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Moving Trade Policy Forward

ARVIND PANAGARIYA

THURSDAY, AUGUST 26, 2004 

 
The Union commerce and industry minister, Mr Kamal Nath, scored an important victory in Geneva last month. To his credit, while he engaged in tough talk and successfully extracted the concessions he sought, he did not shy away from making the necessary concessions of his own.

Abandoning India’s original, self-defeating stance that it will not accept any reduction in its trade barriers in agriculture, he agreed to place agricultural barriers on the negotiating table in return for similar offers by his counterparts.

That led to a happy ending for all — except a handful of obstructionist NGOs which tried until the end of the negotiations to provoke developing countries into blocking the deal.

Kamal Nath must now build on his success by further reforming India’s trade regime. The National Foreign Trade Policy, due on 31 August, offers an excellent opportunity to accomplish this objective. The policy must pay particular attention to two issues — export subsidies and anti-dumping.
 
Consider export subsidies first. Politically, these giveaways are hugely popular: exporters want them and politicians and bureaucrats love to distribute them. Yet, from the standpoint of national welfare, they turn into transfers to the country importing the subsidised products. This is particularly true of the subsidies that are illegal under the WTO rules and, therefore, can be countervailed by the importing country.

To see how, consider a pair of Indian shoes sold in the US market for, say, $100. Suppose the Indian government decides to introduce an export subsidy of $20 per pair so that the exporter now receives $120 in total for each pair he exports.

This induces him to export more shoes. If the US government can now demonstrate that the increased exports have hurt the US shoe producers — not a daunting task under the WTO rules — it can impose a countervailing duty on shoe imports from India at the same rate as the export subsidy: $20 per pair.
 
Suppose the US does just that. Since the shoe pair still fetches $100 from a buyer in the US, the exporter is left with only $80 from the sale after subtracting the countervailing duty. Adding the $20 in export subsidy, he is back to earning $100 per pair exported.

The only change is that the Indian treasury now loses $20 and the US treasury gains $20 for each pair of shoes exported by India. It is as if the Indian government taxed its citizens and simply transferred the proceeds at the rate of $20 per pair of shoe exports to the US government!

This may seem like a scandal but we have been allowing it to happen for some time now by maintaining export subsidies that can be and are countervailed under the WTO rules. One of these subsidies, the Duty Entitlement Passbook Scheme (DEPS), is economically sensible since its purpose is to rebate the duty paid on imported inputs used in exports but it is administered in a way that violates the WTO rules.

Most other subsidies, including the Export Promotion Capital Goods Scheme (EPCGS), Pre- and Post-shipment Export Financing Programme and Special Import Licence Scheme, broadly lack economic rationale apart from being absolutely and thoroughly WTO-inconsistent.

Some analysts advocate seeking legalisation of the subsidies in the Doha negotiations. That is a non-starter. It serves no purpose to expend our scarce negotiating capital on preserving a policy that is largely against our economic interests.

Moreover, there’s no mandate for such negotiations in the Doha round, so the task would be uphill. The best course would be to scrap the subsidies that can’t be redesigned to satisfy the WTO rules.

It makes no sense for a poor country like India to make income transfers to rich countries that result from export subsidies and countervailing duties. Exporters should be rebated fully the duty paid on inputs, but it should be done under the duty-drawback scheme or an equivalent programme that does not violate the WTO rules.

Admittedly, that can create more bureaucratic red tape and corruption, but the alternatives are worse. Eventually, the finance minister must eliminate import duties altogether, obviating the need to rebate them.

The urgency for the elimination of WTO-inconsistent export subsidies arises from the impending end to the rich country import quotas on textiles and clothing starting 1 January 2005. So far, this major export has escaped the countervailing duty because the claims of injury cannot be substantiated when imports are subject to strict quotas.

But once the quotas are gone, we can be sure that the US and EU will hit us left and right with countervailing duties to protect their domestic producers. Once put in place, these duties are not easily rescinded. This means we would be making very large transfers of our tax revenues to the US and European treasuries for a very long time.

The second issue worthy of the minister’s attention is anti-dumping, which India has come to abuse on a massive scale. This came back to haunt us recently when the domestic steel industry decided to exercise its monopoly power, partially acquired through anti-dumping duties on steel imports, and raised steel prices massively.

These price increases in turn fed into inflation and led even our reformist prime minister and finance minister to threaten resurrection of steel-price controls that had been laid to rest some years ago.

In a brilliant paper, Aradhna Aggarwal documents carefully how India hurts itself by abusing anti-dumping measures. In several instances, cases have been brought when imports account for less than 5% of total demand and can hardly cause injury to the domestic industry.

Such actions rob import competition of its role as the instrument of price regulation. In addition to reigning in the anti-dumping directorate directly, Kamal Nath must consider strengthening the Tariff Commission and charge it with injury investigations in anti-dumping cases. The current practice of entrusting the anti-dumping directorate with both anti-dumping-duty and injury investigations makes little sense.

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