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manufacturing sector

How do import tariffs on cars affect competitiveness? The case of India and Pakistan

Priyam Saraf's picture

For decades, various governments around the world have used trade-distorting policies (tariff and non-tariff barriers) to support the development of local automotive industries that would not have otherwise been economically viable. However, to what extent are these policies, which once helped attract market-seeking automakers (or Original Equipment Manufacturers: OEMs), still serving the interests of these countries is uncertain.

In fact, for India and Pakistan, two of the biggest South Asian automotive producers, a recent World Bank Group report highlights that such polices might be reducing competitiveness and slowing down the spread of world-class good practices in the value chain. These effects need to considered carefully. A process of reform via gradual reduction of import tariffs and convergence with international environmental and safety standards is recommended to enhance competitiveness of this sector.

In the automotive sector, India is the world’s sixth-largest auto producer by volume, but it owns less than 1 percent of global export markets compared with more than 3 percent for China, 4.5 percent for Korea and 7 percent for Mexico. The average auto firm in India exported only 5 percent of its total sales, compared to 16 percent in China. Productivity levels in India are one-third the levels in China, and this gap persists for OEMs that are sub-scale, with below-average investment in innovation and skills, and with low participation in global value chains (GVCs). All these factors were discussed in a previous Private Sector Development blog post. The situation is worse in Pakistan, with lower levels of exports and productivity, and with similar factors driving it.

Trade policies, through tariff and non-tariff barriers, play an important role in shaping the external environment, which in turn influences a firm’s incentive to become more productive (or not). Firms facing greater competition in their product markets are inclined to raise the minimum productivity threshold to operate profitably and reduce inefficiencies. They do this both through investing in productivity-enhancing activities and through reducing costs, which in turn helps them capture greater market shares. Competition also helps reallocate resources from the less-productive to the more-productive firms, increasing the incentives for all firms to invest in the within-firm productivity levers such as innovation and skills.

What’s holding back India’s automotive sector?

Priyam Saraf's picture

For several decades, manufacturing in the automotive sector has made a strong contribution to spurring national growth, to promoting technology acquisition, and to raising incomes for workers across skill levels in developing economies as well as in developed nations. In India – the world’s sixth-largest producer of cars, where the automotive sector has been growing but at well below its tremendous potential – productivity levels would need to increase rapidly. A wave of autonomous functionality in vehicles and other technology-driven disruptions are not far away with the involvement of tech giants like Google, Tesla, and Uber. This makes the need to improve productivity in order to respond quickly to changing environments even more critical for traditional automakers. 

Some long-awaited reforms in India to improve automotive manufacturing performance came through this year. In July, the Government of India implemented a unified Goods and Services Tax (GST) regime to replace the multiple taxes that had been levied, in the past, by the state and central governments. This makes for a more integrated market, with uniformity in tax rates where automakers will be helped by easier compliance, the removal of cascading effect of taxes and the reduction of the costs of doing business. Reinforcing this, the union budget allocation in February allows for more investments in roads and highways, farm-friendly policies and income-tax reform for the middle class. Those steps will increase demand for small passenger vehicles and for the farm-equipment segment. This is all good news for the automakers in India.

Still, much more needs to be done to increase overall productivity in this job-creating and technology-rich sector. According to a recently published report by the World Bank Group, entitled “Automotive in South Asia: From Fringe to Global,” productivity (measured by value added per worker) in India’s auto sector remains less than one-third the level of China. From 1993 to 2004, the growth rate of Total Factor Productivity in China’s automotive sector was 6.1 percent per year, compared to only 1.1 percent in India. The growth rate of labor productivity was 9.8 percent per year in China, compared to 3.1 percent in India. Even though India has been increasing production of units at 11 percent to 15 percent per year (from 2005 through 2015) , it could do much better on improving productivity levels.

Rise of informality in the tradable sector-- evidence from India

Ejaz Ghani's picture
The slow growth of Indian manufacturing is a concern for many observers of the Indian economy, and India’s manufacturers have long performed below their potential. Although the country’s manufacturing exports are growing, its manufacturing sector generates just 16% of India’s Gross Domestic Product (GDP), much less than the 55% from services. Since its liberalization, India has undertaken many trade reforms to increase its global integration, and the country has invested in domestic infrastructure projects to improve its regional connectivity.