Shabir Ahmed

Free Trade Agreements (FTAs) are the favourite whipping boys of our industry leaders. The constant refrain has been that FTAs are ‘damaging’ the manufacturing sector. They want existing ones to be renegotiated and the proposed ones (Turkey and Thailand) put on hold.

Even the government has now started to say FTAs, particularly the one with China, were ‘poorly negotiated’.

Both the leaders and the government rest their case on the widening deficit in trade with FTA partners. It is a weak case if that’s the only evidence they can produce to indict FTAs.

We have always had a deficit with China, Malaysia, and Indonesia, and it is not at all surprising that the deficit has grown. Domestic demand for their products has gone up (population growth, urbanization, rising incomes),they have displaced some of the other supply sources, and we have been unable to capitalize on the FTA concessions to export more. Almost certainly, deficits would have grown even without FTAs.

The inconvenient truth is that an FTA is a two-way street. You can’t take and not give. There is also the WTO injunction for FTAs to have ‘substantial’ coverage, meaning all but the most sensitive sectors have to be given concessions. Our dilemma is that our list of sensitive products is too long. That creates a hiccup in our negotiations. Unfortunately, even with the best of friends it can’t be a one way street of ‘unilateral concessions’. We forget EU’s GSP-Plus is not unilateral either – it may not seek reciprocal trade concessions but does demand onerous social, religious and human rights compliances that EU thinks is worth the price of duty-free access.

We have yet to come across a single study establishing a causal link between FTAs and ‘premature deindustrialization’. On the other hand, there is sufficient evidence to suggest that we have a weak manufacturing base that cannot compete, in local or foreign markets, unless protected (against imports) and subsidized (for exports).

In rendering the manufacturing sector uncompetitive, one finds the government and the entrepreneurs equally culpable.

Government policies have been uncertain and unpredictable, nudging investment decisions towards risk aversion; ideally, ‘guaranteed’ returns. Government’s fiscal compulsions have clipped the productive sectors at both ends: less availability of credit and a disproportionate burden of tax and non-tax levies, unintentionally promoting the attractiveness of less productive opportunities like real estate. The regulatory regime is a mind-boggling patchwork of too much, too little, and discretionary enforcement. It has upped the cost of doing business without really serving public interest. The confused trade, taxation, and energy policies don’t serve the cause of manufacturing. They just serve to raise the input costs.

By not nurturing managerial excellence most entrepreneurs pay the heavy price of low productivity. The focus then shifts to rent seeking, a legacy of the ‘permit raj’, that is inherently inimical to a sound manufacturing base. Productivity also suffers from want of sufficient technological diffusion all through the supply chain and production processes, sub-optimal economies of scale, and under-investment in organizational and human resource development. ‘Just-in-time’ management continues to remain an alien concept and Jugaar passes for innovation. To top it all, Competition Commission is looked upon as an implacable foe rather than the catalyst that it is for improved competitiveness.

At the bottom of the pile is the consumer who is paying for government’s wayward policies and the industrialists’ inefficiencies.

More protection to keep manufacturing afloat is neither desirable nor sustainable.

The only way forward is to reboot manufacturing. And this can be only done if we dustbin the ‘gospel according to Washington consensus’ that preaches total faith in market forces’ ability to choose the ‘winners’.

Government would need to step in. Not just to fix the market or coordination failures, but choose the industries to protect and promote. Yes, we are proposing what is anathema to Washington consensus: an Industrial Policy.

There are several examples of countries where a government-led Industrial Policy created a solid manufacturing base, minimized market and coordination aberrations, and facilitated multiplier effects - before allowing the market forces to take over. At our stage of industrialization (where the manufacturing sector’s share of GDP continues to slide) the government has the right, and the obligation, to lead the manufacturing sector towards a greater alignment with its economic development goals.

Of course, no industrial policy can be all embracive. It will have to pick and choose, and prioritize those industries that give a bigger bang for the buck. Choosing industries with reasonable prospects of global competitiveness and potential for the greatest social and economic returns would require the development of sound selection criteria. Producer goods industries (machines to produce machines), technology (state of the art?), employment generation, revenues, exports, backward and forward linkages, exploitation of domestic resources (e.g. agriculture, minerals) could be some of the determinants.

Government should then be willing to provide an incentives package - development finance, protection, and subsidies - for a limited period of time and on a diminishing scale (in order to preclude efficiency-denigrating dependencies).

In return, the beneficiaries of these incentives would need to enter into a contract with the government to meet the predetermined targets of productivity, employment, exports etc., at the risk of management take over (and transfer to another management) for non-compliance.

These incentives should be given for the selected industries through a ‘bidding process’ that rewards interested entrepreneurs with the lowest demands and the highest performance commitments.

The challenge is not in designing such an Industrial policy - there is already the celebrated South Korean reciprocity-based Industrial Policy model that we have drawn upon here. The challenge is in negotiating vested interests. The strongest resistance is likely to come from the industry leaders who have become too used to ‘one way streets’, asking the government for a pound without promising a penny in return.

The kind of reciprocity we are advocating is in industry’s own long-term interest. You can’t, for instance, keep demanding egregious protection levels to keep your auto industry going or subsidized gas to produce fertilizer, without either breaking into exports or bringing the selling price down to international levels. Private benefits and social costs have to be better balanced.

Put another way, if the social costs exceed social benefits you risk take-overs of one kind or the [email protected]