The Indian Economy at a Crossroads

Lotus Temple in Delhi

On Wednesday, March 13, the House Ways and Means Trade Subcommittee held a hearing on the turbulent state of U.S.-India trade relations. The Subcommittee’s hearing reflects growing attention and concern related to India’s recent embrace of a wide slate of “innovation mercantilist” policies that seek to bolster Indian economic and employment growth by distorting global trade rules and forcing investment and production to occur in India. India has erected these policies in a diverse range of sectors from information and communications technology (ICT) to life sciences, clean energy, and retail.

For instance, in February 2012, the Indian Ministry of Communications and Information Technology announced a Preferential Market Access mandate for electronic goods (the PMA Mandate) which imposes local content requirements on procurement of electronic products by government and private sector entities with “security implications for the country.” A specified share of each product’s market—anywhere from 30 to possibly even up to 100 percent—would have to be filled by India-based manufacturers, with the local content share for each product rising over time. The policy’s coverage is so broad it could easily capture half of India’s ICT market. In fact, on March 12, 2013, India’s Department of Telecommunications sought the Defense Ministry’s approval to classify select telecom products as “security sensitive” in the run-up to mandating 100 percent domestic sourcing for private sector gear procurements.

When applied to the private sector, India’s PMA violates Article III of the GATT (the General Agreement on Tariffs and Trade, whose provisions are incorporated into World Trade Organization (WTO) rules), which prohibits a member nation from discriminating against foreign competitors by forcing them into “buy local” contracts with domestic suppliers for purposes of private sector procurements. It’s also poised to violate the WTO’s Agreement on Subsidies and Countervailing Measures (ASCM), which prohibits WTO members from granting incentives based on the use of local content. India’s PMA is significantly and dangerously outside the bounds of the globally established norms of international trade and if implemented will engender serious harm both to India’s economy—and to the entire globally trading system.

Two objectives of the PMA Mandate are for India to have 80 percent of the computers and electronics sold in India by 2020 be manufactured domestically and to increase India’s ICT exports thirteen-fold from $5.5 billion today to $80 billion by 2020. In pursuit of these goals, India has also excluded foreign ICT vendors from participating in the country’s $4 billion national fiber optic network project, introduced a compulsory registration scheme requiring onerous and duplicative in-country certification testing on a range of computer and electronics equipment, and instituted new rules requiring that foreign corporations enter into joint ventures to sell computers online. India has also declined to participate in negotiations to expand the Information Technology Agreement (ITA), which eliminates tariffs on trade in ICT products.

In life sciences, the India Patents Controller has issued at least four compulsory licenses (essentially a government-mandated licensing of a patent) for innovative cancer therapies that were researched and developed in the United States, including Genentech’s breast cancer drug Herceptin, Bayer’s Nexavar, and Bristol-Myers Squibb’s Ixempra and Sprycel leukemia therapeutics. The compulsory licenses were granted on the specious grounds that: 1) the drug prices were too high; 2) the domestic market wasn’t supplied adequately; 3) and the drug wasn’t being adequately “worked” (e.g., manufactured) in India. In at least three more cases, India revoked patents for an alleged failure to demonstrate an inventive step. And India denied Novartis’s patent application for the cancer drug Glivec on the grounds that it did not satisfy a “special” rule for “new forms” of known substances—despite the fact that 75 countries have already issued a patent for the drug.

In clean energy, India has introduced local content requirements for wind turbines and solar photovoltaic cells. Specifically, as part of its Jawaharlal Nehru National Solar Mission, India introduced local content requirements that solar project developers source at least 50 percent of their crystalline solar modules and cells from domestic manufacturers in order to receive significant government subsidies. In response, the United States requested a WTO dispute settlement in February 2013 over India’s solar program.

India’s tariff walls, market access restrictions, local content requirements, licensing of foreign intellectual property to domestic companies, and other trade-distorting practices are part of a concerted industrial policy intended to boost domestic manufacturing in India, in part because the Indian government feels it must create millions of manufacturing jobs to accommodate the more than 250 million citizens entering India’s workforce by 2025. But modernized import substitution industrialization policies that add an export-led growth component simply won’t work.
First, there’s simply no correlation between a medium- or large-sized nation’s balance of trade and its unemployment rate. Second, India’s mercantilist policies miss that India could most readily increase economic growth by raising productivity across-the-board, especially with the productivity level of India’s economy just 8 percent that of the United States. Third, they miss that trade barriers which raise prices (or compel the use of inferior) general purpose technologies like ICTs only hurt consumers and inhibit the diffusion of ICTs among domestic-serving sectors such as financial services, retail, and transportation, causing productivity growth in these sectors to languish. These higher prices also raise the prices of imports for inputs used by Indian manufacturers. This explains why economists have found that for every $1 of tariffs India imposes on imported ICT products, it suffers an economic loss of $1.30. Fourth, they ignore that the best way to ensure that countries participate in global supply chains, such as for ICTs, is by acceding to global multilateral agreements that remove barriers to their trade. That’s why the OECD has found that countries not participating in the ITA saw their participation in global ICT value chains decline by over 60 percent from 1995 (when the ITA was chartered) to 2009, leaving a clear message: countries that don’t participate in open cross-border flows of digital information and ICT products only end up excising themselves from global production networks. Finally, India neglects to recognize that as it erects more barriers to global trade, other countries will respond with their own trade barriers in kind, meaning that India’s own trade-distorting policies will surreptitiously undermine its ambitious export goals.

Rather, the best path forward for India is to offer globally mobile investment and enterprise all of the attractors of China—a large, fast-growing consumer marketplace, a cheaper labor pool, but one that yet features hundreds of thousands of skilled engineers, etc.—with none of the “innovation mercantilist policies” multinational corporations all-too-often encounter in China. India shouldn’t be playing the same game as China, rather it should be offering an alternative and superior model. India should be adopting an attraction, not a compulsion, strategy.

Ultimately, India’s innovation mercantilist policies if not significantly modulated threaten to inflect great harm not only on its own but also the global economy. U.S. government and industry have been engaged in intense dialogue with Indian officials for well over a year toward modifying the PMA, compulsory licensing, and related policies without seeing significant improvement. It’s time to add some sticks to the carrots. Congress should immediately direct the U.S. International Trade Commission (ITC) to initiate an investigation of how India’s mercantilist policies damage the U.S. economy, as it did with the ITC’s 2011 report examining the Effects of China’s Intellectual Property Infringement and Indigenous Innovation Policies on the U.S. Economy. Congress should also begin the process of withdrawing India’s participation from the Generalized Systems of Preferences (GSP), which provides reduced tariffs for Indian goods entering U.S. markets. Finally, the U.S. Trade Representative’s Office (USTR) should start preparing to bring a WTO dispute against India regarding the PMA Mandate’s local content requirements, as it did with solar panels.

To be clear, a strong, growing, and collaborative trade relationship between the United States and India is in both parties’ best interests. But India’s recent trade policies are placing that relationship in jeopardy. The United States should not sit idly by as the Indian government enacts regulations that harm American industry and jobs. Strong leadership will be needed from both sides to ensure a continued constructive and robust trade relationship persists between the two countries.

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About the author

Stephen Ezell is a Senior Analyst with the Information Technology and Innovation Foundation (ITIF), with a focus on innovation policy, international information technology competitiveness, trade, and manufacturing and services issues. He is the co-author with Dr. Atkinson of "Innovation Economics: The Race for Global Advantage" (Yale, 2012). Mr. Ezell comes to ITIF from Peer Insight, an innovation research and consulting firm he co-founded in 2003 to study the practice of innovation in service industries. At Peer Insight, Mr. Ezell co-founded the Global Service Innovation Consortium, published multiple research papers on service innovation, and researched national service innovation policies being implemented by governments worldwide.