Short essay on the Politics of protection in India

The ISI strategy adopted since the Second Five Year Plan was intended to protect the home market with high customs duties for finished products. An overvalued exchange rate made imports cheap but exports expensive.

For example, let us assume that the market driven exchange rate is Rs. 50 = $ 1, but India artificially kept the Rupee overvalued at Rs. 10 = $ 1. Then a machine costing $ 100 would be worth Rs. 50001-in the first case, but only Rs. 10001- in the second case. Case 2 with an overvalued Rupee with respect to the dollar would yield a cheaper machine than Case 1, where the Rupee was valued at the market determined rate.

Imports of capital goods such as heavy machinery used in factories were necessary for import substitution, since India could not produce these goods. These imports benefited from the overvalued exchange rate. Import licensing was used to check the rush of cheap imports, except where imports were absolutely necessary for import substitution.

Private industry was controlled through industrial licensing. In certain sectors, only those industrialists who had licenses could produce goods. For example, if an industrial house had a license for making cars, only it could manufacture the car. Others had to secure a separate license to manufacture a car.

Moreover, multinational corporations headquartered in foreign countries were discouraged from setting operations in India. This system led to a situation that promoted bribes and corruption, which is also called rent seeking. With government regulations in opposition to market forces, firms incurred substantial costs to gain government favours. For example, if an industrialist wanted to import a machine, a license is needed. If the industrialist needed to manufacture something, once again a license has to be secured.

All these licenses could easily be obtained by doing favours for political parties, politicians or government servants. The same expenditure could have been used to make the finished product better or cheaper. The Indian economy was frittering away substantial sums in the form of rents when such expenditure on productive investment could have made Indian goods competitive in the world market.

Allocating resources to determine the size of the license involved making trips to New Delhi, locating an office there, and bribing officials. According to one study, the total value of rents generated in India from public investment, imports, controlled commodities, credit rationing and the railways in 1964 was estimated to be nearly Rs. 15,000 million. Private sector firms benefited from government involvement through regulations. The public sector would produce cheap inputs for the Indian private sector, which were subsidised by the government.

If the public sector did not produce these inputs, they could be cheaply imported with the help of import licenses in the context of an overvalued Rupee. Private sector firms were funded largely by the government’s financial situations such as the Industrial Finance Corporation of India. Sometimes influential industrial houses produced more than their licensed capacity, something that the regulators would simply over look.

This is involved rents from industrialists to politicians and government officials. Democracy and elections in India made politicians dependent on funds from domestic and foreign corporations. This produced a need-based relationship between the politician, the bureaucrat, and the industrialist. Government support for election funds is very limited.

Even though political parties started filing tax returns since 1996, the amounts reported were conspicuously low. Since the 1980s, public sector and defence equipment deals have become a major source of election finance.

In recent times portfolios such as defence and areas of privatisation such as telecommunications have becoming important sources for generating a party’s resources. Corruptions promoting import-substituting industrialisation (1%) negatively affected Indian productivity and competitiveness.

The government subsidised bankrupt industrial units, which would never make profits. According to one study, 17 out of 23 bankrupt industrial units were kept artificially alive through subsidised credit sanction by the Board of Industrial and Financial Reconstruction.

All this contributed to a decline in India’s productivity. Indian goods were expensive and of low quality by world standards. India’s share of the manufacturing exports of all developing countries came down from 22.1 % in 1962 to 3.4 % in 1990. Its share in the manufacturing exports of the world was 0.54 % in 1991 compared with 0.84 per cent in 1962.

In 1980, low rates of economic growth, the loss of an election, and Chinese success with trade convinced Prime Minister Indira Gandhi of the need to promote exports. Various committees of the Government of India had also pointed the need for increased exports for financing India’s development.

But business interests still pursued ISI. The Federation of Indian Chambers of Commerce and Industry (FICCI), the leading industry organisation, sought reduction in the duty on intermediate goods such as newsprint, cement, and caustic soda, but was not prepared to take on 100% export oriented units (EOUs) in the newly established free trade zones.

It was tough to convert industry from manufacturers of low quality products for home consumption, to manufacturers of internationally acknowledged brands. Prime Minister Rajiv Gandhi sought to fight government controls after coming to power in 1984. His reform efforts met with marginal success because of strong political opposition.

However, a substantial section of bureaucracy and politicians became convinced of the need for policy change. Rajiv Gandhi had brought in Montek Singh Ahluwalia from the World Bank into the Prime Minister’s Office (PMO).

In June 1990, Ahluwalia circulated a paper arguing in favour of customs duty reduction, free entry of foreign. Investment and, a variety of measures that would increase the competitiveness of Indian exports and improve the conditions for Indian consumers.