1. Introduction to India’s Foreign Trade:
International business operations at firm level are considerably influenced by various policy measures employed to regulate trade, both by home and host countries. Exportability and importability of a firm’s goods are often determined by trade policies of the countries involved. Price-competitiveness of traded goods is affected by import and export tariffs.
The host country’s trade and FDI policies often influence entry decisions in international markets. Policy incentives help exporters increase their profitability through foreign sales. High import tariffs and other import restrictions distort free market forces guarding domestic industry against foreign competition and support indigenous manufacturing.
Therefore, a thorough understanding of the country’s trade policy and incentives are crucial to the development of a successful international business strategy.
Trade policy refers to the complete framework of laws, regulations, international agreements, and negotiating stances adopted by a government to achieve legally binding market access for domestic firms. It also seeks to develop rules providing predictability and security for firms. To be effective, trade policy needs to be supported by domestic policies to foster innovation and international competitiveness.
Besides, the trade policy should have flexibility and pragmatism.
Trade in developing countries is characterized by heavy dependence on developed countries, dominance of primary products, over-dependence on few markets and few products, and worsening of terms of trade and global protectionism, all of which make formulation and implementations of trade policy critical to economic development.
The strategic options for trade policy may either be inward or outward looking. As a result of liberalization and integration of national policies with WTO agreements, there has been a strategic shift in trade policies. Like other developing countries, India’s trade policies have also made a gradual shift from highly restrictive policies with emphasis on import substitution to more liberal policies geared towards export promotion.
India’s foreign trade policy is formulated under the Foreign Trade (Development and Regulation) Act, for a period of five years by the Ministry of Commerce, Government of India. The government is empowered to prohibit or restrict subject to conditions, export of certain goods for reasons of national security, public order, morality, prevention of smuggling, and safeguarding balance of payments.
Policy measures to promote international trade, such as schemes and incentives for duty-¬free and concessional imports, augmenting export production, and other export promotion measures are discussed in-depth
The multilateral trading system under the WTO trade regime significantly influences trade promotion measures and member countries need to integrate their trade policies with the WTO framework. The WTO trade policy review mechanism provides an institutional framework to review trade policies of member countries at regular intervals.
Trade Policy Options for Developing Countries:
There exists a huge gap in per capita income between the developed and the developing countries. Most of the world’s population lives in countries that are considerably poor.
Efforts to bridge the income gap between developed and developing countries, to raise living standards by increasing income levels, and to cope with the uneven development in the domestic economy, remain the central concern of economic and trade policies of developing countries. With low production base and constraints in value addition, most developing countries remain marginal players in international trade
Key characteristics of developing countries’ trade include the following:
(i) Heavy Dependence Upon Developed Countries:
Developing countries’ trade is often dependent upon developed countries which form export destinations for the majority of their goods. Moreover, developing countries also heavily depend on developed countries for their imports. Trade among developing countries is relatively meagre.
(ii) Dominance of Primary Products:
Exports from developing countries traditionally comprised primary products, such as agricultural goods, raw materials and fuels or labour-intensive manufactured goods, such as textiles. However, over recent years, dependence on primary products has considerably decreased, especially for newly industrialized countries, such as South Korea and Hong Kong.
India’s dependence on agro exports has also declined considerably from 44.2 per cent in 1960-61 to about 10 per cent in 2006-07.
(iii) Over-dependence on a Few Markets and a Few Products:
A large number of developing countries are dependent on just a few markets and products for their exports. For instance, Mexico is heavily dependent on the US which is the destination for 89 per cent of its total exports whereas the Dominican Republic exports 80 per cent and Trinidad and Tobago 68 per cent of its goods to the US.
In terms of product composition, petroleum accounts for 96 per cent of total exports from Nigeria, 86 per cent of total exports from Saudi Arabia, and 86 per cent of total exports from Venezuela. Over the years, India’s basket of export products has widened remarkably with decreased dependence on any single product category
(iv) Worsening Terms of Trade:
Distribution of gains from trade has always been disproportionate and therefore, a controversial issue. Developing countries often complain of deterioration in their terms of trade, mainly due to high share of primary products in their exports.
(v) Global Protectionism:
Developed countries often provide heavy subsidies to their farmers for agricultural production and shield them from competition from imported products, besides imposing tariffs. Moreover, a number of non-tariff barriers such as quality requirements, sanitary and phytosanitary measures, and environmental and social issues, such as child labour offers considerable obstacles to products emanating from developing countries.
Trade Policy Strategic Options for International Trade:
‘Economic dualism’, where a high-wage capital-intensive industrial sector co-exists with a low-wage unorganized traditional sector, prevails in most developing countries. Promoting indigenous industrialization and employment generation become key concerns of their economic policies. A country may adopt any of the following strategic options for its trade policy
i) Inward Looking Strategy (Import Substitution):
Emphasis is laid on extensive use of trade barriers to protect domestic industries from import competition under the import-substitution strategy. Domestic production is encouraged so as to achieve self-sufficiency and imports are discouraged.
Import- substitution trade strategy is often justified by the ‘infant industry argument’, which advocates the need of a temporary period of protection for new industries from competition from well-established foreign competitors.
Most developing countries, such as Brazil, India, Mexico, Argentina, etc., during the 1950s and 1960s employed an inward-looking trade strategy.
The uses of high tariff structure and quota restrictions along with reserving domestic industrial activities for local firms rather than foreign investors were the key features of this import substitution policy. The pros and cons of such strategy are given below.
Pros:
i. Protecting start-up industries so as to enable them to grow to a size where they can compete with the industries of developed nations
ii. Low risk in establishing domestic industry to replace imports especially when the size of domestic market is large enough to support such industries
iii. High import tariffs that discourage imports but provide foreign firms an inbuilt incentive to establish manufacturing facilities, leading to industrial development, growth in economic activities, and employment generation
iv. Relative ease for developing countries to protect their manufacturers against foreign competition compared to getting protectionist trade barriers reduced by developed countries, in which they have little negotiating power
Cons:
i. Overprotection of domestic industries against international competition tends to make them inefficient
ii. Protection primarily available to import substituting industries which discriminates against other industries
iii. Manufacturers based in countries with relatively small market size find it difficult to take advantage of economies of scale and therefore have to incur high per unit costs
iv. Industries that substitute imports become competitive because of government incentives and import prohibitions, leading to considerable investment. Any attempt to reduce incentives or liberalize trade restrictions face strong resistance
v. Government subsidies and trade restrictions tend to breed corruption
Since independence, India’s trade strategy had been largely inclined to import substitution rather than export promotion. Earning foreign exchange through exports and conservation thereof had always been a high-priority task for various governments, irrespective of their political ideologies. Till 1991, India followed a strong inward-oriented trade policy to conserve foreign exchange
In order to facilitate industrialization with the objective of import substitution, important instruments used by the government included outright ban on import of some commodities, quantitative restriction, prohibitive tariff structure, which was one of the highest in the world and administrative restrictions, such as import licensing, foreign exchange regulations, local content requirements, export obligations, etc.
The policy makers of India had long believed that these policy measures would make India a leading exporter with comfortable balance of trade. In reality, these initiatives did not yield the desired results, rather gave rise to corruption, complex procedures, production inefficiency, poor product quality, and delay in shipment, and, in turn, decline in India’s share in world exports.
The protectionist measures of the inward-oriented economy increased the profitability of domestic industries, especially in the import substitution sector. The investment made to serve the domestic market was less risky due to proven demand potential by the existing level of imports.
Formidable tariff structure and trade policy barriers discouraged the entry of foreign goods into the Indian market. There was little pressure on domestic firms to be internationally competitive.
(ii) Outward Looking Strategy (Export-led Growth):
Under the outward looking strategy, the domestic economy is linked to the world economy, promoting economic growth through exports. The strategy involves incentives to promote exports rather than restrictions to imports.
Major benefits of an outward looking strategy include:
i. Industries wherein a country has comparative advantage are encouraged, for instance labour-intensive industries in developing countries
ii. Increase in competition in the domestic market leads to competitive pressure on the industry to increase its efficiency and upgrade quality
iii. Facilitating companies to benefit from economies of scale as large output can be sold in international markets
The economic liberalization during the last decade paved the way for access of foreign goods to Indian market, applying competitive pressure even on purely domestic companies. In order to make exports, the engine of growth, export promotion, gained major thrust in India’s trade policies, especially in recent years
With the integration of national trade policies and export promotion incentives with the WTO, promotional measures to encourage international marketing efforts, rather than export subsidization, have gained increased significance.
Accordingly, policies were aimed at creating a business-friendly environment by eliminating redundant procedures, increasing transparency by simplifying the processes involved in the export sector, and moving away from quantitative restrictions, thereby improving the competitiveness of Indian industry and reducing the anti-export bias.
Steps were taken to promote exports through multilateral and bilateral initiatives. With the decline in restrictions on trade and investment, constraints related to infrastructure and regulatory bottlenecks became increasingly evident.
Instruments of Trade Policy for International Trade:
Various methods employed to regulate trade are known as instruments of trade policy, which include tariffs, non-tariff measures, and financial controls
(i) Tariffs:
These are official constraints on import or export of certain goods and services and are levied in the form of customs duties or tax on products moving across borders. However, tariffs are more commonly imposed on imports rather than exports. The tariff instruments may be classified as below.
On the basis of direction of trade: import vs. exports tariffs:
Tariffs may be imposed on the basis of direction of product movement, i.e., either on exports or imports. Generally, import tariffs or customs duties are more common than tariffs on exports However, countries sometimes resort to impose export tariffs to conserve their scarce resources. Such tariffs are generally imposed on raw materials or primary products rather than on manufactured or value-added goods.
On the basis of purpose: protective vs. revenue tariffs:
The tariffs imposed to protect the home industry, agriculture, and labour against foreign competitors is termed as protective tariffs which discourage foreign goods. Historically, India had very high tariffs so as to protect its domestic industry against foreign competition.
A tariff rate of 200 to 300 per cent, especially on electronic and other consumer goods
created formidable barriers for foreign products to enter the Indian market.
The government may impose tariffs to generate tax revenues from imports which are generally nominal. For instance, the UAE imposes 3-4 per cent tariffs on its imports which may not be termed as protective tariffs.
On the basis of time length: tariff surcharge vs. countervailing duty:
On the basis of the duration of imposition, tariffs may be classified either as surcharge or countervailing duty. Any surcharge on tariffs represents a short term action by the importing country while countervailing duties are more or less permanent in nature. The raison d’etre for imposition of countervailing duties is to offset the subsidies provided by the governments of the exporting countries.
On the basis of tariff rates: specific, ad-valorem, and combined:
Duties fixed as a specific amount per unit of weight or any other measures are known as specific duties. For instance, these duties are in terms of rupees or US dollars per kg weight or per meter or per liter of the product. The cost, insurance, and freight (c.i.f.) value, product cost, or prices are not taken into consideration while deciding specific duties.
Specific duties are considered to be discriminatory but effective in protection of cheap- value products because of their lower unit value.
Duties levied ‘on the basis of value’ are termed as ad-valorem duties. Such duties are levied as a fixed percentage of the dutiable value of imported products. In contrast to specific duties, it is the percentage of duty that is fixed. Duty collection increases or decreases on the basis of value of the product. Ad-valorem duties help protect against any price increase or decrease for an import product.
A combination of specific and ad-valorem duties on a single product is known as combined or compound duty. Under this method, both specific as well as ad-valorem rates are applied to an import product.
On the basis of production and distribution points:
These are as below:
Single stage sales tax:
Tax collected only at one point in the manufacturing and distribution chain is known as single stage sales tax. Single stage sales tax is generally not collected unless products are purchased by the final consumer.
Value added tax:
Value added tax (VAT) is a multi-stage non-cumulative tax on consumption levied at each stage of production, distribution system, and value addition. A tax has to be paid at each time the product passes from one hand to the other in the marketing channel.
However, the tax collected at each stage is based on the value addition made during the stage and not on the total value of the product till that point. VAT is collected by the seller in the marketing channel from a buyer, deducted from the VAT amount already paid by the seller on purchase of the product and remitting the balance to the government.
Since VAT applies to the products sold in domestic markets and imported goods, it is considered to be non-discriminatory. Besides, VAT also conforms to the WTO norms.
Cascade tax:
Taxes levied on the total value of the product at each point in manufacturing and distribution channel, including taxes borne by the product at earlier stages, are known as cascade taxes. India had a long regime of cascade taxes wherein the taxes were levied at a later stage of marketing channel over the taxes already borne by the product.
Such a taxation system adds to the cost of the product, making goods non-competitive in the market.
Excise tax:
Excise tax is a one-time tax levied on the sale of a specific product. Alcoholic beverages and cigarettes in most countries tend to attract more excise duty.
Turnover tax:
In order to compensate for similar taxes levied on domestic products, a turnover or equalization tax is imposed. Although the equalization or turnover tax hardly equalizes prices, its impact is uneven on domestic and imported products.
(ii) Non-Tariff Measures:
Contrary to tariffs, which are straightforward, non-tariff measures are non-transparent and obstruct trade on discriminatory basis. As the WTO regime calls for binding of tariffs wherein the member countries are not free to increase the tariffs at their will, non-tariff barriers in innovative forms are emerging as powerful tools to restrict imports on discriminatory basis. The major non-tariff policy instruments include.
Government participation in trade:
State trading, governments’ procurement policies, and providing consultations to foreign companies on a regular basis are often used as disguised protection of national interests and barrier to foreign firms. A subsidy is a financial contribution provided directly or indirectly by a government that confers a benefit.
Various forms of subsides include cash payment, rebate in interest rates, value added tax, corporate income tax, sales tax, insurance, freight and infrastructure, etc. As subsidies are discriminatory in nature, direct subsidies are not permitted under the WTO trade regime.
Customs and entry procedure:
Custom classification, valuation, documentation, various types of permits, inspection requirements, and health and safety regulations are often used to hinder free flow of trade and discriminate among the exporting countries. These constitute an important non-tariff barrier.
Quotas:
Quotas are the quantitative restrictions on exports/imports intended at protecting local industries and conserving foreign exchange. The various types of quotas include
Absolute quota:
These quotas are the most restrictive, limiting in absolute terms, the quantity imported during the quota period. Once the quantity of the import quota is fulfilled, no further imports are allowed.
Tariff quotas:
They allow import of specified quantity of quota products at reduced rate of duty. However, excess quantities over the quota can be imported subject to a higher rate of import duty. Using such a combination of quotas and tariffs facilitates some import, but at the same time discourages through higher tariffs, excessive quantities of imports.
Voluntary quotas:
Voluntary quotas are unilaterally imposed in the form of a formal arrangement between countries or between a country and an industry. Such agreements generally specify the import limit in terms of product, country, and volume.
The multi-fibre agreement (MFA) had been the largest voluntary quota arrangement wherein developed countries forced an agreement on economically weaker countries so as to provide artificial protection to their domestic industry.
However, with the integration of multi-fibre agreement with the WTO, the quota regime got scrapped by 1 January 2005. Summarily, all sorts of quotas have a restrictive effect on free flow of goods across countries.
Other trade restrictions:
Other trade restrictions include minimum export price (MEP), wherein the government may fix a minimum price for exports so as to safeguard the interests of domestic consumers. Presently, India’s trade policy does not impose any restriction of minimum export price.
(iii) Financial Controls:
Governments often impose a variety of financial restrictions to conserve the foreign currencies restricting their markets. Such restrictions include exchange control, multiple exchange rates, prior import deposit, credit restrictions, and restriction on repatriation of profits. India had long followed a stringent exchange control regime to conserve foreign currencies.
(iv) Demand vs Supply Side Policy Measures:
Policy instruments for promoting exports may also operate on the supply and demand side. Initiatives for creating and expanding export production, developing transportation networks, port facilities, tax and investment systems form parts of supply side policies.
The demand side initiatives for export promotion include programmes to alert companies to the opportunities present in international markets and to strengthen the commitment and skills of those already involved.
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Policy Initiatives and Incentives by the State Governments for International Business:
State governments generally do not distinguish between production for domestic market and production for export market. Therefore, there had been few specific measures taken by state governments targeted at exporting units.
Though, state governments have taken a number of policy measures so as to encourage industrial activity in the state which mainly relate to:
i. Capital investment subsidy or subsidy for preparation of feasibility reports, project reports, etc.
ii. Waiver or deferment of sales tax or providing loans for sales tax purposes
iii. Exemption from entry tax, octroi, etc.
iv. Waiver of electricity duty
v. Power subsidy
vi. Exemption from taxes for certain captive power generation units
vii. Exemptions from stamp duties
viii. Provision of land at concessional rate
These concessions extended by state governments vary among policies of individual state governments and have broadly been based on the following criteria:
(a) Size of the unit proposed (cottage, small and medium industry)
(b) Backwardness of the districts or area
(c) Employment to weaker sections of society
(d) Significance of the sector, for example, software, agriculture
(e) Investment source, such as foreign direct investment (EDI) or investment by NRIs
(f) Health of the unit (sick), etc.
Therefore, it may be noted that most of the exemptions tend to encourage capital- or power-intensive units though some concessions are linked to turnover. Most of the concessions in the state industrial policies have been designed keeping in view the manufacturing industries.
An analysis of industrial policies of various states indicates that most state governments do compete among themselves in extending such concessions. On examination of export promotion initiatives by the state governments, it is difficult to find commonality among various states.
However, some of the common measures taken by the state governments are:
i. Attempting to provide information on export opportunities
ii. Preference in land allotment for starting an EOU
iii. Planning for development of Export Promotion Industrial Parks
iv. Exemption from entry-tax on supplies to EOU/EPZ/SEZ units
v. Exemption from sales tax or turnover tax for supplies to EOU/EPZ/SEZ units and inter-unit transfers between them.
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WTO and India’s Export Promotion Measures for International Business:
The emergence of the rule-based multilateral trading system under the WTO trade regime has affected India’s trade policies and promotional efforts. It provides a rule based framework as to which subsidies are prohibited, which can face countervailing measures, and which are allowed. The impact of WTO agreements on trade policy and export promotion measures is examined here.
The framework of the GATT is based on four basic rules:
(i) Protection to Domestic Industry Through Tariffs:
Even though GATT stands for liberal trade, it recognizes that its member countries may have to protect domestic production against foreign competition. However, it requires countries to keep such protection at low levels and to provide it through tariffs. To ensure that this principle is followed in practice, the use of quantitative restrictions is prohibited, except in a limited number of situations.
(ii) Binding of Tariffs:
Countries are urged to reduce and, where possible, eliminate protection to domestic production by reducing tariffs and removing other barriers to trade in multilateral trade negotiations. The tariffs so reduced are bound against further increase by being listed in each country’s national schedule. The schedules are integral part of the GATT legal system.
(iii) Most-Favoured-Nation Treatment:
This important rule of GATT lays down the principle of non-discrimination. The rule requires that tariffs and other regulations should be applied to imported or exported goods without discrimination among countries. Thus it is not open to a country to levy customs duties on imports from one country, at a rate higher than it applies to imports from other countries. There are, however, some exceptions to the rule.
Trade among members of regional trading arrangements, which are subject to preferential or duty-free rates, is one such exception. Another is provided by the Generalized System of Preferences; under this system, developed countries apply preferential or duty-free rates to imports from developing countries, but apply MFN rates to imports from other countries.
(iv) National Treatment Rule:
While the MFN rule prohibits countries from discriminating among goods originating in different countries, the national treatment rule prohibits them from discriminating between imported products and equivalent domestically produced products, both in the matter of the levy of internal taxes and in the application of internal regulations.
Thus it is not open to a country, after a product has entered its markets on payment of customs duties, to levy an internal tax (for example, sales tax or VAT) at rates higher than those payable on a product of national or domestic origin.
The four basic rules are complemented by rules of general application, governing goods entering the customs territory of an importing country.
These include rules which countries must follow:
i. In determining the dutiable value of imported goods where customs duties are collected on an ad-valorem basis
ii. In applying mandatory product standards, and sanitary and phytosanitary regulations to imported products
iii. In issuing authorizations for imports
In addition to the rules of general application described above, the GATT multilateral system has rules governing:
i. The grant of subsidies by governments
ii. Measures which governments are ordinarily permitted to take if requested by industry
iii. Investment measures that could have adverse effects on tirade
The rules further stipulate that certain types of measures which could have restrictive effects on imports can ordinarily be imposed by governments of importing countries only if the domestic industry which is affected by increased import petitions that such actions be taken.
These include:
i. Safeguard actions
ii. Levy of anti-dumping and countervailing duties
Under safeguard action the importing country is allowed to restrict imports of a product for a temporary period by either increasing tariffs or imposing quantitative restrictions. However, the safeguard measures can only be taken after it is established through proper investigation that increased imports are causing serious injury to the domestic industry.
The anti-dumping duties can be imposed if the investigation establishes that the goods are ‘dumped’.
The agreement stipulates that a product should be treated as being ‘dumped’ where its export price is less than the price at which it is offered for sale in the domestic market of the exporting country, whereas the countervailing duties can be levied in cases where the foreign company has charged low export price because its product has been subsidized by the government.
The WTO’s Trade Policy Review Mechanism:
In order to enhance transparency of members’ trade policies and facilitate smooth functioning of the multilateral trading system, the WTO members established the Trade Policy Review Mechanism (TPRM) to review trade policies of member countries at regular intervals.
Under annexure 3 of the Marrakesh Agreement, the four members with largest shares of world trade (i.e., European communities, the US, Japan, and China) are to be reviewed every two years, the next sixteen to be reviewed every four years, and the others be reviewed every six years. For the least developed countries a longer period may be fixed.
Reviews are conducted by the Trade Policy Review (TPR) Body on the basis of a policy statement by the member under review and a report prepared by staff in the WTO Secretariat’s TPR Division. Although the secretariat seeks cooperation of the members in preparing the report, it has the sole responsibility for the facts presented and the views expressed.
The TPR reports contain detailed reports examining the trade policies and practices of the member and describing policy-making institutions and the macroeconomic situation. The member’s subsidies contained in the TPR is of particular interest for the purpose of the report.
Information on subsidies distinguished in the subsidies and countervailing measures (SCM) can be found in the following three parts of the TPR report:
i. Measures directly affecting exports
ii. Trade policies and practices by sector
iii. Government incentives or subsidies that do not directly target imports and exports but nevertheless have an impact on trade flows
The contents of the report are mainly driven by the member’s main policy changes and constraints rather than subsidy-related issues and problems. Besides, the coverage of the report is determined to a large extent by the availability of data.
As a result, the amount of information contained in the reports varies from member to member. The TPR reports normally do not attempt to assess the effects of the subsidies on trade.
Due to limited availability of detailed information, in many cases, it is difficult to identify the extent to which a benefit is actually being conferred or the identity of the recipient of the subsidy.
Despite the shortcomings, especially with respect to cross-country comparability, the TPR report constitutes one of the few sources that systematically collects and compiles information on subsidies for a broad range of countries and economic activities.
International business operations at firm level are considerably influenced by various policy measures employed to regulate trade, both by home and host countries. Exportability and importability of a firm’s goods are often determined by trade policies of the countries involved. Price-competitiveness of traded goods is affected by import and export tariffs.
The host country’s trade and FDI policies often influence entry decisions in international markets. Policy incentives help exporters increase their profitability through foreign sales. High import tariffs and other import restrictions distort free market forces guarding domestic industry against foreign competition and support indigenous manufacturing.
Therefore, a thorough understanding of the country’s trade policy and incentives are crucial to the development of a successful international business strategy.
Trade policy refers to the complete framework of laws, regulations, international agreements, and negotiating stances adopted by a government to achieve legally binding market access for domestic firms. It also seeks to develop rules providing predictability and security for firms. To be effective, trade policy needs to be supported by domestic policies to foster innovation and international competitiveness.
Besides, the trade policy should have flexibility and pragmatism.
Trade in developing countries is characterized by heavy dependence on developed countries, dominance of primary products, over-dependence on few markets and few products, and worsening of terms of trade and global protectionism, all of which make formulation and implementations of trade policy critical to economic development.
The strategic options for trade policy may either be inward or outward looking. As a result of liberalization and integration of national policies with WTO agreements, there has been a strategic shift in trade policies. Like other developing countries, India’s trade policies have also made a gradual shift from highly restrictive policies with emphasis on import substitution to more liberal policies geared towards export promotion.
India’s foreign trade policy is formulated under the Foreign Trade (Development and Regulation) Act, for a period of five years by the Ministry of Commerce, Government of India. The government is empowered to prohibit or restrict subject to conditions, export of certain goods for reasons of national security, public order, morality, prevention of smuggling, and safeguarding balance of payments.
Policy measures to promote international trade, such as schemes and incentives for duty-¬free and concessional imports, augmenting export production, and other export promotion measures are discussed in-depth
The multilateral trading system under the WTO trade regime significantly influences trade promotion measures and member countries need to integrate their trade policies with the WTO framework. The WTO trade policy review mechanism provides an institutional framework to review trade policies of member countries at regular intervals.
Trade Policy Options for Developing Countries:
There exists a huge gap in per capita income between the developed and the developing countries. Most of the world’s population lives in countries that are considerably poor.
Efforts to bridge the income gap between developed and developing countries, to raise living standards by increasing income levels, and to cope with the uneven development in the domestic economy, remain the central concern of economic and trade policies of developing countries. With low production base and constraints in value addition, most developing countries remain marginal players in international trade
Key characteristics of developing countries’ trade include the following:
(i) Heavy Dependence Upon Developed Countries:
Developing countries’ trade is often dependent upon developed countries which form export destinations for the majority of their goods. Moreover, developing countries also heavily depend on developed countries for their imports. Trade among developing countries is relatively meagre.
(ii) Dominance of Primary Products:
Exports from developing countries traditionally comprised primary products, such as agricultural goods, raw materials and fuels or labour-intensive manufactured goods, such as textiles. However, over recent years, dependence on primary products has considerably decreased, especially for newly industrialized countries, such as South Korea and Hong Kong.
India’s dependence on agro exports has also declined considerably from 44.2 per cent in 1960-61 to about 10 per cent in 2006-07.
(iii) Over-dependence on a Few Markets and a Few Products:
A large number of developing countries are dependent on just a few markets and products for their exports. For instance, Mexico is heavily dependent on the US which is the destination for 89 per cent of its total exports whereas the Dominican Republic exports 80 per cent and Trinidad and Tobago 68 per cent of its goods to the US.
In terms of product composition, petroleum accounts for 96 per cent of total exports from Nigeria, 86 per cent of total exports from Saudi Arabia, and 86 per cent of total exports from Venezuela. Over the years, India’s basket of export products has widened remarkably with decreased dependence on any single product category
(iv) Worsening Terms of Trade:
Distribution of gains from trade has always been disproportionate and therefore, a controversial issue. Developing countries often complain of deterioration in their terms of trade, mainly due to high share of primary products in their exports.
(v) Global Protectionism:
Developed countries often provide heavy subsidies to their farmers for agricultural production and shield them from competition from imported products, besides imposing tariffs. Moreover, a number of non-tariff barriers such as quality requirements, sanitary and phytosanitary measures, and environmental and social issues, such as child labour offers considerable obstacles to products emanating from developing countries.
Trade Policy Strategic Options for International Trade:
‘Economic dualism’, where a high-wage capital-intensive industrial sector co-exists with a low-wage unorganized traditional sector, prevails in most developing countries. Promoting indigenous industrialization and employment generation become key concerns of their economic policies. A country may adopt any of the following strategic options for its trade policy
i) Inward Looking Strategy (Import Substitution):
Emphasis is laid on extensive use of trade barriers to protect domestic industries from import competition under the import-substitution strategy. Domestic production is encouraged so as to achieve self-sufficiency and imports are discouraged.
Import- substitution trade strategy is often justified by the ‘infant industry argument’, which advocates the need of a temporary period of protection for new industries from competition from well-established foreign competitors.
Most developing countries, such as Brazil, India, Mexico, Argentina, etc., during the 1950s and 1960s employed an inward-looking trade strategy.
The uses of high tariff structure and quota restrictions along with reserving domestic industrial activities for local firms rather than foreign investors were the key features of this import substitution policy. The pros and cons of such strategy are given below.
Pros:
i. Protecting start-up industries so as to enable them to grow to a size where they can compete with the industries of developed nations
ii. Low risk in establishing domestic industry to replace imports especially when the size of domestic market is large enough to support such industries
iii. High import tariffs that discourage imports but provide foreign firms an inbuilt incentive to establish manufacturing facilities, leading to industrial development, growth in economic activities, and employment generation
iv. Relative ease for developing countries to protect their manufacturers against foreign competition compared to getting protectionist trade barriers reduced by developed countries, in which they have little negotiating power
Cons:
i. Overprotection of domestic industries against international competition tends to make them inefficient
ii. Protection primarily available to import substituting industries which discriminates against other industries
iii. Manufacturers based in countries with relatively small market size find it difficult to take advantage of economies of scale and therefore have to incur high per unit costs
iv. Industries that substitute imports become competitive because of government incentives and import prohibitions, leading to considerable investment. Any attempt to reduce incentives or liberalize trade restrictions face strong resistance
v. Government subsidies and trade restrictions tend to breed corruption
Since independence, India’s trade strategy had been largely inclined to import substitution rather than export promotion. Earning foreign exchange through exports and conservation thereof had always been a high-priority task for various governments, irrespective of their political ideologies. Till 1991, India followed a strong inward-oriented trade policy to conserve foreign exchange
In order to facilitate industrialization with the objective of import substitution, important instruments used by the government included outright ban on import of some commodities, quantitative restriction, prohibitive tariff structure, which was one of the highest in the world and administrative restrictions, such as import licensing, foreign exchange regulations, local content requirements, export obligations, etc.
The policy makers of India had long believed that these policy measures would make India a leading exporter with comfortable balance of trade. In reality, these initiatives did not yield the desired results, rather gave rise to corruption, complex procedures, production inefficiency, poor product quality, and delay in shipment, and, in turn, decline in India’s share in world exports.
The protectionist measures of the inward-oriented economy increased the profitability of domestic industries, especially in the import substitution sector. The investment made to serve the domestic market was less risky due to proven demand potential by the existing level of imports.
Formidable tariff structure and trade policy barriers discouraged the entry of foreign goods into the Indian market. There was little pressure on domestic firms to be internationally competitive.
(ii) Outward Looking Strategy (Export-led Growth):
Under the outward looking strategy, the domestic economy is linked to the world economy, promoting economic growth through exports. The strategy involves incentives to promote exports rather than restrictions to imports.
Major benefits of an outward looking strategy include:
i. Industries wherein a country has comparative advantage are encouraged, for instance labour-intensive industries in developing countries
ii. Increase in competition in the domestic market leads to competitive pressure on the industry to increase its efficiency and upgrade quality
iii. Facilitating companies to benefit from economies of scale as large output can be sold in international markets
The economic liberalization during the last decade paved the way for access of foreign goods to Indian market, applying competitive pressure even on purely domestic companies. In order to make exports, the engine of growth, export promotion, gained major thrust in India’s trade policies, especially in recent years
With the integration of national trade policies and export promotion incentives with the WTO, promotional measures to encourage international marketing efforts, rather than export subsidization, have gained increased significance.
Accordingly, policies were aimed at creating a business-friendly environment by eliminating redundant procedures, increasing transparency by simplifying the processes involved in the export sector, and moving away from quantitative restrictions, thereby improving the competitiveness of Indian industry and reducing the anti-export bias.
Steps were taken to promote exports through multilateral and bilateral initiatives. With the decline in restrictions on trade and investment, constraints related to infrastructure and regulatory bottlenecks became increasingly evident.
Instruments of Trade Policy for International Trade:
Various methods employed to regulate trade are known as instruments of trade policy, which include tariffs, non-tariff measures, and financial controls
(i) Tariffs:
These are official constraints on import or export of certain goods and services and are levied in the form of customs duties or tax on products moving across borders. However, tariffs are more commonly imposed on imports rather than exports. The tariff instruments may be classified as below.
On the basis of direction of trade: import vs. exports tariffs:
Tariffs may be imposed on the basis of direction of product movement, i.e., either on exports or imports. Generally, import tariffs or customs duties are more common than tariffs on exports However, countries sometimes resort to impose export tariffs to conserve their scarce resources. Such tariffs are generally imposed on raw materials or primary products rather than on manufactured or value-added goods.
On the basis of purpose: protective vs. revenue tariffs:
The tariffs imposed to protect the home industry, agriculture, and labour against foreign competitors is termed as protective tariffs which discourage foreign goods. Historically, India had very high tariffs so as to protect its domestic industry against foreign competition.
A tariff rate of 200 to 300 per cent, especially on electronic and other consumer goods
created formidable barriers for foreign products to enter the Indian market.
The government may impose tariffs to generate tax revenues from imports which are generally nominal. For instance, the UAE imposes 3-4 per cent tariffs on its imports which may not be termed as protective tariffs.
On the basis of time length: tariff surcharge vs. countervailing duty:
On the basis of the duration of imposition, tariffs may be classified either as surcharge or countervailing duty. Any surcharge on tariffs represents a short term action by the importing country while countervailing duties are more or less permanent in nature. The raison d’etre for imposition of countervailing duties is to offset the subsidies provided by the governments of the exporting countries.
On the basis of tariff rates: specific, ad-valorem, and combined:
Duties fixed as a specific amount per unit of weight or any other measures are known as specific duties. For instance, these duties are in terms of rupees or US dollars per kg weight or per meter or per liter of the product. The cost, insurance, and freight (c.i.f.) value, product cost, or prices are not taken into consideration while deciding specific duties.
Specific duties are considered to be discriminatory but effective in protection of cheap- value products because of their lower unit value.
Duties levied ‘on the basis of value’ are termed as ad-valorem duties. Such duties are levied as a fixed percentage of the dutiable value of imported products. In contrast to specific duties, it is the percentage of duty that is fixed. Duty collection increases or decreases on the basis of value of the product. Ad-valorem duties help protect against any price increase or decrease for an import product.
A combination of specific and ad-valorem duties on a single product is known as combined or compound duty. Under this method, both specific as well as ad-valorem rates are applied to an import product.
On the basis of production and distribution points:
These are as below:
Single stage sales tax:
Tax collected only at one point in the manufacturing and distribution chain is known as single stage sales tax. Single stage sales tax is generally not collected unless products are purchased by the final consumer.
Value added tax:
Value added tax (VAT) is a multi-stage non-cumulative tax on consumption levied at each stage of production, distribution system, and value addition. A tax has to be paid at each time the product passes from one hand to the other in the marketing channel.
However, the tax collected at each stage is based on the value addition made during the stage and not on the total value of the product till that point. VAT is collected by the seller in the marketing channel from a buyer, deducted from the VAT amount already paid by the seller on purchase of the product and remitting the balance to the government.
Since VAT applies to the products sold in domestic markets and imported goods, it is considered to be non-discriminatory. Besides, VAT also conforms to the WTO norms.
Cascade tax:
Taxes levied on the total value of the product at each point in manufacturing and distribution channel, including taxes borne by the product at earlier stages, are known as cascade taxes. India had a long regime of cascade taxes wherein the taxes were levied at a later stage of marketing channel over the taxes already borne by the product.
Such a taxation system adds to the cost of the product, making goods non-competitive in the market.
Excise tax:
Excise tax is a one-time tax levied on the sale of a specific product. Alcoholic beverages and cigarettes in most countries tend to attract more excise duty.
Turnover tax:
In order to compensate for similar taxes levied on domestic products, a turnover or equalization tax is imposed. Although the equalization or turnover tax hardly equalizes prices, its impact is uneven on domestic and imported products.
(ii) Non-Tariff Measures:
Contrary to tariffs, which are straightforward, non-tariff measures are non-transparent and obstruct trade on discriminatory basis. As the WTO regime calls for binding of tariffs wherein the member countries are not free to increase the tariffs at their will, non-tariff barriers in innovative forms are emerging as powerful tools to restrict imports on discriminatory basis. The major non-tariff policy instruments include.
Government participation in trade:
State trading, governments’ procurement policies, and providing consultations to foreign companies on a regular basis are often used as disguised protection of national interests and barrier to foreign firms. A subsidy is a financial contribution provided directly or indirectly by a government that confers a benefit.
Various forms of subsides include cash payment, rebate in interest rates, value added tax, corporate income tax, sales tax, insurance, freight and infrastructure, etc. As subsidies are discriminatory in nature, direct subsidies are not permitted under the WTO trade regime.
Customs and entry procedure:
Custom classification, valuation, documentation, various types of permits, inspection requirements, and health and safety regulations are often used to hinder free flow of trade and discriminate among the exporting countries. These constitute an important non-tariff barrier.
Quotas:
Quotas are the quantitative restrictions on exports/imports intended at protecting local industries and conserving foreign exchange. The various types of quotas include
Absolute quota:
These quotas are the most restrictive, limiting in absolute terms, the quantity imported during the quota period. Once the quantity of the import quota is fulfilled, no further imports are allowed.
Tariff quotas:
They allow import of specified quantity of quota products at reduced rate of duty. However, excess quantities over the quota can be imported subject to a higher rate of import duty. Using such a combination of quotas and tariffs facilitates some import, but at the same time discourages through higher tariffs, excessive quantities of imports.
Voluntary quotas:
Voluntary quotas are unilaterally imposed in the form of a formal arrangement between countries or between a country and an industry. Such agreements generally specify the import limit in terms of product, country, and volume.
The multi-fibre agreement (MFA) had been the largest voluntary quota arrangement wherein developed countries forced an agreement on economically weaker countries so as to provide artificial protection to their domestic industry.
However, with the integration of multi-fibre agreement with the WTO, the quota regime got scrapped by 1 January 2005. Summarily, all sorts of quotas have a restrictive effect on free flow of goods across countries.
Other trade restrictions:
Other trade restrictions include minimum export price (MEP), wherein the government may fix a minimum price for exports so as to safeguard the interests of domestic consumers. Presently, India’s trade policy does not impose any restriction of minimum export price.
(iii) Financial Controls:
Governments often impose a variety of financial restrictions to conserve the foreign currencies restricting their markets. Such restrictions include exchange control, multiple exchange rates, prior import deposit, credit restrictions, and restriction on repatriation of profits. India had long followed a stringent exchange control regime to conserve foreign currencies.
(iv) Demand vs Supply Side Policy Measures:
Policy instruments for promoting exports may also operate on the supply and demand side. Initiatives for creating and expanding export production, developing transportation networks, port facilities, tax and investment systems form parts of supply side policies.
The demand side initiatives for export promotion include programmes to alert companies to the opportunities present in international markets and to strengthen the commitment and skills of those already involved.
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Policy Initiatives and Incentives by the State Governments for International Business:
State governments generally do not distinguish between production for domestic market and production for export market. Therefore, there had been few specific measures taken by state governments targeted at exporting units.
Though, state governments have taken a number of policy measures so as to encourage industrial activity in the state which mainly relate to:
i. Capital investment subsidy or subsidy for preparation of feasibility reports, project reports, etc.
ii. Waiver or deferment of sales tax or providing loans for sales tax purposes
iii. Exemption from entry tax, octroi, etc.
iv. Waiver of electricity duty
v. Power subsidy
vi. Exemption from taxes for certain captive power generation units
vii. Exemptions from stamp duties
viii. Provision of land at concessional rate
These concessions extended by state governments vary among policies of individual state governments and have broadly been based on the following criteria:
(a) Size of the unit proposed (cottage, small and medium industry)
(b) Backwardness of the districts or area
(c) Employment to weaker sections of society
(d) Significance of the sector, for example, software, agriculture
(e) Investment source, such as foreign direct investment (EDI) or investment by NRIs
(f) Health of the unit (sick), etc.
Therefore, it may be noted that most of the exemptions tend to encourage capital- or power-intensive units though some concessions are linked to turnover. Most of the concessions in the state industrial policies have been designed keeping in view the manufacturing industries.
An analysis of industrial policies of various states indicates that most state governments do compete among themselves in extending such concessions. On examination of export promotion initiatives by the state governments, it is difficult to find commonality among various states.
However, some of the common measures taken by the state governments are:
i. Attempting to provide information on export opportunities
ii. Preference in land allotment for starting an EOU
iii. Planning for development of Export Promotion Industrial Parks
iv. Exemption from entry-tax on supplies to EOU/EPZ/SEZ units
v. Exemption from sales tax or turnover tax for supplies to EOU/EPZ/SEZ units and inter-unit transfers between them.
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WTO and India’s Export Promotion Measures for International Business:
The emergence of the rule-based multilateral trading system under the WTO trade regime has affected India’s trade policies and promotional efforts. It provides a rule based framework as to which subsidies are prohibited, which can face countervailing measures, and which are allowed. The impact of WTO agreements on trade policy and export promotion measures is examined here.
The framework of the GATT is based on four basic rules:
(i) Protection to Domestic Industry Through Tariffs:
Even though GATT stands for liberal trade, it recognizes that its member countries may have to protect domestic production against foreign competition. However, it requires countries to keep such protection at low levels and to provide it through tariffs. To ensure that this principle is followed in practice, the use of quantitative restrictions is prohibited, except in a limited number of situations.
(ii) Binding of Tariffs:
Countries are urged to reduce and, where possible, eliminate protection to domestic production by reducing tariffs and removing other barriers to trade in multilateral trade negotiations. The tariffs so reduced are bound against further increase by being listed in each country’s national schedule. The schedules are integral part of the GATT legal system.
(iii) Most-Favoured-Nation Treatment:
This important rule of GATT lays down the principle of non-discrimination. The rule requires that tariffs and other regulations should be applied to imported or exported goods without discrimination among countries. Thus it is not open to a country to levy customs duties on imports from one country, at a rate higher than it applies to imports from other countries. There are, however, some exceptions to the rule.
Trade among members of regional trading arrangements, which are subject to preferential or duty-free rates, is one such exception. Another is provided by the Generalized System of Preferences; under this system, developed countries apply preferential or duty-free rates to imports from developing countries, but apply MFN rates to imports from other countries.
(iv) National Treatment Rule:
While the MFN rule prohibits countries from discriminating among goods originating in different countries, the national treatment rule prohibits them from discriminating between imported products and equivalent domestically produced products, both in the matter of the levy of internal taxes and in the application of internal regulations.
Thus it is not open to a country, after a product has entered its markets on payment of customs duties, to levy an internal tax (for example, sales tax or VAT) at rates higher than those payable on a product of national or domestic origin.
The four basic rules are complemented by rules of general application, governing goods entering the customs territory of an importing country.
These include rules which countries must follow:
i. In determining the dutiable value of imported goods where customs duties are collected on an ad-valorem basis
ii. In applying mandatory product standards, and sanitary and phytosanitary regulations to imported products
iii. In issuing authorizations for imports
In addition to the rules of general application described above, the GATT multilateral system has rules governing:
i. The grant of subsidies by governments
ii. Measures which governments are ordinarily permitted to take if requested by industry
iii. Investment measures that could have adverse effects on tirade
The rules further stipulate that certain types of measures which could have restrictive effects on imports can ordinarily be imposed by governments of importing countries only if the domestic industry which is affected by increased import petitions that such actions be taken.
These include:
i. Safeguard actions
ii. Levy of anti-dumping and countervailing duties
Under safeguard action the importing country is allowed to restrict imports of a product for a temporary period by either increasing tariffs or imposing quantitative restrictions. However, the safeguard measures can only be taken after it is established through proper investigation that increased imports are causing serious injury to the domestic industry.
The anti-dumping duties can be imposed if the investigation establishes that the goods are ‘dumped’.
The agreement stipulates that a product should be treated as being ‘dumped’ where its export price is less than the price at which it is offered for sale in the domestic market of the exporting country, whereas the countervailing duties can be levied in cases where the foreign company has charged low export price because its product has been subsidized by the government.
The WTO’s Trade Policy Review Mechanism:
In order to enhance transparency of members’ trade policies and facilitate smooth functioning of the multilateral trading system, the WTO members established the Trade Policy Review Mechanism (TPRM) to review trade policies of member countries at regular intervals.
Under annexure 3 of the Marrakesh Agreement, the four members with largest shares of world trade (i.e., European communities, the US, Japan, and China) are to be reviewed every two years, the next sixteen to be reviewed every four years, and the others be reviewed every six years. For the least developed countries a longer period may be fixed.
Reviews are conducted by the Trade Policy Review (TPR) Body on the basis of a policy statement by the member under review and a report prepared by staff in the WTO Secretariat’s TPR Division. Although the secretariat seeks cooperation of the members in preparing the report, it has the sole responsibility for the facts presented and the views expressed.
The TPR reports contain detailed reports examining the trade policies and practices of the member and describing policy-making institutions and the macroeconomic situation. The member’s subsidies contained in the TPR is of particular interest for the purpose of the report.
Information on subsidies distinguished in the subsidies and countervailing measures (SCM) can be found in the following three parts of the TPR report:
i. Measures directly affecting exports
ii. Trade policies and practices by sector
iii. Government incentives or subsidies that do not directly target imports and exports but nevertheless have an impact on trade flows
The contents of the report are mainly driven by the member’s main policy changes and constraints rather than subsidy-related issues and problems. Besides, the coverage of the report is determined to a large extent by the availability of data.
As a result, the amount of information contained in the reports varies from member to member. The TPR reports normally do not attempt to assess the effects of the subsidies on trade.
Due to limited availability of detailed information, in many cases, it is difficult to identify the extent to which a benefit is actually being conferred or the identity of the recipient of the subsidy.
Despite the shortcomings, especially with respect to cross-country comparability, the TPR report constitutes one of the few sources that systematically collects and compiles information on subsidies for a broad range of countries and economic activities.
