PM Modi, Nehruvian Economic Policies Aren't Going to Get Us Anywhere - Vivek Kaul's Diary
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PM Modi, Nehruvian Economic Policies Aren't Going to Get Us Anywhere

Feb 19, 2018

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This is something that we should have written on a while back, but as they say it is better late than never.

In the annual budget of the government of India, presented earlier this month, the finance minister Arun Jaitley raised custom duties on a whole host of products. In his speech, Jaitley made it clear that this wasn't a one-off thing, but a change in policy direction.

As he said: "In this budget, I am making a calibrated departure from the underlying policy in the last two decades, wherein the trend largely was to reduce the customs duty. There is substantial potential for domestic value addition in certain sectors, like food processing, electronics, auto components, footwear and furniture. To further incentivise the domestic value addition and Make in India in some such sectors, I propose to increase customs duty on certain items. I propose to increase customs duty on mobile phones from 15% to 20%, on some of their parts and accessories to 15% and on certain parts of TVs to 15%. This measure will promote creation of more jobs in the country."

The customs duty has been raised on around 45 products. The maximum increase was in case of cranberry juice from 10% to 50%. (All you cranberry juice drinkers out there, maybe it is time to start appreciating the taste of chilled filtered water with a dash of lemon in it). The idea as Jaitley explained is to create jobs within the country. With increased custom duties, imported goods will become expensive. This will make domestic goods competitive. As people buy more and more of domestic goods, the companies producing goods in India will do well. Once they do well, they will expand and create jobs in the process.

Alternatively, because imports will become uncompetitive, the domestic companies can continue operating, and jobs can thus be saved. QED.

The problem with this argument is that it stinks of Nehruvian era economic policies, in particular import substitution, which was the norm in independent India, up until the economic reforms of 1991. Import substitution as a policy was introduced by Jawahar Lal Nehru and carried forward by Indira Gandhi, two individuals, the Bhartiya Janata Party keeps blaming for everything that is wrong in this country (even though we are four years into the term). At its simplest level, import substitution is basically an economic policy which promotes domestic production at the cost of imports. And it is an economic policy, which doesn't work.

As the French economist Jean Tirole writes in Economics for the Common Good: "In economic matters too, first impressions can mislead us. We look at the direct effect of an economic policy, which is easy to understand, and we stop there. Most of the time we are not aware of the indirect effects. We do not understand the problem in its entirety. Yet secondary or indirect effects can easily make a well-intentioned policy toxic."

What does Tirole mean here? Another French economist Frédéric Bastiat explains what secondary or indirect effects are, through the broken window fallacy.

Bastiat basically talks about a shopkeeper's careless son breaking a pane of a glass window. He then goes on to say that those present would say: "It is an ill wind that blows nobody good. Everybody must live, and what would become of glaziers if panes of glass were never broken."

The point being that if windows weren't broken, how would those repairing windows, the glaziers that is, ever make a living. This seems like a fair question to ask, but things aren't as simple as that.

As Bastiat writes in Essays on Political Economy: "This form of condolence contains an entire theory, which it will be well to show up in this simple case, seeing that it is precisely the same as that which, unhappily, regulates the greater part of our economical institutions."

Bastiat then goes on to explain what exactly he means by this. Let's say replacing the pane of the broken window costs 6 francs. This is the amount that the shopkeeper pays the glazier. If the shopkeeper's son would not have broken the window there was no way that the glazier could have earned these six francs.

As Bastiat puts it: "The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen." This leads us to conclude that breaking windows is a good thing because it leads to money circulating and those who repair broken windows doing well in the process.

Nevertheless, this is just one side of the argument. As Bastiat writes: "It is not seen that our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps have replaced his old shoes, or added a book to his library. In short, he would have employed his six francs in some way which this accident prevented."

How does this apply in the case of the Narendra Modi government increasing custom duties on a whole host of products? The seen effect of this, as already explained above, is that domestic Indian companies can compete with cheaper imports because of the custom duties being increased. This is likely to create jobs and if not, it is at least likely to save jobs. This is the first order effect or the seen effect.

What is the second order effect or the unseen effect? It is well worth remembering here that consumers only have so much money to spend. If cheaper imports no longer remain cheaper because of an increase in custom duties, the consumers have to pay a higher price for the goods made by domestic companies. Once this happens, they are likely to cut their spending on some other front.

The trouble is that this some other front on which consumers cut their spending, is not easily identifiable. Once consumers cut their spending on other fronts, some domestic businesses are not going to do well, and jobs will be lost there. The trouble is this is not something which is very obvious. It is an unseen effect.

If the consumers keep spending the same amount of money as before, they will end up cutting down on their savings, which isn't necessarily a good thing. As Henry Hazlitt writes in Economics in One Lesson: "The fallacy... comes from noticing only the results that are immediately seen, and neglecting the results that are not seen."

Another point that needs to be made here is that the domestic companies are organised well enough to lobby with the government. The end consumer never is.

Increasing customs duties is not a solution to creating jobs. For jobs to be created Indian firms need to be globally competitive. When companies produce for the global market, they need to compete with the best in the world. This automatically leads to a situation wherein the products which a company produces need to be globally competitive. On the other hand, when import substitution is the norm and companies need to produce just for the internal market, almost anything goes. This explains why the Indian corporate sector on the whole, has not been able to be competitive on the global front. It has still not been able to come out of the import substitution era. (We hope people do remember the Ambassador Car which had the same engine between 1944 and 1982.)

In order to be globally competitive, India needs to introduce a whole host of reforms, from labour law reforms to land reforms. It needs to start pricing electricity correctly. The governments need to control their fiscal deficits to ensure that they don't push up interest rates in the long-term. Our education system needs a paradigm shift (We find this phrase absolutely cringeworthy, but nothing explains the situation better). The corporate bond market needs to function much better than it currently is. The number of inspectors that an average business needs to deal with has to come down. The paper work needs to be simplified. All these distortions in the system need to go.

Long story short-going back to Nehruvian economics is not going to do any good to the country. The sooner Narendra Modi understands this, the better it will be for India. India has suffered enough because of the mess initiated by the economic policies of Nehru and Indira Gandhi. And there is no point, going back to it.

Warm Regards,

Vivek Kaul
Editor, Vivek Kaul's Diary

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Vivek Kaul is the Editor of the Diary. He is the author of the Easy Money trilogy. The books were bestsellers on Amazon. His latest book is India's Big Government - The Intrusive State and How It is Hurting Us.

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14 Responses to "PM Modi, Nehruvian Economic Policies Aren't Going to Get Us Anywhere"

Lakshminarayanan

Feb 25, 2018

Wish any government follows what is good for people rather than blindly doing such things.

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ashoksinghania

Feb 23, 2018

you have wrong diagnosis. when consumer spend money on domestically produce good the money remains in the nation. no doubt everything cannot be produced locally. it is net exports which drive economic growth. you need to study modern monetary theory to understand it. you need to come out of billbonner gold standard understanding. it is financilization of economy which is root cause of problem.

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Taj Hoda

Feb 21, 2018

Overall, an excellent article, but blaming Nehru for all ills doesn't look justified, rather these are the rhetoric and narratives of one particular group to malign them. Nehru did what he could, during his times and as per situations prevailing in those days. Do you remember PL-480 under which US used to send Wheat and Milk powder for an impoverished India?? Had Nehru not started Green revolution, and created IITs, IIMs or Missile or Satellite or Atomic plants or Institutes like Indian Institute of Science, Bangaluru to name a few, I don't know how far we would have progressed??
Secondly, increasing Customs duty is certainly going to be counter productive !

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SRINI

Feb 20, 2018

May be they are taking us nowhere. But one thing for sure, vivekkaulian policies will take us downhill. Vivek kaulian policies make sensational headlines and are good for nothing other than ensuring making of some quick buck by the author.

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Arunotpal Kanti Roy

Feb 20, 2018

These measures are aimed at China and are justified. Since when has China played by the rules? It creates tariff and non-tariff barriers to exports from India and other countries. I agree that raising import duties is incorrect in principle but in certain circumstances can be justified. China intends to hollow out our industrial base. Its companies are owned by the Chinese government and these companies execute the Chinese foreign policy objectives.

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N K Sharma

Feb 20, 2018

Why do we always look for negatives in every change in policy? Today when every country whether US EU China or Japan tries to protect it local industry or business as far as possible,thru Tariff or non tariff barriers, why India should not do the same? In any case we are not talking of duties of the order of 100% or more applicable in Nehru or Indira Era. More so how many internationally competitive Electronics TV or Mobile manufacturers do we have after over 25 years of near zero duties? In auto components where our industries have done better it make sense to protect their local turf against cheap/ subsidized exports into India.
Further,when talking of reforms if there are 15 things to set right, is it necessary that you do all together or nothing at all? I think one needs to take up one at a time to manage the process better.

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Balasubramanian

Feb 20, 2018

Total free market is a mirage where only the "efficient" win. Does this mean let others perish ? You need protections in some cases and in some cases its counter productive. The only question whether FM calls correctly and for our sake I hope so. But act he has to to the best of his judgement and honestly.
Certainly economists have not done better - they are good at postmortem but not in predicting upheavels.

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Abhishek Acharyya

Feb 19, 2018

HM Ambassador did not have same engine from 1944 to 1982. HM Ambassador came into existence only in 1957.

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Thiruvalluvan

Feb 19, 2018

Please think about the status of other western countries which have not followed the Nehruvian polices. They are much worse.

Like (1)

sheelaa

Feb 19, 2018

Your article made for interesting reading, for its simplicity in association of facts by examples.There is just one effect that I disagree upon and that is that less savings are bad for the economy.Considering the way banks have let down the real savers by indiscriminately dividing the public savings with a host of corporate thieves, while needy farmers commit suicide,it is perhaps better that people spend more and save less.

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