Deconstructing “Import-Substitution” in India

India’s Industrial Policy stance is an intriguing one to follow over the past 30 years. In 1991, India opened itself up to international markets unprecedentedly,  marking a monumental shift from self-sufficiency and public-sector dominance to freer markets. In recent years however, ideas like import-substitution and “Atmanirbhar Bharat” have been pivotal in shaping policies like “Make-in-India” and the Production-Linked-Incentive scheme, which signify a notable change from the liberalisation reforms of 1991. Those are a lot of big words and complicated concepts, but they are indicative of India’s attitude towards trade, and its relationship to economic development. After reading this article, you should have a fundamental understanding of these terms and about India’s industrial policy-scape.

What is Industrial Policy?

Briefly, it refers to the country’s plan to achieve development, answering the question: how does the government aim to improve citizens’ income and living standards? One aspect of this is how the domestic economy can leverage international markets to boost growth and development, called Trade Policy. The core problem addressed by trade policy is: “Should goods be produced at home for consumption and export, or imported from foreign countries?”, which is what this article focuses on. 

The Story of Liberalisation: A Brief Summary

Post-Independence, Prime Minister Jawaharlal Nehru was insistent that India should be self-sufficient and not reliant on other countries to fuel its growth. This was a rationalisable overcorrection from the country’s colonial experience, during which its resources had been heavily exploited by foreign countries, and gains never reached citizens on the ground level. The policy-scape was defined by licensing and bureaucratic procedures which made it difficult for firms to enter the market, and exorbitant import duties which made international trade inefficient. These policies had resulted in little to no reduction in the poverty rate since independence, and a severe balance-of-payments crisis (India was importing way more than it was exporting, so we owed foreign countries a lot of money). 

In 1991, the economy reached a state which necessitated complete restructuring. Firstly, India started encouraging Foreign Direct Investment, allowing the inflow of technology and ideas from abroad, thus increasing efficiency and scale of production. Secondly, the slackening of licensing procedures improved the ease of doing business and reduced barriers to entry for firms. Subsequently, India experienced unprecedentedly high growth rates and record levels of poverty reduction as a result of efficiency gains from these interventions, which are termed the 1991 Liberalisation Reforms. 

One noteworthy effect was a shift in significance to exports of services, leapfrogging the manufacturing sector in this regard. India’s poor manufacturing infrastructure during 1991 is cited as the reason for this peculiar pattern, fuelled by the fact that several multinational corporations chose India to set up their call centres and software departments. Currently, India makes up 4.1% of service exports worldwide (ranked 7th by WTO) but only 1.5% of merchandise exports. 

The Indian economy continues to reap the benefits of liberalisation until today; the reforms have had an indisputable positive impact on India’s development.

Recent Changes in the Industrial Policy-scape

Despite the widespread praise for liberalisation, recent policy has reneged on that ideology. “Import-substitution” is the new fashionable term, referring to the replacement of imports by domestically produced goods. It aims to increase GDP by shifting sections of the value chain into the home country. Too many big words in that sentence? We’ve got you covered:

Suppose the value chain for Good X looks like this:

Initially, no production occurred in the home country, and the finished product was imported for straight consumption—taxes on imports were levied at point B. To achieve import-substitution, the government might tweak their policy a tiny bit: increase tariffs on the assembled, ready product (at point B) but keep the tariffs on unassembled parts at the old rate while offering other incentives for domestic producers. The foreign producer might find that it is cheaper to import the unassembled parts into the home country and assemble them there. 

But how would this shift benefit the country? There are obvious direct boosts to investment, employment and productive capacity, but proponents also cite larger issues such as self-sufficiency and structural transformation. Over-reliance on imports increases dependency on other countries: a macroeconomic shock in another economy could have catastrophic consequences on the home economy. Domestic production reduces this risk considerably. 

“Structural Transformation” in this context refers to increasing the relative importance of the manufacturing (secondary) sector. 

% of GDP	Primary	Secondary	Tertiary
1990-91	29.53	27.63	42.55
2009-10	14.64	28.27	57.09

The post-liberalisation service sector boom is visible through these numbers. Unlike some of its neighbours, India was never able to grow the manufacturing sector into an export giant, and the lack of development in these sectors led to high imports. Schemes like Make-in-India aim to address this gap in the domestic economy by incentivizing manufacturing within the country. 

The Plastics industry is a major benefactor of import-substitution: The All India Plastic Manufacturers Association (AIPMA) has been lobbying for incentives and higher import duty which would allegedly help them substitute imports worth Rs 37,500 crore over 553 plastic products. Production-linked incentives (PLI) reduce manufacturing costs and allow domestic firms to keep costs low, while higher tariffs make it difficult for imports to stay competitive. The AIPMA’s plan forecasts a significant increase in machinery as well as jobs created: import substitution may assist in the achievement of dual macroeconomic objectives in increased investment and employment. Apart from this, predicted growth for the industry is just below 300% within the next 5 years. The story thus far seems picture-perfect, but we must ask, what’s the catch?

Is Import-Substitution really all that?

This section aims to evaluate the impact of import substitution on the economy. Some larger concerns include lesser spending on welfare as a result of the diversion of budget to PLI schemes, and negative consequences for India’s reputation as a trader and international relations with foreign countries. The indirect nature of these effects makes it difficult to measure, and there is little evidence in support of these hypotheses.

A relevant line of criticism relates to the implementation and targeting of the policy. A major argument in favour of domestic production is the creation of jobs—but Make-in-India also focuses on industries that aren’t labour-intensive, limiting employment gains. Additionally, focussing on capital-intensive industries like Space, Aviation and Biotechnology means that Make-in-India is unable to leverage India’s cheap labour to maximise its effectiveness. 

Prioritising domestic production increases market power held by producers, and this power is liable to be abused. For example; Vedanta Resources, a company worth nearly 100,000 crore rupees, used import-substitution as a defence for exploiting natural resources. It is a major concern that Make-in-India may be promoting Self-sufficiency at the expense of responsible use of resources, which is unlikely to benefit the country in the long run.

A key objective of import-substitution and self-sufficiency is to create strong domestic industries which can eventually fuel export-led growth. However, results have been middling in this regard. Since 2014, the electronics industry has been a recipient of import-substitution policies. By 2019, imports in the industry had increased by almost $23.3 billion, while exports had gone up by just $1.3 billion, and no substantial exporters had established themselves. In November 2023, Electronics & Information Technology Minister Ashwini Vaishnaw said the industry is finally ready to move into export-led growth—nearly a decade into import substitution, underwhelming returns to say the least.