Big Lesson From Small Nation: On import substitution

Synopsis: Import substitution cannot deliver “Make in India for the World”. Lessons from Vietnam.

Introduction

In 2015, India decided to promote mobile phone industry through import substitution. The eventual goal was to make a success of “Make in India for the World”.

Though, there has been a significant expansion of domestic production of telephones since 2015, but the success is rather modest when measured against what Vietnam. Vietnams electronic goods exports stood at $122 billion in 2020 against India’s $12.8 billion.

How has Vietnam achieved this success?

Signing FTA’s: Indian leaders were constantly apprehensive of signing free trade agreements (FTAs) even with countries accounting for minuscule proportion of the country’s trade.

Whereas Vietnam has boldly embraced such economic giants as China and the European Union in FTAs. It also has FTAs with every single Asian country of any significance.

Reduced tariff due to FTA’s. For instance, consider the case of iPhone. The iPhone contains 1,600 components supplied by approximately 200 firms spread over 43 countries. Even small custom duties at each border-crossing can add up to large cost escalations. FTAs among countries playing host to suppliers eliminate this problem.

What are the consequences of high tariff on imported components?

i). Prices out consumers: A rising tariff not only allows progressively less-efficient producers to add to supply, it also prices out more and more consumers.

For instance, take the case of “Phased Manufacturing Programme” (PMP) scheme where the basic customs duty on the imports were increased to develop domestic industry.

The tariff undoubtedly encouraged domestic production of components but it also raised the cost of components for producers assembling them into smartphones.

Therefore, most of those who had entered assembly activity would be rendered uncompetitive after the imposition of the original tariff.

ii). Encourages smuggling: Further, the high tariff brings smugglers into business who pocket custom duty due on legal imports as their profit.

iii). Consumers lose: The biggest losers are consumers who must now pay higher prices, with some of them priced out of the market or forced into switching to inferior-quality smartphones.

iv). Encourages rentseekers: Another major consequence is, producers that enter production activity in response to high protection are likely to be predominantly rentseekers rather than risk-takers. It is a mistake to think that they would eventually turn into export powerhouses (Rent seeking is the fact or practice of manipulating public policy or economic conditions as a strategy for increasing profits)

What are the benefits of lower tariffs?

In the absence of increased tariffs India could benefit from the competitiveness of Local manufacturers who are involved in assembling the components.

Also, it allows manufacturers involved in assembly to compete against imported smartphones.

Source: This post is based on the article “Big Lesson From Small Nation” published in TOI on 15^th Sep 2021.