Recently the government of India raised import duty on electronic items including cellphones and TVs to allegedly boost its Swadeshi campaign of Make in India as well as government revenues (sic).
Let us analyze this protectionist policy of government using sound economic laws and see if it is capable of achieving its stated goals.
Economics and Psychology of Protectionism
In the immediate aftermath of this hike in import duties the price of the imported electronic goods will go up choking some of the demand. This price rise will though not choke all of the demand. Those people whose price elasticity of demand is inelastic, e.g., a diehard iPhone fan, will continue to purchase these now costly imported goods. The price rise will reduce the purchasing power of their money e.g., if the iPhone was selling at 100 rupees before the 10% duty hike then it will now sell at 110 rupees. This means consumer will have to now spend more on iPhone leaving that much less income in his pocket to be spend on other items e.g., suppose his nominal income was 200 rupees before import duty hike and he was spending 100 rupees on an iPhone so his remaining income, which he can spend on, let’s say, other Indian manufactured items, was 100 rupees; but after the hike that income has come down to 90 rupees, which means he has 10 rupees less left to spend on other make in India items! This means the demand for make in India items, in the non-electronic market, will actually go down because of this import duty hike; and lower demand means higher unemployment. This policy will help only few sellers of electronics market while hurting consumers and sellers from all other sectors! This is zero sum outcome of this policy which is antithetical to the make in India goal.
Another problem is with the make in India products itself. The reason why Indian consumers buy imported products is because they are not satisfied with the price and quality of the make in India products! Forcing them to buy make in India product via protectionist measure of import duty hike is not going to solve this original problem of low quality and higher price of make in India products! Here there is no incentive for the Indian manufacturers to compete in the market for customers by implementing innovations and improving quality of their products and reducing their prices to the lowest possible level. In fact, the protectionist measure erects exactly opposite incentive structure for the make in India manufacturers. Import duty hike eliminates the competition coming from the foreign manufacturers. In the absence of this pressure of competition, the Indian manufacturers will relax and not improve either quality of their product or its price. They will continue to fleece the Indian consumers by providing them low quality high price products as has always happened in past!
Not only this, this policy will indirectly result into higher smuggling and creation of another vast underground economy in the electronic market. As I explained above, the import duty hike is not addressing the problem of why Indian consumers don’t want to voluntarily buy make in India products. Import duty hike might deter some demand of imported electronic goods in the short run, but in the long run it will remain ineffective because the underlying cause of imported item’s demand will be still present. In the absence of high quality low price local electronic goods, consumers will still want to buy imported items. This continuous demand will give rise to new entrepreneurs, in vulgar language they are known as smugglers, who will now take risk of providing these contraband items to the needy customers. In this way huge underground market of smuggled imported electronic items will come into existence as it used to exist during the Nehruvian era of import substitution policies. This underground economy will also create more corrupt customs officials increasing corruption in India! And this underground economy and corruption are the two things that Modi government is supposedly trying to eliminate. As usual, governments never learn from their past mistakes. Modi is creating the same monster that he is trying to eliminate!
Conclusion
The import duty hike will not boost make in India campaign. It will, in fact, reduce the demand of make in India products! Also, protectionism will give rise to an underground economy in the electronic goods market in India resulting into loss of revenue (sic) for the government.
Good analysis. Important conclusion – ” As usual, governments never learn from their past mistakes. ” Full agreement here.
Import duties used to be sky high in the past, but it did not encourage any domestic manufacturing. For example, the import duty on foreign made cars used to be as high as 200%. It did not encourage production of Indian made cars. Instead simple economics took it’s natural course and the Ambassadors and Padminis gradually went extinct.
How will it be different this time? No one in government thinks to ask such a basic question before setting national policy.