India may be about to become one of the world’s most open economies

CAN ONE of the world’s most protectionist economies become one of its most open? Can a country that has consistently failed to exploit its vast pool of unskilled labour to build a strong manufacturing sector reverse that failure? The cheery answer today is: India might be about to make such a leap.

In our recent book, “A Sixth of Humanity: Independent India’s Development Odyssey”, Devesh Kapur and I posed two puzzles. First, why India, despite the cost, continued to embrace inwardness. Second, why, despite rapid economic growth since 1980, it failed to achieve structural transformation, specifically in creating a large, competitive manufacturing-based export sector. Both of these puzzles might find an answer this seismic week.

India has just negotiated the mother and father of all free-trade agreements with the European Union and America, respectively. It is likely that the latter reflected the logic of competitive liberalisation: American business anxiously realising it would be at a competitive disadvantage in India after the EU agreement. Details on the American deal are still unclear but, even allowing for slippages, the two agreements could make India a near-open economy, with protection largely restricted to agriculture, and could open up markets for its low-skilled manufacturing exports.

Consider the likely content of the two pacts. The deal with the EU will be unlike other free-trade agreements negotiated by India, which were appropriately characterised as “Swiss cheese”: ridden with exemptions and carve-outs and requiring only partial or delayed opening. Having mostly left out agriculture, which is politically sensitive on both sides, India and the EU have struck a deal that is substantially more ambitious than those previous agreements. India will have fully liberalised its manufacturing sector within seven to ten years.

The India-EU deal is also serious in another sense: implementation. Its free-trade agreements with ASEAN countries like Australia and New Zealand have been asymmetric, with India as the stronger partner, prone to interpreting commitments flexibly. Not only is the EU powerful, it has a strong, rule-of-law-imbued trade-implementing apparatus that will closely monitor India’s compliance with the agreement. As zealous as their Indian counterparts are prickly, EU officials will ensure India gets no easy let-offs.

Though many details of the deal with America are unavailable, it looks likely that India will have to reduce tariffs dramatically—with the result that in trade with both America and Europe, India’s tariffs (outside agriculture) will be unprecedentedly low. Factor in its other free-trade agreements, and India’s low-tariff regime may soon exclude only China and Latin America.

To appreciate how remarkable this is, one could look back at the long, messy history of Indian trade policy. But one could also just look back at the record of the government of Narendra Modi. It has been protectionist by conviction. For almost a decade it repudiated a quarter-century-old domestic consensus in favour of gradual liberalisation, occasionally using policy instruments that recalled the worst of India’s licence-quota raj. It has been a kneejerk nay-sayer, spreading dread through the ranks of other countries’ trade negotiators. For this government to negotiate serious free-trade agreements with two major trading partners shows a commitment to openness that goes against its deep nationalist instincts. Moreover, India is using external anchors to implement domestic reform in a way that it was loth to do in the past, unlike China, which used its accession to the World Trade Organisation to radically open up its economy.

Turn next to the market-access opportunities. For India, having failed to successfully develop its manufacturing, the rising prosperity of China, combined with broader geopolitical shifts, presented one last chance to reverse that failure. India’s share of low-skilled exports to low- and middle-income countries is 2-3%, compared with China’s 53%. If India can raise its share to double digits just as China vacates that export space, it could create tens of millions of manufacturing jobs—even allowing for advances in technology that could attenuate the gains.

That shift is already under way, reflected most notably in Apple and FoxConn deciding to relocate more of their operations to India. States such as Tamil Nadu were reaping the benefits of increased foreign direct investment. However, Donald Trump’s tariffs were a serious setback. The 50% tariffs on India hurt crucial sectors such as clothing, jewellery and fisheries. But their impact was felt more keenly as possibilities forgone: namely the flood of capital fleeing China that, because of the tariffs, is taking longer to reach India or is diverted away from it.

An entire development strategy was under threat. With the two agreements, “China Plus One”—the business strategy of supplementing Chinese suppliers with those from at least one other country—is back on the table for India. The substantial disadvantage that India suffered in the European market relative to Vietnam, Bangladesh and other poorer countries (about 10% higher tariffs) will now be redressed. The highest tariffs on labour-intensive sectors such as clothing, footwear, toys and electronics are currently the EU’s, and these will fall the most. As a result, India’s share of EU imports in these sectors, currently a measly 2-3%, should rise.

In America, tariffs on Indian exports will be around 18%. However, what matters for market access is the level of tariffs India faces relative to other countries, especially Bangladesh, Vietnam and China. And it can expect access not to be significantly worse than that of Asian countries, and better than that of China.

Many challenges lie ahead. American policies will remain unpredictable under Mr Trump. The EU’s environment-related trade restrictions, known as CBAM (for carbon border adjustment mechanism) will be irksome for India. On the other side, Indian policy can still be erratic and unnerve investors—the country allowed most of its bilateral investment treaties to lapse and has negotiated few new ones. It continues to weaponise tax administration to target investors, and self-reliance is still etched in the DNA of the Modi government.

But for now it deserves credit for recognising the stakes and negotiating these two agreements, the path to which has involved moderation of India’s self-regard, not to mention some humiliation. Along with other reforms recently implemented—to taxes, labour codes and the energy and insurance sectors—they hold the potential to transform India into a paragon of openness and a manufacturing powerhouse. Those would have been laughable propositions even a few months ago. ■