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The global headlines these days are dominated by the unfolding trade spat between the United States and China. It seems to be following a tit-for-tat sequence. First, the U.S. imposed higher tariffs on import of aluminium and steel, mainly from China. To which China responded by imposing tariffs on goods worth $ 3 billion imported from the U.S. This was followed by the US imposing 25 per cent penalty tariff on 1,300 Chinese items including electronics components, medical devices, auto and aircraft components. This was to punish alleged theft of intellectual property of US patents. China retaliated within hours, extending their list by another 106 items, affecting US export of beef, cars, soybean and aircrafts to China. This is escalating into a trade war and the world markets are watching nervously.
But away from the high profile spat, one must note that the first action that the US has taken to the WTO is against India. The US has specifically targeted five export oriented schemes of India which include the following: merchandise export incentive scheme (MEIS), export oriented unit scheme (EOU), electronic hardware technology parks scheme, special economic zones (SEZ) and export promotion capital goods scheme (EPCG).
Much of this fits with President Donald Trump’s rhetoric and anti-trade stance. He believes that the world treats America unfairly, in benefiting from open borders and low import duties in US, and access to its consumers, but not reciprocating by keeping their own countries protected behind high trade barriers. So the US under President Trump is determined to play a game selectively, by offering carrots of tariff exemptions to “friends”, and high barriers against others, like China. It is possible that this selective action against few countries violates the rules of the World Trade Organisation. By the time member countries drag the U.S. to the WTO and prove their case, it may be too late, and much damage would have already been done.
But away from the high profile spat, one must note that the first action that the US has taken to the WTO is against India. The US has specifically targeted five export oriented schemes of India which include the following: merchandise export incentive scheme (MEIS), export oriented unit scheme (EOU), electronic hardware technology parks scheme, special economic zones (SEZ) and export promotion capital goods scheme (EPCG). It is interesting to note that the US is seeking legal remedies from the WTO against India, thereby showing faith in the multilateral institution, which it otherwise seems to have undermined by its unilateral actions against China and others. So that is a heartening point, since India’s interests too are in strengthening the WTO mechanism. The allegations against India are that the schemes violate norms and are WTO non-compliant. In particular MEIS is prohibited by WTO rules, i.e. members cannot provide specific export subsidies. The other schemes like EOU, EPCG and SEZ can also attract countervailing action against India. These charges are currently at the consultation stage after which they may be taken to dispute settlement.
China pursued the SEZ policy not explicitly to promote exports per se. It was to provide capitalist havens in an otherwise communist country. In over three decades, China managed to move almost 300 million people from rural areas to urban manufacturing clusters, including its SEZs.
India has hitherto taken refuge in a WTO exception rule, which allows it to have export subsidies so long as its per capita income is below 1,000 dollars. But faster GDP growth has ensured that India has crossed this threshold and can no longer use this to get an exception from WTO rules. The Commerce Ministry, which formulates the Foreign Trade Policy, has been aware of this, and in its statement has cautioned Indian industry to be aware that schemes like MEIS may need to be phased out to be WTO compliant.
This brings us to the topic of Special Economic Zones. This policy was thoroughly debated in Parliament for more than five years, before the SEZ Act was passed in 2005. The idea was to provide for manufacturing havens which would be exempt from most taxes and would have world class infrastructure and a very light regulatory burden. The SEZ model was inspired by China’s success, which proved to be a critical instrument in its exports-led growth.
It’s important to note that China pursued the SEZ policy not explicitly to promote exports per se. It was to provide capitalist havens in an otherwise communist country. In the SEZs, foreign investment was welcome, labour laws were flexible, most taxes were exempt and infrastructure and connectivity was on par with the best in the world. In over three decades, China managed to move almost 300 million people from rural areas to urban manufacturing clusters, including its SEZs. The initial strategy of labour intensive, low value-added manufacturing expanded employment hugely and also contributed hugely to exports. The State support for the growth of SEZs was broad based and helped industrial cluster development but was never interpreted as a specifically targeted export subsidy and hence did not run afoul of WTO rules. Of course, China joined the WTO much later, and was accorded a handicap, a non-market status until quite recently. And all these years, China has been the recipient of anti-dumping measures from many other WTO members. But their SEZ policy is not seen as WTO non-compliant.
The proliferation of India’s bilateral and regional Free Trade Agreements, like the one with ASEAN, Thailand, Korea and Japan have proved to be death-knell for fresh manufacturing investment. It is profitable for a new unit to come up in Thailand and get duty free access to India’s consumers rather than locate in an Indian SEZ and face stiff duty barriers.
The same cannot be said about India’s SEZ policy. It is explicitly aimed at promoting exports, and its tax exemptions are in fact export subsidies. However, in the past decade and more, SEZs in India is a promise largely unfulfilled. Almost 60 per cent of SEZ units are IT and IT-enabled services. They seem to have shifted to SEZs from their earlier locations simply because their 10A/10B tax benefits expired. Less than 10 per cent of operating SEZs in the country are multi-product manufacturing units. The SEZs in India were handicapped further because tax promises of the 2005 Act were broken with the introduction of MAT. Goods manufactured in SEZs face duty barriers if trying to sell in India (the so-called domestic tariff area). The proliferation of India’s bilateral and regional Free Trade Agreements, like the one with ASEAN, Thailand, Korea and Japan have proved to be death-knell for fresh manufacturing investment. It is profitable for a new unit to come up in Thailand and get duty free access to India’s consumers rather than locate in an Indian SEZ and face stiff duty barriers.
So India should use the opportunity of the US challenge and reorient its SEZ and other export-oriented policies and subsidies. The new replacement should be such so as to benefit industry clusters which cater largely to domestic markets and also incidentally can be exporters. Thus export promotion should be subsumed in a larger framework of industrial policy.
(The writer is an economist and Senior Fellow, Takshashila Institution)