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.