Government inaction a major hurdle for progress.
Bureau Report
WASHINGTON, DC: To advance Indian prosperity and perpetuate American prosperity, the private sectors of the two countries need to do more together, and the two governments need to be more proactive, says a report released by The Heritage Foundation.
Titled ‘Unleashing the Market in the India-U.S. Economic Relationship,’ the first part of an exhaustive multi-part project, expounds on how India, who will soon have the largest population of any country in the world, has the potential, with extensive and difficult reforms, to become the world’s most important free market -a position currently held by the United States.
The report says the role of the Indian and American national governments should largely be to allow specialization and comparative advantage to bring greater mutual prosperity. This can be done unilaterally, without diplomatic mediation. Official India-U.S. ties are not as vital as often assumed, particularly in India, where even many private actors reflexively see the central government as the chief economic player.
The report says that with the exception of Indian exports of services to the U.S., bilateral trade and investment flows remain woefully underdeveloped compared with the two countries’ combined gross domestic product (GDP) and population.
Where permitted, the Indian and U.S. private sectors have formed consequential partnerships, notably in technology services. More ventures of this type may need to sidestep Delhi and Washington.
“Entrepreneurs and companies should no longer accept the endless wait for the national governments’ green light, and instead take the initiative themselves. Much Indian economic progress has occurred despite government intervention; so economic progress must be made despite the two national governments,†says the report co-written by six experts: Laveesh Bhandari, founding Director of Indicus Analytics; Jeremy Carl, Research Fellow at the Hoover Institution; Bibek Debroy, professor of economics at the Center for Policy Research; Michelle Kaffenberger, Research Manager at InterMedia; Pravakar Sahoo, associate professor at Delhi University’ and Derek Scissors, Senior Research Fellow at The Heritage Foundation.
The report highlights the difficulties in getting consensus on free markets. It says that an important factor is sub-national governments. Individual U.S. states have differing attitudes toward India – some seeking to block Indian labor, others welcoming Indian investment. Individual Indian states see wider varieties in economic policymaking than U.S. states. Certain Indian state governments will likely be unreceptive to enhancing the India-U.S. economic relationship. Others will be far more accommodating than the central government. There will be also be an audience effect: As more open and market-oriented states thrive, they will be imitated by others.
And the report says one of the main culprits in the way of greater wealth in both countries are the two national governments, more so in India, but with a sizable U.S. contribution. The Indian central government has proven unable to implement decisive actions, and the American federal government seems unwilling. Rather than assisting reform, the unjustified deficit spending of the American federal government is a model for what India should not be doing. In addition, the U.S. has limited aspects of the bilateral economic relationship involving services and labor, while correctly insisting that India permit expansion in aspects of the relationship involving capital and information.
“The Indian central government is famously ineffective and has shown signs of predatory behavior—putting revenue ahead of what is best for the country. It has acted as a barrier in bilateral economic relations, for example in agriculture trade and financial market access. More harmful actions, such as the recent introduction of retroactive taxation of multinational corporations, discourage foreign participation in the Indian economy in general. These actions are not targeted at American firms, but chill bilateral ties nonetheless,†said the report.
Another handicap is ‘compensatory’ says the report: how individuals, companies, and sub-national governments can outweigh the effects of unwise national policies. For instance, some harmful national tax policies can be neutralized by state-level incentives. Companies can provide partners with crucial market research and information on legal requirements needed to participate successfully in local markets despite national government barriers.
The report says national governments ending their intervention in some areas, other players compensating for bad national policies elsewhere, and individuals, firms, and state governments expanding free exchange on their own will greatly improve India-U.S. economic relations and benefit hundreds of millions of people.
The movements of goods, services, capital, and labor between India and the U.S. are inadequate for two such large economies. There are also disputes about the movement of information, in the form of intellectual property. That is why India is not yet shining in The Heritage Foundation’s Index of Economic Freedom (123rd of 179 countries in the 2012 edition). (The U.S. has also dropped from a classification of “free” to one of “mostly free.”)
The cases examined in the report include two-way trade in goods and services, investment with additional focus on American investment in Indian mining, two-way labor mobility, and protection of intellectual property rights (IPR).
In trade, many Indian states are large enough to be individually valuable. They should act to offset national trade barriers while American companies should bypass Delhi to seek business relationships. In services trade, the U.S. government should accept the large and important import of services from India.
In investment, individual U.S. states should be more active in marketing to Indian companies. It would be helpful if the Indian central government were to remove various restrictions on multinational corporations. Even if that does not occur, Indian states can greatly improve their local investment climates. Mining in particular is largely a state matter in India, and American companies can assist the process by demonstrating their record in environmental protection and social remediation of mined areas.
In labor, American companies and universities should prod the federal government to roll back recent increases in visa fees and effective reduction in visa quotas, says the report. Indian firms should enhance credibility by doing a better job of self-policing, and Delhi should look at its own restrictions on foreign labor. In intellectual property, international negotiations have led to progress and enforcement is the most pressing issue. For that, Indian states are well positioned.
The report says the India-U.S. services trade is a good model for trade in goods, direct investment, and other economic activity. American services exports to India stood at $2.56 billion in 2000, while services imports were $1.89 billion. By 2010 (latest data available), American services exports to India had quadrupled to $10.3 billion, and imports had sextupled to $13.7 billion. In 2000, India was the eighth-largest destination in Asia for American services exports; in 2010 it was the fifth largest. This is a respectable performance, but not spectacular given the high Indian overall economic growth. In 2000, India was the 10th-largest source of American services imports; in 2010, it was second only to Japan. This is an outstanding economic accomplishment, it says.
American goods exports to India stood at $3.76 billion in 2001, while imports were $9.74 billion. Ten years later, American goods exports had almost sextupled to $21.6 billion, and imports had almost quadrupled to $36.2 billion. This increase appears far more impressive on paper than it is in reality. Bilateral trade in 2000 was absurdly small. While Indian GDP, for instance, is roughly the same as the combined GDP of Saudi Arabia, the Netherlands, and Taiwan, each of the three economies individually ranks ahead of India in trade with the U.S. The Indian-U.S. goods trade of $58 billion should be close to the $100 billion that is taking place between the U.S. and South Korea.
The low volume suggests that comparative advantage is being distorted by government actions; this is borne out by trade components. In 2001, exports from India to the U.S. were highly concentrated. Jewelry was by far the largest at $2.6 billion, more than one-fourth of the total by itself. The next-largest item was men’s and boy’s shirts at $500 million. In 2011, jewelry was again first at $6.5 billion, followed by oil products at $3.4 billion.
Seen in a vacuum, these numbers may appear reasonable. Seen in the context of American exports to India, they are not. Ten years ago, American exports were diversified, with only aircraft exports exceeding $250 million in value. The second-largest export was cotton, at almost $200 million. Fast forward to 2011: The volume is higher but the situation is arguably worse. The top American export to India by far is also jewelry, again, at $3.6 billion, one-sixth of the total. Fertilizers were next, followed by waste and scrap, the only other categories that exceeded $1 billion.
Agricultural products see very high Indian tariffs, with bound tariff rates averaging over 100 percent compared to, say, 36 percent for Brazil, says the report. American fruit and poultry exports are either inhibited or blocked altogether. India is now the largest arms importer in the world, and the U.S. the largest exporter. But India requires the reinvestment of 30 percent of the value of the transaction, so the best companies and products may not be selected.
On another front, still-weak patent protection in pharmaceuticals inhibits imports into India, reduces the incentive to tailor drugs for India, and disproportionately harms American firms as industry leaders. India is chronically short of electric power, yet equipment imports are restricted. Tariffs are high and firms not producing in India often cannot compete for tenders. For solar energy, an American strength, the Indian government requires joint ventures.
In health care, the action is centered on companies. For example, the American company Abbott Laboratories bought a division of the Indian company Piramal Healthcare, Ltd. Not coincidentally, Piramal now plans to invest $1 billion in the U.S. Subsidiary operations can be used to expand business despite the presence of trade restrictions, enabling the flow of goods to be determined more by market demand than by government restrictions. American and Indian companies, in health care and elsewhere, should try to ignore Delhi-Washington relations and evaluate the complimentarity between the two economies, says the report.
The report also says there is a considerable two-way investment relationship between the U.S. and India amounting to a total of over $30 billion through 2010. The U.S. is currently the fifth-largest source of foreign direct investment (FDI) in India after Mauritius, Singapore, the U.K., and Japan, and Mauritius is a transit point for investment by other nations, including the U.S.
Some restrictions on Indian investment in the U.S. actually originated in Delhi. Progress has been made here too. Indian companies are now permitted to invest up to 400 percent of their net worth in overseas joint ventures and wholly owned subsidiaries. Listed Indian companies can invest 50 percent of their net worth in portfolio investment abroad. Previously, there were tighter limits due to fear of capital outflow. There has also been a helpful increase in the ceiling for Indian mutual funds to invest overseas, from $5 billion to $7 billion. In finance, Delhi could go further and allow Indian investors to participate in overseas derivatives trade subject to a specified ceiling.
One further step would be to permit all types of investors—non-resident Indians and foreign institutional investors, among others—to invest in any asset class they choose (stocks, mutual funds, etc.). Right now, the central government steers foreign investors away from some assets, employing, among other measures, outright quotas. The investment process could be streamlined by establishing only one window for clearance of all portfolio investment and debt management and harmonizing the regulation of futures, forwards, and options. Similarly, there should be less, or no, distinction between FDI and portfolio investment, to allow investors to freely choose their preferred method.
These changes will deepen Indian capital markets, says the report. In general, the simple creation of more transparent and accessible laws and regulations would be useful to all Indian market participants, including American and other foreign investors.
Further, India seems to be going in the wrong direction. The new law on employment visas bans foreigners from accepting employment at less than $25,000 per year. Twenty-five thousand dollars is a considerable sum in India and foreigners could live well on such an amount except in Delhi, Mumbai, and a few other cities. This is a question of saving employment for a small number of elite Indians; the average Indian would not be harmed. The visa rule deprives Indian organizations of access to the global labor market and reduces the exposure of foreigners to the Indian economy, which can only hurt India in the long term.
As an illustration, the report points out that due to labor regulations, there are multiple barriers for highly qualified American physicians even simply to donate their time. This is especially strange in light of India’s demand for more extensive health care. Many of India’s top-class private hospitals cater heavily to medical tourists, who would welcome U.S. physicians on staff. If these hospitals pushed for American physicians to work more easily in India, it could greatly boost medical tourism, thus adding thousands of jobs for Indians as well.
In the US, the Stopping Trained in America Ph.D.s from Leaving the Economy (STAPLE) Act was proposed in the 112th Congress by Representative Jeff Flake (R-AZ). It would have “amend[ed] [the] Immigration and Nationality Act to authorize certain aliens who have earned a Ph.D. degree from an American institution of higher education in a field of science, technology, engineering, or mathematics to be admitted for permanent residence and to be exempted from the numerical limitations on H-1B non-immigrants.”
Regulations followed the enactment of legislation and supplemented them. India also signed the Patent Cooperation Treaty in 1998, the Paris Convention in 1998, and the Budapest Treaty in 2001, with the Madrid Protocol being considered for ratification. After the Trade Marks Act was amended in 1999, there remained no direct legal obstacles to signing the Madrid Protocol, though there may be systemic problems in actually adhering to the requirements, in trademark offices and at the state level, says the report