US-China trade dispute: geopolitics alone may not help Indian manufacturers

Against the backdrop of restarting sustainable growth after the pandemic, it is often heard that India’s participation in the Quad can give it the opportunity to be part of the “secure supply chains” the United States wants. As US Secretary of Commerce Gina Raimondo recently said, “we are talking about relocation, but we are also talking about relocating friends.” The trade dispute between the United States and China, since the tenure of Donald Trump and continuing under Joe Biden, has often led experts to say that geopolitics favors India.

It is not unreasonable to believe that due to the escalation of the US-China conflict, having China on the same global supply chains or production networks as the United States is now much more costly for businesses. American manufacturers, thus opening up new opportunities for Indian manufacturers.

However, India’s domestic policies and institutions make it difficult for it to take advantage of these favorable circumstances.

India’s labor regulations restrict the dismissal and reassignment of workers’ duties and, in turn, reduce incentives for hiring, making it very difficult for companies to respond flexibly to technology and labor shocks. request. Entry of new businesses and expansion of existing businesses are limited by Indian land acquisition laws, as well as restrictive building height constraints through a low maximum floor area index. Thus, reforms are needed in these laws, despite some recent improvements in labor law. In addition, the huge problem of poor infrastructure, in the form of low density and quality of roads and lack of availability of electricity, makes matters worse.

Large Shenzhen-style Autonomous Economic Zones (ZAEs), not just relatively small Special Economic Zones (SEZs), are needed. In these EAZs, imported inputs should be able to enter duty-free and production can take place with relatively relaxed factor market restrictions. The resulting agglomeration of economic activity will lead to higher productivity.

In recent years, India has raised a number of import tariff rates, partially reversing trade reforms of the previous 25 years. Even before the recent tariff increases, India had high tariffs on automobiles (60-125% even after the 1991 reforms), rendering the sector inefficient due to lack of competition and high component costs.

Likewise, the high tariffs (20-25%) on artificial fibers and yarns make the production of clothing using these inputs quite expensive. 25.4% of industrial product tariff lines had rates above 15% in 2020-21, compared to 11.9% in 2010-11, the simple average of industrial tariffs falling from 8.9% to 11.1% in during the same period.

In 2018, India doubled its import tariffs not only on electronic and communications devices, but also on cosmetics, watches, toys, furniture, shoes, kites and candles. – a clear recognition of a lack of competitiveness in these labor-intensive entry-level products. some products. Without addressing these issues, favorable geopolitics will be of no use.

While it is still a question of attracting foreign direct investment (FDI), India’s protectionist measures do the opposite. Government and public sector company procurement policies include a preference for products with 50% or more domestic content, giving them a 20% price advantage in procurement decisions. While FDI ceilings have been raised in several sectors, rules strongly favoring management and majority control over being Indian do not help attract FDI.

In addition, the equalization tax on foreign electronic and digital commerce firms adds to the bias against FDI. In addition, the scope of this levy was retroactively widened, thus preserving India’s bad reputation for retroactive taxation, making it difficult to attract FDI on the basis of current incentives.

India’s new Model Bilateral Investment Treaty (BIT), introduced in 2015, does not fulfill the standard function of the BIT of protecting the interests of investors. Its protection of investors’ rights is conditioned on the length of its existence and on a vague notion of contribution to development.

Investor-state dispute resolution methods are only permitted after India’s legal and other domestic remedies have been exhausted, which can take forever. The new BIT model ended 73 existing models. In addition, recent rules requiring localization of data storage for US payment system providers, later applied to foreign banks retroactively with penalties, will seriously discourage FDI in India.

While the incentives for U.S. companies to keep investing in China are currently weaker, it is uncertain whether they are small enough to take them out of China, especially in areas of manufacturing requiring skills accumulated in China. years of experience. In addition, for low-skilled activities, Vietnam, Thailand, the Philippines, Malaysia and Indonesia offer a more favorable environment for FDI than India.

So just a Quad membership doesn’t help. Real economic incentives are important. Businesses in democratic countries are not told by their governments where to invest. They respond to incentives. Disincentives like those in India push them back.

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