India had an Industrial Policy Resolution in 1948, which is of historical interest now. There were subsequent refinements in 1956, 1973, 1977, 1980, 1990 and 1991—sometimes as resolutions, at other times as statements. Why does the government need a ‘policy’? Many years ago, wags used to say that India’s Y2K software boom occurred because there was no policy; a policy, definitionally interventionist, would have killed the incipient boom.
So what is industrial policy? It depends on the country and the timeline. Traditionally, our industrial policies have focused on reservations for the public sector, reservations for small-scale and cottage industries, licensing for the private sector, import duties to prevent competition, export promotion subsidies, subsidies and incentives to promote balanced regional development, and foreign direct investment limits.
Though the word ‘industry’ is used, the focus is manufacturing. The Latin etymology of manufacture is manu factum, or made by hand. If India possesses relatively more labour and thus a labour cost advantage with many hands, manufacturing (and industry) should automatically be competitive. No interventionist policy should be needed. Nevertheless, the classic industrial policy argument—other than distrust of the private sector, especially large private sector—is based on import-substituting industrialisation and infant industry protection. Every country in the world has travelled down that route, including developed economies. Depends on the timeline. It should be clear that this isn’t a road less travelled.
At some point, LPG (liberalisation, privatisation, globalisation, not liquefied petroleum gas) became fashionable. Pre-1991, India was castigated, not merely because of intervention, but because the costs of intervention were becoming disproportionately high, compared to the benefits. WTO agreements such as TRIMs (trade-related investment measures) and SCM (subsidies and countervailing measures) knocked the bottom out of local content requirements and export subsidies, the building blocks in many historical industrial policies. Plus, there were tariff bindings and reductions, demolishing any infant industry attempt. Once India liberalised post-1991, those traditional industrial policy themes became irrelevant.
What does an industrial policy do? Does it single out specific sectors for incentives? If it singles out sectors, aren’t distortions created in resource allocation? How does one know which sectors to choose? At best, this is based on static comparative advantage, which can often go wrong in a dynamic world.
Aren’t sector-specific tax-breaks against the grain of exemption removal? If there are across-the-board improvements and reforms, such as in infrastructure and labour laws, what role is there for the special economic zones and national investment and manufacturing zones? While these policy issues will be discussed and debated, critics and commentators have lambasted India’s new version of industrial policy—encouraging FDI, but not necessarily reducing tariffs by as much as expected—as being protectionist.
Such critics have a laissez faire view of the world. The complete French expression is ‘laissez faire, laissez aller, laissez passer’—allow to do, to go and to pass. The intellectual support for this LPG comes from Adam Smith, David Ricardo or the Washington Consensus, an expression coined by John Williamson in 1989, depending on your inclinations. There are two problems with this.
First, after the global financial crisis of 2007-08, developed countries seem to be doing exactly what India is accused of, formulating industrial policies on strategic grounds, a broader canvas than narrow ‘invisible hand’ perceptions. What is sauce for the goose ought to be sauce for the gander, too. ‘Strategic’ doesn’t make protectionism more acceptable on narrow welfare grounds. Second, it is not the case that intellectual support for such state intervention has no bench strength. The debate between physiocrats and mercantilists is only one example.
It is worth reading what John Maynard Keynes wrote in the Yale Review in June 1933, in an essay, ‘National self-sufficiency’: “I was brought up, like most Englishmen, to respect free trade not only as an economic doctrine which a rational and instructed person could not doubt, but almost as a part of the moral law. I regarded departures from it as being at the same time an imbecility and an outrage.” This describes many who criticise India, but not the US, for being protectionist. Why did Keynes change his mind? The answers are given in the 1933 essay. Keynes, like many economists, was accused of being inconsistent. There is a quote attributed to him, though there is no evidence he said it: “When the facts change, I change my mind. What do you do, sir?” He wasn’t an imbecile and the facts changed. Or the facts didn’t change, but he became aware of new facts.
But there are other economists, like ones who selectively criticise India for being protectionist. In this column, I don’t intend to get into that. I only wish to point out that there has been a strong intellectual strand supporting interventionist industrial policy too. If Adam Smith and David Ricardo shouldn’t be ignored, nor should this strand. For instance, there was Alexander Hamilton. Irrespective of whether one should call him an economist or not, his ‘Report on the Subject of Manufactures’ was published in 1791, roughly the same time as Adam Smith’s Wealth of Nations. And there was Georg Friedrich List, who can most certainly be described as an economist. His 1841 book, which was translated into English as The National System of Political Economy, is definitely worth a read. For instance, on the distinction between objective functions of an individual, a la Adam Smith, and a nation. Does interventionist industrial policy reduce welfare? The question is, for whom?
For the world as a whole, there are welfare losses. But this is a real world, where Kaldor-Hicks-Scitovsky type of compensations, with winners compensating losers, don’t exist. One can cite prisoners’ dilemma games as much as one wants, but it is by no means obvious that an individual country’s welfare is diminished, regardless of what happens to the globe, especially when strategic and dynamic considerations are brought in. Such jargon is recent and contemporary, but the arguments exist in List’s book.
The moral is that critics and commentators should broaden their reading lists. India’s policies will then be seen to possess a rationale that narrow interpretations of trade theory might miss. I have spoken about intellectual support from the external world. In the next column, I will turn to intellectual support within India.
Bibek Debroy
Chairman, Economic Advisory Council to the Prime Minister
(Views are personal)