India must buck up and increase its participation in global value chains
The latest World Development Report (WDR; bit.do/fo3VE) of the World Bank focuses on global value chains (GVCs), which have become vital for production and trade. Items once designed, manufactured and sold within one country are now designed, made and marketed in several countries, with each country specialising in one or two aspects. Specialisation has greatly raised productivity, while the transport and communications revolutions have slashed the cost of shipping and coordination. This has facilitated the rise of GVCs.
The main reason why India negotiated for seven years to enter the Regional Comprehensive Economic Partnership (RCEP) — covering 15 countries with half the world’s population — was to attract the GVCs that had spearheaded economic growth in many Asian countries, like Bangladesh and Vietnam, but largely bypassed India.
Not the Best of ReCEPtion
Ultimately, India backed out of RCEP because of opposition from several domestic lobbies fearing competition from Chinese manufactures and agricultural products from New Zealand and Australia. The right policy is to join RCEP after tough bargaining on entry conditions, and then use membership rules to strengthen the case for economic reforms that would otherwise be checkmated by domestic lobbies.
The WDR shows that GVCs can greatly raise productivity, benefiting both the investor and investee countries. GVCs create more and better jobs, accelerate economic growth and reduce poverty. Good outcomes depend on supporting economic policies such as open markets, investor-friendly regimes, predictable and stable taxes and rules, and high-quality infrastructure.
GVCs will locate in countries with logistics and procedures that ensure fast turnaround of goods and services. Alas, India’s logistics costs are double that of Bangladesh and triple that of China. This explains India’s limited GVC participation. The WDR says that one day’s delay hits competitiveness as much as a tariff of over 1%.
India must reform its import and export procedures, including goods and services tax (GST) rules, ensuring quick paperwork and trade clearances. It must focus on trade facilitation, and invest in world-class ports, rail transport, air cargo and electricity. Land acquisition difficulties and inflexible labour laws hinder GVCs. Legal and tax disputes must be settled quickly, instead of meandering through the courts for decades. India has improved its ‘ease of doing business’ ranking in Modi’s first term, but has a long way to go.
India’s ratio of trade in goods and services to GDP peaked at 56% in 2011, and fell to 43% in 2017. (It must be lower today.) This share remains higher than in the US or Europe. China and most other countries have followed a similar downhill pattern. Yet, trade, and the GVCs that spur it, remain extremely important.
The WDR says the share of GVCs in world trade rose rapidly in the 1990s and 2000s to 52% by 2008, but then slipped to 37%. This was caused by three factors: protectionism, Chinese selfsufficiency and automation. US President Donald Trump has gone protectionist in his ‘Make America Great Again’ scheme. This has created uncertainties inhibiting global investment, trade and GDP. Brexit is another straw in the wind.
China used to be the greatest GVC player. But, in recent years, it has started making more components at home instead of importing them, lessening chains. The other dampening factor has been automation, which ends the third-world advantage of cheap labour, and enables production to shift to rich consumers. All countries, including India, will need to move up the value chain to remain competitive.
Missed the Bus, But on Time
The greatest leaps in productivity, says the WDR, take place when poor countries shift from agriculture to simple manufactures that can be exported en masse. India has missed the bus on this shift, and that has cost it dearly. The next shift is from simple to skill-intensive goods and services.
Here, India has done well. It has leapfrogged over the simple manufacturing phase to sophisticated areas like computer software, pharmaceuticals and autos. It is part of GVCs in all three.
All forms of globalisation, including GVCs, create losers as well as winners. In principle, taxing the winners should compensate for the losses of the losers, by providing retraining and safety nets. In practice, taxing the winners has proved difficult.
Countries have competed to slash tax rates and offer subsidies to attract global firms, so some winners are subsidised rather than taxed. Besides, GVCs offer an opportunity to shift the main profits from sales to intellectual property rights (IPR) that are held by subsidiaries in low-tax havens like Ireland or Luxembourg.
The WDR says that to take GVCs further, international cooperation is needed to create common standards that lower non-tariff barriers, and to coordinate tax rates, infrastructure and regulations.
Acritical area is the taxation of companies with massive sales but very low tax payments in many countries. The Organisation for Economic Cooperation and Development (OECD) has negotiated a draft agreement on taxing the revenue rather than only the profits of such companies. But France’s attempt to take this further has attracted criticism, and possible sanctions from Trump, who does not want the profits of US companies to be diverted to France. Tax cooperation is essential but politically difficult.