In recent years, the union government has revealed a fiscal strategy for growth that seems to comprise of three elements: protectionism through tariff hikes, production-linked incentives, and capital expenditure to create infrastructure. In this essay, I consider two elements of this strategy—protectionism and production-linked incentives. India’s pivot toward protectionism began in 2017, and the 2022-23 union budget moved the country further in that direction by phasing out of the concessional rates in most capital goods and projects imports and announcing that more than 350 exemption entries would be phased out. Since 2020, the government has also announced several production-linked financial incentive schemes. These began with pharmaceutical ingredients, electronics manufacturing, and medical devices and have expanded to include telecom and networking products, food products, certain household appliances, textile products, drones, and more.
As this year’s budget will be released a week from now, it is worth considering whether these two policy pivots are sensible given what we know about India’s economy. One way of doing this is to compare with other countries on the relevant metrics. International indices can be useful for understanding where a country stands, thereby informing policy choices. This is not to suggest that the organizations that prepare these indices are infallible. In a
previous issue of this newsletter, we pointed out how India’s improved measurement of trade facilitation may have forced OECD to revise its scores retrospectively. So, experts from any country should, with evidence, challenge the validity, reliability, or objectivity of a measure. Such discussions should, however, proceed from a premise that there is value in well-prepared comparative indices.
Arguably, one such index is the Economic Complexity Outlook Index (COI) developed by Ricardo Hausmann, Cesar Hidalgo, and their colleagues. They study economic development in terms of productive capabilities (know-how) that go into making products. The more complex products usually require a wider combination of capabilities. These products also tend to be more valuable and provide better quality employment opportunities. In this respect, economic development can be seen as the transformation of a country’s economy towards the production and export of more complex products.
COI measures how well a country is positioned to grow through diversification into more complex products, by quantifying how close the products it makes are to the products that it does not make, weighted by how complex those products are. A high score on this index reflects that there are many nearby complex products that require capabilities similar to those reflected by a country’s existing production. Hausmann, Hidalgo, and their co-authors suggest that a higher ranked country on the index should be able to more easily sort out the problems associated with coordinating the development of new industries and the accumulation of required productive capabilities because the industries that are closer to a country’s existing capabilities tend to have fewer coordination failures to resolve and hence provide an easier path to the accumulation of capabilities.
If we look back at the COI rankings at three points in time—the years 2000, 2010, and 2020—India has ranked number one in each of these years. In contrast, China’s ranking on this index has gone through many changes—from the second rank in 2000 to the seventh in 2010 to rank forty-three in 2020. India not only ranks number one on this index, it also scores much higher (India’s score is 2.96) than the country that ranks second (Turkey with a score of 2.4). What are the implications of this for India’s growth?
First, while the index shows that Indian economy’s existing capabilities are well-suited to support rapid growth in the next decade or so, we cannot take it for granted that this potential will be realized. Back in 2015, it was
projected on the basis of this work that India’s economy would grow at an average of 7.9 percent over the following eight years. In 2016-17, the economy grew at 8.3 percent, and it seemed that the actual growth would be consistent with the projection. However, India’s growth decelerated after that—to 6.8 percent in 2017-18, 6.5 percent in 2018-19, and 3.7 percent in 2019-20. The average for the four years before the pandemic—2016-17 to 2019-20—was 6.3 percent. Further, as noted in a
recent issue of this newsletter, the economy is yet to properly recover from the impact of the pandemic. So, while the existing productive capabilities can support rapid growth, the political economy and the institutions would determine whether they are put to good use.
Second, looking at existing productive capabilities can help us understand where we stand relative to other countries when it comes to attracting foreign investments. Let’s consider one aspect of the emerging geoeconomics of foreign direct investments: the attempt of some firms to diversify away from China. China is a leader in many sectors, but in 2020, its share in the trade of textiles (37 percent) and electronics (28 percent) was particularly high. For firms in these sectors looking to move away from China, the natural choice would be to look at countries with some demonstrated productive capabilities in these sectors. Moving production to such countries would be easier. If we consider, say, Vietnam between 2010 and 2020, its share in the world trade of electronics goods rose from 0.4 percent to 5.2 percent, and that in textiles rose from 2.4 percent to 5.8 percent. It is no surprise that Vietnam has attracted significant investments from those looking to diversify away from China. India’s share in electronics exports remained stagnant at around 0.5 percent all through the decade, and that in textiles fell from 3.4 percent in 2010 and 2.9 percent in 2020. This does not mean that India cannot attract investments in these sectors, but in the near future it may be harder than it is for Vietnam.
A journalist recently
shared on twitter that India has taken over a large part of the Davos promenade at this year’s World Economic Forum. From the union government to certain state governments to private corporations, India has a large presence in this year’s forum. This is part of a broader effort to position India as a preferred destination for foreign investors. However, given the existing productive capabilities of India’s economy, if we do more to fix the political economy and institutional problems in Delhi and Dispur, we may not need to do so much at Davos.
Third, India’s standing on the COI can also guide the choice of a suitable strategic approach for creating growth opportunities. Countries that are at the technological frontier and are already producing existing highly complex products need to invest in developing new products and build capabilities for doing so. Germany and Japan are examples of such countries. Countries like Bangladesh and Nigeria, whose existing capabilities do not afford significant opportunities to diversify into more complex products, need to make leaps to build capabilities in strategically chosen areas that allow for diversification in the coming years, otherwise their economies may slow down. Bangladesh, for instance, relies heavily on textiles exports but has few demonstrated capabilities that can allow it to diversify into other more complex product categories. India is in neither of these categories. Its existing productive capabilities are quite close to those required to make a variety of more complex products. So, the suitable approach for India is a light-touch one, even though some states may choose to implement “parsimonious industrial policies” that identify and address specific bottlenecks to enable production of related products.
This takes us back to the question: why is India betting so much on fiscal incentives and tariff hikes to boost domestic production? In other words, why has India chosen more activist trade and industrial policies than seems necessary on the basis of its existing productive capabilities? One answer is that in some product categories, such as active pharmaceutical ingredients, India is keen to reduce dependence on countries that it does not trust. Another answer is that India may be looking to build capabilities in certain technologies that could yield diversification opportunities in the long run. Examples of this include semiconductors and related products. But such justifications can be offered only for a few sectors, and in those as well, questions can be raised about the methods through which these objectives are being pursued. They do not explain the proliferation of production-linked incentives schemes in sectors ranging from food products to textile products. They also do not explain why tariffs have been hiked on so many goods, including many intermediate goods. If the government believes that some market failures are preventing the productive capabilities from being used for producing more complex products, it is better to identify and address the same directly and precisely.
—By Suyash Rai