Wednesday, December 29, 2010

Trade Policy for the Indian Auto Industry

We all want all our industries to flourish despite the increasing global competition. How do we do this? Well, there are two ways. With little protection of the domestic industry, it may learn how to outperform its competitors from abroad in the domestic market. This may probably ensure a structural development of competitiveness in the industry eventually, helping the domestic industry grow up as a global player. This is the crux of export-oriented industrialization. This model had been followed in the past by the countries like South Korea, with great success.

Another way, which has been conventionally popular among the Indian trade policy-makers, is to protect the domestic industry heavily by imposing huge tariffs on imports. Thus, the domestic market is dominated by products from domestic industries as the imports are rendered too expensive. In a country where imports are dominant, this policy would tend to substitute the imports with domestic production. This is what we economists call import-substitution, which is usually implemented when there is an 'infant-industry' condition, whereby the domestic industry is too uncompetitive to face global players.

On the face of it, 'import-substitution' looks like a sensible thing to do: imagine how many Chinese motorcycles would flood the Indian market if we reduce the protection for Indian motorcycle industry. Roughly, our tariffs on Chinese motorcycles are about 50%, while they may be about 50% cheaper than Indian motorcycles. But, reducing the tariffs gradually would force the Indian manufacturers to somehow reduce the costs by increased efficiency, better technologies, research and development, reduced wastage, etc. This is is not a mundane statement, but is a well-researched conclusion arrived at using field-surveys and econometric analysis in an ICRIER study sponsored by the Govt of India.

A simple evidence exists in the trade policy structure of Indian auto industry. Auto-components sector, which primarily produces all types of parts required for the industry, has tariffs close to 8%, which has been systematically reduced over the years and this sector has expanded phenomenally, especially in terms of exports. Automobiles and motorcycles segment that has enjoyed immense protection has not grown so much in terms of exports, on the other hand.

This raises the important question of how to deal with diversity in the tariffs within an industry like automotives in India. Often while conducting research on trade policy for framing research-backed arguments in the trade negotiations such as WTO, one has two different alternative approaches to adopt. Firstly, as most of the consultancy organizations and governmental policy researchers do, one can consider all the hundreds of sub-sectors in the auto industry and do some impact-analysis. This approach misses several important points, such as the inter-linkages in the economy and overall welfare implications. For example, such analyses can seldom deal with the fact that auto industry depends on steel and plastics and they can seldom quantify how many dollars will Indian public at large lose by cutting some tariffs.

A second approach, adopted by academicians and some governmental researchers, is the Input-Output based approach or the Computable General Equilibrium approach. Here, one has the opportunity to consider inter-sectoral and international linkages and compute the approximate welfare measures of the tariff policies. These models are understandably complex and data-demanding, so they typically deal with aggregate data. For example, GTAP Data Base, which is prominently used in such simulations, gives Motor Vehicles and Equipments as a sector, which consists of the dozens of sub-sectors within the auto industry.

So both approaches have their shortcomings. We developed a model that would marry both approaches so that we can get the best of both worlds to analyze the issues in the trade policy of Indian auto industry. While our conclusions pointed out the better performance of this model, one of the few lessons for Indian trade policy makers here was this: slowly but steadily, reduce the tariffs in the automobiles/motorcycles. Steadily - because the customer stands to gain from the lower prices and the producer may become more cost-competitive in due course. Slowly - because drastic reduction of tariffs will perhaps wipe out the Indian industry due to the flooding of imports from countries like China. Further the extent of reduction should be specific to the sub-sectors, based on their competitiveness, size, etc. - something to investigate in future. Is'nt it amazing to see such simple and practical policy measures emerging from extremely complicated models and data?

Tuesday, December 28, 2010

Indian Textile Sector: Fiscal Structure and Changes in Commodity-mix

Generally, it is expected that changes in fiscal structure have a direct impact on prices of commodities, which gets translated into changes in demand and hence a change in the commodity-mix. A close look at fiscal structure and consumption behaviour of textiles in India helps us understand the complexities involved in this economic phenomenon and the policy lessons arising from them. Textile sector may broadly be classified as natural/conventional fibres (NF) and man-made/unconventional fibres (MMF). Decades ago, the excise and customs duties relevant for the MMF were set much higher than NF and this trend has been continuing till today, supposedly to protect the declining conventional sectors. However, the recent Indian budgets have been reducing the gap gradually. Excise duties for MMF are still quite high: 8-16%. This analysis will point out what more is needed in this direction and why.
Textile consumption contributing to about 6-7% of an average Indian’s consumption basket (calculations based on NSS 60th Round, 2005-06), by itself is vital for enhancing the economy, in addition to the fact that textile sector accounts for a major part of employment, GDP and exports of India. Of late, textile sector is becoming demand-constrained domestically, though the external constraint is far less than the MFA quota regime. Given these factors, enhancing domestic textile consumption, as a whole, is an important policy outcome.
The basic premise behind high excise duties for MMF is that without them, low prices of MMF products might destruct the NF market, owing to substitution. However, an empirical analysis using a huge reliable household-level survey data on Indian textile purchases from 1994 to 2003, proves that demand for MMF is more elastic to its own price and also that MMFs and NFs do not any more substitute each other, as seen from their negligible cross-price elasticities, which reflect the extent to which the demand of NF falls with a fall in price of MMF. So, a fiscal-measure-induced fall in MMF prices will lead to a greater expansion in MMF demand than the one in NF prices. What this means to a policy-maker is: If you decrease the excise/customs duties for MMFs, you are not harming NFs because they are not substituted and in fact, you are facilitating an expansion of the textile consumption, which is in the interest of the entire textile industry and economy as a whole. This has been one step that is almost never missed by any Finance Minister of India in the Annual Budget. Perhaps this is a testimony to sound research-backed policy-making in India?

Changing Demography and Indian Steel Industry

India is the seventh largest steel producer in the world, producing 42.64 million metric tons of finished carbon steel in 2005-06. Its domestic consumption stood at over 38 million tons in 2005-06, holding sixth position in the world. Indian steel exports are mainly to the USA, EU and South East and East Asia. Indian steel production has been growing for the past 15 years at a rate of 7% per annum and is projected to grow at a faster pace. India exported over 5 million tons of steel and imported nearly 4.7 million tons in 2005-06.
In the meantime, various demographic changes are taking place in India. Rural population in India in 1991 is thrice that in 1901, while urban population in 1991 is nine times that in 1901. About 400 million Indians comprise the working population in 2001 as against 314 million in 1991. At the same time, number of enterprises and employment have grown more rapidly in rural areas, as inferred from Economic Census, 2005. India has the highest youth population (Aged 15-35 years) in the world. People aged between 15 and 59, who have the potential to contribute to the economic activity, comprise around 60% of Indian population and this is likely to increase in future. Further, the middle and higher income-classes have been expanding in India in the recent years and are expected to retain the momentum, thanks to increased economic activities in the country.
The number of people living in urban areas has risen to 27.8% in 2001 from 25.7% in 1991. Urban population in India is 285 Million, which is close to the US’ total population of 300 Million people. Further, the urban sector contributes 50-60% to GDP of India. Moreover, number of towns and cities in India has increased from 3891 in 1981 to 4378 in 2001. Number of migrants from rural to urban India has grown from 229 million in 1991 to 307 million in 2001.
All these trends point towards the fact that the country is at the threshold of a huge urbanization and consumption spree. This may lead to massive surge in steel demand along with urban construction and associated change in the lifestyle of the population. Facing such a steel demand surge, India has a recoverable reserve of 13460 million tons of iron-ore. However, reduced iron ore exports from India have grown from a mere 2 million Kgs (Rs. 16.6 Million) in 200-01 to 20 million Kgs (Rs 233.7 Million) in 2005-06, despite fluctuations over years, necessitating an import of 2.48 million Kgs of pig iron. On the other hand, iron-ore mining leases might not be given to the new steel cpacities in many Indian states. Further, tribal people need to relocated for the expansion of minig activities in the Eastern states. All these socio-economic and demographic aspects affect both supply and demand of Indian steel industry. This needs to be scrutinized further by both the industry and the government for any policy or strategic decision.