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May 23, 2017 | 09:30 GMT

9 mins read

Trade Profile: India's Struggle to Create Jobs

(Chandan Khanna/AFP/Getty Images)
Series Introduction:

As each country tries to find the best way to thrive in the global economy, it must consider its comparative advantages. Take Brazil, for example. Like many other countries in North and South America, Brazil has an abundance of land that it exploits efficiently through large, modern farms. Japan, on the other hand, is light on land but has a wealth of capital at its disposal. And India's biggest strength is its massive — and growing — labor pool. These disparate assets help determine not only a country's economic development but also its stance on trade.

Every international trade negotiation starts out with a goal and a price. The goal is typically to open up an area of another country or bloc's economy that could benefit the nation driving the negotiations. In return, the negotiator must pay a price, often by opening a sensitive part of its economy to the other party's products. But even while pursuing its offensive interests in trade talks, a state must also consider its defensive interests — less competitive areas in its domestic economy that it must shield against foreign competitors, lest they overwhelm the sector. Defensive interests are sometimes more strategic; Japan, for example, has long protected its agricultural sector as a way to ensure its self-sufficiency in the event of a trade disruption. Either way, the industries that fall under a country's defensive interests often have outsize political influence and powerful lobby groups on their side to resist liberalization.

Global trade, meanwhile, is changing. The kinds of multilateral agreements that characterized the postwar years have stalled out over the past two decades, prompting countries and economic blocs to try to negotiate smaller deals with fewer partners. Nations and blocs have more leeway under this new model to negotiate the trade agreements that best suit their interests and to avoid those that don't. Now, more than ever, the future of international trade depends on a country or bloc's defensive interests, offensive interests and underlying factors of production. Our fortnightly Trade Profiles aim to break down these factors to facilitate an understanding of where global trade stands today and where it's headed.

In this first installment, we focus on India.

India Infographic

Economic Background

India has traditionally taken a defensive stance on trade. Its first leaders adopted a closed economic model when the country gained its independence in 1947. Wary of external influence following centuries of imperial domination, the newly minted government instated rules to prevent majority foreign ownership of Indian companies and erected formidable trade barriers. These, along with high taxes and extensive domestic regulations, restrained the market. Protected from external competition and undermined by chronic government corruption and poor infrastructure, Indian industry became deeply uncompetitive. One notable exception was the pharmaceuticals sector, in which the government's disregard for foreign patents created a nimble and innovative industry based on reverse engineering and reproducing Western goods.

Agriculture was also of high political importance, given India's closed and poor economy and its largely rural population. Domestic farmers, however, struggled to feed the country, which for a time relied on agricultural donations from the United States to avoid famine. The Green Revolution of the 1960s transformed agricultural productivity, banishing the specter of famine — but also creating a need for government subsidies to sustain the burgeoning farming industry. The farm lobby steadily amassed influence in India; Charan Singh, in fact, rose out of the camp to rule the country for a brief stint as prime minister in 1979, and huge farmers' marches characterized the 1980s. 

Then in 1991, an economic crisis in India, along with the fall of the Soviet Union, signaled an abrupt change. The government toppled tariff barriers, eased regulations, cut taxes and opened up much of the country's economy to international competition during a three-year liberalization campaign. Companies around the world entered the market in force, sending India's share of global foreign direct investment from 0.5 percent in 1992 to 2.2 percent in 1997. (The movement stopped short of a full revolution, though; extensive regulations and widespread corruption still hampered the economy, while rules limiting foreign direct investment — and investment in India's capital market — remained in place.) India has signed 84 bilateral investment treaties since 1994, a number consistent with the overall global trend.

The reforms of the 1990s cost Indian farmers some of their clout. The sectors that thrived under the country's economic liberalization were the newer industries, such as information and communication technology, that the old regulations least affected. India's relatively low labor costs and large number of English speakers made it a natural hub for business process outsourcing, and today, the country ranks fifth among the world's top services exporters (discounting trade within the European Union). Agriculture, meanwhile, lost ground in the Indian economy — it accounted for just 18 percent of the country's gross domestic product in 2014 compared with 52 percent in 1950. As agriculture declined, debt levels climbed among India's farmers. The mounting financial pressures led to high suicide rates in the sector; more than 270,000 farmers have killed themselves since the mid-1990s, causing widespread consternation. The industry, after all, is still politically relevant, since more than two-thirds of India's population lives in rural areas. To try to address the problem, Uttar Pradesh's new chief minister decided to forgive all farming loans in his state, which stand at $5.6 billion total, or 2.5 percent of India's GDP.

The liberalization did little to boost India's manufacturing industry, either. Poor infrastructure and uncompetitive labor costs relative to countries such as China, Vietnam and Bangladesh have held the sector back. Today, India's merchandise exports account for just 1.6 percent of the total trade, while its exports of information and communication technology, for instance, make up 17 percent of the total worldwide. The pharmaceuticals sector, by contrast, has continued to boom in the wake of the reforms, even if they curbed its freedom. On joining the World Trade Organization in 1995, India had to sign the Agreement on Trade-Related Aspects of Intellectual Property Rights, or TRIPS, which protected foreign patents in the industry. But since the agreement took effect in 2005, Indian pharmaceutical companies have drawn on the skills they learned in their days of replicating drugs at a lower cost to make their country the world's leading exporter of generic medications.

And remittances have also grown substantially since India liberalized its economy. The country's sizable diaspora — now the world's largest — dates back to colonial times. But as new opportunities have arisen for Indian software engineers in countries such as the United States, and capital controls have relaxed, personal remittances to India skyrocketed from $2.4 billion in 1990 to $70.4 billion in 2014. Half of the money comes from Indians working in Arab states, including the United Arab Emirates, Saudi Arabia and Kuwait.

Trade Implications

Defensive Interests

Notwithstanding the reforms that India undertook in the early 1990s, its trade policy has long centered on resisting liberalization. Antipathy toward free market competition extends to a societal level in India, and in the decades after its period of liberalization, the country largely reverted to its defensive ways. In 2001, for instance, India's staunch opposition to the lower trade barriers proposed in the WTO's Doha Development Round contributed to the negotiations' failure.

The agricultural sector is the primary focus of India's protectionism. With a mean farm size of only 1.33 hectares (about 3.3 acres), India can't compete in the global market against countries in South America, where farms average 50.7 hectares, or North America, whose farms cover 186 hectares on average. India paid out an estimated $51 billion in agricultural subsidies in 2011-12, putting it on par with Japan, though its economy is only half as large. India's applied agricultural tariffs of 32.7 percent dwarf those of its fellow BRICS — Brazil, Russia, China and South Africa, countries recognized for their rapid economic growth and potential. If New Delhi continues down this path, its refusal to reduce agricultural tariffs could keep new trade partners away. Proposed regional trade agreements such as the Regional Comprehensive Economic Partnership (RCEP), after all, emphasize tariff reduction, particularly on commodities.

Investment is also emerging as another target of India's protectionist policies. Over the past 14 years, the country has brought 21 dispute cases against investors — a sharp increase, albeit one that conforms to global trends. (State-investor disputes tripled between 2005 and 2015, though countries, and particularly developing nations, are usually the defendants in these suits.) India has lost 80 percent of its cases, prompting New Delhi to express its dissatisfaction with the process. The country went so far as to scrap 57 existing bilateral investment treaties in 2016 in hopes of renegotiating them under the new contract model it introduced the previous year. Then this year, it blocked discussion of multilateral investment facilitation at the WTO on the grounds that the measure would limit its policy options. 

New Delhi is even more eager to protect its pharmaceuticals sector, something else that could cause strife with its trade partners abroad. Many developed countries are pushing to extend the patent terms for pharmaceutical products through so-called TRIPS+ trade agreements. But because longer patent terms would cut into India's booming generics business, New Delhi will resist the initiative. The country's labor standards, too, could create problems. Recent multilateral trade agreements, such as the Trans-Pacific Partnership, have included prescribed labor standards. India, which ranks 105th on the Human Capital Index, may struggle to meet the new requirements.

Offensive Interests

Nevertheless, demographics could force India to resist its protectionist impulses. Compared with countries such as China, whose population will peak in 2028, India has a much younger demographic profile. A projected 280 million people will flood the workforce by 2050. Already, roughly 1 million people are entering India's workforce each month, a rate that far exceeds the country's job creation. In 2015, for example, India created just 135,000 new jobs. And though that year was particularly slow, even in 2009 — the best year for job growth in recent history — the country managed to add just 1.2 million positions. The situation could lead to massive unrest if India's leaders don't find a way to address it.

Other developing countries have traditionally relied on manufacturing to employ growing populations. Japan, South Korea, Taiwan and China all achieved solid export-led growth by rising gradually through the value chain from textiles to cars to advanced engineering. India, however, is in no position to follow their example. In addition to its relatively high wages and deficient infrastructure, the country has a dearth of available land, making it ill-suited to industries such as manufacturing. And the problem will only get worse as the population keeps growing. India's shortcomings aside, though, the age of manufacturing-driven economic development also seems to be reaching its end. More and more, the world is spending its disposable income on services rather than goods, while the manufacturing sector itself is yielding increasingly to automation.

Yet New Delhi has not given up on manufacturing. Prime Minister Narendra Modi's administration, in fact, has made boosting India's manufacturing industry one of its main priorities through the "Make in India" campaign. Under the initiative, the government has eased restrictions on foreign investment in the defense, railway, civil aviation, broadcasting and pharmaceuticals sectors. It has even taken some tentative steps toward liberalizing India's capital markets (although foreign financial services still face significant barriers). New Delhi has revived ambitious infrastructure projects, as well, and the Goods and Services Tax bill, introduced this year, stands to facilitate the transport of goods across state borders, once India's state legislatures approve it. The legislation could inspire the country's trade negotiators to prioritize reducing barriers to exports of manufactured goods in future talks.

The country's services sector, meanwhile, is probably India's best bet for coping with its demographic problem. The industry is hardly a silver bullet, considering that large swaths of the population are still illiterate and don't speak English. Still, strong competitiveness has created a $33 billion trade surplus in services — compared with a $126 billion trade deficit in goods — and external demand promises to increase in the future, given the global market's development. An added benefit is that services can often be performed by an Indian worker living abroad, an arrangement that would not only cut down on the number of jobs to be created domestically but could also further increase remittances.  

With these factors in mind, India has recently shifted to a more offensive stance to further open the services sector. The country has been working to make it easier for Indians to move across borders for work through its free trade agreement negotiations. Last year, it proposed a multilateral trade facilitation in services deal at the WTO (following the signing of an equivalent agreement over goods in 2013) that would, among other things, encourage relaxed visa restrictions. But in a global climate in which immigration has become a highly charged subject, particularly in the developed world, India's focus on sending its workers abroad is likely to meet some resistance from potential trading partners.

India's Trade Pacts

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