Egregious Indian Protectionism Against Trade in Services

by Ajay Shah

For many decades, India was one of the most protectionist countries in the world. This did great damage to growth and knowledge in India. Tariffs dropped from ridiculous levels to ridiculous levels in the early 1990s and then got stuck there. Yashwant Sinha, as Finance Minister, initiated a remarkable program of cutting the peak rate by five percentage points every year. This worked very well: It steadily got rates down and also gave a roadmap to the domestic industry about what would happen next.

In January 2004, Jaswant Singh as Finance Minister announced further cuts to customs duties even though it was not part of the budget. This was criticised in the press as being a ‘populist’ move. I thought it was a big day in India’s history: when a Finance Minister feels that trade liberalisation is so important that it cannot wait for February 2005 (since Feb 2004 was to be a vote on account), and when he gets criticised on the grounds that this is populist.

While there is more ground to cover on removing barriers to trade in goods (e.g. barriers to trade in agricultural products), by and large, India is doing well on this. The old instinctive protectionism has subsided. Two big areas for work remain. First, all customs duty rates are not yet at zero. And, we have one big gap: the lack of a proper GST, through which we would get to residence-based taxation. The GST on imports would be charged on imports, giving parity between a factory just inside the border and one just outside. And, the zero-rating of exports would mean that the GST burden suffered by a non-resident is refunded to him. The fundamental law of tax policy in this age of globalisation is: You do not tax non-residents.

Does this mean that we’re in good shape on trade liberalisation? No. The big gaping problem is trade in services. Most of world GDP and India’s GDP today is services. Even if we do full free trade on agricultural and non-agricultural goods, that only covers 40% of GDP. The real story of international trade is now in trade in services.

With trade in services, old-style Indian protectionism reigns. For the first time now, we have some hard data on this. The World Bank has released a ‘Services Trade Restrictions Database’ which measures protectionism in services across the world. To get the story about what was done, read the voxEU column by Aaditya Mattoo, Ingo Borchert and Batshur Gootliz. Here’s the key picture:

The graph puts per capita GDP (in log scale) on the x axis and the measure of barriers to services trade on the y axis. Values of “0” imply perfectly open and values of “100” imply perfectly closed. The regression line shows us that by and large, when countries get richer, they reduce restrictions. The score goes down from roughly 40 (on average) for the poorest countries to roughly 20 (on average) for the richest ones.

India sticks out as an outlier, with a score of above 65.7. We are more restrictive than Iran. Only Ethiopia is more restrictive than India, among all the countries of the whole world. Here is some more detail about what is going wrong:

This shows us the variation of India’s restrictions by sub-sectors and by modes. While there is some variation, it is all appallingly bad. If we only got to the conditional mean for the Indian level of per capita GDP, we’d have to get the score from 67.5 to roughly 37.5, which is a big decline. And there is no reason to stop there; we need to eliminate protectionism far beyond what’s seen in the conditional mean.

To be open to trade in today’s world is to be open to trade in services, given the preponderant share of services in GDP. What we are doing is profoundly wrong. We always had an instinctive sense that India does worse on trade in services when compared with trade in goods. The World Bank has made a great contribution by building a comparable database across countries, to give us a concrete sense of where we are and how bad things are.

If we want to harness gains from trade in goods, we have to open up to trade in services also. Finance, transportation, and other services are the vital glue that makes trade in goods possible. Our mistakes on services trade liberalisation are holding back our gains from trade in goods also.

You may like to also see older blog posts: Globalisation: the glass is half empty, 28 January 2011, and Getting to a liberal trade regime, 15 December 2009.

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