Import Substitution: A Lesson To Be Re-learnt

Introduction

“Union Minister Nitin Gadkari recently said that the government is considering introducing a policy on import ion and urged to come up with cost-effective substitutes to reduce the country’s inward shipment.”

But will this policy really provide the economic benefits our country needs at this point?

What is Import Substitution?

“Import Substitution is a strategy under trade policy that abolishes the import of foreign products and encourages the production in the domestic market. The purpose of this policy is to change the economic structure of the country by replacing foreign goods with domestic goods.”

Post-independence India had adopted the policy of import substitution by imposing heavy tariffs on import duty. This industrial policy that the country had endorsed was linked to the trade policy. In the first seven Five-Year Plans, trade in India was distinguished by the inward-looking trade strategy. This strategy was essentially known as Import substitution with the aim to boost domestic production and achieve growth.

This was the strategy that India had pursued until 1991. That year, India finally recognized its total failure and switched to an outward orientation. Those seeking its revival argue, however, that it will be different this time. But will it?

Experience with Import Substitution Policy in India

It is interesting to look that in the post second World War era, nearly all emerging countries chose the path of Import Substitution to achieve industrialisation. The common consensus was that this would prove highly beneficial for the economy and achieve great growth. But by the mid 1960s Singapore, Taiwan and South Korea had broken away from this consensus and switched to export-oriented strategies.

While these countries had achieved growth rates of 8%-10% following this breakout for the next 3 decades, India chose to stay on this course determined to make import substitution a success. Our imports as a proportion of the gross domestic product (GDP) dropped to just 4% in 1969-70 from a peak of 10% in 1957-58.

By the 1960s, we had banned consumer goods imports which completely took away any motivation from the producers and made them devoid of any kind of pressure to supply high-quality goods. It not only denied the producers access to high class raw materials and machinery but also created a condition to use domestically available materials wherever possible, irrespective of their poor quality

The results were obvious. Our products’ quality fell drastically and failed to compete in the global marketplace. The poor performance of exports affected the foreign exchange inflow which led to a greater tightening of import controls. This cycle took an adverse hit on the growth of the country.

This experience points towards how our policy-makers are choosing to forget the lessons of the past, and are determined to ignore the immense economic benefits to the country and citizens post 1991.

It is due to the reforms of certain ministers that we are now a 2.303 trillion-dollar economy and with a great percentage of imports. Unfortunately, initiatives like Make in India, etc. by the government are inspired by the yet new temptation for the policy of Import Substitution in present times. The idea is to increase output from the present level of about 16% of the gross domestic production 25% by 2022.

What reasoning lies behind this? The rationale is that by replacing imports we would be increasing our domestic production which would eventually add value to the Make in India initiative. However, this does not hold true because the very foundation of the idea is incorrect.

To easily put it, if the foreigners cannot sell their goods to us, they will not have the revenue to buy the goods from us. The large decline that was experienced in our oil import during 2015-2016 was actually accompanied by an almost equivalent decline in our exports. To surmise the argument, whatever value would be added to the import substitution will get subtracted from the losses that would arise in exports.

There is another problem that makes Import Substitution doomed to failure. Since domestic production is basically encouraged through an assortment of tariffs and subsidies under this plan, it will only attract small scale firms that are fixated on making a quick risk-free profit with no plans of becoming exporters. Additionally, the move tends to draw a bias in favour of small domestic firms especially in the case of recently announced production linked incentive schemes.

Way Forward

The key point here is that we export products that we produce at the lowest cost and import those commodities and services that partner countries produce at the lowest cost. This is the way to maximizing gains in trade. On the contrary, import substitution rests on the premise that raising barriers against imports or subsidising our products will lead to trade again. In fact, it reverses these gains.

“There is no wisdom in producing at-home products that we can buy abroad at a lower cost using our export earnings. It is best to let a doctor do what he does the best and nuclear scientists do what she does the best. It is a trap to think that the doctor can also do what the nuclear scientist does and vice versa. The same principle applies to nations.”

A more effective policy to boost competitiveness can be formulated by investing in infrastructure, ensuring provisions of cheap power and reforming land marketing and most importantly creating conditions where companies can compete in global markets. By doing so, we are likely to assist producers on the verge of becoming competitive against the best in the world.

Lessons from the past should not be forgotten so easily. India should not become more inward looking because that does not benefit producers or consumers. Research suggests that India’s trade balance has widened due to part of raw materials, intermediate products and capital goods implying that the imposition of tariffs will only hurt export competitiveness. If we want to achieve our dream of increasing India’s share in world trade over 2 percent, we require a more outward strategy pointing towards greater trade liberalisation. It is essential that this time we mustn’t head down a slippery slope in the wrong direction.

References:

Govt mulling introduction of import substitution policy: Gadkari, The Economic Times, 2020.

https://economictimes.indiatimes.com//news/economy/foreign-trade/govt-mulling-introduction-of-import-substitution-policy-gadkari/articleshow/75558654.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

India’s trade policy folly: Current turn to import substitution will take economy down from turnpike to dirt road, The Times of India, 2018

https://timesofindia.indiatimes.com/blogs/toi-edit-page/indias-trade-policy-folly-current-turn-to-import-substitution-will-take-economy-down-from-turnpike-to-dirt-road/

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