Is Boycotting China a decision in true spirit of Free trade, or should Public Sentiment drive consumption?

Is Boycotting China a decision in the true spirit of Free trade, or should Public Sentiment drive consumption?

Renowned Economist Adam Smith quoted that ‘It’s not because of the benevolence of the butcher or the brewer or the baker that we expect our dinner, but with regards to their own self interest.’

This means that the self-interest of each economic agent compels them to specialize in the production of such goods/services that they are good at and to exchange it with others to satisfy their own needs. This is known as “Comparative Advantage Theory”. The factor abundance theory or the “Heckscher Ohlin theory” of economics says that a country shall export that thing in which it uses its abundant factor more. (E.g. India exports IT services). Thus India needs to assess its comparative advantage and accordingly formulate its trade policies. No country can be self sufficient in producing everything it wishes to, and thus each country shall export or produce in excess that thing in which it enjoys a Comparative Advantage and exchange with others based on their own needs, thus allowing free trade in the economy. Restricting imports substantially (through Public policy initiatives) and thus becoming self sufficient would hamper free trade economics.

It is to be noted that at the time of financial crisis in 1991 IMF bailed out the Indian economy on the condition that it would open up the economy. Whilst the times of COVID-19, when India has announced its fiscal cum monetary package without having clearly spelt out the source of funds, a very relatable assumption of securing funds is approaching IMF/World Bank (the other being monetizing govt debt). It cannot be ignored that IMF/world bank entrusted with the function of stabilizing the economy may not impose such a covenant again while granting loan to India.

The concept of Boycotting Chinese Products seems like a non tariff barrier (i.e we don’t impose tariff but we stop using them)

Why did a need arise to be Atma-Nirbhar or Boycott Chinese Products?

Ex NITI Aayog Chairman Mr. Arvid Panagriya said that,

”Post Independence, any economic policy hardly went right. During British rule, the policies were best suited to serve colonial powers but Post British rule, economic policies were

best suited to serve national interest. Since India through its policy development focused on balanced regional development (BRD) from initial stages of 5 year plan, now the resultant we have issues in connectivity for port, harbors etc.

India desiring to be an Export hub cannot set up industries in backward areas of UP, Delhi etc and incur substantial Logistic expenses, when the bottlenecks exist in Port Connectivity. An example can be drawn from China where majority of its Export oriented industries are set up near Port Area.”

In India the growth was low as government started manufacturing all that they could starting from coal, insurance to oil, gas , banks, aviation etc , where Privatization could have ensured longer rate of growth like countries of south-Korea, Japan etc. Obviously privatization cannot be the sole criteria for all. Nationalization is best suited where there is Exclusivity (i.e. one cannot enrich himself with higher purchasing power) and Non Rivalry in consumption (meaning we can consume the service/goods, at the same time we cannot restrict others from consuming the same). In economics this phenomenon of non rivalry in consumption and Exclusivity is called Club goods. E.g Defense Sector

Does Self Centric policy help in reviving the ailing economy?

An emotional response is easy but not productive; neither does it reduce the dependence on China.

While it may be argued that history demonstrates that boycotting products has worked to bring rogue nations and governments in line, the fact is that China is a vital player in the global economy. A jingoistic response to the developments being tackled by diplomacy must not be the Indian approach.

(Source: July 9 publication economic times) 

Noted Economist Meghnad Desai who is also a Labor politician at House of Lords, UK says that, ”Self reliance cost the country slow growth and persistent poverty. Self sufficiency means import substitution, discouragement of modern technology and promotion of small enterprise over large ones.

If India was one of the richest countries up until 17^th century, it was so because it was a trading nation with an extensive global trade and finance network. Until the steam power revolution totally changed productivity of labor on machines compared to handicraft, India was at the forefront of technology as well. But in mistaking the capitalist industry with Imperialism, the Indian elite subjected its masses to poverty.”

Recently the Chief Economic Advisor of India Mr K.V. Subramanian said that the country had followed Import Substitution Model since 1991 and that approach has been discredited since then. He also said that India has to compete with other countries and insulating itself from others will not help.

Industry impact if boycotting Chinese products is followed nationwide:

• Impact on MSME sector

The MSME body has reported that curbing imports from China would shoot up the cost of production by 40% which in turn would impact the Export oriented MSMEs in their final product. If one would argue to provide incentives to the MSMEs catering to the export sector, there would be further rise in fiscal deficit which eventually would be unsustainable (impact on fiscal deficit vis a vis growth discussed in detail further)

• Rubber industry

The United Planters Association of Southern India asked for immediately stopping the imports of NR natural rubber for manufacturing of tyre. The Automotive Tyre manufacturing industry replied that current import are “woefully deficient” as it’s just serving 60% of the demand. If moratorium was to put on imports, the Tyre industry would puncture and become uncompetitive. There is a huge gap in domestic production to consumption ratio (around 4. Lakh tonne), which certainly gives necessity to import rather than waiting for domestic players to commence production. This would led to Demand Pull inflation. 

• Cell phone & Telecom Industry:

The cell phone market is around 2 lakh crore where about 70% share is dominated by Chinese products. Any higher duties would impact the market in terms of price as the duty impact would be passed from vendors to manufacturers and down to consumers.

In the TV market, share of China in smart TVs is around 45%. Increasing duties to cut down on imports would allow other players to capture the market as Non-Chinese Smart TVs are way costlier than those from China by around 30-50% said Director General of Automotive Component Manufacturers Association of India.

The recent example of concerns rising over awarding of BSNL 4G tenders to foreign players like Huawei, LTE, Nokia etc signifies public sentiment takes precedence over effective functioning of economy. The domestic players are asking to grant them preferential market access (PMA) in participating for tender bids (a criteria mostly present in the government tenders). A  Financial Express report quoted that the Telecom market size being 12,000 crore is dominated 25% by Chinese Vendors. If Chinese players were to be banned it would result in increase in cost by around 20%. Further the telecom Industry would lose out on attractive Vendor Financing provided by the Chinese players.

Is it prudent to sacrifice quality and cost advantage (which will ultimately benefit the end consumers) just for favoring nationalistic ideologies?

• Impact of custom duties not in favor of SEZ players:

The DGFT while it ceased the safeguard duty by imposing custom duty of 20% in place of that on imported solar cells and modules, the SEZ players are affected the most. Law says any goods sold or services sold/provided by SEZs would be treated as Exports. Thus any Exports from SEZs (which are deemed to be outside India) into the Indian Territory would be treated as Imports into India by the Domestic players, thereby attracting custom duty for the buyer (i.e Domestic players).Thus the Domestic players purchasing from SEZ will have to incur additional cost in the form of custom duty which would not be a level playing field for the SEZ players as compared to their counterparts in Domestic Tariff Area (DTA). The resultant would wipe out the SEZ players. This is like Atma-Nirbhar India backfiring bullets towards self.

Is the Business Environment conducive for attracting Industries looking to shift their production bases from China? :

Dr Subramanian Swami a noted economist and a China Expert pointed out that

“Countries are not like kirana shops offering the same products at marginally different prices which may encourage buyers to shift from one place to another. These decisions are not impulsive and not event driven and are far more complex”.

The Survey by American Chamber of Commerce in March found that more than 70% of companies said they had no plans to relocate production and supply chain operations or sourcing outside China due to Covid-19.

As said by Dr Raghuram Rajan that when we talk about bringing industries from China and ensure them of red carpet, we need to build institutions to ensure how this could be done.

For in the past as well as in the present we have seen harassment of the foreign investors be it Vodafone Dutch Tax case, or Cairn-Vedanta Oil exploration arbitration issue w.r.t profit petroleum, new equalization levy of 2020, another arbitration issue involving Indian airline industry, the NAFED etc.

When it comes to attracting foreign players in India, there are likes of Thailand, Vietnam and Indonesia.

 As per the World Bank’s Report, out of 56 industries seeking to exit China, only 3 of them have set up their manufacturing hub in India.

When asked Japan of their move behind seeking exit of their industries set up in China, it replied that the Chinese Market has brought about significant efficiency in terms of logistic, supply chain, manpower, technical knowhow etc. A lot of industries are driven by Chinese Consumption and thus it would be futile to shift industries out of China and again supply the output to Chinese market incurring unnecessary fixed as well as variable cost. Thus this economics of demand driven production should be kept in mind by the legislatives while making tall claims.

• Dispute Redressal Mechanism & Turnaround time for obtaining clearance:

The Director General of Trade Remedies which is the investigation arm of the Commerce ministry dealing with anti dumping duty, safeguard duty and countervailing duty said in its report that Average time taken to probe trade disputes is 234 days. Even if the figure has been improved from 400 days in the preceding fiscal, a lot of improvement has to be done by ensuring speedy redressal of claims and disputes i order to attract Foreign Investments.

Further the Average time taken to obtain clearances:

• Environment Clearance : 270 days
• Forest Clearance : 530 days
• Land Acquisition : Years

(Recently the Embedded clearance mechanism has been started on a pilot basis for Greenfield projects particularly; still the question of implementing it successfully across the sector remains a question).

• Uncertain Tax laws
• The Mauritius Tax Treaty

No sooner the clarity immerges for tax treatments on gains made in Mauritius for Asset located in India, than the tax authorities’ crop up a new issue often arbitrary and involving non application of mind. Sometimes it’s the Advance Ruling Authority (AAR), sometimes it’s the PIL, sometimes the tax authorities or an odd court judgement, Investors are still clueless as to whether the gains made by Mauritius entities from sale of assets situated in India are tax treaty protected or not. Thus the lack of intent to clear spell out the objectives is not doing any good to promote investments into India.

• The Equalization levy 2016 and the new Digital Services tax introduced by Finance Act 2020

The levy introduced in 2016 was particularly focused on taxing Advertisement Revenues earned by a Non resident on the services provided to Indian resident or Non-resident having PE in India. The burden of this levy at most of the times was borne by the Indian Residents. While the 2016 levy didn’t affect most of the Non Resident Digital Service Tax Providers (NRDSP), the 2020 levy has surely raised eyebrows of the International Fraternity as it mandatory raises the burden of tax on NRDSP. It obliges the NRDSPs owing or operating an ecommerce platform to pay tax on consideration earned by them for the supply of their own goods and services including the consideration earned for facilitating supply made by third parties on their platform. Tax experts have raised concerns on the taxability as it is in the nature of transaction tax (which should have been charged under the Indirect tax laws and ideally it is) and not taxes on income to form part of income tax act. While it is Clear that the provisions of DTAA or Income Tax Act whichever is more beneficial to the assessee would apply, the Ministry has very intelligently placed the 2020 levy outside the income tax act, by making it form part of Finance Act ( in the same manner in which Service Tax was placed as Chapter V of Finance Act 1994)

• Bureaucratic hurdles:

If one advocates Self sufficiency by backing MSMEs, one must also analyze as to whether the tax laws are in sync with the MSME exporters. While the Finance Budget announced reduction in tax rate to 15% for Corporate by way of ordinance it did little to please the MSMEs.

Indian Customs Department took 7 long years to provision the automated express courier terminals. And having started them howsoever belatedly, one would expect it would be a centre par excellence, but disappointingly, the pilot project served the interest of MNC E-commerce companies like the China’s Club factory but not our MSME exporters. (Source: Financial express: Make MSMEs competitive: by Ajay Agnihotri)

How can Consumers make an informed decision?

From consumers point of view it would be very difficult to gauge the proportion of Chinese inputs into a product and make a decision (recent case of DABUR products being not permitted in army canteen as it had some proportion of raw material from China). Even if that becomes possible, then a decision as to whether the entity which is a major component supplier is backed by Chinese investments, if not then whether China is a beneficial owner in such entity (blanket criteria for “Beneficial Ownership” under discussion currently), or if such investments have linkage to sovereign fund or Communist party of China. Consumers will be surely lost in this maze. Hence I think we should believe in free market economy with the weighing scale more inclined towards domestic products (obviously to the extent if we have alternatives, we shall avoid consuming Chinese products as they didn’t follow the rules of the game at the Galwan Valley ground) until we establish substantial part of supply chain which hopefully will be the case in long run. Keynesian economists would however quote, “In the long run we all are dead”

Wherever alternatives are available, one must give preference to the Domestic Manufactured products.

What China can do to reciprocate on India’s stance to boycott Chinese materials other than invoking a cowardice fight against the rules of the game?

Years ago China purposely devalued its YUAN in order to make its Export cheaper and dump its products in highly importing markets, thus damaging the domestic industries of that country. This concept is known as “Beggar thy neighbor policy”. If china devalues its currency again, and dumps the Indian market, we would have no other option but to resort to cheaper inputs as the purchasing power of Indian masses has been tremendously affected due to unprecedented crisis of COVID-19. 

Would incurring higher fiscal deficit to provide stimulus to Domestic players for competing with Chinese Counterparts be the way forward?

A holistic assessment of the fiscal space is the evolving Debt/GDP ratio of the government over the years.

As per calculation by JP Morgan,

If this year’s fiscal deficit widens by 3% more and a nominal GDP growth rate of 8% (i.e real GDP growth rate of 5%), the Debt/GDP ratio reaches 90% in the next decade. While a further widening of deficit by 6% with 10% nominal GDP growth rate of 10%, flattens the Debt/GDP ratio to 80% in the next decade.

This proves that even relatively conservative fiscal response this year becomes unsustainable while a bigger fiscal intervention is sustainable only if medium term growth prospects are lifted in tandem.

Thus the subsequent trajectory depends on medium term growth, that includes measures like revival of MSMEs, stabilizing and controlling the unemployment rate, access to working capital etc.