Free trade vs protection, and India's trade-policy journey

Detail

1. Basic ideas

• Free trade: trade between countries with no barriers at all. There are no import taxes, no limits on quantity and no licences.

• Class 10 (Globalisation and the Indian Economy) says the WTO and other powerful international organisations promote free trade. They argue that "all barriers to foreign trade and investment are harmful".

• Protectionism: a policy that shields domestic industry from foreign competition. It uses tariffs, quotas and other barriers.

• Trade barrier: a restriction set by the government to control what kinds of goods, and how much of each, come into the country (Class 10). Main types:
• Tariff: a tax on imports. It raises the price of foreign goods inside the country.
• Quota / quantitative restriction (QR): a fixed upper limit on the quantity of a good that can be imported.

• Non-tariff barriers: licences, quality standards and similar rules. Class 12 (Open Economy Macroeconomics) notes that tariffs and quotas are one reason purchasing power parity (PPP) does not hold exactly, because they stop prices from evening out across countries.

• Worked example: how a tariff protects

• An imported toy costs ₹100 at the port. A domestic toy costs ₹115 to make.
• With a 20% ad valorem tariff (a tax charged as a percentage of value), the imported toy costs ₹100 + ₹20 = ₹120.
• The domestic maker can now sell at ₹115 and still undercut the import. The consumer pays more than the ₹100 free-trade price. That extra cost is the price of protection.

2. Arguments for protection

Infant-industry argument (Alexander Hamilton 1791; Friedrich List 1841)

• A new industry has high costs at first. It has not yet reached economies of scale (the fall in cost per unit as output grows).
• Temporary protection gives it time to grow → costs fall → it can then compete with established foreign firms.
• India in the 1950s–60s: Class 10 says competition from imports "would not have allowed these industries to come up".
• Class 10 also notes that all developed countries protected their producers in the early stages of development.
• Key condition: protection must be temporary. If it never ends, the "infant" never grows up.

Strategic trade policy

• Some global industries are oligopolies (markets with only a few big sellers), such as large passenger aircraft.
• A government may use subsidies or protection to help its own firm win a bigger share of the high profits in such an industry.
• Standard example: the Airbus (EU) – Boeing (US) rivalry, with long-running WTO disputes over subsidies from both sides.

Saving foreign exchange

• Class 11 (Indian Economy 1950–1990) says planners "feared the possibility of foreign exchange being spent on import of luxury goods".
• Scarce dollars were kept for capital goods, machinery and essential items.

Protecting jobs

• Protection defends jobs in import-competing sectors (domestic industries that make goods that are also imported).
• Class 10 uses the case of Ravi, a small capacitor maker in Hosur. When import duties were cut, cheap imports took his buyers away and workers lost their jobs.

Other arguments

• National security: a country should not depend on imports for defence, energy or food.
• Anti-dumping: dumping means exporting a good at a price below its normal home-market price or below its cost. Anti-dumping duty offsets that unfair price.
• Bargaining power: tariffs can be used as a bargaining chip in trade negotiations.

3. Costs of protection

Inefficiency and poor quality

• Class 11 (Indian Economy 1950–1990) says producers had a captive market (buyers who have no other choice).
• So producers had "no incentive to improve the quality of their goods".
• The result was low-quality goods sold at high prices to consumers.

Rent-seeking

• Rent-seeking means earning income by winning favours from the government, not by producing better goods.
• Firms spent effort lobbying for licences instead of improving their products. This became known as the "permit licence raj".

Beggar-thy-neighbour policy

• One country tries to gain at its trading partners' expense, for example through high tariffs or competitive devaluation (cutting the value of its own currency to make exports cheaper).
• It invites retaliation: partners hit back, and everyone ends up worse off.
• Classic case: the US Smoot-Hawley Tariff Act (1930)
• It was signed into law on 17 June 1930. It raised already high US import duties on farm and industrial goods by about 20% [8].
• About two dozen countries put up high tariffs of their own within two years [8].
• International trade fell by about 65% between 1929 and 1934 (NCERT scaffold: "about two-thirds") [8].
• The fall in trade deepened the Great Depression. Economists estimate that most of the US welfare loss came from the retaliation, not from the Act itself [8].
• This experience is one reason the GATT (1947) was created: to lock in lower tariffs through a multilateral agreement.

4. India's journey I — import substitution (first seven Plans, 1951–90)

• Import substitution: replacing imports with goods made at home. Class 11 (Indian Economy 1950–1990) calls this an inward-looking trade strategy.
• Two tools were used:
• Tariffs, which made imports costly.

• Quotas, which fixed the quantity that could be imported.

• Export promotion (policies that encourage exports) got no serious thought "until the mid-1980s".

• Rupee-rouble trade with the USSR was a form of countertrade (goods swapped for goods).
• It was settled in non-convertible rupees (rupees that could not be freely changed into dollars), not in hard currency.

• This saved India's scarce foreign exchange.

• The overall appraisal of the planning era belongs to planning-mixed-economy.

5. India's journey II — 1991 trade liberalisation

Source: Class 11, Liberalisation, Privatisation and Globalisation: An Appraisal.

• Trade liberalisation: cutting or removing tariffs, quotas and other barriers to trade.
• The 1991 reform steps:
• Tariff cuts: peak tariff rates were above 300% (1990–91). They were brought down step by step.
• Import licensing abolished, except for hazardous and environmentally sensitive industries.
• QRs removed: quantitative restrictions on imports of manufactured consumer goods and farm products were fully removed from April 2001. This followed India's WTO obligations.

• Export duties removed, to make Indian goods more competitive abroad.

• Critique in the same chapter

• Export-oriented farm policy shifted land from food grains to cash crops.
• Less food grain was grown → food-grain prices came under pressure.

6. Trade openness today

• Formula: Trade openness = (Exports + Imports) ÷ GDP × 100
• Worked example (hypothetical numbers)
• Exports = ₹80 lakh crore; Imports = ₹90 lakh crore; GDP = ₹350 lakh crore.

• Openness = (80 + 90) ÷ 350 × 100 = 48.6%.

• India's level

• About 45–50% of GDP for goods and services trade (recent years; verify current), compared with about 15% in 1990–91 (NCERT scaffold).

• Latest export data (2024-25)

• Total exports (goods + services) reached a record US$ 824.9 billion (2024-25), up 6.01% from US$ 778.1 billion (2023-24), as reported from RBI data [6].
• Services exports were a record US$ 387.54 billion (2024-25), a rise of 13.63% [7].
• Merchandise exports were US$ 437.70 billion (2024-25) [7].
• Takeaway: services now make up almost half of India's exports.

7. Foreign Trade Policy (FTP) 2023

• It came into force on 1 April 2023, with no end date. It is updated as needed instead of being replaced every five years [2].
• Four pillars: (i) incentive to remission, (ii) export promotion through collaboration with states, districts and Indian missions abroad, (iii) ease of doing business, with lower transaction costs and e-initiatives, and (iv) emerging areas such as e-commerce exports [2][3].
• From incentives to remission
• An incentive is an extra reward for exporting. WTO rules object to export subsidies.
• Remission only refunds taxes the exporter has already paid. This is WTO-compatible, because the principle is "export goods, not taxes".
• RoDTEP (Remission of Duties and Taxes on Exported Products) refunds the central, state and local taxes and duties built into the cost of an export.
  • It has been in force since 1 January 2021 [4].
  • It was extended to steel, pharma and chemicals from 15 December 2022 [4].

• RoSCTL (Rebate of State and Central Taxes and Levies) does the same job for apparel and made-ups (finished textile items).

• Districts as Export Hubs (DEH)

• Each district identifies products with export potential, and bottlenecks are removed [2].

• 734 districts have been identified with export potential, and District Export Action Plans have been prepared for 590 districts (2025) [5].

• Export target: US$ 2 trillion by 2030 (goods + services) [2].

• Gap check: US$ 824.9 billion (2024-25) → US$ 2,000 billion (2030) means exports must roughly 2.4 times in about 5–6 years.

8. The "new protectionism" debate

• Atmanirbhar Bharat (2020): a self-reliance push that followed the COVID-19 shock.
• Calibrated tariff hikes from Budget 2018-19 onwards on electronics, toys, furniture and other goods.
• Quality Control Orders (QCOs): mandatory quality standards (see Section 4). They also act as a non-tariff barrier.
• Budget 2025-26 simplification
• It removed seven customs tariff rates for industrial goods, on top of seven rates removed in Budget 2023-24 [9].
• Only eight tariff rates remain, including 'zero' [9].
• No more than one cess or surcharge is to be applied to a good. Social Welfare Surcharge was exempted on 82 tariff lines that already carry a cess [9].

• It also addressed duty inversion: cases where inputs are taxed more than the finished product, which hurts domestic makers [9].

• The two sides

• Critics: is India going back to import substitution? Higher tariffs raise input costs, hurt export competitiveness and weaken India's bid to join global value chains.
• Supporters: this is targeted infant-industry support for electronics and semiconductors, working alongside PLI schemes. It is not a blanket 1970s-style wall.

Prelims Hooks

• Trade barrier (Class 10): a government restriction such as an import tax or quota that controls what kind and how much of a good is imported.
• Infant-industry argument: Alexander Hamilton (1791) and Friedrich List (1841). It justifies temporary protection until a new industry reaches economies of scale.
• Smoot-Hawley Tariff Act (1930, USA) → retaliation by about two dozen countries → world trade fell about 65% (1929–34). Classic beggar-thy-neighbour case.
• Complete removal of QRs on imports of manufactured consumer goods and farm products: April 2001, not 1991.
• Trade openness = (X + M) ÷ GDP. India: about 15% (1990–91) → about 45–50% now.
• FTP 2023: in force from 1 April 2023, with no sunset date. Target of US$ 2 trillion exports by 2030.
• RoDTEP in force since 1 January 2021. It refunds embedded taxes (remission), so it is WTO-compatible. RoSCTL covers apparel and made-ups.
• Budget 2025-26: seven customs tariff rates removed for industrial goods, leaving eight rates including zero.
• Trap: rupee-rouble trade was countertrade in non-convertible rupees, not a hard-currency trade.
• India's total exports reached a record US$ 824.9 billion (2024-25). Services contributed about US$ 387.5 billion.

Mains Points

• Protection is a question of timing and design, not "good vs bad"
• The infant-industry case worked where protection was temporary and linked to performance.
• Under India's import substitution, protection was open-ended. It produced a captive market, poor quality and rent-seeking (the "licence raj").

• Lesson for today's electronics and semiconductor push: protection needs sunset clauses and export targets.

• The "new protectionism" dilemma (GS-III)

• Tariff hikes and QCOs support domestic manufacturing.
• But they raise input costs, hurt downstream exporters and clash with the US$ 2 trillion export goal and with integration into global value chains.

• Budget 2025-26 tariff rationalisation and the fixes for duty inversion show a middle path.

• FTP 2023 and WTO compatibility

• The shift from incentives (for example, the old MEIS subsidy scheme) to remission (RoDTEP, RoSCTL) cuts the risk of WTO subsidy disputes.

• Districts as Export Hubs link trade policy to decentralised development and employment.

• History as a warning in an era of fragmentation

• Smoot-Hawley shows how tariff retaliation can deepen a global slump.
• With today's sanctions, tariff wars and FTAs, India must balance strategic autonomy (self-reliance in critical sectors) against openness.