Sitharamans Tariff Increase are Based on a New Economic Gambit

Context: India's return to higher tariffs will induce inward investment flows and is in compliance with a new economic paradigm.



Arguments in Favour of Returning to Higher Tariff Regime:

• Supports emerging new economic policy: that encourages economic policy mix of restrictive import tariffs and loosening controls on capital flow return.
• In consonance with conventional theory of economic policy: that supports the lowering of trade barriers while maintaining prudential controls on potentially-destabilizing capital flows
  • In other words, promoting domestic manufacturing and exports simultaneously.
  • Jagdish Bhagwati and Joseph Stiglitz have been critical of the "Washington consensus" view favouring unfettered capital mobility.
• Integrating trade barriers with industrial policy: similar to East Asian model;
  • India's custom duty policy should have the twin objectives of promoting domestic manufacturing and helping get India onto global value chains and export better.
  • Thrust now has to be easy access to raw materials and exports of value-added products.
  • In the Indian case, the favoured industries will not be restricted to manufacturing/labour intensive but may take advantage of IT and other services where it is competitive.
• "Tariff jumping" as a motive for foreign investment: Tariff barriers were used for inducing foreign investment inflow by newly industrializing countries of North America.
  • "Tariff defusing" foreign investment means foreign investment could enter in advance of anticipated tariffs. For E.g. Canada's entire manufacturing base flourished due to tariff policy.
  • Tariffs are welfare-improving is the capital is subject to taxation.

Way Forward: Sound public policy formation should check whether the quantum of the gain would outweigh the distortion costs to the economy of policy errors or misjudgements.

• Tariff increases should fall on finished products (or final services): as tariff increase on intermediary inputs would disincentivize domestic manufacturing and inward foreign investment.
• Improve the environment for doing business which is a necessary precondition for enticing high-quality and durable FDI.