 Welcome to the discussion series on free trade and liberalisation as part of the 1991 project at the Mercator Centre. I'm Shruti Rajagopalan and in this conversation series I will be talking trade with Professor Arvind Panagariya, who is the Director of the Deepak and Neera Raj Centre on Indian Economic Policies and the Jagdish Bhagwati Professor of Indian Political Economy at Columbia University. In the past, he has served as the first Vice Chairman of the Niti Ayog in Government of India and as Chief Economist of the Asian Development Bank. He's the author of a number of books, but for today's conversation in particular, we will focus on his recent book, Free Trade and Prosperity. Welcome Arvind. Hi Shruti, very pleased to be back with you. Thank you for joining us and talking trade and reforms. I wanted to talk today about a few aspects of protectionism as a continuation of our conversation last time. So in the last episode, you detailed some of the common arguments against free trade and for protectionism, especially in developing countries. Now I want to come to one of the most, to me, it's one of the most annoying arguments in favour of protectionism and against free trade and I am yet to see the economic logic of it, even though I've thought about it for a long time. There seems to be this implicit bias against imports and there is a bias towards exports, right? So everyone wants that we should import nothing and we should keep exporting, right? That's the idea and this is driven by some, I don't know, some kind of like basic misunderstanding of trade deficits. This idea that trade deficits are this terrible thing in any economy. It's going to tank the economy. We need to keep trade deficits low and always be insurplus. So that's one part of the argument and this keeps coming back. I mean, a very large part of this make in India movement which is going on right now. I mean, with 30 years post-liberalization and these arguments come back with a vengeance. So this just doesn't go away. I don't understand the economic logic that supports it or the fascination with it. So what exactly is this argument? And what is the merit if any? Why isn't this case closed once and for all? Yeah, no, no. This is absolutely right that this may, you know, so when you say what is the argument, there is no argument. So the answer is difficult to give. But one can try to explain why there is not an argument, but we can also come back to why. I think partly why it keeps coming is that somehow you think that when imports come in, they displace my products, that whatever is imported, I would be producing. And so then we can also, this is also the sort of fallacy, same fallacy runs through the import substitution argument as well, to which we can come in at the end, you know. But I mean, that's the sort of thing going on here. But to see how fallacious, how wrong that argument is, just think of the two options. One is that the country can import whatever it needs without having to export anything at all. You can all go on vacation, man, you know, somebody else do the production activity, we all have to do leader. It would be amazing. It would be fantastic. So there's one option. You got the second option where the country kind of sends out exports and receives nothing in return as imports. So you can even think because you think that exports are good, imports are bad. So you say, all right, I don't want any imports, but I want to export. Well, put your goods on the ship. Let them go halfway into the ocean. Dump all the goods there. Let them come back. Now, on your books, these have been exported. So your exports would look very, very good. And you didn't want any imports in return anyway. So what does it matter if the goods got dumped into the ocean? You can see how foolish that would be. And no country would actually do that. And that's the point. That this whole idea somehow that exports are good and imports are bad is totally conquered because in the end you want to export so that you can import. The whole idea ultimately is to be able to export so that you can import. Imports is what you are seeking. And we always say in trade, we say that if you get a higher price for your exports, which will mean that for any given amount of exports, you get more imports. That's better. That's an improvement in your terms of trade. I work for Columbia and if Columbia raises my salary, that's a good thing for me. It's not a bad thing. I want more and then I can spend more. It's the same thing that if we can get a higher price for our exports, then we will be able to import more for that money, for those dollars that we get in return. So Milton Friedman once famously said, and he wrote it out, but somewhere in speech 3, this video exists somewhere and I remember watching it. He said that, look, exports once sent are gone. We can't eat, but imports we can eat. So he said we can't eat exports because they're gone, but we can eat imports. So once gone, they can neither be consumed nor used to produce any other products, but imports allow you to produce other products or it can be directly consumed. So that part, somehow this notion of exports are good and imports are not. It's totally wrong. I mean, is this because we used to have terrible capital controls? So the foreign exchange problem was really bad, which means the only way you could import anything was if you earned foreign exchange. So they tried to reduce the number of people who were spending foreign exchange and therefore encouraging people who were earning foreign exchange. In the Indian context, that seems to be the only sort of like, recent logic I can trace. It's very illogical. It's a bad autarkic system of a closed economy, but that's the only place I can even understand why someone would suggest something like this. On every other margin, I simply don't get it, but I have a few more specific questions here. So the first is you give this wonderful example of yourself, right? You are earning, you are in a perpetual trade surplus with Columbia, right? You sell them your services, you buy very few services from Columbia and you're in a perpetual trade deficit with West Side Market or Fairway, which is the grocery store in your neighborhood, right? And because you are constantly buying things from there every single day. Now, this is not a problem for you at all. In fact, the larger your trade deficits with restaurants and grocery stores, in a way, the happier you are because you're able to buy more. Why does this seem so logical at the individual level, but completely loses the plot at the country level? Why are we talking about trade surpluses and deficits at the nationwide level? That part of the argument, I don't understand. So now you are actually talking not about the aggregate trade deficit or surplus, but you're talking about the bilateral ones. So you switch to the bilateral ones. Before I come to that, something you said earlier, I just want to comment about how this in the Indian context, love for exports and hate for imports arose. But if you dig a little deeper, it is precisely because you're wanting to import that you want to export. They were encouraging more and more export because it was inability to import. So somehow anybody translating that to, oh, exports are good, imports are bad. I mean, you're right actually in literal sense. You're absolutely right. That's how it is sort of drilled into the citizenry. But it's really actually the deep down it's being drilled down because of the fact that you really desperately want to be able to import because even your normal production capacity doesn't get fully used because you're not able to import certain raw materials, inputs, components, etc. And so there was always excess capacity in production in India during the 70s and 80s because of the trade constraint. But it was not because imports were bad, imports were incredibly valuable. So now come to the... The bilateral versus aggregate, you are not in an aggregate trade deficit. But you are in bilateral trade deficits quite frequently depending on who your trading partner is. We don't seem to translate this individual logic that I just explained in your specific case. We translate it in a very bizarre way at the country-wide level. We want to reduce our imports from China seems to be the latest clarion call. So can you just walk us through what is going on here? And why is this a terrible argument? It's so harmful to have this bias against imports because imports buying components, buying cheap technology, having access to global production technology is what enables us to be happier consumers but also better, more efficient producers because it'll be an input in our output. So actually, import bias I find very harmful for the economy overall. So can you just put this in context for us because I just don't understand this. So I think things are getting mixed up here. You see what happens is that a specific case of India-China even perhaps what I'm going to say applies to the US-China because US-China is the same deficit problem with China. Well, first actually take back a little bit before I come to this argument. First of all, at the aggregate level you do care about the deficit because that's largely what defines your current account deficit and you don't want overly large current account deficit because that would mean that you're accumulating foreign debt at a very fast pace which can, if you're foreign exchange reserves are not good, if you're export are not vibrant, somewhere can create a crisis. Means there's a kind of 1991 balance of payments crisis we have had. So but nowadays after the 1991 crisis, this Reserve Bank of India has been very cautious and we have accumulated vast amount of reserves and all and it runs the current account quite conservatively. Anytime it goes beyond 2%, current account deficit goes beyond 2%, the RBI really kind of begins to worry about the exchange rate and all. So aggregate is fine. So therefore the issue is only the bilateral one. First of all, why this is happening? Certainly one part of this, the analogy of my personal life of surplus with Columbia University and deficit with everybody else is clearly applicable to the countries as well first of all. Because the whole idea of trade is that you buy your goods from the country that sells you the cheapest and you sell your goods to the countries that give you the highest price for your goods. That's how you do it. And it is going to be a hell of a coincidence that the country that sells you the cheapest also gives you the highest price for your goods. It's the same. Generally they'll be different. So therefore you would run surplus with somebody and you'll run deficit with somebody and the central bank RBI will ensure that on aggregate your deficit is contained to a couple of percentage points of the GDP. So there is an optical illusion here obviously that you are complaining about the bilateral deficit with China but you're not complaining about the you're not seeing the fact that you've got a bilateral surplus with the United States. And if you actually actively try to reduce your trade with China your exports, your surplus with the United States will also fall. I mean at the end of the day, RBI is going to worry about that keep it to one to two percent of the GDP. So that's not going to aggregate deficit is not going to change. You reduce imports, your exports will ultimately somewhere get impacted. But that we don't see. Now I think part of the political issue here is that there is a lot of protectionism is embedded in this that you see if the United States is having too many imports from China India is having too many imports from China those who are producing import competing goods they see that this is an opportunity to seek some protection against it. So that everybody if these large countries are importing so much from China without exporting them something is wrong in China. So it's the vested interest in the import competing sectors which would make the greatest noise that China is dumping. That they are dumping these products on us. They would not and then nobody this existence of subsidies etc. is very hard to verify. And China in any case is also you know after all it's a communist country. So you make these allocations oh they are subsidizing their exports and all and this is how they are competitive and etc etc. But of course you know if the subsidy was the really reason then you could have challenged them in the WTO those you know any kind of output or export subsidies that impact trade are challengeable in the WTO but we are not doing that. But even though basically if the Chinese government is subsidizing my t-shirts sitting in India I am not too upset about that. That's a separate point. But that's not the producer. That's not a producer concern that's fair. The producers couched it as dumping what is in fact very well and competitively priced goods. Yeah I mean the thing is that China is exporting that to the United States and to India because they are much more competitive in these products. I mean that's the point. But when there is this very large volume of imports coming from one country into India and into the United States also then you say oh there is something wrong in the Chinese economy that they are doing something you know which is unlawful. And so that becomes the you know then you start focusing. Now that's one part of the story. The other part of the story of course is that any country seeking concession with the country trade concessions with the country that is exporting a lot to it is in a good position. I think it gives you a handle. It gives you a handle that hey I'm importing so much from you but I'm not being able to export something is wrong in your system. I mean that's what the United States says. They even start fixing the actual quantitative targets that you know this is like the voluntary exporter. You know voluntary sort of incentives to import more from the United States. Yeah and also other aspects which are not trade related like intellectual property and things like that. You also have better position to negotiate other things you may want. Human rights or you know better safety codes and you know treatment of workers or intellectual property when you're a very large importer from one single country. So what do you mean? So to some degree this bilateral deficit gives you a handle. That part is okay. So if India wants to use this it's leverage of this large trade deficit with China to get some concessions out of China. That's okay. I think you know that countries do that. That's a strategic. That's a more strategic move and taking advantage of it. But as far as economics of it is concerned beyond this strategic advantage you want to exercise I don't think there's anything wrong at all with the bilateral deficits with one set of countries and bilateral circumstances with another set of countries. No but I mean why is the unit of analysis always the producer and not the consumer. This is a very big problem I have when we talk about this bias against imports. So the bias against imports is really only talking about two out of three parties. One party that it's talking about is the producer. The second party it's talking about is the exchequer because they want larger revenues that come in if there are higher tariffs. There are very few producers usually in any economy the very large number of consumers and this import bias enormously disadvantages consumers. So if you have 20% tariffs on cheap Android Chinese phones it's going to really impact Indian consumers and it's going to impact the poorest consumers the most and this just seems to be missing from the overall discussion. Usually the arguments that economists like you and I give is yeah it's going to disadvantage this group of producers but cheaper inputs means that other producers have cheaper components and cheaper inputs and they can be more productive. But what about the consumer that's all of us. Trade economists always actually take the side of consumers I would contest that that's what we do. Trade economists are the only players in the game who appoint themselves actually to speak for the consumer. I don't just mean trade economy. I meant sorry I should have been I should have clarified I meant the people who are peddling this import bias. Yeah I mean that goes back to the political economy of it that producers are better organized consumers are almost unorganized completely. So therefore the consumer interests are not represented. Otherwise I think I probably said this before Henry George wrote it the best. He said that look we are calling this protection but who are we protecting here? The buyer wants to buy it the seller wants to sell and then the government steps in say I'm not going to let you buy who is being protected here. The seller is not being protected how is this protection you know. So but this is the age old problem you know that the fact that in the political process consumers producers are always much more dominant players than the consumers are. So which is why as I said you know the trade economists are the self-appointed representatives of the consumers and they are the ones who go and play for you know a very good example on the Indian context which also somewhere I mean I said before but is the mobile revolution that took place in India during the 2000s you know. If India had high protection high degree of protection that mobile revolution you know within a span of eight or ten years produced a billion mobile phones in the hands of the Indian citizens would have never happened never happened. So in that case it's very visible very visible and certainly you know the protectionism we are doing right now against the smartphone for example that would impact the access to the smartphones you know so many people who would buy low-end smartphones would stay for a while with the feature phones. But you know even more basically the import bias being more about the producer than anyone else a few years ago I was in Mumbai during the Ganpati festival right and you know there is a demand shock for Ganpati idols during that time because every home will get one and then they will of course dissolve it you know in the sea and that's the ritual. I everywhere you go in Mumbai shops will have these Ganpati idols and that year I asked them who is making these and they said ma'am they're all imported from China right. The Chinese entrepreneur is aware of this highly local cultural festival is able to make these idols that can actually satisfy human taste is able to do it better and cheaper and most Mumbai families at this point apparently have access to a Ganpati that is produced in China right. To me this doesn't seem there was some outrage over it while I was there but to me this doesn't seem like it's hurting anybody right like in general one would assume that the more families who could afford a Ganpati idol simply to dissolve in the sea a few weeks later the better if it's too expensive fewer families might be able to engage in it. So this is the sort of thing that I always think about as an example where if the importing sorry the exporting country from which India is importing can actually make something so culturally specific better and cheaper then perhaps we should let them do it. Well I mean I wouldn't say that nobody is hurting right because the producers who could produce otherwise those idols are the ones who are hurting right I mean so it's again goes back to the producer interests consumer interests are better served obviously by the imports I mean it's not limited to the Ganpati statues there are Raki is there a kite you know Patan you know there all this which are all cultural products but but we have to sit back rather than slap these anti-dumping duties etc on the import from China we need to sit back and say what are we doing wrong and that this is happening you know why are our producers not able to compete I mean what it is about. What are the relevant constraints that we can't produce at scale and produce so cheap. The moment you say I'll provide protection then basically you have said okay you know you have a handicap but live with the handicap I will just smooth out the highway for you but simply not letting anybody else enter on the roads. Now related to bias against imports but a separate argument in itself is import substitution right this is the big one when it comes to trade protectionism for developing countries and import substitution policies were you know absolutely the mainstream prescription especially post-world war 2 for developing countries so you know free trade is a luxury that only developed economies can engage in and afford and developing countries must have import you know substitution policies and this was sort of the idea. Now what is the reason that this became the orthodoxy post-world war 2 and now you are seeing import substitution arguments return right anytime there is a crisis like the global financial crisis or now the Covid pandemic crisis import substitution just comes back in a big way in all the arguments you know in policy circles and newspapers and so on. So can you tell us a little bit about the original argument as a prescription for developing countries in the 50s and 60s and is there any merit in returning to import substitution policies as India is attempting to do now? Okay so you are absolutely right this is a very omnipresent kind of issue you know historically or contemporary wherever you look you know this in one form or the other it keeps coming back. Of course the older argument was as I discussed mentioned earlier you know resulted from this export pessimism that the primary products is what these countries will export and you know but that argument is now out of the window because the Koreans in Taiwan showed us that you know you can export manufacturing products the labor intensive manufacturing products from the beginning you don't have to and there is no elasticity pessimism issue associated with that so that was primarily academically at least when India's context was very different which we will come to in some future episode right you know so I will not touch on Indian context which is actually quite dramatically different. Now you know the arguments that why this has such such an appeal one is of course that you know when you are importing something demand is important that it's there you know when for example even today when smart phones are being imported or future phones are being imported you know that there is domestic demand for it and so there is no uncertainty anything you know you don't know where who is going to buy this there but here you know that you got your buyers here and so that makes import substitution attractively you know why are we importing we can produce it at home so it also insights nicely with the nationalistic kind of you know that why are we the examples you mentioned Ganesha statues all things like Iraqis etc even more kind of in that direction that these are our cultural goods you know why should we so there is that demand certainly which is very important also I think you know ministries like to demonstrate success and what is the easiest thing to do to demonstrate success well if demand is there you know just keep out the keep out the imports you can easily demonstrate success I mean you know even in the Indian context I remember I'm sure you also must have noticed that our previous minister for the IT Ravishankar Prasad love to go out and say that you know I have created this new 200 many or some very large number of manufacturers of mobile phones right so there was a he would sell it as a huge success you know but I've never heard anybody you know bragging about export success that they have produced in the Indian context I can't I can't think of anyone where you would say you know export successes are not defined by the policy guys the export successes are our IT you know software very early success that happened that was not the success even the government said that we actually created that success I'm sure government played some role somewhere but largely we always see that as you know success with entrepreneurs etc but import successes we all claim auto industry we make a claim you know because we provided the protection so for ministries right also it finds traction politically because the damage that import substitution does and this is you know old point made by Frederick Bastiat you know where he said that the good that protection does is apparent to the naked eye but the harm it does is spread throughout the economy and can be seen only by an expert I mean and so you know this reduced exports which inevitably happens when you reduce imports is too indirect for others to detect so you only see the benefit side of it you don't see the cost side of it and in fact the cost side is higher than the benefit side and therefore cost benefit analysis is against import substitution but you just don't see that cost side and so that also makes the import and I mean the politicians is also this belief that they can simultaneously reduce imports and expand exports is also then this also gets size into you know imports are bad and exports are good etc. but you know we all know if you look at the data that there's no country that has reduced imports and did not reduce exports I mean it may happen but if you look at the long term trends export and import series move together take any time period any country you know this isn't kind of practically practically iron clad role and the flip is also true the more you export the more you must import import yeah I mean I sometimes say that you know they if you compare India and China for example in the 2000s and later India's export response was much weaker than the export response that is happening in China they often said this that look part of India's problem is that the import response has been very muted that when we open to trade we went from complete prohibition on trade almost I mean you know effectively right in a prohibitive barriers to relatively open right by 2007-08 the top tariff rate had come down to 10% with some exceptions and yet imports didn't expand as much yeah you know and if had the exports imports expanded simultaneously exports would have expanded as well so I often attribute actually the muted export performance to muted import response import response so but these are the factors you know which explain why the import substitution remains an attractive thing and even you know people who otherwise believe in trade often you know fall for it they fall for it and now historically if you look at it you know what is currently happening in India is to some degrees similar to what happened in the 1970s in South Korea right you know the economy imports grew because exports grew imports grew and by 1973 imports had become large enough that the policy makers said that yeah we can produce these things at home why are we importing and with us it is similar thing has happened now that imports did grow I mean at peak imports had become about almost 30% of the GDP compared with 10% in 2001 yeah and so policy makers thinks that oh this is a large amount why am I importing I can produce them at home and they also think that this is a net addition to GDP whatever I do because they don't see the negative effect that simultaneously happens on exports and that is the problem so they just think that by adding this I am actually adding to the GDP there is no subtraction happening it's only addition that is happening and it's that kind of and they confuse the political entity with an economic entity right the economic process is global it's deeply intricate right it's highly decentralized who is producing what how they are competing on price how there's a new producer an entrepreneur in a new country who might suddenly provide you something cheaper but the national entities remain the same so the way the policy makers think about it is us versus them in a country sense without thinking about producers and consumers as just you know individual firms or individual entrepreneurs who might be doing a very intricate global social cooperation in some sense right right right but you know there is another sort of fallacy that goes which enhances this import substitution and that is not understanding the massive protection the import substitution of financial providing and so let's take this example you know this goes back to our old idea of the effective rate of protection as opposed to the nominal rate of protection and so I want to take a little example and explain you know exactly how this kind of this protection gets so under stated actually when you look at the tariff rates right so think of the mobile smartphone you know some smartphone let's for simplicity think of this that it costs 100 dollars to import it right and the smartphone sort of is made of large number of components which account for about 90 dollars part of its cost so you can if you import this under free trade let's say if you import smartphone you can get it for 100 dollars and components themselves if you were to import only components that will cost 90 dollars so then any local manufacturer who can assemble the components for 10 dollars or less can effectively compete with the imported smartphones right so there is this margin of what 10 dollars for assembly per smartphone that is available to those and anybody who can carry out that activity can compete now suppose the government says that well you know there are all these massive large number of smartphones being imported why can't you manufacture them at home so let's give some modest protection to the domestic producers and say we'll give you know we'll impose a 10 percent custom duty on the imports of smartphones right so it may look like okay 20 percent there's not such a big deal you know but just think what happens now the price of the imported smartphone has gone up to 120 dollars yeah smartphones can still be imported at 90 yeah so the margin between the 120 and 90 has now gone up to 30 dollars yeah so now previously under free trade you had to be so efficient as to assemble the smartphone in just 10 dollars per unit of cost yeah now you can do up to 30 dollars yeah right so the protection is now 20 percent protection on assembly activity is 200 percent it's a 200 percent protection and so you are encouraging massive inefficiency here that anybody you know so no it's no surprise that when you do this kind of derivative very large number of manufacturers come in you know anybody I mean look you know even you and I could sit down and assemble a smartphone for that kind of margin right you know you got 100 percent advantage over the best competitor so and so you are not going to get these super efficient and super predictive assembly manufacturers you are going to end up with actually all these inefficient guys you know think that as long as the protection remains we can survive yeah and so this is the damage right and now that's the one that's the one problem right but it compounds because so the mobile industry becomes vibrant it comes in and all and then at that the politicians and the government all of them have the look you know we created a mobile industry that hardly existed we have done it and so now we have to increase the success so now which means let's have more value added so let's you know extend protection to maybe half of these components right so you say I'm just taking an example so you take half of the components you say slap a 50 20 percent duty on these components now the 10 percent duty on those components ends up adding about what $4.50 to the cost yeah so what was importable for $90 now becomes $94.50 well I have cut the no sorry it's 20 percent duty right so it's $9 it's $9 of duty so from $90 you go to $99 well $99 and $120 the gap is now reduced to $21 yeah what will happen to all those assembly fly by night assembly manufacturers whose cost was between $21 to $30 for mobile phone they are all gone either that or you increase the protection to the final mobile import usually the latter because they lobby for it well so and once you are becoming a manufacturer you become more credit or you create an employment right I mean that if you if you don't do that then you will create an employment so the government is also sympathy is okay 20 percent will go to 30 percent so this cascading happens and then more components are protected more protection at the top level at the final stage so either this cascading or so you are really adding all these costs now very I mean this this obsession also with value added for units is so misplaced right so misplaced because now if you do this this kind of protectionism and increase the value added you think that finally assembly finally assembled smart phone will be competitive yeah even here you will have to you know raise just to offset the impact of this 20 percent duty on half of the component imports by 9 percentage points so 20 percent will have to go to 29 percent so the mobile phone your domestic guy is producing mobile phone at 129 dollars and then if the other components are also done then you have to read it put another 29 percent and so it goes to 38 percent and so $138 who is going to buy in the global marketplace what is available for $100 for $138 you will never capture the global marketplace you are never going to do that so this obsession with high value added per unit is so misplaced because anybody can manufacture entire 100 percent value added product of anything you can produce an aeroplane 100 percent domestic value added but it's only the captive buyers at home who can buy it you will never capture the global marketplace you have just described the Indian auto industry start to finish it is exactly they can't so this is why the 1 percent they hardly have even 1 percent share in the global marketplace my favorite example here is particularly with respect to this this obsession with value added per unit I mean look at China iPhone supposedly 1600 different parts to it current supply chains are spread over about 200 different firms which are spread over 43 different countries and China has total value added in its iPhone of about 10 percent yeah but it's 100 million plus iPhones yeah that's a lot of total value added you can produce the 100 percent mobile phone smartphone in India all parts components everything homemade but how many buyers are you going to get not many so total value added is constrained by your domestic market which is also domestic market at that very high price yeah even domestic price at $138 for a $100 smartphone will shrink yeah and you'll never get the global marketplace so what did you achieve total value added along total value added you lost out whatever you gained on per unit value added now this problem actually has now become much more serious than it was perhaps in the 60s and 70s because the transportation costs were high yeah right so you had a comparative advantage in let's say clothing and so you could have the entire including fabric or including fiber etc maybe you could produce because price crossing you know that importing fiber importing fabric etc will add to your cost because transportation costs are so high yeah but today transportation costs have really plummeted yeah and then production processes have become more complex also yeah but at the same time it has also become much easier to break up the production process into many more I mean this breakup existed before and you gave the Adam Smith example of the you know making a needle etc so this specialization along different parts of the existed before but today it's much more yeah so this breakability of the production process put together with the very low transport costs has meant that the suppliers have got much more spread out each activity is undertaken by the one who can do it the best and that one takes most of the global market yeah so you so you don't work on value edit per unit but you act on total value edit even if it's in very small number of components there is what you need to do so if you know today India's comparative advantage largely lies in labor intensive activities they capture all the assembly activities for example or capture some very labor intensive things that can maybe services whatever it is and get the labor intensive exactly and spread it and take over the entire global marketplace rather than doing everything more value edit now whether it's true I have not verified but like our PLI scheme the production link incentive scheme at least somebody was telling me so I have to check this but if it is true then it is really fatal because saying that you get this incentive if you produce 80% of the value added domestically that's a surefire recipe that this anybody who takes advantage of that subsidy is not going to be competitive in the global marketplace I mean it's a double whammy for the country because also this subsidy in many cases is being provided for highly capital intensive industries so if you do find some takers what you are doing is you are massively kind of moving capital which is a very scarce factor relative to labor into these highly capital intensive sectors will create no jobs actually there is more I think it's triple whammy so you are providing these subsidies at the cost to the taxpayers that's one problem the second is the Indian consumer pays far more for a car or something that has similar protection then they would pay if they imported that car or compared to the global consumer and the third is the Indian manufacturer which has been completely coddled into becoming not competitive and is not able to export in the global market so it's multiple whammy it's not just double whammy and the scarce capital being utilized so there is so many distortions that are being created this is actually an incredibly incredibly helpful exposition on the import so there is something in India called phase manufacturing program PMP it is a favorite of our bureaucrats and this created massive problems I gave you earlier that tube light example that was exactly the phase manufacturing program that will give you license to produce provided after four years you also source the components that go into tube light from home from domestic suppliers this is the PMP and it didn't succeed at all actually what happened was the quality of those domestic tube lights only went down because the local guys whatever quality parts they manufactured the fellows had to buy and so therefore the quality of the tube lights that were manufactured was very poor also multiple failures of that program that happened but that has been not resurrected you can hear Piyush Goyal talking about phase manufacturing program you could previously I remember the Hasmukh Aadiyah who was the revenue secretary was talking about this phase manufacturing program as if 20 years 30 years passed and we are completely over asleep and suddenly woke up and say oh we have to do phase manufacturing program again it's it's tragic I mean no and it keeps coming back this is actually by I can't even imagine how frustrated you are having worked on trade your entire career but for me each time I read these arguments in popular press or when ministers are talking about it I just I just feel so like frustrated and annoyed because it feels like this is settled we understand this as economists but we haven't managed to communicate this you know more generally and of course there are all these political economy issues of consumers not being able to collectivize and organize and producers being able to do that and you know so on so forth you know on frustration let me say no frustration here because there are so few of us who are making that case and yet it's not so bad we didn't actually score pretty good success it also means our jobs are not going to be obsolete or substituted any time in the near future for sure if protectionism doesn't go away then trade economies will not have to go away that's true but I think one needs to see some successes and I think you know we have scored quite a bit of success actually these reversals do happen will happen and all and sometimes you know you get a big win which cuts through the seen and the unseen problem you know like the big bang liberalization that happened in 1991 you can really see everybody can see the benefits of that kind of opening up so there are these nice wins that sometimes become very seen and can you know help propel other arguments right but not just 91 continued very similar actually very similar mutually reinforcing the insolvency in bankruptcy code the GST third your labor law reforms and fourth your corporate profit tax knocked down to 17% and 205% for the rest these are very mutually reinforcing reforms you know it could be really the benefit could be multiplied yet more if we also work on trade side because and also streamline those reforms right GST can be streamlined that's happening a lot of IBC also needs to be some streamlining and all but that's a constant the whole big thing has happened there will be bumps on the road you have to clean those up I mean GST the bumps for example have been cleaned up which is why you are seeing this massive expansion tax revenues the GST platform was working very poorly earlier but that has been sorted out and people like you know the public finance experts going there he says that you know this GST revenue will go up a lot more I actually think the revenues will go up the more we simplify the GST structure you know this rate proliferation that has taken place for various political economy reasons I think that needs to you know really come back down I recently there is also outstanding issue bringing the petroleum products into the GST but look you know India is a very difficult country and today of course you know we have seen from what they had to finally be back down on the farm law reforms you see they agreed to repeal them so the reforms don't have a linear path they go so I want to move on next to this idea of coordination externalities right this is one more externality argument in favor of protectionism if I understand it correctly this is basically Rosenstein and Rodan's work this is mostly in Eastern Europe but it argues that the government needs to engineer production of many items simultaneously rather than focusing on a single item and here there is a question of externalities that can propel processes not just the goods so this is the rough model of course this is in the context of while Soviet Union and then transition economies some of these models what is this coordination externality argument and does it have any merit for having any kind of trade protectionism? So Shruti you know this is one argument where there is absolutely no validity to it for protection it may be validity conceptually for some kind of intervention but for protection it has zero validity and it's very simple I'll tell you take a very very simple example it's a very simple example that you need to brush your teeth you need brush and you need toothpaste now suppose I can make a toothbrush but it will sell only if you produce toothpaste if you don't produce toothpaste then my brush is no good but of course if you produce toothpaste and I don't produce toothbrush then your production of toothpaste is no good it's not going to get anything so there is a coordination failure problem and if the government steps in and incentivizes each of us to produce it promises that if there are any losses I will recover I will cover all your losses then each of us produces and there are no losses that are happening and the government really actually doesn't have to spend any money on covering either your losses or mine and the problem is solved right but not think about the possibility of interaction trade if toothpaste can be important I can go ahead happily produce toothbrush and toothpaste will be imported and problem is solved so in fact protection will precisely be the wrong thing to do in this case because it is going to hamper it will in fact what can be coordinated internationally will fall out of coordination so that argument was actually originally Rosenstein Rodin made it was entirely in the context of a closed economy and to apply it in an open economy is actually completely the wrong argument so this argument Danny Rodrick again here is the one leading the charge and he makes this argument in the context of South Korea and Taiwan and all that coordination problem is what the Taiwanese South Korean government solved in the 60s and 70s now first of all for that he has to really assume that there are certain activities that require coordination that were non-traded that simply trade was not possible so certainly then it can't be an argument for protection because if you are assuming that the product itself is completely non-traded which is the only context in which coordination failure can happen then it's it's not a trade issue in the first place so the protection it certainly it may be argument for any kind of intervention it cannot be an argument for protection coordination in fact trade actually is what helps you solve the coordination problem I mean you know if you go back I'm old enough to remember the development literature was coming through and we had this literature the same kind of issue but in terms of balanced and unbalanced growth and balanced growth guy saying that so they was always worried about the demand side of it and all very much the Rosenstein and Rohnan style that look you know if you do certain activities all together then there is demand therefore for each other if you do a big shoe factory then you will pay these workers higher wages than what you are paying them in agriculture but what are these what are these workers going to spend these higher wages on because they can buy only a small fraction of the shoes that they are producing but on the other hand if you could make a massive investment and invest simultaneously in shoes, clothing other consumer products then they will have demand for each other's products and therefore you will clear the market that was Rosenstein and Rohnan's original argument but obviously it's assuming the existence of very large scale economies so that each of these activities has to be done on a certain scale because if they run on scale economies then there is no reason any entrepreneur could come in and produce because production costs are constant so you can produce all these different products in one one entrepreneur could do it and have a diversified basket of production and so it will automatically market will solve the problem. Today in any case with very large investors the big business houses even in the Indian context like the Ambani's and the Tata etc. very big business houses so they can actually solve the coordination problem right I mean in their context for example you want to produce an automobile now you need auto parts and you need all sorts of othercillary products which contribute to the manufacturing of the automobile. Of course if trade is possible then in any case you can import these but even if trade is not possible you know they get a piece of land which is 100 acres and then they put up everything that they need in one place so they manage to today large investors can solve but you know I have a more fundamental question here Adam Smith very early on in the wealth of nations right he tells us that the division of labour and the degree of specialization is going to be limited by the size of the market right so when he starts talking about the division of labour in the pin factory he's very clear that people are going to dedicate themselves to pulling out the wire in a pin factory 12 hours a day, day after day and engage in that kind of division of labour and specialization only if they are able to purchase everything else that they need right so if they can't you're not going to get that kind of division of labour so in this Smithian open economy free trade model you will get a lot of diversification if the trade is very limited right that is each person needs to produce multiple things and coordinate if the trade is relatively frictionless open and the size of the market is large then you can get very high degrees of specialization so to me it seems like it's endogenous to the model right there isn't an exogenous quantity of optimal specialization in any economy and therefore coordination right the assumption is I'm going to spend all my time making toothpaste only if I'm confident that we can purchase toothbrushes right otherwise the toothpaste won't be forthcoming in the first place what am I missing in this kind of Adam Smith you know free trade which endogenizes the degree of division of labour and specialization vis-a-vis these models that you just talked about where we're talking about coordination failures which need to be engineered I just don't understand why so maybe I'm missing some step or some assumption yeah I think you know basic point comes across in what you're saying right that you know if I'm an open economy then in fact I don't need to coordinate and I in fact want to specialize I don't want to you know and particularly if I'm not only open but I'm also a little bit small right and every developing country no matter population wise how large whether it was India or China in the 1950s it's a very small economy I mean if you look at till 1980 or so or the GDP in India was smaller than the GDP in South Korea and we used to sort of you know smugly talk about South Korea as being a quite small relative to us but the fact of the matter is the GDP of South Korea exceeded our GDP today things have changed you know after we opened up and also started growing so really if you're a relatively small economy which as I said all developing countries are when they start off then you don't want to undertake too many activities precisely for the reasons that Adam Smith very clearly laid out that you know you want to take advantage of the specialization process and you know import what inputs you don't produce and that is what really even allows you to begin to industrialize right if you're starting with assembly then you can import components and still assemble and get going so absolutely you know so this coordination argument is very strictly look I mean you know it's not a coincidence that Rosenstein Ronan was the one who kind of first wrote it out because he was a Polish economy. These are closed economies these are centrally planned economies where now instead of the market process you need an engineered process to do everything that the market would have naturally done endogenizing the solution to most of the problems that they've highlighted so this is actually as far as protectionism is concerned this is the weakest argument in fact it's not even an argument really you know well I'm happy we still went over it even though it doesn't have much merit in the literature because my problem with protectionism is these arguments never seem to go away you know every decade they come back in some random you know completely made up context in some industry gathering or some op-ed article and then everyone is gaga and say yes we are normally all for free trade but for the purpose of diversification or for the purpose of coordination you know now we need some kind of intervention actually this is a good point to set up our next conversation which we will start talking about India finally you know I think you've been very patient with us in explaining and laying the ground for arguments in favor of free trade and sort of walking us through the merits mostly demerits of arguments in favor of protectionism so starting in the next episode it will be great if we can now focus on Indian political economy and the history of Indian protectionism you know starting in colonial times and then continuing through Indian socialism and then of course the liberalization so hopefully we can continue this conversation in that direction and also touch upon the more recent reforms that you just mentioned we shall do that yes thank you so much as always have a nice day take care and I will see you in the next video bye