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5 Aug

“We have this at home.”

I am sure every middle-class Indian kid resonates with the “we-have-this-at-home” meme.

The meme is about feeling disappointed at your mum’s response to having something at home, and the version at home is no fun or is just downright not as good as what you get outside.

Now, something similar to the “we-have-this-at-home” meme is happening in India. Just a few days ago, the Indian government restricted the import of laptops and many other consumer-electronic devices. The reason? To encourage local manufacturing of laptops and reduce imports of these products.

But before I begin, let me set some useful context first.

India’s electronic imports are about 7% to 10% of the country’s total product imports and are a major drain on India’s foreign exchange reserves.

As per government data, the imports of finished electronic goods grew by 32% from $32 billion in 2019–2020 to $43 billion in 2021–2022.

More specifically, in April-June 2023, electronics imports, which include laptops, tablets, and personal computers, were $19.7 billion, up 6.25% year-on-year. And this is concerning because forex reserves are a buffer for a country's economy against external shocks and uncertainties. With draining forex reserves, a country is exposed to global volatility.

In simpler terms, we are sending more money out of the country by importing more laptops. It is similar to when your mother points out that eating restaurant food regularly harms your health.

But we import electronic products heavily because of a few (or many) shortcomings with our own manufacturing capabilities:Inadequate infrastructure, weak domestic supply chain and logistics, high cost of finance, inadequate availability of electricity, lack of components, limited design capabilities, and inadequate skill development are a few of these.

However, the demand for electronics within India has grown, and with little to no manufacturing prowess, India resorts to imports.Now, the good thing about the situation is that the government realizes that they must build India’s manufacturing muscle and reduce imports. It is doing this by adopting an import substitution trade policy or what I am calling the “We-have-this-at-home” phenomenon.

So, what is import substitution?

Import substitution refers to an economy’s strategic choice to reduce the import of foreign products and encourage production in the domestic market. The policy aims to change the country's economic structure by creating substitutes for imported products.

Think of the policy as similar to your “I will order restaurant food less often this year” resolutions because you want to save money, or learn how to cook, or develop healthier and sustainable eating habits. You stand to gain if your resolution can become a way of life in the long run.

Likewise, if a country can create competent substitutes for the products it imports, it directly benefits the country by creating jobs, fostering innovation, and local competition. It is healthier for the country’s economy in the long term as it makes it more self-reliant and capable.

So the government’s decision makes sense, right?

Ideally, yes.

However, this import restriction announcement is being criticized because, to many, it signals a return to the ‘license raj’ policy India pursued until 1991.  

But I believe the criticism is misplaced. Because there is a vast difference between then and now, and the contexts in which the two policies were enacted.

Back in the late 1900s, under the license raj, India’s manufacturing was largely government-led. The government decided which industries to set up, how many factories to sanction, what the labour laws should be, and so on. It protected local manufacturers from global competition. It was a healthy policy option for a newly independent country.

Now, the problem with license raj was that in many ways, it also became limiting because the government sanctions became a bottleneck. It gave rise to red-tapism, thereby limiting competition and new entrants into an industry.

Consequently, liberalising the economy in 1991 to eliminate the license-raj limitations and encourage free trade significantly expanded our economic activity.

However, merely liberalizing the economy didn’t lead to more innovation on the manufacturing front. We did not see more entrepreneurs setting up factories, now that the trade rules were more relaxed. And we bypassed a crucial stage in the growth of any economy — developing manufacturing prowess. New entrepreneurs in the new and economically liberal India did not have a significant incentive to set up factories, and manufacturing-led growth remained stunted.

But today, these new import restrictions are paired with some key measures to avoid the trappings of license raj.

One is the production-linked incentive scheme (PLI) to encourage manufacturing.  For instance, in the case of smartphone production, India has emerged as a leading manufacturer of mobile phones in recent years. As of April 2023, India surpassed a remarkable $10 billion worth of smartphone exports in the fiscal year 2022-2023.

And we achieved this all thanks to the PLI scheme introduced to execute the import-substitution policy. PLI’s official description reads:

“The PLI scheme aims to give companies incentives on incremental sales of products manufactured in domestic units.

The scheme invites foreign companies to set up units in India; however, it also aims to encourage local companies to set up or expand existing manufacturing units, generate more employment and reduce the country's reliance on imports.”

The fact that the scheme is designed to encourage foreign companies and local businesses alike to set up manufacturing units is what makes the current version of import substitution different from license-raj.

Import substitution through PLIs makes sense because such a partnership between international businesses creates job opportunities in the local markets. Additionally, it creates local knowledge transfer, given that the know-how of an international company can be used to create innovation that works for India. And when India becomes a manufacturing hub, it can export finished goods, improving its forex reserves and making quality products affordable for more people.

So, to play devil's advocate and give the benefit of the doubt to the government:

I think that the policy isn't intended to usurp control, but intended to merely channel local production in a way that creates more avenues for the country’s manufacturing muscle to develop.

Re-adopting an import-substitution trade policy isn’t limited to India.

Globally, this trade policy is making a return so far as developing economies are concerned.

“The Covid-19 pandemic has reinforced the notion that African countries should produce locally, rather than importing from abroad. Announcing a lockdown in March, Uganda’s President Yoweri Museveni expressed his hope that the crisis would help to build manufacturing capacity, rather than “turning our market into a dumping point for foreign goods.”

Why is this happening, though?

Why are more developing countries returning to some form of import substitution? I think the answer has to do with the possibility that, perhaps, pursuing free trade policies hasn’t benefited all stakeholders in the world economy.

You see, in the 1990s, something called the Washington Consensus was in vogue.  It was a set of ten economic policy prescriptions considered the “standard” reform package promoted for crisis-wracked developing countries and promoted by the International Monetary Fund (IMF) and World Bank.

Trade liberalization, i.e., allowing inward foreign direct investment were two of the ten prescriptions promoted as the way out for developing economies that struggled to trade at a global level. They allowed you to open up your economy to compete in global markets so your country's capabilities developed accordingly.

However, the opening up of fledgling economies under the context of making them competent at trade left them worse off.

The local economies in developing Latin American and South Asian countries hadn’t fully matured, making their exports less competitive globally.

A country like China which didn’t fold under the pressure to liberalize its economy or partake in free trade built its manufacturing muscle and outdid the other economies globally. The developed economies of the world also favoured China because most other economies couldn’t supply products at China’s price point and simply didn’t have the ability to manufacture at the scale China did.

So, the trickle-down of wealth through free-trade policies didn't materialize for the developing economies that adopted the free-trade approach. And developed economies didn’t have much to lose because most of their margins are created via great sales and branding, so importing at scale and lower costs from Chinese sweatshops didn’t impact their forex that much.

However, this also led to an over-dependence on China’s manufacturing. And now, even developed economies are looking to diversify their manufacturing. So, a combination of developing economies encouraging local manufacturing (to improve forex) and developed economies diversifying their manufacturing trade partners are making import-substitution cool again.

To be fair, the people criticizing the restriction on laptop imports have some good reasons to rebel against the policy.

While I have explained what import substitution is and how it is different this time, there are some looming doubts to contend with, with the return of import substitution.

For one, import substitution cannot be a reason to protect local manufacturers who cannot produce quality products that sell at global markets. For instance, until India can produce an Apple Macbook or a product to match that quality, it shouldn’t give local manufacturers a free pass on the quality of their products. Restricting laptop imports shouldn’t mean any laptop can be manufactured because there is a government incentive to do so.

Secondly, simply imposing high tariffs on imports without having the necessary know-how to create products with locally available resources can also hamper local productivity in companies that rely on those imports to do good work.

Thirdly, the government has to be extremely strategic about which industries it provides subsidies to. The industries have to be the ones that manufacture products with global demand. A report from The Economist explaining the success of a few Asian economies that employed import substitution highlighted —

“…the governments of the Asian Tigers meddled extensively in their economies, subsidising favoured industries and firms. But global competition placed relentless pressure on exporters, forcing them to become more efficient and encouraging the acquisition of technical know-how. Those in isi economies, sheltered behind high tariffs, tended instead to be small, inefficient and complacent.”

For import substitution to fully benefit an economy, policy choices, subsidies, and incentives cannot breed complacency in any form.

And global standards for products should also be the north star metric for locally set-up manufacturing units.

Thankfully, as I mentioned earlier, the current version of import substitution employed in India is directionally accurate because it is not strictly favouring local manufacturing over and above international manufacturers — although that can be its short-term impact.

But, in the long run, I think this only incentivizes more foreign brands to set up manufacturing in India, because the policy doesn't apply to Macbooks or other electronics from foreign brands that are manufactured locally, only to those that are imported.

How this trade policy plays out will be an exciting phenomenon to witness.

And I hope that by then, your “I will order restaurant food less often this year” resolution has become a way of life.

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