing every single product than workers in other countries.

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But how could this be possible? Ricardo used the following example to prove his point. Let’s say the world has only two countries, Portugal and England. Each produces only two goods, cloth and wine. The quality of produce in both countries is the same. In England, it takes 100 hours of labour to produce one piece of cloth and 120 hours to produce one litre of wine. So it takes a total of 220 hours to produce one piece of cloth and one litre of wine.

In Portugal, it takes 90 hours to produce one piece of cloth and 80 hours to produce one litre of wine. Portugal is more efficient than England in making both cloth and wine. We say Portugal has an absolute advantage in making both products. Should Portugal produce both?

Let us say both countries decide to produce only one item in which it is more efficient and buy the other. England decides to produce cloth as making one piece of cloth takes fewer hours than making one litre of wine. Portugal chooses wine for similar reasons.

A small calculation shows that in 220 hours, England will produce 2.2 pieces of cloth (100 hours for making one piece) and Portugal 2.125 litre of wine (80 hours to make one litre of wine). Now England sells one piece of cloth to Portugal for one litre of wine. After consuming one piece of cloth, England is still left with a surplus of 0.2 pieces of cloth. Portugal, after consuming one litre of wine, still had an excess of 0.125 litre of wine. Both the countries now have a surplus, and trade has created this surplus.

The above example shows the two countries are better off when they trade than when they produce and consume everything. In a testimony to the truth of Ricardo’s theory, trade expanded 6,000 times in the past 200 years.

But free trade principles work only as long as everyone plays by the book. The delicate balance is distorted when some countries take liberty with the globally agreed rules. For example, China uses a combination of massive subsidies and intellectual property theft, to become the dominant producer and exporter of many essential products.

For solar panels alone, China used to give an annual subsidy exceeding $15 billion. Local manufacturing in most countries could not compete with cheap imports from China, and died. China also uses the third country FTA route to sell subsidised products. For example, it’s alleged Chinese steel firms based in Indonesia export subsidised steel products to India using the low duty benefit under the India-Asean FTA. The comparative advantage theory goes for a toss, if products from one country become competitive because of massive subsidies.

How should India promote its manufacturing and trade? A fourfold plan will help.

First, reduce input costs. High duties on raw materials, expensive credit, erratic power supply, time taking land transactions, delay in refund of taxes, and less productive labour increase the input cost. Deep reforms in these areas will make India an attractive place to do business.

Second, define ‘Make in India for the world’ standards and make it a quality label. This will require setting up a large number of design studios, innovation labs, and strengthening of standards and quality infrastructure. MSMEs should have free access to such resources.

Third, expand manufacturing and trade of the products the world buys most – electronics, organic chemicals, machinery, apparel, telecom etc. We must avoid becoming a hub for superficial assembly of imported components. It makes us critically dependent on a few supplier countries. We have a better model. Nokia in 2007, while setting up mobile phone manufacturing facilities in Tamil Nadu, collocated most component manufacturers. This ensured high domestic value addition.

So a better alternative is becoming a component manufacturing hub. But this requires deep expertise, which currently we do not have for most components. We need joint ventures and external investments. Countries use attractive sectoral packages to get investment in scale manufacturing and promote global value chain participation. India will also need reforms in import duty structure, building efficient ports, and online systems.

Finally, avoid critical dependence on any country. We need to develop self-sufficiency in bulk drugs/ APIs, power equipment, everyday use goods, and defence related products etc. We should be willing to pay the additional price for this.

Becoming a great trading power would require participation of business and technology experts and not mere economists and bureaucrats. It will transform our agriculture, manufacturing, technology, logistics, education, and most other sectors.

(The writer is an Indian Trade Service officer. Views are personal.)



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