16

New Economic Policy of India

Chapter Outline

16.1 New Economic Policy

16.1.1 Apprasial of NEP
-
1991
Industrial Output
16.1.2 Impact of NEP 1991 on

16.2 Structural Adjustment Programme

were marked with the

economic development
(1950-1980)of planned
The three decades
number of PSEs had been set up where productivity
Large industries. For
stagnationof industrial development. utilization was extremely low in strategic
Capacity
was low and costs were high. licensing practices and comprehensive regulatory system w e r e
on modernization
the private sector industries, (due to restrictions
productivity
entrepreneurial growth, of up gradation
Adversely affecting the production. Absence of competition andlack for few big
the quality of Indian industries. Except
and expansion) andresponsible for the sorry plight of in In the late eightees, all
w a s dismal.
OTtechnology was of Indian industries
plight This step proved too little
ndustrial houses, the average licensing except a list of 26 industries.
were exempted
from untenable and foreign exchange
ndustries Deficit (CAD)
was becoming
and too late. Current Account c i r c u m s t a n c e s the year
1991 heralded a new

Under these
bottom.
reserves had touched the rock
in India.
era in the history of industrial policy

16.1 NEw ECONOMIC POLICY

announced the New Industrial Policy, which proved
Govternment ofIndia in the country ILWas termed as
New
On July 24,1991, the of Industrial development and
PRIVATISATION

Deginning in the history on

LIBERALISATION.
emphasis
laid special
which
onomic Policy,
 16.2
Econon
GLOBALISATION of the economy. It was in sharp contrast to the system of controls, reo
and licenses that had been in vogue for a long time. Manmohan Singh, our pres gulations
resent Pr
Minister, is regareded as the father of this policy. He wasthe Einance Minister at that time e
the
announcementofthispolicyoureconomywas.exposedtointernationalcompetition. Ind With
wAs expected to become stronger by adoptingcostsaving technology. Industries were toc
out of the veil of protectionism, that had been in practice over the decades. Come
The basic objectives of the New Industrial Policy (NIP) are as under:
(1) Abolition of Industrial Licensing: Under the licensing system, for starting a new
industr.
or for any capacity expansion, prior permission was
necessary to be obtained, NID
announced that industrial licensing would be done away with for all industrial
proiecte
except for a very short list of industries. These truncated industries produced goods of
strategic or sensitive or national interest. The number of these reserved industries
pruned to six in 1999. This category included the following industries (i) Drugs was
and
pharma chemicals, (ii) Hazardous chemicals, (ii) Explosives (including gun powder and
detonating fuses), (iv) Tobacco products, (v) Alcoholic drinks and (vi) Electronics
aerospace and defence equipment. Thus, almost the entire industrial sector was
made
completely independent of the licensing regime.
Foreign Capital and Technology: The inflow of foreign capital and inward transfer of
technology were vulnerable to various restrictions and regulations, in the pre 1991 era.
NIP announced several concessions to
encourage inflow of foreign direct investment
and inward transfer of
technology. The limit of foreign direct investment (FDI) was
raised up to 51 percent of
equity (and even up to 74 percent) for a special group of
industries which were capital intensive and ultra-modern. In the current year, FDI limit
has been raised up to 100 in
percent case of industries operating under Special Economic
Zones (SEZs). In case of transfer of
entertain such transfers
technology into India, domestic investors are free to
implying a
lump-sum-payment of Rs.1 crore or less.
(3) Smal-Scale Enterprises:
Importance of the
duly recognized in NIP-1991. These industriesdevelopment of Small Scale industries was
have been accorded high
focus on the diversification of the priority, with the
of industrialization, so that balanced
process regional
growth can be achieved. To address the credit needs of these industries, scale
have been allowed to large industries
participate up to 24 percent holding in the total equity of small
enterprises. The definition of the small scale
having investment up to Rs 5 crore is called smallenterprise
has been revised in 2006. A unit
scale unit. Further, to help these industries,
production of 35 items has been reserved exclusively, for small scale industries.
(4) Public Sector Enterprises: The
under scrutiny through supremacy of public sector enterprises was brougn
NIP. These units were éxpected to
perform better. Parameters o
'efficiency' and 'profitability' came to be applied to PSEs.
contemplated with regard to the role of PSEs in NIP-91 Following changes were
(i) Large number of
production areas, which had been reserved for the
public sector, were reduced to bare minimum. operation
three atomic areas, Now, the reserved areas were o
railways and minerals. Indirectly it was a green I for
private sector to expand its activities. siga
 16.3
NewEconomic
Policy ofIndia
Policyof

PESs. The
suggested the policy of dis-investment in non performing
IIP
realized that the non performing PSEs may be revived by gradual
(i) Novernment reali
vernment to taken serious note of the futility
State seems have
rivatization of these units. The
80
rivatizat

resources (tax payers' money) on inefficient

PSEs.
of spending precious with accountability.
to PSEs accompanied greater
(ii) NIPprovided
:lNIP provided greater autonomy that PSEs were not important
free to take any
had been complained
Often it These enterprises
(because of the prevalent red-tapeism).
operational decisions controls. It was made clear
that the
under undue administrative
had been working zero tolerance towards
'corruption'and 'inefficiency
would have
to have assets of Rs.100
government,
any enterprise proposed
MRTP Act: Earlier, the stumbling
Restructuring commission. It was
clearance from MRTP of
NIP 1991, the working
seek
crore, was
required to industrial houses. According
investment of big
or

block in the units which indulged in unfair trade practices

those
Act would
restrict only
MRTP unethical cartels, etc.
which promoted in the private
sector for
inducement to invest most
the
1991 aims at promoting considered
Industrial Policy,
are
improvements
New and productivity exclusive powers
had been
development. Efficiency or
industrial Public sector's monopoly liberalization,
was on
focuss of NIP-1991
industrial progress.
scales of the main
important industries only. Thus,
restricted to the strategic
privatization and globalization.

NEP-1991 to
imperative
16.11 Appraisal of mark policy, it
becomes

of this land discussed as

appraisal may be
unbiased Merits of the policy
In order provide the
to demerits of the policy.
merits and
discuss the probable hurdles of
time consuming
under: industrial efficiency, industry
levels of with o r made
of raising the either be done away
(1) With the
aim would
restrictions would be encouraged.
licenses and transfers
regulations, technology increased
and foreign would result in
Inflow of FDI and technology
friendly. investible
resources

the supply
of
Additions to of
liberalization
01) 5, the w a v e
and productivity. except
industrial production i n d u s t r i e s
in most
of licensing system the e c o n o m y . p r o f e s s i o n a l i s m in
abolition
(1) With the skills in boost
entrepreneurial s e c t o r would
w O u l d boost
the the public
industries for
betterment.
of for the
dynamism
usher in
of small scaleindustries.
Pruning/de-reservation
would
autonomy

andimportance
Increased
role village
about the small, tiny and
his sector.
mention
and strengthen
made a special to promote unemployment,
NIP-1991 measures
the problems like
The State would
initiate
to deal with
have large potential and
inflation.
industries, which inequalities workers, This
of workers, policy
This policy
income
the interests of
to protect the interests
egional disparities, is obliged to
protect and social
the e c o n o m i c
the c o u n t r y w e l f a r e and upgrade
A s the government of to
enhance
the
relations between the
workers
emphasis and cordial
would lay special To ensure
long-lasting

status of the
workers.
 6.
Economics-
and the management, they (workers) would participate in the management decisions of
the enterprises.

any industries reserved for public sector earlier, were dereserved in the new policy. It was
alleged that this move might cause slow down the growth of basic and key industries. Liberalizatiorn
and privatization would result in 'erony capitalism' unaccompanied with increased efficiency.
oncentration of economic power in fewer hands would perpetuate the widening gap between
haves and have nots. Liberalization of licensing might lead to regional imbalances. Enhanced
role of FDI and increased inflow of technological transfers might jeoparadize the sovereignty of
the country. Small scale industries
might not succeed to face competition.
16.1.2 Impact of NEP-1991 on Industrial Output
Since the NIP-1991.
brought a shift from licensing to liberalization; controls and restrictionsto
privatization, FDI and technology transfers of huge amounts have flown into the country. Besides,
a host
of concessions were offered in the form of custom duties, excise duties and corporation tax
However, the annual growth rate of industrial production has been volatile. It was 9.1
1994-95, percent in
13.0 percent in 1995-96, 2.7
percent in 2001-02, 11.6 percent in 2006-07 and I percent
in 2011-12. To understand these wide fluctuations we need to evaluate the
factors impact of the following
(1) Unstable Agricultural Growth Though India has lived through 64 years of planned
economic development, agriculture is still dependent on monsoons to a very large
Success or failure of industries to a extent.
great extent is linked with the sufficient and regular
supply of agricultural raw materials. Many industries in India are
cheaper and sufficient availability of raw materials from agriculture agro-based.
So, the
helps industries. As
agricultural output is vulnerable due to a number of factors, the resultant industrial
production continues to be volatile.
(2) Underdeveloped Infrastructural Facilities: Over the plan period, the total
generated has increased from 6.6 billion kwh in energ8
1950-51 to 1051.4 billion
12. Similarly, length of surfaced roads has increased by more than 11 times kwh in 2011-
over the plan
period. Still the demand for these services is much
Electric supply is not higher comparison to the supply
in
only meager but erratic also. Constantly
transport facilities a costly proposition affecting industries rising fuel prices make
finished goods and raw materials.) (the cost of transportation of
(3) Fiscal Deficit: Public
expenditure has been rising unabated
large part of this has been in the form of over the decades. Avery
unplanned and non-development expenditure.
Any government of the day spend huge amount of money on
food, fuel, power, fertilizer and
on giving subsidies(like subsidy
PDS). The amount of money spent on subsidies is
unproductive consumption expenditure. Had that been
would have increased the total spent on productive purposes,
GDP
(4) Inflationary Pressures : India has been
through the plan period, experiencing inflationary pressures almost al
investment prospects.
toleading high interest rate which is not very
As a
conducive
corollary, inadequate growth of investment affects industriai
progress.
 E c o n o m i c
Policy of India 16.5
New
concluded that with the announcement of New Economic Policy resolution in 1991,
co
t maybe
of India appears to have shifted its emphasis from public sector to private
kegovern the engine of economic growth.
t h eg o v e r n m e n t

Instead of going for indiscriminate large scale

as
Es, the government should have struck a suitable balance between public
sector

vestment from PSES,

In fact, a healthy competition between these two would have raised the
sectors.
1
d private
and rought a kind of stability to industrial growth.
productivity
levelof

ADJUSTMENT PROoGRAMME
STRUCTURAL
16.2
dominant egalitarian
role to achieve socialist aspirations of the
e t 1090 Dublic
sector played a
in like banking, insurance,
economic system. It was also given priority
Till areas
ntry under mixed
co
int
the exploitative tendency of
the private sector. The command of public
to check concentration of
transport, etc. was sought to prevent
sphere of economic activity
sector Over the expanding
economic power. in of
since 1991 with the ushering
however been a shift in the development stragegy
framework was reformulated
There has economic policy
with the Eighth Plan,
economic reforms. Starting and sector in planning development
as more responsible role to private the primacy of
a wide as well was gradually replaced by
so as to assign of the public sector
dominant role over the
economy. The had a decisive edge
ofthe those areas where its efficiency
and capability
area of its operation
the private sector in sector having
been pruned and
role of the public The role of
sector. With the heights of the economy.
public control the commanding of i n f r a s t r u c t u r a l
curtailed, it is no m o r e
supposed to redesigned as provider
has been
in the development process welfare activities,
of strategic importance,
the government
and other social
education, housing the market.
services like health, done just as well by
can be Economic
rather than producing goods
that
the implementation New of
a marked
shift with indicated
initiative on lines
in India witnessed private
Strategy planning
coordinate
of in the in the
role of the
sector would
now

1991. The public qualitative change

Folicy July in reflecting
quantitative
as well as

n the Five Year

Plans
reliance is being
government. justice. But, n o w greater from
social There is a shift
with equity and investment.

Tne tocus is still o n growth i n t e r n a t i o n a l trade and foreignfrom public sector to privatization?,
Phaced on the market
forces, liberalization',
and foreign
to (FDI)
from controls
investment
direct
competition, foreign accorded high
PTOection to globalization.
Both
promotion
has been
to
indigenization to while export been reoriented
have
Om have been
minimized,
(EXIM) policy
of the strategy
institutional invest vestment export-import feature
monetary
policy and development
is an emerging
Fiscal policy, Sustainable
rty. forces.
tate free play ofmarket and red tapism
and to
corruption
governmenti
nt to avoid
ofthe
freedom
implies owned
1. ofa s t a t e
Liberalization of the economy

investment. in those areas of production

break the deadlock of low sector to v e n t u r e sector.
enterprises to
private
ofinvolving private of trade and
vatization is the process
or partial
sale of public
of the world
with free flow
through wholly with the rest technology and
CEprise directly
services,
or economy and
domestic flow of goods
unrestricted
zrating
3. Globalization means integra facilitate
borders to
across
r s of
production
interdependence.

expertise througheconomic
16.6 conomics-I
of planning in India. It aims at achieving rapid economic growth, which is in harmony wiek
nature and environment. The process of economic growth over time results in depletion of
natural resources eroding production capacity of future generations besides environment
degradation. This strategy recognizes the need for environmental protection as an integral part
of overall development process. Further, with the environmental pollution of different types
spreading so fast, the physical and mental capacities of present andfuture generations may
deteriorate to such an extent that their work efficiency may take a dive. I his calls lor rationalizing

of the pace of growth within the realm of its sustainability.

Following are the reasons for the shift in economic policy and consequent shift in the stragegy of
planning necessitated by unprecedented economic crises.
(1) Mounting Fiscal Deficit: Fiscal deficit is the difference between the total expenditure
and total receipts (other than loans). This deficit had been mounting due to rising non.
developmental expenditure. It rose from 5.4 percent of gross domestic product (GDP) in
1981-1982 to 8.4 percent of GDP in 1990-91. The government had to take loan to meet
the growing deficit. Thus, a persistence rise in fiscal deficit resulted in rise in public debt
and interest liability. The government was thus heading towards debt trap, shaking the
confidence of even international financial institutions like World Bank. Therefore, the
government had to scale down non-development expenditure to reduce the fiscal deficit.
(2) Dismal Performance of Public Sector Undertakings: The functioning of the public
undertakings was satisfactory in the initial 15 years of economic planning. However,
later on, these enterprises started showing losses. They became a liability rather than asset
for the economy.
After the announcement of New Industrial Policy (1991), the
scope ánd area of private
sector has been expanded. Private sector consists of
proprietor firms, partnership firms,
and joint stock companies. Joint Stock
Companies may be doemstic units or multinationals
These are also known as Large scale industrial units. Private sector also includes
Micro-
Small and Medium Enterprises (MSME) and
Unorganised production units.
After 1991, private sector has been allowed to
industries also which were earlier reserved for
expand its area of operation, in those
public sector only. Government has
sanctionaed various concessions in industrial
also repealed the MRTP Act, which had been a
licensing. It the year 2002, government
great hurdle in the growth of private sector.
The New Industrial Policy in 1991 marked a
U-turn in the euphoric attitude of the
government. The announcement of this policy turned the tables on public sector. It
discarded public sector enterprises as a social-dead
shifted to the policy of disinvestment. There was weight. From then on government
clear admission
on the of
government that in future private sector would be the key component of the part strategythe
or
economic growth and developement.
articles in the Hindustan Times. "The
Narayan Murthy N.R. had remarked in one ot his
public sector and disinvestment debate mistakenty
equates common goods with public sector. The common
good must take precedence.
Remember the time when it took months to get a telephone connection
Now competition has done away with this
or a gas
connection.
problem. What is required is the existence of
multiple players and fair systems." Here we are inclined to suggest that both public and
 Policy
of
ofIndia
India
16.7
wbeononic
priva. as should co-exist as complementary to each other rather than perceiving
sectors s h o u l d

ivate alternatives to each other. Public sector must not consider its birth right to give
sector as its yournger brother.
t h e m .
as
to private
monsoon for three consecutive years, prices of
dictates
to
Prior to 1991, in spite of good
substantially. India often experienced double digit inflation. Expansion
nflation:
substa
nains
(0) grains
rose rose

for inflationary tendencies. Even deficit financing

food
foou pply
supply
was the main reason
was
the cost of production. Consequently,
wasresponsibleffor the inflationary pressures raising
money
of
cnonsible The economy was thus driven to a
both domestic a n reign demand started shrinking.
s t a t e o fs t a g l a t i o n . "
was in the trap of foreign
exhange
(BOP) Crisis: Our economy The crisis
Ralance of
Payment and insignificant exports.
developmental imports failed to
icis on
account of rising our domestic industry
crisis
as under
the policy of protectionism, failed to earn foreign
chronic international markets and thus
hecame in the had been
competitive edge on current account
senerate Deficit in balance of payment 1990-91. To
through exports. 717,367 c r o r e in
exchange from 2.214 c r o r e to market, which
since 1980-81, i n t e r n a t i o n a l money

be raised in the
continuously Further,
rising loans had to the s a m e period.
deficit, of GDP during
finance this to 23 percent from 15 percent
12 percent of GDP and interest) rose
increased from
debt servicing
(payment loan We
of w e r e thus
driven into a

of foreign s a m e period. 1990-91

the burden earnings during the of Iraq
war
account

of o u r export crisis. Gulf

crisis on from gulf
to 30 percent
remittances

exchange receive
failed to
fell to such
a
of foreign crisis. India
vicious circle bonfire ofthis
reserves

to the
exhange had to
India's foreign
further added a log
Government

In 1990-91, bill of 15 days. The

exhange. an import obligation.
countries in foreign sufficient for debt servicing
hardly its foreign condition
that India
these were
to discharge under the
level that reserves
loans only
mortgage
country's gold institutions
offered us
financial
international market.
with the global
would integrate
C H E C K Y O U R P R O G R E S S

on
Evaluate
its impact
India.
of
Economic
Policy

elements ofNew 20 years. to provide

growth
the main the last How is it
expected
DISCuss during 1991.
development
industrial of July Industrial

Industrial
Policy India? of New
New in in the
context

2. Discuss
uss the industrial
sector
privatization

to the and
nentum l i b e r a l i z a t i o n

of
3 Xamine the policy
Policy of 1991.
1991
4. Write short note on: Policy
E c o n o m i c

(SAP)
Effects ofNew Programme

Adjustment

S t r u c t u r a l

nflation.
with infla
coexists

stagnation

State in which economics

Free Trade and
17
Protection
Chapter Outline
17.1 Introduction
17.2 Free Trade
17.2.1 Some Regional Agreements
17.2.2 Some More Steps Towards Free Trade
17.3 Protection
17.4 Fallacious Trade Policy Arguements

17.1 INTRODUCTIOON

at the beginning of the century, tarifts were primarily

nineteenth
During the eighteenth and was probably the easiest existing
SEa to raise Government revenue. The taxing of imports
income. In the 1840, the teachings of the classical
neans by which Government may acquire Income taxes were introduced,
onomists started to bear fruits in their
home coumtry., England.
Corn Laws were repealed in 1846.
abolished, and the famous
Protection of agriculture was
class. The tariffs which helped
Capi and workers joined against the land-owning towards free trade and from
forces
continued its course
were abolished. England
ngish agriculture purposes) became a free-trading
nation.
1850: the First World War (for all practical tollowed England's path and
to France
and Germany,
Oth countries, especially States alone stood as a fairly protectionist
lo European 1860s. The
United
red already low tariffs in the of trade was also predominant. World trade
towards the liberalisation
uOn, though a trend
this period.
at an extremely fast rate during
o heard. There were two specific
rotectionist policy were

Soon, however, demands for a p

more
One w a s the invasion ofthe European
Continent
factors protectionism.
orS in the
1870s, which helped
 17.2 Economics-I

by cheap grain from the United States and Russia. This was made possible by railways, steamships
and innovations in agriculture. The other was the depression of 1873-79, the longestanddeepest
period of stagnant trade the world had yet known. Distressed farmers in Germany and France
started to ask for protection. At first Bismarck in Germany did not want to listentothem.But, as
the need for Government income grew, he gave in. Further, during the1850s tarits oniron and
were introduced. France also revised her trade policy in the 1890s and increased
food products
tariffs.
The period between the world wars saw a drastic increase in tariffs and other trade impediments
The 1930s especially was a
period when protectionism increased. However, since the Second
World War, the trend, especially among leading industrial nations, has been towards trade
liberalisation. Many impediments to trade have been abolished and the average level of tarifs has

fallen.
Protectionism is not always bad. The majority of the post war tariff cuts have been concentrated
on trade between developed countries (LDCs), and largely on manufactured goods. Even in that
case, there are still important non- tariff barriers to trade. The less-developed countries still face
barriers to trade with the developed world, often under the guise of 'managed trade as in textiles
and footwear".
Trade restrictions through protectionism not only distort the idea offree trade. These also hamper
competition and cause economic inefficiencies through monopolisation of activities. This chapter
discusses case for and against protectionism under global commercial policy.' It also covers some
other forms of trade restrictions such as cartels, dumping, export subsidies and strategic trade
policies.
17.2 FREE TRADE

Theproponentsof thistheoryagree in favour offree movements of goods and services across

bordersoasto.create world economy withsuch greater integrationand.competition. Under this
freetradepolicy,thereis nointerference withtrade,Such policy maximises theworldoutputof
diversegoods and services. Further, each.country is able to produce the commodity at the least
costbyapplying the principle.ofcomparativeadvantage.
In the words of Adam Smith, free trade means
"that syustemofcommercialpolicy which draws no
distinction between domesticand foreign commodities and therefore, neither imposes additional
burden, nor grants any special favour to the former". Even when duties are imposed, these should
not at all for protection under free trade.
Before 1947, every country was íree to impose any tariffs on its imports. This generally invoked
a retaliatory action by its
trading partners. In fact, the Great Depression of the 1930s saw a high
water mark of protectionism, as each country
sought to increase its employment by raising its
tariffs. The end result was lower efficiency, less trade and certainly no increase in
employment.
Since that time, lot of effort has been put into reducing trade barriers at various levels
a

several multilateral and regional agreemen through

1 The policy of the government towards international trade.

 i r F r o t e c t i o n

17.3
regional trade agreements like GATT, WTO,
and and EFTA, NAFTA, etc. have brought
in tariff barriers leading to
reduction
tariffb;
phenomenal growth of trade and greater econonic
E
a o n g nations.

m i c theory and evidence suggests that pressure should be put on countries tha
e trade. Evidence also suggests that the pressures are best
y r e s t r i c t trade.
applied using the
institution, the TO to avoid a round of mutually escalating trade barriers.
muiateral

ulated trade criticises the inabilities of governments and their subsequent failures
iea otmes exceed those ot markets.
a t times exceedi
I he tollowing arguments can be given in defence of free

2ndmake
against protectionism.
a case
ae
and Well Being from Specialisation: Self sufficiency is meant only for
Cain in Output
national interests like defence, energy, health, etc. Rest of the commodities
siected items of
to make people better off.
should be traded openly
in this way would achieve a more efficient allocation ofresources
Specialisation and trading
well being. Consequent gains from trade due to economies
with higher level of output and account of small demands.
obtained under protectionism on
of scale cannot be could
the Government under protectionism
followed by
Growth Effect: The policies class of society.
in nature causing benefits to only segment
a or

also be discriminatory There is danger of corruption

industry suffer, as a result.
a

Both consumers and unprotected stimulates economic growth.

benefits. While free trade
to corner protection The higher level of
of
real income through free trade raises the level saving.
The increased formation. in this way,
the developing
investment and capital
saving ensures higher rate of and achieve self
sustained growth. The

cOuntries can break the

'vicious circle of poverty' ot
in exchange for exports
to import capital goods increases
enables a country
opening of trade materials. Addition of capital
stock in this m a n n e r
successive
Consumer goods o r surplus
raw diffusion and
Free trade results in transfer,
the productive capacity of
the economy.
in the world.
Thus, through trade,
developed anywhere economic
mprovement in the technology accelerating the pace of
each other
tends to feed on
Ecnnological progress
subsidies bring in greater
growth. that export of
administrative
Protection especially and
Implications: the form of technical
rinancial Those in overhead costs.
G o v e r n m e n t finance. to
increased
Durden o n leading
well as efficiency lags in the
ictions
create time as
results in the emergence of monopolies
While tree
trade
costs and prices.
Protectionism

Competition:
with rising It
on inefficiency cost of
production.
causing with reduced Further,
ICeconomy in efficiency products.
thus results the quality of their choose.
Competition and
Es and to improve to
also compels them tot
be
innovative
from which
products of hostility
between
a wide range
consumers reduces the
Provides between
interdependence Trade
5) ,Inter of disputes.
economic

Country Relations: The

Counte incentives for peaceful
resolution

potential
losses from
war
and reduces

untries. It provides powerful

po d e c r e a s e s the
countries
endent
economically interdeper well as retaliation
friction as
conflict,
Kelihood of armed
 17.4 Economics-ll
17.2.1 Regional Agreements
Agreements seeking to liberalise trade over a smaller set of countries
with preferential arrangements among themselves, are called regional agreements. A number of

regional agreements emerged till GATT completely replaced by WTo. These include free
was
trade area (FTA), customs union and common market with different degrees of economic
integration.
(1) FTA: It is the least comprehensive ofthe three. It allows free trade among the member
countries, but leaves the members to impose trade restrictions on imports from non-
member countries. As a result, members have to maintain customs points at their common
borders to make sure that imports don't enter at all into the free trade area through the
member that is levying the lowest tariff on each item. They also have to agree on rules of
origins of a good. If the good originates in a member country, it should be allowed to pass
duty free across its border. If it originates in a non-member country, it should be liable to
pay duty.
(2) Customs Union: This is a free trade area plus an agreement to establish common barriers
to trade with the rest of the world. This means that members need neither customs control
on goods moving among themselves nor rules of origin because they have a common tariff
and quota against the outside world.
(3) Common Market :It is a customs union that also has free movement oflabour and capital
among its members. It has common system of taxation, laws and regulations governing
production, employment and trade with absence of special treatment by member
governments of their own domestic markets.
(4) Economic Union: It is an agreement between countries that involve not only free trade of
goods and services, free mobility of labour as well as capital within member countries,
mmon external tarifs, but also some degree of unification in monetary as well as fiscal
policies. Creation of common currency is essential to form economic union. Thus,
economic union is deeper form of economic integration.
European union has adopted
uniform policies of providing agricultural subsidies to their farmers to protect them trom
cheaper imports from developing countries and the United States
Regional trade liberalisation affects on resource reallocation, which may be studied
under two effects
(a) Trade Creation: It occurs when producers inmember country can undersell
one
toproducers in another member country because the latter lose their tariff
protection.
This leads to
specialisation occurring in new commodities and reduces costs.
Hence, it increases the welfare of the member nations. A trade
union also raises the welfare of creating customs
non-members as some of the increase in real
income spills over into increased
imports from the rest of the world. It also
stimulates flow of technical information and
innovation.

2 Euro is common currency of several European countries,

though UK has still its own currency,
Pound Sterling. Thus, European union is strongly moving to become fully integrated economic
union.
 and
P r o t e c t i o n
17.5
Trade
ne

Tade Diversion : It occurs when exporters in one member country replace

exporters as to another member as a result of preferential tariff
suppliers
foreign
union are replaced by
treatment. Here, cheaper imports from outside the customs
Irom a member country. This leads to reduction
in

more expensive imports

mor
inefficient
shift in production from efficient non-members to
welfare due to
allocation of the resources is worsoned as production
international
members. Thus,
fromthe principle of comparative advantage. In brief,
a trade
diverting
is diverted leads to both trade
union (unlike the trade creating customs union)
customs members and reduces
trade diversion. It increases the welfare of only
creation and
of the rest of the world.
the welfare

Some Regional Agreements

the regional level:

agreements at formed in
are some
Following
Free Trade
Association (EFTA was

and Other FTAs: European to join the European

FFTA, NAFTA countries that were unwilling Switzerland.
of seven European Sweden and
1960 by a group United Kingdom,
These included trade among themselves
Economic Community (EEC). all tariffs on removed
member in 1961. They
EEC-EFTA
became the EEC. This made the
Finland also agreement
with industrial goods
each country signed a FTA world. It achieved free
trade in
On
Further, in the
tariff free market on trade
in industrial goods.
market the largest to reduce
barriers Economic Area
w e r e made
few provisions to form European
in 1967 and Union (EU) services, capital
and
EFTA joined
European goods,
m o v e m e n t of
most
January 1, 1994, that allows the free
union
EEA), a customs free trade
17 member countries. and the US instituting
people among between
Canada flow of
w a s signed the worlds largest
agreement
sweeping services covering extended into
the
n 1988, a non-government
was
this agreement
all goods and
most
countries. In 1993, of the
Canada-USA

0 trade between any

two
(NAFTA)
negotiation
by
association

ternational into an
rade Agreement have also entered
North American Free New Zealand c o u n t r i e s . A group
Australia and b e t w e e n the
two
Mexico. services countries
to include and 1977 with
greement trade in goods group in
restrictions
the ASEAN tradeThailand.
on
removes
Asia have formed and
South East Singapore
COuntries in Philippines,
tor many
decades. While
FTA
like unei, Indonesia Malaysia, with
has been
experimenting alled Mercosur
have been trade area calle
America durable union in
Ountries of Latin
more customs
a became a
recent years 1991. It
in in
the earlier attempts failed,
Brazil, Paragay
and Uruguay
associate
members.

formed by Argent
entina, in 1996 as
market.
Its back to the
and Chile common origin goes
1995 and joined
joined by
Ud
Bolivia
suc es ful the only way

is by far the most

in Europe that
a strong beliet
European Union:It i time,
there was
economik
integration
among
level of
end of the WWI 1945. At that create a high block
wWII in
e c o n o m i c

was to
to create a powerful
to avoid Turther
further military conflict shilted
motivation

Later, the
s existing nation
nation states.
states. 1.ac U.S.A.
that g with Japan
and
COmpete

moden era
m the
area
(F'TA)
trade
3. EF free
important
the first
17.6
Economics-II
In 1952, first step towards economic union, France, Belgium, West
as a
Germany, Italy
Luxembourg and Holland formed the European Coal and Steel Community, which removed
trade restrictions on coal, stel and iron ore among these 6 countries. In 1957, these countries
signed the Treaty of Rome creating the EEC, which later became the European Community
(EC) and after 1993 the European Union (EU).
In 1973, the UK, Denmark and Ireland
joined the association followed by Greece in 1981
and by Spain and Portugal in 1986. Austria, Sweden and Finland
joined in 1995 after leaving
EFTA. The EU is negotiating further to admit 13 new members such as Poland,
Czeck Republic, Cyprus, etc.
Hungary, the
In the first 2 decades, the main objectives of the EEC was to eliminate internal tariff
barriers
and establish common external tariffs or to form.a customs union. Free trade in
industrial
goods, establishment of common Agricultural Policy were other important objectives. Other
signifant EEC policies such as regional aid and competition policies did exist, but were not
very successful in the initial stages.
By mid 1980s, the intended Common Market had not been achieved, because non tariff
barriers to trade and to the mobility of labour still existed. Achievement of quality standards,
meeting licensing requirements and recognition of qualifications were some other issues. So,
a new push to turn the customs union into a genuine common market began in 1985.

17.2.2 Some More Steps Towards Free Trade

Following specific steps were taken to further promote free trade.
(1) Single Market Act: It was signed in 1986 amending the Treaty of Rome.The objective of
this was to remove all remaining barriers to free flow of
goods, services and resources to
create a fully integrated single market
by the end of 1992. This act simplified administrative
procedures where most of the single market legislation needed only a weighted majority
rather than unanimity. The single market itself was to be created by a large number of
Directives, which are drafted by the European Commission, the EU's civil service. These
become community law after they have been
'adopted' by the European Council (a
committee of the heads of state or other ministers of member
states). They then have to be
ratified in the law of each member state. Once in force, these
have precedence over the
domestic laws of member states, if there is a conflict. Some border checks
have also been
removed among member countries.
Elimination of non-tariff barriers has been considered on a product
by product
Only in this way could minimum quality standards be maintained without the threat of
basis.
quality checks as a pre-requisite to entry.
The single market programme is thus an on
going process, not a discrete jump. Many
important steps were achieved by the end of1992, but the process of increasing economic
integration continues today.
(2) Single Market Financial Services: Financial markets
in
gained from singleas market
programme. Although the treaty of Rome called for free movement of capital well as
goods, this was ignored until the mid 1980s. Most member countries had exchange controls
on capital movements restricting residents of each country from investing in any other
 and Protection 17.7
Free Trade

country. The Capital Liberalisation Directive abolished controls by June 1990. All except
of its
Greece fully abolished their controls by the end of 1992. Greece abolished most
controls by 1994. The introduction of Euro'in 1999 added further impetus to globalisation.
This mutual recognition of regulatorshas been wrongly interpreted as permitting financial
rules. It
services firms to trade anywhere in the EU on the basis of their home country's
the Union by the home
simply means that a firm can be authorised to trade throughout
regulator, but the trade itself must obey the local laws in the country concerned. Allowing
home countries to regulate entry and host countries to regulate performance is a simple
of the
of the principle of national treatment that was developed in the context
application
round. It means that foreign firms get treated just
the same way as local firms.
Uruguary
trade barriers is politically tortuous.
According to Richard Baldwin, the process of reducing GDP
increases in economic efficiency and
In the long run, it would lead to considerable
of member countries.

Maastricht 1992, which pushed the process of EU integration

Treaty: It was signed in
(3) common currency-the Euro,
that came
further by including an agreement creating the and
the price system much more transparent
into being in January 1999. This made soften
also included a social chapter to
eliminated the exchange rate risk. The Treaty
markets and other social areas.
various policies with respect to labour

17.3 PROTECTION

tries to protect the interest of its producers

nation, inspite of several benefits from free trade, the
Every are created to trade.
This has been observed primarily in
and c o n s u m e r s . Hence, barriers
of the countries, of course, varying degrees,
in
nations. As a result of such policies of the
developing to differences in relative prices.
Most
according
goods are prevented from moving freely
Barriers to exports are quite
uncommon.

barriers are imposed on the imports.

as popular form of protection
in the actual practice.
Tariff is used the most common as well
as
on those commodities
which compete or are expected to
Under this form, duties are imposed tariffs
in the domestic market. In this manner,
with the home produced commodities
compete trade.
and regulating international
can be used for controlling
economics (LDCs), but are also more advanced by
Walls of tariffs are used not only by developing the following
economies with developed industries. Tariffs are used by the countries to fulfill
objectives. commodities up to
about limiting the physical quantity of certain
Quota, as the name suggest, is a direct quantity
a fixed level. Import quota
is an important trade restriction after tariffs and is
can arbitrarity Ilimit the amount of commodity to
be a
restriction strategy whereby a country
imported or exported.
The restriction of quantity is introduced through licensing system. For example, only a particular
firm or group of firms allowed to import nuclear fuel for power generation in India, with each
are
can be
having pre-determined quantity allocated by the government to be imported. This quota
allocated among several supplying countries.
Protectionism is often used to make desirable redistribution of income from one section of the
society to the other. Protection raises the profits of the domestic producers at the cost of the
 178

it denies them consumption oflou.

Economics-lI
iw ef arISuPEr Surfplus.
orsuners nar sar a

of posible by imposing high tariffs on i e dimpor.

inavme is
priced importe
gois Better redistributim
This will help in the redistribution ofincome of luxur nports
goods and iower ones on nevessities. abundant factor (under
Tom the
the ririchto
the poor. Further. as trade benetits relatively
International Trade). scane factor needs to be given protection. Finally, protection s h l Heckscher-Ohlin Model of
provided to thesvtors having potential to achieve a reasonable level of growth. be
Free trade may lead to infiur ofharmful commodities through unscrupulous merchants os
n
of international movements. Consequently, governmentssstart acting
fre count
rather
internationally. Although. people as a whole lose globally, when trade is controlled. th an
nationally
particular country gain. Even temporary drain on golad and foreign exchange reserves r ofthe
halted by controlling imports. This helps in correcting temporary balance be
of pau ents
disequilibrium.
As opposed to free trade, protectionism promotes trade restriction to safeguard the
interestof
rading countries from low prices imports. A nation may choose different
based upon several factors. These include the size of the forms of protection
country and the share in world trade. the
economiccompetence of the country's domestic producers, the quality and
product the globe based upon its nature, the areas which
across acceptance of the
need to be
policies and the amount of welfare affect that needs to be targetted from the
Free trade is difficult to establish. Its
generated, etc.

various reasons apart from the

long term survival with stability is also questionable due to
both for and against the existence complexity of the product and parties involved. There are cases
or
adoption of Protectionist
convincing. Nations keep trying to solve issue arising out of Policies, both of which look
platforms like World Trade Organisation (WTO) and such conflict of interests on global
issues redefine the
Free trade makes
people accustomed arguments.
local industries. The
to
cheaply manufactured foreign goods and thus destroy
destruction of Indian handicrafts,
imports of English textiles is a glaringparticularly cotton textiles, through free
and unrestricted
The growth of nations was a necessary condition example.
self sufficiency or self post world war. Every nation wanted to
reliance through
greater import substitution at the create
by rigorous export beginning stage rouo
promotion of both capital and consumer
One of the
biggest challenge facing ahead durable goods.
acted as a
hinderance towards swift of these economies was the level of
were able to movement of products and divergence.
easily dominate and services, as larger ecouomies
threat to smaller acquire greater show of global trade. This acted as stant
developing
policies are the only solutions economies, which kept their co ion
market. The for economies to make a space for progress delayed. These pion
arguments should hence be their pr o duct s in the
ine
I. Economic Arguments
understood in
the context of above
explanau
Following are the economic
(1) Alteration of arguments in _upport of
a large
Terms of Trade (TOT): Fof
part of worlds demand
protectionism:
countties producing and
product, terms of trade exporting hroughin
for some
impostion of tarifts and other trade
the exporting country restrictions. This down the prices
consequent upon the helps in forci
rcing oods in the
reduction in demand for
toreig
 Protection 17.9
and
Trade
Free

mestic
dom
market. However, it requires that the demand for the commodity is more elastic
this
as the increase in price is primarily borne by the producer. Practically,
than supply, which supplies
also requires
that (1) the producing country has no alternative markets to
the demand
and its factors of production have limited alternatives uses. (i)
can be diverted
imposing the tariff must be unaffected by the loss of incomne
for the exports of the country
who find their sales abroad reduced.
suffered by the countries restrictions
also help in
maintaining equilibrium in BOP by imposing
The restrictions can to growth.
But, these can raise retaliation and act impediment
as
non-essential imports.
on
relations with other countries.
also strain economic and political
They may and turning
OPEC restricted their output of oil, thus driving oil prices up
the
In 1970s, reduction in
led to drastic
their favour. While in mid 80s, an increase in oil output
TOT in
the relative price of
oil and an adverse TOT. to
demand may cause prices
fraction ofthe world's
Similarly, a country providinga
large Both these techniques
lower
TOT in its favour.
demand. This may turn share of this world
fall by restricting countries may get a larger
a small group
of tariff
world output, though their tariffs, the ensuing
However, if foreign countries retaliate by raising
output. with a lowered
income.
leave every country assessment
war can easily pursued following a
rational
have sometimes been

Although restrictive policies often than not they are used for political
objectives.
cost, more for
of the approximate and bargaining power
provide
also negotiation
The policies But, this policy arguments
Natural Monopoly: a natural monopoly.
(2) if the country is nations would also
because other
trading partners especially survival is short lived,
the fact that its
is not free from will try to develop
substitutes.
themselves and substantial gains.
want to sustain cannot offer a
affected if trading partner on its
also gets fails to exert pressure
Bargaining power monopoly, a small economy unavoidable and
existence of a are
Also e v e n after
measures
counter
c r o s s or
like
Further, factors
large trading partner.
cannot be ignored. dictate that a country
advantage might
While comparative
D i v e r s i f i c a t i o n Advantage:
the Government might prefer
(3) of
a n a r r o w range
products, of
producing could get a wider range
should specialise in The
consumers

economy. for a decline in living

of a m o r e diverse
the social advantage This would m o r e
than compensate
well as products. shock on the declining
industry.
occupations as cushion the
restrictions can also and creations of
sectors
standards. Import productive
scope for expanding
Protection policy thus provides
external economies. war when
very dangerous during
Reliance: Dependence proves substitution.
(4) Self Sufficiency/Self domestic capacity via import
off. One major goal is to create Nations want export
foreign trade is cut difficult requires complete closure of economy. be
Sufficiency, is though, to be able to
Agriculture needs to be protected for a country
based import development.
self-sufficient.
The industry first to enter the field has tremendous advantage
(5) Infant Industry Argument: well established
A newly started infant industry may
find itself unable to compete with the home
on a large scale. The guaranteed
id
big bullies competitors, already producing
17.10
Economics-I
will enable it to
get over its teething problems. Over time, it will be so strong that it can
compete on equal terms with the rest of the world. With even temporary nurturing,it will
be able to adapt inventions in the local
and match the
economy technological efficiency
typical of mature industries.
This argument is a means for raising the living standards, in static as well as
dynamic
form.
In least
developed countries, there is an advantage for production in terms of low cost due
to abundant labour
resulting in economies of scale. But, the real problem lies in
establishment of an industry even in the
lack of knowledge. Thus, nations
presence of advantage because of small size or
argue that such industries can only survive under
protection and restriction from foreign competition. This
once they are able to protection can be later removed,
compete effectively. This static form assumes that the world technology
is constant.
The dynamic form of the argument focuses on the constantly changing natureof
technology. Here also the early entrants in the field enjoy a larger
terms of
experience and advantage over others in
acquired ability. But, the expansion of these skills requires
protection of domestic industries in the
early stages of their development. Once these
countries catch up with the advanced
policy may lead to stagnancy. However,technology, protection may be removed. But, this
if a clause is added that
the industry becomes successful
in foreign markets in a
protection will be given if
may be effectively dealt with. This was the method followed specified time period, this problem
economically advanced countries like Germany, France and by and large in all the currently
English industries during the Industrial Revolution, which were to some extent the early
of imports of Indian cotton
goods.
helped by the prohibition
This argument is seen with
sketicism because of certain drawback.
survives with fuller effect for a The infant industry
developing country
onomy. Other problem like identification of an
as
compared developed industrial
to a

rather than tariff is an infant industry and provision of subsidy

important point. A Government can also
exemption, which can be beneficial. provide a or tax subsidy
(6) Learning by Doing Practice: The dynamic versions of the
supported by the reason based on learning by infant industry
doing. Skills and other
argument is
develop comparative advantage may be learned if things required to
to take
place. fact, the pattern of comparative
In enough time is allowed for the
learning
The successes of advantage can even be changed over time.
many newly industrialising
countries
Taiwan, etc. seems to be based on this (NICs) such as Brazil, Hong
that created favourable business agrement of acquired skills and Government Kong,
conditions policies
industry from foreign competition may toitsacquire them. Thus, protecting a domestic
and its labour force time to give management time to learn to be
acquire the needed skills. But, the efficient
take measures to see that such Government has to
protection does not lead to growth of weak constantly
constantly requiring protection. Identification of industries that will be industries
goods in the long run is therefore, a able to deliver the
pre-requisite for the success of this policy.
 Protection
17.11
and
Trade
Free
the first firm to
Exploration of Strategic Trade Advantage: In the case of new products, of the
If
develop and market it successfully may earn a substantial pure profit. protection firm
increase the chance that such a firm may become an established
domestic market can
market in the long run, the protection may pay off.
in the international
initial fixed
of today's high tech industries, e.g, computers, aircraft, etc. have huge
Many be room for only a few firms.
Yet
of entering a market. In such industries, there may
costs sales.
have a large volume of
these costs have to be recovered, each of the firms must
if for subsidising development
are sometimes used to provide arguments
These characteristics market with a tariff. Government
should
industries and/or protecting their home
ofsuch more broadly than what they
do now if they are not to
lose to

adopt strategic
trade policies
and North American trade partners.
the more aggressive Japanese firms
'unfair' actions by foreign
Unfair Action: To protect against
Protection Against be adopted
(8) practices like giving subsidies to the exporters may
and governments, predatory go in for price
discrimination
their price and harmdomesticproducersor These
to artificially lower international borders).
practices are then
when done across with
(called 'dumping' anti dumping duties
tariffs called countervailing and
countered as a bluffby levying
everybody losing.

. Non Economic Arguments and human

cultural, environmental
fulfill national objectives (liberty,
Countries protect trade to
and to promote
social policies.
to foster political ties
rights), equipments need to
be protected
Industries producing defense above economic
(1) Defence and Security: is important for a nation o v e r and
Internal security which can be strategically
for strategic r e a s o n s . the political will power
can dilute
loss. Excessive dependence
in the event of
war.
nationalistic
harmful, particularly for o w n goods through
also protective to
during depression protect
nations are
(2) Employment: Some are made particularly
'Swadeshi' appeals home made goods, thus,
feeling. Accordingly, e n s u r e s that
income is spent on
industries. This industry. t then spreads
our indigenous to import competing
at home and stimulus
providing employment growth
effect.
through general
to other industries
made goods, employment
actively leads to reduction
of home
(3) Social Welfare: By promotion unemployment and inequality, etc.
1S social problems
like poverty, of products may involve
to a n a r r o w range
Limiting specialisation take e.g., given the rate of
(4) Riskof Specialisation: small one, does not want to
a
risks that a country, especially product in which the country
has a comparative
advancement, the major this risk, there
technological While everyone understands
rendered obsolete very fast. that
be can do about it. Proprotection groups say
advantage may what governments
to domestic industries.
is little agreement as
by protecting
the Government c a n
diversify production GDP o v e r
Although free trade will maximise per capita
(5) Protection of Specific Groups: navehigher incomes
under protection than
some specificgroups may competition is
the whole economy, which gets monopoly power when
under free trade, e.g., a
firm or industry of NI and being better off
a tariff may end
uP earning a large share
restricted by imposing free trade.
rather than
under restricted trade
 17.12
Economics-
17.4 FALLACIOUS TRADE POLICY ARGUMENTS

Both arguments for protectionism and against protectionism have been around for a long time
but there are certain fallacies attached to both, which we shall now examine (Table 17,1).

Table 17.1: Fallacious Trade Policy Arguments

Fallacious Arguments for Free Trade Fallacious Arguments for Protectionism
(1) One argument against prot-ectionism (1) To prevent exploitation, it is necessary for
is that free trade always benefits all the weaker trading partner to protect itself
countries. This may not necessarily be tariffs
by levying or trade restrictions.
This
so. A small
group of countries who gains is based basically on the
argument that in
a
larger share of a smaller world output trade, one country can only gain at
by restricting trade may actually lose the
expense of the other.
more by moving towards free trade.
If we follow the argument of free and
mutually advantageous trade, then the
principle of comparative advantage refutes
the
argument of exploitation.
(2) Infant industries abandon
never
tariff (2) To protect against low wage foreign labour.
protection. Hence, granting protection According to this argument, the less
to infant industries is a mistake. Once
again this is valid if the infant industries developed countries (LDCs) where labour
never
grow up. If the industries do grow
is relatively cheap will be able to produce
and price its products cheaply thus driving
up and achieve the expected scale and
the producers of the industrialised nations
learning economies, the real costs of (like US and countries of European Union)
production are reduced and resources
from the market and
are freed for other
uses. pulling their living
standard down to those of its
poorer trading
partners. But, there are few fallacies in this
argument:
(1) If any one stands
lose in this set up, it is
to
not the
producers the rich nation but the
of
producers of the LDC who get a lower wage.
The consumers of the rich
nation stand to
gain by paying a lower price for the
imports
i) Gains from trade
depend on comparative
advantage, not absolute
advantage. If two
countries can
specialise in the good in which
they have a comparative
gain and advantage.both can
be better off under free
trade than
under restricted trade.
Therefore, in the
long run, trade cannot hurt a
exports pay for.
as country
(3) A thirdargument given
protectionism is that free against
trade (3) Exports raise
living standards, imports lower
maximises world income. This is valid if them. According to this argument exports
technologY and comparative create domestic income and
costs are
whereas imports create
employment,
income and
 Protection 17.13
and
Trade
Fre
If technology for foreigners. Therefore,
and
constant. employment
given
then the above statement may exports should be encouraged and imports
changes, While this
not hold true.
should be discouraged.
intuitive appeal, it is
argument has an

important to remember that living

increase in
standards improve by an
while
domestic consumption. Therefore,
domestically,
exports are goods produced
are consumed
abroad. While imports
they
and consumed
are produced abroad of
importance
domestically. The only to
permit other goods
exports is that they exchange
be imported through foreign
earned.
and reduce
To create
domestic jobs
(4) Protection is an even

unemployment. to reduce
means
ineffective
unemployment.
While it might initially
the domestic,
create more employment in
run, it
industries. In the long
protected
redistributes employment among
only efficient exporting
industries from
industries to
inefficient import competing
industries.

CHECK YOUR PROGRESS

agreements.
trading
benefits of various regional tree trade not a global
and Why
was
Analysis the
costs
protectionism.
against
2.Explain the
arugments
significance?
phenomenon ever? What is their empirical

arguments
in of protectionism? of
favour protectionism? Critically
examine

Explain the strategy

developments of the
historical
Analyses the versus
protection.

The controversy
of free trade