Withdraw India’s GSP Preference If It Continues to Impose Localization Barriers to Trade on Foreign Enterprises

Recent months have seen India introduce several disconcerting localization barriers to trade (LTBs) that discriminate against foreign companies. The Indian government already has imposed LTBs in government procurement contracts, and has further proposed far-reaching local content requirements on even private procurements of electronic goods. Most recently, on January 21, 2013, one news report indicated that India was preparing to exclude foreign information and communications technology (ICT) vendors from participating in the country’s $4 billion national optical fiber network project that will bring high-speed Internet connections to rural areas throughout India.

This follows the Indian Ministry of Communications and Information Technology’s February 2012 announcement of a preferential market access mandate for electronic goods (the PMA Mandate), which if implemented would require a large percentage of high-tech goods sold in India to be manufactured there. A specified share of each product’s market—anywhere from 30 to possibly even 100 percent—would have to be filled by India-based manufacturers, with the local content share for each product rising over time. One of the goals of the PMA Mandate would be to have 80 percent of the computers and electronics sold in India be manufactured domestically by 2020. This requirement already is being applied to public procurements, but now, and more troubling, it’s clear India intends to have the mandate spill into private sector procurements as well.

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. Clearly, the PMA is outside the bounds of the globally established norms of international trade.

While the Indian government has indicated the import restrictions inherent to the PMA are intended to address security concerns, the reality is that India is harkening back to its import substitution industrialization (ISI) policies of the 1970s—policies that unsuccessfully attempted to seed the development of an indigenous computer and electronics industry by blocking or deterring foreign imports. Only this time, apparently inspired by China, India wants “ISI with an export kicker,” meaning that India both wants to fill its own demand domestically while also wanting its computers and electronics sector to become a major exporter to help manage its current account deficit.

As in the 1970s, this is a wrong-headed approach that if implemented will ultimately work to damage India’s growing economy, for as ITIF explains in The Benefits of the Information Technology Agreement (ITA) for Developing Countries, ICT products serve as critical inputs in all countries’ manufacturing and services sectors. Any policy that raises the cost of ICT inputs or that forces domestic companies to use less than best-of-breed ICT products only damages all the other sectors of an economy. This is why the economists Kaushik and Singh found that for every $1 of tariffs India imposed on imported ICT products (in its effort to seed development of a domestic ICT industry), the Indian economy suffered a loss of $1.30 due to lower productivity. As they conclude, “High tariffs did not create a competitive domestic [hardware] industry, but [they] limited adoption [of ICT by users in India] by keeping prices high.”

Not only will the PMA Mandate insidiously damage India’s economy (hurting both its consumers and producers), it also hurts multinational corporations and the jobs they support in their home countries while threatening the broader global economy. As a clear violation of the GATT (and hence the WTO), these types of localization barriers to trade threaten to undermine confidence in and adherence to the global rules of trade mutually established by over 150 nations.

The first step U.S. policymakers should take is to articulate the damage the PMA would do to India’s own economy—not to mention the global economy—and to work with Indian authorities to swiftly withdraw the PMA rules. But if this collaborative approach for the mutual benefit of both the Indian and U.S. economies does not engender an alacritous reply, U.S. policymakers may need to act to protect the broader interests of the U.S. economy and consider a more serious response.

A next step should be to withdraw India’s status as a beneficiary nation under the Generalized System of Preferences (GSP). GSP is a development assistance program launched in 1976 that eliminates duties on thousands of products from developing countries, intending to promote economic growth through a “trade, not aid” approach. In 2011, $18.5 billion of imports from the 129 GSP-beneficiary countries entered the United States duty-free, saving the exporting countries $700 million in import duties. India was the top developing country GSP-beneficiary in 2011, with $3.7 billion in imports entering the United States duty free. As a 2011 report, Is the US GSP scheme benefitting India’s trade?, by ICRIER, an Indian economic policy think tank, finds, “GSP concessions [have] helped to accelerate India’s exports into the USA.” In fact, the United States is now India’s number 2 export market, receiving 11.3 percent of India’s exports in 2012 (more than double the 5.8 percent in exports India sent to China). And GSP benefits not just Indian commodity or agricultural exporters, but rather in particular a number of medium-high technology and high-technology Indian exporters (the very kinds of firms India wishes to empower). In fact, the top five categories of Indian imports to the United States under GSP in 2010 were: vehicles and parts, nuclear reactors and machinery, articles of iron or steel, organic chemicals, and plastics.

Title V of the 1974 U.S. Trade Act established the GSP, requiring the President to take into account four factors when designating a country as a beneficiary of the GSP system: (1) an expression of interest by the country concerned; (2) the level of its economic development, including its per capita gross national product; (3) whether other major developed countries had extended the benefit to the country concerned; and (4) the extent to which the country has provided assurance to the United States that it “will provide equitable and reasonable access to the markets and basic commodity resources of such country.” Clearly, India’s PMA rules would place the country afoul of its obligation to “provide equitable and reasonable access to [its] markets” as a condition of being designated a GSP beneficiary. The Trade Act further gives the President the authority to withdraw, suspend, or limit the GSP benefit of a country at any time after its original designation as a beneficiary.

While clearly a measure that impacts only about ten percent of India’s exports to the United States ($3.7 billion out of the $35.9 billion in 2012) is minimal, such an action would signal to India the seriousness with which the United States regards the proposed PMA rules and its concern that if India were to enact such a policy, it would only encourage other countries to do so as well, imperiling the global trading system.

To be sure, the underlying reason why India is considering the PMA—its desire to boost levels of domestic manufacturing and employment—is understandable. With the so-called “demographic dividend” meaning that India will have to create 200 to 250 million new jobs for the citizens coming into its workforce by 2025, manufacturing can certainly play an important role in helping India meet these employment goals. In fact, a McKinsey Quarterly report, Fulfilling the promise of India’s manufacturing sector, finds that India’s manufacturing sector could grow six-fold to $1 trillion by 2025, creating up to 90 million domestic jobs. For India’s manufacturing sector to achieve that level of impact, it will both have to build its domestic manufacturing base and also attract robust levels of foreign direct investment (FDI) from multinational manufacturers. But mandating and forcing companies to manufacture in India in order to be able to sell products there is not the way to go about it. In fact, such an approach will only backfire and make multinational corporations leery of moving forward with FDI projects in India. (Such an approach is one reason why foreign direct investment in India, which reached a record $47 billion in FY 2011, had fallen by 67 percent in the following year [up to September 2012]).

A better path 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” globally mobile corporations all-too-often encounter in China, including intellectual property (IP) theft, forced IP or technology transfer as a condition of market access, standards manipulation, etc.

Rather, India can realize its goals and attract globally mobile investment—and within the time frames it desires—if it focuses on enacting a range of “good” innovation policies that enhance the competitiveness of its economy. In particular, India needs to implement a range of policies to increase the productivity of its manufacturing sector, a problem because workers in India’s manufacturing sector are almost four and five times less productive, on average, than their counterparts in Thailand and China, respectively.[1] (As a whole, India’s economy has just 10 percent the productivity level of the United States.)[2]

As ICRIER’s Rajiv Kumar and Abhijit Sen Gupta write in Towards a Competitive Manufacturing Sector, six key factors are holding back the competitiveness of India’s manufacturing sector, including: 1) the presence of entry barriers (e.g., making it difficult to start a new business); 2) labor market rigidities; 3) procedural constraints; 4) exit barriers; 5) emerging skill constraints; and 6) infrastructure. For instance, it takes 35 days to start a business in India, 62 days to register property, 25 days to complete one procedure to enforce a contract, and 10 years to close a business—all durations well in excess of those seen in developed and developing countries alike, including India’s principal competitors such as China and Korea. Meanwhile, more than $60 billion in committed capital investment awaits environmental or land clearances. And over both the near- and long-term, India must tackle an infrastructure investment deficit of some $350 billion that affects particularly its energy and transportation infrastructure. Addressing these issues is the best way for India to empower its manufacturing sector to realize the kind of contribution India’s government would like it to make to bolster the country’s economic and employment growth.

However, developed nations, including the United States, can take measures to help other developing nations such as Brazil and India resist the tempting lure of adopting China-like mercantilist policies by stepping up action against Beijing. For example, pressing China to stop manipulating its currency for competitive advantage would make it easier for India’s manufacturers to succeed. Without rolling back Chinese innovation mercantilism, the temptations for nations such as India and Brazil to go down the innovation mercantilist path may prove to be irresistible.

Nations and multinational corporations alike are sensitive to India’s desire to boost its manufacturing sector, and are willing to collaborate in helping India achieve this goal (to wit the United States’ GSP program), but policies that distort international trade and that attempt to force (rather than attract) behavior by globally mobile enterprises are not the right path forward and are likely to only end up producing the opposite effect.

[1] Rajat Dhawan, Gautam Swaroop, and Adil Zainulbhai, “Fulfilling the promise of India’s

manufacturing sector,” McKinsey Quarterly, March 2012, http://www.asia.udp.cl/Informes/2012/manufacturing_india.pdf.

[2] The Conference Board, “2012 Productivity Brief—Key Findings,” 2012, 7, http://www.conference-board.org/pdf_free/economics/TED2.pdf.

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About the author

Stephen Ezell is vice president, global innovation policy, at ITIF. He focuses on innovation policy as well as international competitiveness and trade policy issues. He is coauthor of Innovating in a Service-Driven Economy: Insights, Application, and Practice (Palgrave MacMillan, 2015) and Innovation Economics: The Race for Global Advantage (Yale, 2012). Ezell holds a B.S. from the School of Foreign Service at Georgetown University.