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?

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