Arvind Panagariya on Free Trade and Prosperity

In this episode, Shruti speaks with Arvind Panagariya about his book, Free Trade and Prosperity: How Openness Helps Developing Countries Grow Richer and Combat Poverty. Panagariya is a professor of economics and the Jagdish Bhagwati Professor of Indian Political Economy at Columbia University. From January 2015 to August 2017, he served as the first vice chairman of the NITI Aayog, Government of India, in Prime Minister Modi’s cabinet. His primary research focuses on international trade policy, economic development and Indian political economy.

SHRUTI RAJAGOPALAN: Welcome to Ideas of India, a podcast where we examine academic ideas that can propel India forward. My name is Shruti Rajagopalan and today my guest is Arvind Panagariya, who is a professor of economics and the Jagdish Bhagwati Professor of Indian Political Economy at Columbia University. He is also a former vice chairman of the NITI Aayog. His recent book, Free Trade and Prosperity: How Openness Helps Developing Countries Grow Richer and Combat Poverty, provides the most comprehensive theoretical overview and empirical evidence between free trade and economic growth in developing countries.

I had a chance to speak with Arvind about how India transitioned from a closed economy in the ’50s to market liberalization in the last three decades. We also discuss the Indian growth story, a single domestic market within India, the difficulties in the reform process, Arvind’s intellectual influences and much more. For a full transcript of this conversation, including helpful links of all the references mentioned, click the link in the show notes or visit mercatus.org/podcasts.

Hi, Arvind. Thank you so much for coming on the show.

ARVIND PANAGARIYA: My pleasure, Shruti. Great to be with you.

India’s Pre-Liberalization Development Policy

RAJAGOPALAN: More than half of Indians living today were born after liberalization, and they never experienced the closed economy and the process of liberalization. A bulk of our podcast listeners probably fall in that age group.

Can you give us some context about how India was closed to global trade starting in the 1950s? Then the liberalization that followed in later decades—can you just walk us through some of that context since you’ve lived through it and written about it?

PANAGARIYA: Sure, Shruti. Post-independence, there was general consensus among policymakers and scholars—economists included—that as far as the developed countries were concerned, they needed more open markets. Alongside the discussions for the International Monetary Fund and the World Bank under the auspices of the Bretton Woods conference, there was a parallel process—which was, actually, separately under the auspices of the United Nations—to start a new institution called the International Trade Organization or the ITO to liberalize trade, largely among the developed countries.

It took another almost 50 years, until 1995, when the World Trade Organization came to life. In between, as a part of the discussions of the ITO, the General Agreement on Tariffs and Trade was signed off, which more or less ended up substituting for the ITO.

Under the auspices of the General Agreement on Tariffs and Trade (GATT), the United States brought the European Economic Community (as the European Union was known then), Japan, Canada and other developed countries, but really these four Quad countries, as they used to be called—they launched the liberalization process.

Now, in parallel, developing countries were participants. Some of them, including India, were original signatories of the GATT, but the view taken at the time, again, by policymakers, scholars, everybody, was that as far as the developing countries were concerned, they were just starting their development process, and they really needed some protection.

The intellectual underpinnings of that thinking was as follows. Generally, economists thought in those days in terms of a two-sector economy. One was agriculture, and the other was industry. Agriculture was sometimes more broadly described as primary products. Even if there were three, then, still, it was primary, secondary and tertiary, which would be services. The point was that these developing countries, as far as exports are concerned, have a competitive advantage in primary products. That’s what they would be exporting.

But the problem, as identified, was that primary products really cannot serve as the engine of growth, and this was rooted, in turn, in this elasticity pessimism, that both income elasticity of demand and price elasticity of demand for primary products were low. Low income elasticity meant that as the incomes rise in the industrial countries, the demand will continuously shift away from primary products—low income elasticity—towards manufacturers.

Therefore, the relative prices will move in favor of industrial products and against the primary products. If the developing countries themselves actually increased productivity in primary products, if they increased investment in primary products and tried to expand the exports of primary products, because of low price elasticity, the prices will drop dramatically.

The revenues, in turn, that they would get for yet larger volumes of exports would actually be lower than what they were getting for a smaller quantity of exports previously. It was a self-defeating thing.

Then, of course, as economists, we always try to concoct some clever arguments for why industry ought to be protected, so the infant industry argument, of course, came to the fore. “Oh, look, you are just starting industrialization, and if you really expose yourself to freer trade, then your industry will be swamped by these well-established foreign industries,” and so forth.

That was the intellectual underpinning of the processes. In the Indian case, there was an additional and perhaps a more powerful factor at work, that after independence, Prime Minister Nehru very much felt that, look, we need to be self-sufficient. For him, self-sufficiency really meant that we ought not to have to depend for our exports on the world markets and for our consumption also on the imports from the world markets. We ought to produce what we consume.

His thinking was more driven by this old nationalism, and that we have just got political freedom and if we remain economically dependent, then this is going to be a problem. That’s where it started. This kind of thinking also sat very well with Nehru’s socialism where he wanted the state to expand. His socialism was a little bit more enlightened, I would say, than subsequently Mrs. Gandhi, his daughter’s, was.

He felt that we ought to really expand the public sector through incremental investments over the years, that we increase the share of the state in the investment, and over time, more and more production activity will take place in the public sector, and that would expand the public sector. Later on, Mrs. Gandhi—when she succeeded in 1967 after Nehru had died, her socialism went much further. She tried to expand the public sector through nationalization of industries. Nehru in this sense was a little bit more enlightened.

Nevertheless, what did it mean? When you say, “Look, we’ve got to produce what we consume,” that means that if you are going to need bicycles, you not just assemble the bicycles, that you also produce the various parts of the bicycle.

Then, of course, if you are going to produce these different parts of the bicycles, you also need the machines that produce those parts, so you need to produce machines. Then, you need to also produce the steel because steel goes into the machines and the different parts of the bicycle. That, of course, meant trying to produce everything.

This whole diversification of the industry had to be so incredible, for which you really didn’t have the capital. How do you really make it all add up? Well, the way they tried to add it up was that all the capital-intensive industry is only the part where we will allow larger units, and there also we will limit the number of units so that we can get the diversification.

On the one hand, many sectors were reserved for the public sector, and in many others where private sector was allowed, they also decided that through investment licensing, we will control. And so anything that was larger than even, say, a million dollars’ worth of investment in those days, in the initial ’50s and ’60s, became subject to either monopoly of the state or licensing by this state, so you had to get a license.

Of course, everybody knew, even in the ’50s, that if you were seeking a license for a large-scale unit in apparel, or in footwear, furniture—those sorts of industries—you’ll never get it, so they knew nobody would apply, in fact. But the government will point out that, look, chemical industries are all private industry. Steel industries are private industry. They knew that licenses will be issued for those industries.

Basically, you reserved most of the available capital, which was very meager in those days anyway—the savings rate was not even 10%—and so you try to reserve that for these capital-intensive industries. Labor-intensive industries, therefore, became cottage industries. All the employment got put into these cottage industries. On the one hand, you’ve put up some industrial units in products such as steel, tires, those sorts of things—even to automobile companies we had, and then later on, scooters and so forth.

But as far as the labor-intensive industry in which India had a competitive advantage as export%—that’s what the Koreans and Taiwanese, Singaporeans all exploited, actually, in the ’60s, ’70s and ’80s, to become these real export powerhouses—were neglected in India. We simply neglected.

Now, the quality of the product in these obviously deteriorated because you stop the imports. You won’t allow the imports. There is not enough foreign exchange, so you’ll not allow imports, and you, domestically, also limited yourselves to these cottage industries, so the quality was abysmal.

I quoted in the book this one example, where Jagdish Bhagwati in the very early ’60s returned from Cambridge to India, and at that time, he was also, like everybody else, very nationalistic. He wrote to his mentor, Harry Johnson, saying, “Dear Harry, I’m really amazed how much craze of the foreign goods exists in the country. I just don’t understand why.”

Harry Johnson wrote him back saying, “Well, dear Jagdish, if the quality of the paper on which your letter is written is any indication of the quality of Indian products, then it seems to me that the craze for foreign goods among the Indians is quite rational.”

[laughter]

You couldn’t export. Also, the substantive point is that, with such poor quality, you couldn’t export, and if you couldn’t export, then you couldn’t import. So, this became a vicious circle. We all suffered. Because of this licensing business, also, you produce very little of the quantities. Automobiles were limited in quantity, scooters were limited in quantity, and so, therefore, you couldn’t just walk in and buy in a showroom this product.

For many products—cement was another one—we also created this . . . This is how the bureaucratic mind works. The supply is limited. Well, if limited supply, the price will be very high. That, of course, means very high profits for those who got the license. But then we are a socialist country. How can we allow profits to be made like that for an assured market?

The government will say, “No, no, we’re going to control the price.” Well, you control the price, that means there is excess demand below market price. If there is excess demand, you’re going to allocate the quantity.

RAJAGOPALAN: A great example of what you just described is Bajaj scooters. They went through this entire process, and I learned from my parents, who got married in the ’70s, that apparently, in those days, the number one dowry demand was a Bajaj scooter.

PANAGARIYA: [laughs]

RAJAGOPALAN: But you had a wait list of multiple years to get a firsthand Bajaj scooter, so actually the price of a secondhand Bajaj scooter in the open market was higher than the price of a brand-new, firsthand Bajaj scooter because you could get the secondhand one immediately, whereas you’d have to wait for the firsthand for another four years, and the daughter has to get married immediately.

[laughter]

RAJAGOPALAN: There were these incredible unintended consequences out of these artificial scarcities that were generated at that time.

PANAGARIYA: Absolutely.

RAJAGOPALAN: Like you described, every intervention leads to a more bizarre intervention immediately after because that’s how bureaucratic minds think. That’s how the economics of control works.

PANAGARIYA: Absolutely. I remember, actually, because the price is below market—the fixed price, official one—so you start thinking, “What criteria do I use to now allocate the limited quantity that I got?”

RAJAGOPALAN: Yes.

PANAGARIYA: One of the quotas for allocation was foreign-exchange quota for scooters. Absolutely. Again, Lambretta and Bajaj scooters both—there was a foreign exchange quota. After I came to the U.S., there would be demands from my relatives, “Please can you bring me $800?” Eight hundred dollars, when converted to rupees, got the price of the scooter. Then they could get it immediately.

[laughter]

PANAGARIYA: There was a premium, as you said—get the foreign exchange, buy the scooter at official price. There is market, so you can immediately sell it in black.

RAJAGOPALAN: Exactly. These times are incredible. I lived through it for a short period. I didn’t think of it analytically. I was too young, but even for me, through liberalization, the change in the quality of chocolates. How many more consumer goods one could buy was very quick and very stark. In the early ’90s, we saw the changes quite quickly.

Even to kids, it was apparent that something is different when you go to the store because you got Amul and Cadbury chocolate, and now you have KitKat and four other kinds of chocolate. For me, as a child, that’s my first interaction with liberalization in one sense. You can drink Coca Cola and things like that. If Michael Jackson has Pepsi in his hand, now I can also drink Pepsi. For me, that’s the miracle of liberalization, where previously I remember a time when I couldn’t.

PANAGARIYA: That is a very interesting perspective.

When and How Did India Liberalize?

RAJAGOPALAN: When did India liberalize and how did it happen? We usually pick 1991 as the big date, but as you’ve described in multiple books, there have been moments when there has been delicensing. There has been some openness to trade in bits and pieces, not wholesale. Can you just walk us through that?

PANAGARIYA: Yes, good. By the late ’70s, the growth rate really had plummeted and all. At least the first 13, 14 years, you were getting a growth rate of, on average, about 4.5% or so. I came into the U.S., I left in 1974, September, and if I take the 10-year period preceding it, the growth rate was hardly—particularly when you look at per capita income growth rate—it was so low that you didn’t see . . . In the 10 years, I saw no kind of improvement in the living standards.

By the late ’70s, even to some, at least, enlightened bureaucrats, it began to look like things had gone too far. There is an interesting book by an Indian bureaucrat from somewhere in the mid-1980s, I can’t off the top of my head remember his name. He wrote, “Look, nobody wanted to admit that this whole thing was a mistake, particularly in the political class, and therefore there was no real policy shift, but within the existing policy framework, could we make some changes?” So those changes began to be made.

Now, it got held by one important development, which was the oil crisis. There were a lot of Indians who went to work in the Middle East, and they started sending some modest remittances. That began to ease up a little bit the foreign exchange situation. As you know, we had foreign exchange control, so all exchange, of course, had to flow through the Reserve Bank of India and all.

That was one factor which made it a little bit possible that we got a little bit more cushion in terms of the availability of the foreign exchange. In addition, pressures also started coming from the industry. Whatever little bit of industry got set up at the time, the industrialists began to push. “Look, we got the capacity to produce, but we don’t have the inputs that we need to produce, so please allow the inputs to come in.”

Some reform happened beginning in the late 1970s. Look, let us begin to allow at least some of the critical inputs that we don’t produce domestically at all. There was this idea of open general licensing that was introduced, that anything that you put on the open general licensing list will not require an import license, although you still required the permission for foreign exchange, so exchange control still. You still had to get the justification that foreign exchange is made available, but it became a little more liberal.

What they did in the 1980s was to expand this list gradually, and by the late 1980s, the list had been expanded quite a bit. In the second half of the 1980s, when Rajiv Gandhi became prime minister, actually, some of the delicensing of investment, but easing up of investment licensing also had begun to happen, and there was an idea introduced called broad banding—if you were given license to produce, let’s say, spoons, and you also wanted to use some of that capacity to produce some knives or forks, then you could do that.

You can see how tight this licensing was, that it will specify exactly. You couldn’t even produce related products without permission. This is broad banding. If you tell the Americans here about broad banding, they say, “What are you talking about? Shouldn’t they be producing all three in the first place?”

[laughter]

When Rajiv Gandhi became prime minister, he was clearly very liberal-minded, and some of the noises he made were absolutely fantastic. Although his big steps really were taken in the first two years, and then he really got captured by the protectionist lobbies again. But some of that happened, and he was big on the information technology industry, so some imports of computers, et cetera, were also eased up a little bit.

What also happened—the Reserve Bank got a very enlightened governor. This was Mr. Malhotra. What he did was, he recognized that there had been gross overvaluation of the rupee, which was hurting India’s performance on exports. He kept this fiction that we’re pegged to a basket of exchange rates. The political problem was such that you couldn’t openly say that we’re going to let rupee float. He said, “Well, it’s pegged to a basket of currencies.”

Then the exchange rate can move depending on how the basket moves, but actually, if you look back, there is no way the basket of currencies was not moving enough to cause the kind of depreciation that happened in the second half of the 1980s, and that helped big time. If you look at the last three years, actually, of the 1980s—’88–’89, ’89–’90 and maybe ’90–’91—those three years, particularly ’88–’89, growth rate was almost 10% or something, some bizarrely high growth rate, which we never had seen.

The average was over 7% for those last three years, and that was held quite a bit. Then they also introduced some East Asian–style export incentives. While imports were not so much . . . Well, some liberalization imports were happening through the continuous expansion of the open general licensing list, but then they also started giving export incentives that if you exported, you’ll be given foreign exchange. Part of it you could keep and use for other imports.

Of course, because there was a huge premium still, even though some depreciation of the rupee happened, there still remained a very large premium because the rupee still—the old valuation was so much that even after depreciation, it remained overvalued, and so those are the things. You got a bit of liberalization, and you also got some return on it, so if you look at the 1980s, growth rate did shift a bit, particularly the last three years that I mentioned—7%.

When you combine those years, then you easily get more than 5%, something between 5% and 6% over the ’80s. That was the early kind of liberalization.

1991 Reforms

RAJAGOPALAN: Then in ’91 we, of course, had the big dismantling of a number of tariffs and also industrial licensing in a big way.

PANAGARIYA: Yes, 1991 was, of course, a complete change of the framework. I think here, the political economy is very important. One thing I’ve already pointed out, that internally, this realization was progressively happening, that this system that we’ve adopted of these strict controls is not working. That was helping, and there were some enlightened bureaucrats who very much were wanting liberalization to happen.

Actually, external events were very important in changing the thinking, particularly the political level. One was that the Soviet Union, after which we had chosen all the planning system under Nehru, and then that continued under Indira Gandhi and all, all the way till very recently, until Prime Minister Modi actually decided to replace the planning commission by the NITI Aayog. Once the Soviet Union collapsed, I think that was a big jolt to the planners that something was not right about the planning system.

The second thing that happened was that there were only a handful, like Jagdish Bhagwati, T. N. Srinivasan—very, very few people who would make the case for liberalization in an unreserved way, but they never got any traction because you cite the example of Singapore or Hong Kong, and they say, “Oh, they’re just single cities. They’re irrelevant. What does it matter?”

Even if you cite them South Korea, which was a somewhat larger country, and Taiwan, which was not as large as Korea but still larger than the city-states, still it would be “Oh, they’re too small to be relevant for us.”

But then China in the late 1970s liberalized. They liberalized under Xiaoping, and 1980s, China grew 10% a year. Of course, you know, China was in population bigger than India, so [laughs] if there is a country which is bigger than you and, at that, a communist country—when that happens, you can’t sustain the argument that these other countries are too small to be relevant for us. China was clearly relevant to India.

The South Korean Growth Miracle

RAJAGOPALAN: I’m surprised by this because if you look at South Korea’s trajectory post–World War II—I think South Korea was the second-poorest country or something like that. They had no real natural resources, no minerals. It was a country entirely propped up by American aid in one sense, right? And The transformation of South Korea from basically one of the poorest places in the world with no opportunity to a properly developed country—even during COVID, we see how South Korea has handled it better than the United States, right. Better than the United Kingdom. The kind of trajectory South Korea had over, say, 30 or 40 years is better than what some countries, like the U.K. and U.S., had over 200 years. Why do you think that experience is marginalized so much in the trade and development literature? To me, South Korea’s probably the greatest success story we’ve ever had.

PANAGARIYA: Absolutely. I couldn’t agree more with you. I sometimes lament that even South Koreans are not very comfortable talking about Park Chung Hee, who was really the maker of modern South Korea, because he was authoritarian and so forth. So subsequently, he doesn’t occupy the same place in South Korea that Lee Kuan Yew does in Singapore, but if one thinks about it, really, in some way, South Korea’s achievement was even bigger for the reasons you mentioned that—it was completely devastated.

The civil war between North and South Korea—you’ll come to 1954. They’d lost a million people in that civil war, and devastation economically was just complete. To rise up from that is absolutely phenomenal. Now, that was not all Park Chung-hee, because Park Chung-hee comes in 1963, but if no Park Chung-hee, of course, no South Korea story, no question.

RAJAGOPALAN: In this South Korean story, how much of it is free trade and prosperity, and how much of it is industrial policy? Because this is one constant source of discussion between trade economists and development economists. How much is trade part, or outward embracing of global markets part, of the success story of South Korea?

PANAGARIYA: Shruti, in this, I must say that the proponents of this industrial policy school have so obscured the reality of South Korea, and I must say that a lot of the people on the side of free trade advocacy have not done a great job, actually, on defending. Often, they give in, “Yeah, yeah, yeah,” you know. This is what I separate out, when does Korea start? About 1963 is the turning point. This starts with liberalizing the economy, and 1963 to 1973 there is no industrial targeting.

Even when I started looking at all the evidence, I came in thinking that Korea was doing some industrial targeting all through. Then from ’63 to ’73, I see no industrial targeting. I was a bit puzzled. This is while writing this book, actually. I wanted to be 100% sure. I had worked in the summers during my graduate work at the World Bank with Larry Westphal.

Now, not many people know who Larry Westphal is today, but Larry Westphal was the first American, actually, to study South Korea very, very closely, and he was no kind of free trader. He, in fact, firmly believed in infant industry targeting or protection, but he was much more nuanced, and also a very honest scholar. I wrote to him because he had written in the Journal of Economic Perspectives in 1993, or somewhere there—early 1990s—the Korea story.

I knew Larry because I’d worked in the summer with him, so I wrote to him. He had then moved to Swarthmore College [Westphal died in November 2020], and I said, “I don’t see anything going on.” He said, “You’re absolutely right.” That only some of the petrochemicals and fertilizer complex that they tried to promote, because of the obvious reasons that every country does fertilizer for agriculture and petroleum for energy security, but other than that, he said the incentives regime was completely neutral across products.

That shows up in some of the products that they exported because early 1960s, you look in the data. There is one product, which is hardly present. It’s absent actually, it’s zero, and by the ’70s, 10% of the exports are coming from this one single product, and nobody would ever guess what it was. It was the human hair. [laughs] The Koreans were exporting very large volumes of wigs to the Americans. How could they be targeting? To begin with, there was nothing of that product being exported.

The incentives regime is completely neutral during ’63 to ’73. What is the growth rate? 9.5%. There is zero targeting at this time. By early ’70s, a bunch of things happened. The Americans decided that they were going to cut back quite a bit on their military presence in Korea, and that meant that a lot of the expenditures they were doing will no longer be there. Also, there were some pressures beginning to double up in the US against some of the exports of the Koreans. Korea was exporting a lot of steel to the United States.

Some protectionist sentiment was boiling in the United States against Korean exports and all. They felt that they needed to do something, so then some industrial targeting started, but if you look at the next decade, 1974 to 1984, growth rate dips to below 7%.

Whatever then appears, you can look up because again, actually, by early ’80s, Korea had already turned around, even probably late 1970s. That’s six, seven years during this some targeting happened, during which growth rate was not 9.5%. It was at least two percentage points or three percentage points below.

RAJAGOPALAN: So, it was despite industrial licensing and targeting that Korea managed to do so well because of its trade policy.

PANAGARIYA: Absolutely, yes.

Some people like Ha-Joon Chang, et cetera, really tried to make their case by saying, “Oh, look, we protected the auto industry, and it is such a successful industry today.” This is a post hoc fallacy. Post hoc ergo propter hoc, whatever you say. “After this, therefore, because of this.” But I’ve never understood—just because you did something before, and eventually some industry succeeds, that doesn’t mean anything, and moreover, what about the ones that failed?

I don’t have it in the book but actually, Anne Krueger pointed out to me that they put up this very, very large ball-bearing factory in S. Korea, and it was so inefficient, there was no way it could compete on the global marketplace. And it was so large that the S. Korean market was not large enough to consume it, so it became a white elephant and eventually had to be closed down. Nobody remembers it. Only successes are remembered. Failures are gone. That also gives a bit of a bias to this.

This debate happened, by the way, between Ian Little and Robert Wade. Robert Wade was saying that Korea grew pretty well with this industrial policy, and to say that without industrial policy, it would have grown even faster is far less credible than the opposite, to which Ian Little replied, “Well, Taiwan actually intervened less and did grow faster than South Korea, so why does Mr. Wade think that S. Korea would not have grown faster with less interventions?” [laughs]

Industrial Policy in India

RAJAGOPALAN: I want to ask you about the industrial policy interventions in India specifically. Most people are familiar with the License-Permit-Raj erstwhile, and a lot of it still remains. We might have dismantled the licensing system in large parts, but the Permit Raj in India, in some sense, is still alive, like to sell land, to get change of land use certificates, to hire labor, to fire labor, to change the task of labor.

Even now, we need permissions for so many things, especially in factor markets, which are inputs for virtually every kind of manufacturing.

Now, coming to this License-Permit-Raj bit, if you think about international trade and tariffs specifically, tariffs are a tax on foreign producers, right? The logic is that if we impose tariffs, then we tax the foreign producer and, therefore, incentivize or benefit, relatively, the domestic producer. Now, industrial licensing and Permit Raj in India does the exact opposite. It taxes the domestic producer.

In some sense, even after we have reduced tariffs and we’ve allowed foreign producers, our domestic manufacturer is not able to compete in the global markets in the same way that you saw in, say, South Korea, when they opened up to the rest of the world. What do you make of this argument, and how does one solve for it?

PANAGARIYA: There is a concrete example of what you’re saying from India. You remember that we spoke earlier about how all the labor-intensive products were left for cottage industry. In 1969, Prime Minister Indira Gandhi actually formalized that into a policy. She created this list in the industrial policy called small-scale industries list, and that list will carry products which were allowed to be produced only on small-scale industry basis. Therefore, what was basically a policy anyway, even under Nehru, became formalized that these products are to be produced, are to be reserved only for small-scale manufacturers.

Now what happens? In ’91, we launched our reforms, and all licensing was gone on only capital goods and intermediate inputs. Final goods, consumer goods were still not liberalized. Come 2001, the US challenged us for that in the WTO, won the case, and 2001, we had to liberalize everything. All import licensing had to be given up.

Now, whatever was under small-scale industries reservation could be imported from abroad. Those guys who were producing on large scale—Chinese had no small-scale industries reservation. Only we had it. What we said, “Oh, foreign guys who were producing it can produce on large scale, but my own manufacturers cannot produce on large scale.”

It was a crazy situation. Even then we took a long time to completely eliminate the small-scale industries reservation list. The last 20 items actually went out under Prime Minister Modi. [laughs]

The question you’re raising is, why was there no pressure from the domestic industry? The answer really is simple, that those who were producing these things were producing in small scale. They had no interest in a large scale they didn’t want, and probably, the quality of the product domestically produced was low enough that there were no perfect substitutes for what was being imported. What was being imported was higher quality, but probably also higher price.

Also, by the way, there was some tariff protection, like on clothing. Clothing large-scale manufacturers did start coming, and some imports did occur, but this was subject to very high tariffs. That protection also kicked in. The really sorry state of India today is that with these 50-plus years of small-scale manufacturing, of all the products in which India has a potentially competitive advantage because of this massive workforce.

Industry mindset also has become such that none of the large industrialists wants to do it. They have become very hardwired to manufacturing information technology products, to doing pharmaceuticals, to doing machinery products, to doing petroleum refining—you name it—auto parts. They want to do all this, but making shoes, stitching clothes—no, that’s not for us. I sometimes say that there’s a Brahminical attitude of the Indian industrialists.

RAJAGOPALAN: Do you think that’s because the margins in some of those goods are so small, you have to be so competitive, and there’s something about the Indian production system which doesn’t allow that, either because of the labor regime or the difficulties in acquiring land or infrastructure? Most importantly, the domestic transport costs are so high in India, by the time you get some of these things to the ports, you might lose all your competitive margin.

In one sense, you’re right, there might be some elitism and some preference explanation, but I think there also has to be some cost explanation. Bangladesh is able to do this, and they also have a thriving elitism and caste system. Very South Asian, they’re exactly like us, but they’re able to compete so well in garments and footwear in a way that we are absolutely not able to do at all. We are completely paralyzed.

PANAGARIYA: Yes, Shruti, all very good points, actually. But first, very quickly on Bangladesh—of course, they don’t have that history of small-scale industries reservation. That’s very different.

RAJAGOPALAN: They don’t.

PANAGARIYA: They also let the Korean manufacturers actually come into Bangladesh early on. Foreign investors also catalyzed some of the domestic industry. A little different history made a big difference. And they did not have to deal with this socialism in the way we had to, whereby these Bombay mills—remember 1980s, Datta Samant, these massive strikes. All that is in the heads of the industrialists—that was my theory of the industrialist.

All the points you make are extremely important, very good ones. I agree with you that a lot needs to be done to make this labor-intensive industry tick in India. However, is it not incumbent upon the industry associations? Forget, I don’t expect individual industrialists to come and say, do this or do that, because industrialists say, “Well, these are my rules. I’ll do what is most profitable for me.” That’s what they do, fair enough.

Industry associations, FICCI, so Federation of Indian Chambers of Commerce and Industry, CII, the Confederation of Indian Industry—as associations, do they not have some obligation to come in and say, “Look, government, do 1, 2, 3, 4, 5, 6, 7, 8, 9, 10—these 10 things—and then I assure you that I’ve got a lot of these industrialists waiting who would just jump into these industries, create these great jobs for a very large number of workers.” You’ve never seen that happen.

RAJAGOPALAN: Yes. They’ve become complete rent-seeking chambers. In one sense, they are only lobbying for protectionism, and they’re only lobbying to make sure that the people who’ve already gotten on the bus, already in this entrepreneurial class, can preserve their rents, in some sense, and keep the competition out.

PANAGARIYA: Exactly. This is the comfort level. At the end of the day, then, who is left to make this push for reforms? It’s yours truly. You know what I mean, meaning some people, very few people who actually play for reforms in India.

Why Isn’t Free Trade More Popular as a Policy?

RAJAGOPALAN: On the reform question, I want to take two steps back, and this is really inspired from your book. When one reads your book, you explain very clearly that you are telling us something that has been a truth for more than 250 years.

You start with Adam Smith. You talk about the contributions of Ricardo and comparative advantage, of Henry George or Frédéric Bastiat, all these great economists who have consistently talked about gains from trade, how the wealth of nations comes from gains from trade, and how protectionism is just a terrible idea. They’ve dismantled all this infant industries argument. Frédéric Bastiat, of course, wrote great satirical pieces of how the candlemakers are petitioning the government to save them from competition that comes from the sun.

You walk us through this incredible history of thought, which is really rich. Even despite having this huge body of work, and now your book, which is showing all the contemporary studies, somehow this is not intuitive, that free trade and prosperity are so closely linked. It has just not penetrated the traditional zero-sum way of thinking.

Where do you see that in India, since you’ve also been in policy and also been in the academy? Is it with the bureaucrats? Is it the political class? Is it the rent-seeking lobby which is propagating these myths? Is it the average citizen who has no understanding of economics? Why are these truths not self-evident?

PANAGARIYA: First, I would put a slightly different lens on what the reality is, and I think, all said and done, we have scored lots of victories. I think the markets today are way, way more open than at any point in history, developing and developed. If you start post early to mid-1990s, even the developing countries have opened up in a big way. Nobody has the kinds of tariffs and protection that India had in 1991. Nobody.

At least, I don’t know of any. They may exist. There may be some tiny, small country which may have that, but not to my knowledge. We have most certainly scored a huge amount of victory. I want to be, in that sense, a bit optimistic. Let’s not lose sight of that victory.

RAJAGOPALAN: Fair enough.

PANAGARIYA: Nevertheless, there is no doubt that the protectionist forces keep asserting themselves. I think this was either at a presentation or somewhere, I remember Paul Samuelson once saying, “Fighting protectionism is like fighting the skin disease. You fight it in one place, and it appears in another place.” [laughs] It is like that.

You remember we earlier talked about the Korean industrial targeting and so forth. Import substitution in the early ’70s to late ’70s, that six-, seven-year period. How did that happen? I think what happens is . . . I’m speaking a bit more anecdotally, but it seems to me that once you liberalize, you succeed, your exports expand dramatically—happened to Korea—and, of course, the whole purpose of expanding exports is to expand imports.

Most people don’t think of it this way, but the fact is that if you are not getting anything in return, there’ll be no purpose to exporting. You may as well take these goods and throw into the harbor. You have exported, but you didn’t want any imports in return. Why are you getting out of shape? Well, the point is that you are exporting to somebody so that you get foreign exchange in return, which you can use to import something, so imports also expand.

By this time, the exports are almost close to 30% in South Korea in the early ’70s. Imports are even more because there is actually a trade deficit. Imports are even more.

RAJAGOPALAN: The incredible thing that I noticed in the book—when you talk about as exports increase, imports also increase—is that very often, they are exporting and importing the same class of goods, doing different varieties. The kind of steel they are producing in South Korea is different from the kind of steel they are importing in South Korea, but they’re doing both simultaneously, probably because you need a particular kind of steel as an input for some other industry, which is now an export, right?

PANAGARIYA: Absolutely. This is the [Paul] Krugman style of specialization and variety, particularly if you’re a smaller economy. Then you want to specialize in a handful of varieties which you also export. If you are really good at it, then you also export those varieties and import the rest.

That’s absolutely very true, but now what happens, Shruti, in the Korean cases—I think that when you then see that 30% to 35% of my goods are being imported, then some “smart” bureaucrat or policymaker, politician begins to think, “Why am I importing this? I should produce it at home.”

That is what is happening today in India. Very same thing. India—if you look at it in ’91, imports are only 10% of the GDP. By 2012–13, they’ve gone to something like 30%. They begin to see that, and somehow, they don’t connect. This is the hardest part that I find, in actual policy interactions, to explain, “Look, you restrict imports, your exports will automatically go on the side. It’s a given.”

That is not seen. They think that I can continue to export what I am exporting, but I can cut the imports and produce it domestically, so my GDP would rise and I’ll create more jobs.

RAJAGOPALAN: But it’s actually the other way around because you can import it cheap, which means your exports are more competitive. This is classically like India’s current pharmaceutical industries. We are huge exporters of generic pharmaceuticals, but we are huge importers of the chemicals that are required to produce the generic pharmaceuticals. So without the import, there’s no export.

Now, do you think this misunderstanding comes from this two-country, two-good, stupid economic models, or do you think it comes from some other kind of thinking—economic nationalism or something like patriotism, self-sufficiency? What’s the root cause of this misunderstanding? Have economists messed things up by making these abstract models?

PANAGARIYA: No, I think the economists—they’ve not done enough to push the idea that openness is what leads to success in the countries. Whereas the evidence is there, it’s not read by everybody. That’s part of the problem. The other part of the problem is that, of course, in our profession, we’ve got some very powerful voices which say, “No, some bit of import substitution is good.”

We’ve got my colleague here, Joe Stiglitz. We’ve got Dani Rodrik. Not many, but certainly a few very, I must say, strong, powerful voices. They provide the intellectual support to the policymakers, who then love to quote these economists, saying, “Look this is what Professor Rodrik of Harvard or Professor Stiglitz of Columbia University and Nobel laureate says,” and so forth.

That makes it a little harder, but on the other side also, the economists who believe that free trade has been good have not done enough to push the ideas in the public domain. Bastiat, 170 years ago, already said it’s much easier for the politicians to see, “Look, if I protect, then output goes up. I can see that if I protect steel, steel output goes up.”

RAJAGOPALAN: But at what cost? That’s the unseen effect.

PANAGARIYA: At what cost that’s unseen? Yes. In the end, exports will fall, and as you said just now, exports is what you were good at, and that has shrunken. And import competing is what you’re not good at, and that has expanded, so your GDP actually will decline on net, but that’s what is harder to see. Most politicians think, “My export is given, and so if I add to the imports, add to the output of import-competing goods, that’s extra GDP.”

RAJAGOPALAN: That’s just fundamental misunderstanding.

PANAGARIYA: Even politicians can see C+I+G+(X–M), and if my X is given and if minus M, I reduce that. Then my GDP has gone up.

RAJAGOPALAN: The X is not given. That’s the part that they don’t quite understand.

Before I come to India, India is also now, as you said, it’s the old wine in a new bottle. It used to be Nehruvian self-sufficiency. Now it is Atmanirbharta and there is this . . . it’s mired in multiple things. It’s mired in economic nationalism.

But what I’m really surprised in India is, after seeing and viscerally feeling the gains from three decades post liberalization, now, all the old arguments are back. There is, of course, the infant industry protection. That argument somehow just never dies. It’s like whack-a-mole. It keeps coming back.

The other part of it is, there are some security concerns now with the border conflict with China that we need to think about strategic interests and things. We shouldn’t rely so much on imports from a partner with whom we might have a conflict. There’s some of that mired into this.

Then there is, of course, the whole “We can make in India.” Now, the Make in India banner started out as “make it productively in India and use and export,” but now it has flipped on its head as “make in India and be self-sufficient.” It’s very Nehruvian.

Comes with it the same points of diversification, problems in coordination. I haven’t heard any externality arguments yet, but I’m sure they will also come. I’m sure some economist is going to talk about capital market imperfection. Some of the old nonsense comes back. How do you think about that in the present form? Is there any merit? Or is it the same thing all over again and all the myths that you have been busting for such a long time?

PANAGARIYA: I can’t think that there is any new argument here. I just don’t think there’s any new argument here, particularly this infant industry argument being made. There is no doubt.

RAJAGOPALAN: Actually, it’s not just infant industry. It’s the entire Indian manufacturing is infant. It all needs protection.

PANAGARIYA: That too, but particularly specific industries like mobile phones, et cetera, that we are protecting now. Of course, some of the import substitutions, we’ve never given up. Auto industry, 125% tariffs. Who imposes, in modern times, tariffs of 125%? But there is no effort. The industry has done so badly with that protection. It has never been an export industry in the world markets. Its share is only 1%, less than 1%. But all the arguments, I would say, have been there.

India and China

PANAGARIYA: The China one is a little different, you could say. That’s a strategic one, and I accept that, that a country has to worry about the geopolitics of what you do in terms of economic policy also. I’m sensitive to that and in the context of RCEP, the Regional Comprehensive Economic Partnership, which is a free trade agreement amongst these currently 15 countries, and with India, would have been 16. Originally, I was very much pushing very hard for it.

RAJAGOPALAN: To join it, yes.

PANAGARIYA: To join, but I think, post-Galwan events on the Ladakh border—

RAJAGOPALAN: Which is the border conflict between India and China on the Ladakh border.

PANAGARIYA: Right. After that, I backed off on that because, I think, in China, the politics ultimately trumps economics, and particularly when it comes to international trade, it will trump it.

RAJAGOPALAN: I have a question on China specifically. India and China are involved in the border conflict, and we all understand that there needs to be some changes made in economic policy because of the geopolitics. That, I think we can all concede, but there are some really bad ideas going around in policy circles and the external affairs ministry and things like that.

One is, some people want unilateral discriminatory tariffs on China. The problem with this is, of course, China will retaliate, which you don’t want to get in a trade war with China. They usually retaliate quite badly. The other problem is that India’s largest share of imports comes from China. Those automatically become more costly, which means inputs into India manufacturing, for instance pharmaceuticals, become more costly. In a sense, it might impose some costs on China, but it’s imposing even larger costs on fellow Indians.

Another, even worse idea, in my opinion, that is being thrown around is just impose nondiscriminatory tariffs across the board, so that China doesn’t get excluded and doesn’t retaliate specifically, and we have higher tariffs across the board, and we make more in India.

But according to me, that’s an even worse idea in some sense. You’re really cutting off your nose to spite your face, and now, instead of 16% imports that come from China, you’re punishing 100% of imports that come from everywhere. It just makes no sense to me.

On the free trade optimism end, I have heard some libertarian friends say things like “Oh, actually, we should increase our trade with China because trading partners never get into war.” There’s that extreme argument, and then there is a realistic argument in some trade realism which says maybe we start looking for other trading partners and reduce our reliance on China, not through tariffs but by other free trade agreements with other countries.

How do you think about this China problem? Because all these four ideas keep coming up in some way or the other in the newspapers.

PANAGARIYA: Clearly, we shouldn’t do a nondiscriminatory tariff against China. What I said is that where we have very direct security threat—like TikTok—those we ban and that’s okay. I think wherever there is a very direct threat—5G for example—that may be a direct threat. If you want to exclude China from 5G, I think we should do that. That’s one step.

Second, in terms of actual trade with China, where there is no direct security threat, only an indirect one in the sense that somebody sitting in the politburo may make telephone calls that will stop importing such and such from India, and so imports from India begin to be stopped and that sort of threat—we need to deal with it, but I would say let’s deal with it slowly.

Right now, China is not giving us any of those threats, but to prepare, let’s move our trade away from China. The natural thing to do is to liberalize your trade with the other countries. Forge as many free trade agreements as you can with countries that are not China.

How Can India Sign More Free Trade Agreements?

RAJAGOPALAN: On that margin, we haven’t been very successful. We have some free trade agreements with Japan and South Korea and Singapore and things like that, but they make up, I believe, less than 10% of our total trade. How does one move towards having genuine free trade agreements with really large trading partners?

Here, I mean, of course, the quadrilateral partners—US, Australia and things like that, but also the European Union is a really potentially large partner. The Middle East, where we get a lot of remittances from, where also we get a lot of oil from, is a potentially very large trading partner.

How do you go about striking really significant free trade agreements with these partners? And why hasn’t it happened yet? What’s the roadblock in forming these partnerships?

PANAGARIYA: If there was a will, by now, we should have had an agreement already with the European Union. We should be now proceeding towards the United Kingdom. It’s the problem of the will, and in my experience, our commerce ministry bureaucrats tend to be very protectionist.

Even if the higher authority, meaning the prime minister or his office, wants progress, often this is how the commerce ministry will proceed. It will go to the European Union and say, “Well, we really want to have a free trade agreement with you, but our competitive advantage is in services. What you need to do for us is to allow our workers to come into your country to provide the services.”

Of course, this is an immigration issue everywhere. They will say, “Sorry, this is not a good starting point. We can’t talk with you.” Then the commerce ministry comes into the prime minister’s office and says, “Well, we want to talk to the European Union, but they don’t want to talk with us.” And the matter ends there.

RAJAGOPALAN: The privilege and the interests of a tiny, elite, educated, tech and English class at the cost of the entire agriculture and manufacturing classes in India in some sense.

PANAGARIYA: I’m just not sure whether they are sacrificing those other interests to protect these interests or they are using them to be protectionist, to stop an agreement. My own interpretation is that they use these things to prevent any opening up.

RAJAGOPALAN: So there are no genuine good-faith attempts to create free trade agreements. That’s the roadblock.

PANAGARIYA: At least at the level of the commerce ministry, that at least, is a very strong sense I have.

RAJAGOPALAN: This is irrespective of governments and irrespective of bureaucrats. It’s been the trend for a long time.

PANAGARIYA: Yes, see, it’s particularly the entrenched bureaucracy within commerce ministry. The way the Indian ministries work, there is a permanent bureaucracy within the ministry. Top leadership changes, the joint secretary, the commerce—

RAJAGOPALAN: And the minister, of course, changes.

PANAGARIYA: The minister—they change. As you know from Arun Shourie’s book, an old one called Governance, every file begins at the bottom official. It works like a silo, and then the file begins, it travels up to the higher and higher-level official, by which time enough “notings” have been done that nobody at the top wants to change.

I was different in NITI Aayog. I didn’t even used to read what the people below wrote. I just looked at the issue and then made up my mind, and after I made up my mind, then I’ll read what the others thought. I was different, but that’s not how the bureaucracies actually work.

RAJAGOPALAN: These old ideas never die.

PANAGARIYA: They don’t die, yes.

RAJAGOPALAN: They keep coming back.

PANAGARIYA: I think I’m exaggerating because if, in an extreme form, that was true, then no change would happen. We have had changes happening and so forth. But most of the things we initiated from the top, not from the bottom. Typically, the changes, whenever they happened, they happened from the top.

I think this is where we need to make up our minds, but if we think that somehow we got shortchanged in our FTAs with South Korea and with Japan, et cetera, because we didn’t get the opening up of services, et cetera, I think then you begin to not go any further. That, to some degree, has been happening. Even the political leadership seems to think . . . I don’t know why they think so. I don’t think the evidence is correct.

Also, this thing always plays negatively, that if my imports expanded more than my exports expanded, then I think that was a bad thing to have happened. Whereas the economics of this free trade agreement will tell you that if your imports are expanding at the expense of your domestic inefficient producers, that’s a good thing. That’s not a bad thing. That’s what we call trade creation.

RAJAGOPALAN: Yes, and it’s more money in the pockets of your consumers and citizens.

PANAGARIYA: Exactly.

RAJAGOPALAN: This is also a fallacy that doesn’t go away even in developed countries. Everyone thinks trade deficit is a bad thing.

PANAGARIYA: Oh, absolutely. That is what economists need to continuously explain.

Relationship between Free Trade and Poverty (or Lack Thereof)

RAJAGOPALAN: There are two parts to the argument which comes directly from the book, which is the free trade and prosperity part, which is that the relationship between outward orientation that is either declining or already low tariffs, which embraced global trade. The link between these outward orientations and economic growth is really, really strong. Now my question is, what are the precise mechanisms through which it alleviates poverty?

Normally, one of the big things that you constantly hear in India is, “Yes, but all this free trade is for rich people. It is for the tech sector. It is for the IT sector. But what about poor farmers? Foreign countries also have tariffs.” There’s that usual typical argument. Every time I write about more liberalization in any newspaper column, the first thing I hear is, “But even developed countries are imposing tariffs.”

[laughter]

That keeps going on. If you can walk us through, what is the precise mechanism by which this kind of free trade increases growth and thereby alleviates poverty? I think that’ll be very useful for people to hear.

PANAGARIYA: Yes. If we look back at the successful countries, and here, I would say three particular ones: South Korea, Taiwan, and China. I’m choosing those three because they also started with a sizable agricultural sector. Growth in the case of all three was driven initially by expanding exports of labor-intensive products. They really expanded.

That, of course, meant that your manufacturing of these products expanded very, very rapidly. Now, what happens in this process is that your share in the GDP of these products begins to grow. It is not just the share in the GDP that grows. It is also share in employment that grows. You begin to draw workers from other sectors, principally agriculture.

Now, this is across the board, including in India, that the share in GDP of agriculture as your incomes grow, the clients and share of services in industry grows. That is inescapable because agriculture—you can grow maybe at most 3% to 4%. In good times, best of times, you will grow—over a longer period of time, half a decade or decade and a half or more—it will grow 4% in the best of times, but usually, 3.5% is the best you can do.

Any economy that grows faster than 3.5%, by sheer arithmetic will actually shift the shares in favor of industry and services. The GDP share—of course, that’s changed. The question is, are you also able to change the employment share? In the case of all these three countries, employment shares of agriculture also declined quite rapidly.

South Korea—you start in 1965. It was maybe something like 65% in agriculture—drops to about 20% by 1990, some very dramatic shift of workforce. Now think about it. As an economist, you would think that so much of the workforce is moving into industry that will cause the wages to collapse. So much workers are coming in.

But no, in South Korea, wages are rising at 9% to 10% a year. Every year, it rises because the productivity is rising so rapidly, and you’re constantly expanding your exports, sending the goods. Also, these are all good jobs that get created.

In the South Korean case, if you look at it, there were no anti-poverty programs of the kind that we had in India. I provide some evidence in the book. There’s one small program, a very tiny fraction. It was a very, very small fraction of the population that use that program anyway. It’s practically non-existent, unlike India, where the NREGA, the Food Security Act, all kinds of different things we do, all sorts of anti-poverty programs where the government spends large sums of money.

None of that in Korea. By the late 1980s or mid-1990s, abject poverty—the extreme poverty—is gone from South Korea.

China is very similar, actually. They’re kind of starting from 2000 onwards. I think there’s even a story in the current issue of The Economist, where they talk about their anti-poverty programs and all. It’s all very recent origin, but extreme poverty, China had more or less eradicated by the mid-2000s. Taiwan, of course, the same, very similar story. The mechanism really is that it generates incomes for the people.

What happens is that when incomes rise of the people through higher wages and better paid jobs, they are also able to access other social services, public services, better. If you’re dirt-poor in a village in India, even if there is free education available or free health services available, you need to be able to go to the center which may be the village next door or 10 miles away or something. Banking services, same thing. You need the means to be able to get there.

Rising incomes help. Certainly, in India, that mechanism worked. When you look at poverty levels, when did the poverty levels fall the most? It was 2004–’05 to ’11–’12. I’m picking up those dates because that’s where we have the two surveys, large expenditure surveys, 2004–’05 and ’11–’12. Prior to that, you can look at ’93–’94.

The poverty declines across almost every single group, whether it is the overall, rural poverty, urban poverty, scheduled caste, scheduled tribes, Muslims, Hindus, Sikhs, you take it. Every group experiences much larger and accelerated declines in poverty ’04–’05 to ’11–’12 than between ’93–’94 and ’04–’05. Although that period is 11 years, this period is 7 years or something. Yet, absolute decline is a lot more in the second period and almost, as I said, across the board.

Of course, I also believe that anti-poverty programs are a good thing to do because you can double up. You can accelerate the process. But there can’t be anti-poverty programs unless you have grown. Growth has to be there to give you the revenues.

RAJAGOPALAN: Anti-poverty program is different from import substitution and tariffs. You can have outward-looking economy while simultaneously having an anti-poverty program or universal basic income or something like that. Those two are not necessarily mutually exclusive, or at least that’s—

PANAGARIYA: No, no. Not only that. Not only that. In fact, if you are not open, you’re not going to grow. You will not have the revenues.

RAJAGOPALAN: That’s true, absolutely.

PANAGARIYA: You need revenues to do anti-poverty programs. Today, can we do a universal basic income in India? No chance. Even America cannot do it because not enough revenues.

RAJAGOPALAN: Absolutely. I was recently speaking with Chandra Bhan Prasad who has written a lot on Dalit capitalism. One of the really interesting things he told me was, he said liberalization really helped Dalit entrepreneurs because prior to that, when you had this industrial licensing system, only people who could reach the chambers to get the licenses, got the licenses, and Dalits were never among that elite group who would even have access to those spaces.

The moment you eliminate this licensing system, you can create a good product and find a market for it. A lot of the Dalit capitalists, according to him, make generics. He is, in fact, telling them now to start branding these goods, but initially, they started out making generics that they would supply to other entrepreneurs. He said, “We were able to do it because we finally did not require anybody’s permission.”

It’s not just poverty levels, but it’s also changes within socioeconomic groups in a particular way because of liberalization. This idea never occurred to me because we just look at aggregate numbers. We don’t look at disaggregated changes within the social groups.

PANAGARIYA: Absolutely. In fact, in my earlier book with Jagdish Bhagwati, the Why Growth Matters, I think somewhere we quote, actually, Chandra Bhan because this was very much in the news in those days that, apparently, the Planning Commission invited some of the Dalit entrepreneurs and all.

There’s this famous story that came in the newspapers that, I think, Montek Ahluwalia who was the deputy chairman of the Planning Commission asked them how many of them had been helped in their success by the government. The story says that not a single hand went up. [laughs] These were stories of the Dalit crorepatis [millionaires].

Relationship between Free Trade and Inequality

RAJAGOPALAN: That’s an incredible story.

Now that we’ve talked about the different socioeconomic groups, there’s a question of inequality. I want to talk about inequality and free trade from two different points of view, one in developing countries and one in developed countries.

In developing countries, you know all the usual arguments that free trade has only helped the IT sector and the English-speaking elite and those sorts of things. It’s never really helped the regular folks and the poor man.

The other part of that argument comes from how developed nations impose tariffs on agricultural produce and tend to be very highly protectionist on agriculture, which, of course, is going to be a disadvantage for India, where so many Indians rely on agriculture in terms of the labor share in the population.

There are a lot of free trade naysayers on the margin of inequality that the gains from free trade, even if you recognize them, will not be shared equally. Now, what is the global experience with that, and what is the Indian experience with that?

PANAGARIYA: There is a short chapter in my book on inequality and openness. You can look at it from, in my thinking anyway, openness works through growth. If you look at these periods of growth and changes in inequality, evidence doesn’t show you anything. You can look for all these Gini coefficients and all. You can plot them against growth rates, and you just see the dot set all over the place. There is no pattern to that.

For sure, as measured by Gini coefficient, you don’t see that. Much of the debate in the US, of course, happened on wages and unskilled-to-skill wages. There also, I think a lot of that debate only relied on the relative wages, but we also have to look at the real wages, and certainly you don’t see any relationship. Suddenly, the real wages trade has not . . . There’s some work like Rob Feenstra that shows that it did not hurt any of the real wages trade by itself.

In the developing country context, one thing I always say is that ultimately, to me, it is poverty that trumps inequality, even if it so happens that inequality rises a little bit as a result of this growth. If I’m really massively cutting poverty, I’m willing to take that tradeoff.

Do you want everybody to be left poor as we were for 50 years?

RAJAGOPALAN: Your argument is that the overall level has to increase, the size of the pie has to increase.

PANAGARIYA: Especially if I’m starting dirt-poor where everybody is poor. There was an interesting conversation that Jagdish Bhagwati often tells me. One of these Polish economists—I’m forgetting the name, but he visited India once, and he would tell Jagdish, “You know, Bhagwati, the problem of India is that there are too many poor to whom to redistribute and too few rich from whom to redistribute.”

You just don’t have that. Then we can see that. I have written that in the ’60s or even ’70s, if you distributed equally India’s entire income, that will put every single individual below any acceptable poverty line because that’s how low the bloody income was.

RAJAGOPALAN: One important thing that I think a lot of the free trade critics miss is that because of cheap imports with an outward orientation, if imports become really cheap, you actually dramatically reduce consumption inequality. Not all inequality is income inequality or wealth inequality.

If you get a huge influx of cheap cell phones from China, that means that most people I know, like my parents—their maid and their driver have a cellular phone. It’s a smartphone. Now, it’s not the same as my Apple phone, but it does 90% of what my phone does, maybe more. In that sense, consumption inequality has just collapsed on certain margins if you allow cheap imports to come in.

In fact, right now with school closures, so many children from even poorer backgrounds and marginalized backgrounds—of course, not all of them have access, but a lot of them are able to cope because there is a smartphone in the household. That smartphone was likely imported from some Chinese manufacturer and is really cheap compared to any other smartphone that Indians could make.

PANAGARIYA: Absolutely, great equalizer. Now, what is India doing? Actually, India is imposing these tariffs so that we can produce these things at home—assembly mostly. Who are you then disadvantaging? It’s precisely your driver or whoever was getting those phones cheap.

Domestic Free Trade Zone within India

RAJAGOPALAN: Now, I want to change gears from global trade to domestic market for a minute. One major difference between China and India and all the Asian Tigers—people kept saying, “Well, those are really small countries” and so on. Now, India is large enough that even despite having 125% tariffs on automobiles and having this horrible policy, we still have somewhat of an auto sector because domestic demand is just so large that we can, even then, chug along.

If you count all the states and union territories, we’re talking about roughly three dozen entities. Think of them as three dozen small and large countries. Now, one of the biggest strengths of the American founding was that they managed to create a free trade zone within the United States of America. Even though America was dirt-poor when it started out, the free trade zone permitted that there were no domestic barriers.

Now India does not have a single large domestic market. What are some of the barriers in that process? One, of course, was all the basically indirect taxes, which got collapsed into GST. GST could get better, but at least it’s a start on having one single country and one single market.

But what are some of the other factors? Is the problem domestic demand because it’s a poorer country? Is the problem infrastructure? Is the problem some other kind of fractionalization that I’m not imagining? Is it linguistic? Is it geographical? Why can’t we get our act together and make India a single free trade zone?

PANAGARIYA: A lot of legacy. When you compare to America, what was the presence of the government during those years in America? Very little. The robber barons were there to roam the country and do what they wanted to do.

RAJAGOPALAN: But the robber barons also helped build the railways and connect all of America.

PANAGARIYA: That’s precisely what I meant. Today, if you think, in India, if somebody wants to build private railways—

RAJAGOPALAN: It’s impossible. You can’t even build a rail line from your industry to the port.

PANAGARIYA: No, no, no. Even if you want to just run a private train, that’s a challenge in India. It’s the omnipresence of the government which is such a problem everywhere. You mentioned three dozen entities, but you don’t mention the three dozen governments. Each state has its government, and then the central government and all. We have created this maze of regulation.

I always say when people like Dani Rodrik go and say, “This laundry list of reforms you talk about and all, but why not just look for two or three binding constraints?” They’ve gone into advice, a lot of these African countries, on how to identify the binding constraints and all. I challenge you, if you can tell me the binding constraints in India. You can tell them, but what you would do is, you remove one layer, which is today binding. The moment you remove that layer—It is binding right below. We had this small-scale industry reservation. First, we had the licensing. Then we had the small-scale industry reservation. Then we had the labor laws. Then we got the land problem. Then we got electricity rates that are very high. There are so many of these things here still.

But on the other hand, I don’t want to leave it so pessimistic either. We have done, actually, a good job of removing a lot of the restrictions, I think, within the last five, six years under the prime minister—five, six very big reforms. We cut the corporate profit tax big time. We’ve put in place a very modern insolvency and bankruptcy code, very important. GST—single, nationwide indirect tax. We’ve got the labor laws, and we’re also doing something on the marketing of the farm products.

RAJAGOPALAN: Let’s say, whether it’s labor laws or farm products—

PANAGARIYA: Land is very important.

RAJAGOPALAN: We have free movement of labor, and we had this migrant crisis recently, which just taught us how many people leave the village to actually go work in the city. Labor movement has not been an enormous constraint. Whether seasonal or year-round, that’s been happening. But what stops goods and services from moving across India?

I’ll give you an example. This has become my pet peeve in India. My family is south Indian, but I grew up in Delhi. I’ve never found the banana chips that I would like to eat in the North India. You go to Kerala or you go to Tamil Nadu, and you get 30 different kinds of banana chips. They are fresh. They are amazing. But you cannot get them in the north.

If you go and talk to these sellers, one, of course, they’re very small scale, but they say, “Even if you’re willing to package it, by the time the transportation costs and it reaches Bombay or it reaches Delhi, the cost per packet will be 300, 350 rupees. Then we can’t compete. Nobody in Delhi is going to pay 350 rupees for banana chips because the diehard South Indians will make it at home.”

I actually get better and fresher banana chips in the United States at the Indian store than I get in Delhi. One example of this is the transport cost. What are some of the big barriers in trade becoming bigger? Because the farm bills that you mentioned—the goal is to allow farmers to sell anywhere in India.

My question is, do we have the infrastructure for farmers to sell anywhere in India? What are those infrastructural constraints? What are the warehousing constraints, transportation constraints? How does one get around those problems in making India a unified market?

PANAGARIYA: Personally, I think, actually, the problem is coming from the size of the enterprises. I think our enterprises tend to be very small.

RAJAGOPALAN: You think if the size increased, they would have their own storage and warehousing and transport. Is that the argument?

PANAGARIYA: The farm laws, of course, were required because until these farm laws, you couldn’t move the product across state borders in the first place. The more infrastructure would then come into . . . which is specific to these moments. Also, the Essential Commodities Act problem was there, that if you stored anything on a large scale, then you could be put in jail. At least the laws could be invoked.

That also we have done away with. All three laws that have been put in place now are complementary. They complement each other. People can begin to . . . It will follow. I think it will take time. It’s not that easy, and right now, of course, there is a lot resistance to even these reforms by at least two states—Punjab and Haryana. All that, I think, will have to be sorted out.

But in general, the problem in the kinds of products you’re talking, like banana chips—it is the scale problem. Everything we do on a small scale. That mindset for all these consumer-oriented goods—everything that was on small-scale industry reservation list, still, mindset remains. None of the big guys want to enter. We’re very, very few.

Apparel is my favorite example. We have, at most, two or three entrepreneurs who have some scale. Otherwise, these are all small, little tailor shops. How do you succeed? I think that is the big key, the key for India to address.

PANAGARIYA: The scale of the enterprises still remains. In the data, you see some movement but it’s incredibly slow. It’s incredibly slow.

RAJAGOPALAN: So, the typical factors, like India is a poor country and domestic demand is low—all that is nonsense.

PANAGARIYA: Of course, that’s nonsense because who’s stopping you?

PANAGARIYA: There’s my critique of the Indian auto industry. About six months ago—or prior to COVID—about a year ago, let’s say. They were complaining, “We’re suffering. There’s no demand and all.” I said, “Who is stopping you from exporting? Why don’t you export? You’ve got two trillion or some very large export market there in auto.”

RAJAGOPALAN: But they are not competitive.

PANAGARIYA: That is the problem. Even to the domestic guys, you’re selling at one and a half times the price, and that automobile is not exactly the same quality as what I get in the United States. You can take a Camry in the United States, and you can take whatever is the equivalent model in India, and you’ll see the quality differences. I don’t mean Toyota, but I’m just saying any particular car. These guys will not give you the same international quality, and you have to charge one and a half times the price, so what are we helping here?

RAJAGOPALAN: Absolutely. If you protect people from competition, they won’t be competitive.

PANAGARIYA: Why should they?

Intellectual Influences

RAJAGOPALAN: How did you become an economist? And how did you become a trade economist?

PANAGARIYA: [laughs] Becoming an economist was a sheer accident because like any other father, my father also wanted me to become an Indian administrative services IAS officer. That was the top, elite Indian civil service. That’s what he more or less groomed me for, and in my generation, largely, fathers or parents were very influential people over their children. They could persuade them.

I basically studied to become that. Interesting story here, which is that due to some sheer coincidence, after I finished my MA, master’s and would have then taken the civil service exams, I was underage by a few days, by a month of two.

So what do you do? That year, you couldn’t take the exams, and so you had to wait for the next year. That is when I became a lecturer at Rajasthan University, and I was just copying my brother, who is an engineer who had been applying to and had been accepted at Stanford, although he never went. Because he couldn’t get funding, he didn’t go.

But I said, “I am also going to apply abroad.” I was getting 750 rupees salary, so that was good enough for the postage etc. because applications are expensive and all, but I was not serious. Obviously, I was not serious, so I never actually took any GREs. Basically, about six, seven universities to which I applied, I said, “Look, GREs are not given in my hometown, and it’s very difficult to go to another, to Delhi and all.” Yale said, “No, without GRE, we don’t consider.” But some other schools considered it.

So I got admitted to Princeton, Cornell, and Chicago—totally unexpected. I couldn’t believe it because Rajasthan University—I was not at Delhi School. If you’re at Delhi School, then of course, everybody knows, but I was at Rajasthan University. Nobody from Rajasthan University had ever gone to any of these universities to do a PhD. But then there was still the issue of money because I couldn’t afford . . . Princeton gave me the fellowship. [laughs]

RAJAGOPALAN: So you went to Princeton.

PANAGARIYA: Even then, actually, because my father was so keen that I should do IAS, I still wrote to Princeton saying, “Look, can you delay my coming by a year?” The idea was that during that year, I would take the IAS. If I get selected, then fine, I’ll not go to Princeton. If not, then I’ll go. They said, “We can defer your admission, but we can’t defer your financial aid.”

I had gone to Hindi schools, so I was very skeptical that I’ll get into IAS because, normally, you will do okay maybe in the written exam, but when it goes to interview, you have to fluently speak in English and all, at least in those days. After that, things have changed. Now the rules have changed completely. So I was afraid. I told father, “Look, I don’t want to miss this chance.” My brother, who is now a very famous neurologist in India—he supported me, so I came to Princeton.

RAJAGOPALAN: Princeton was a trade economics school at that time.

PANAGARIYA: Now, trade. How I got in was, I think, a lot of credit to my teacher who gave the course in trade. He was brilliant. It was Carlos Rodríguez, and the year I was doing my trade courses, my local professors, Peter Kenen and Bill Branson—they were both on leave. Carlos used to be associate professor at Columbia University. They got him to come and give the course, and he would drive down one morning, Friday, and do a three-hour class.

He was absolutely brilliant, and he was a paper machine. He used to produce papers at a rate nobody else could, and all in the top journals and all, and that really got me very excited about international trade. In this case the teacher was very important. Because your obvious inclination, coming from India, is that you will do development economics.

RAJAGOPALAN: Exactly. But the funny thing about your book is, you show that trade economics is development economics.

PANAGARIYA: That is true too. In fact, it was a good, happy thing because, eventually, I went to development economics.

RAJAGOPALAN: Because there is no development program which has led to the kind of prosperity in South Korea and Taiwan and China that can compete with the trade policies, right?

PANAGARIYA: Yes, even India. The years of high growth, about 2003 to ’11—9 years of 8%-plus growth—that’s trade.

RAJAGOPALAN: I would actually argue that you are a development economist.

PANAGARIYA: [laughs] I’m not the development economist of the kind that is respected in the profession today.

RAJAGOPALAN: True, which is unfortunate. It tells you something about the profession also. In a sensible world, all trade economists would be considered development economists. Then you might actually have a shot at slightly better policies.

You also have a unique advantage—you served, of course, famously, in Prime Minister Modi’s cabinet at the NITI Aayog. Can you share your experience with trade and development policy as an academic on the one hand versus as a policymaker on the other? What are the really big differences? Because this is a sort of fork in the career of a lot of young scholars. “Do we go into policy or do we go into the academy?”

PANAGARIYA: I say that if you are a really solid, good economist, then for a while, still stay in the academy. Don’t go so quickly because you should generally establish your credentials and be a good, solid research economist because you have to earn the respect of your colleagues also.

Even if what you do as a scholar in the academy may not be necessary, let’s say, for what you would do in policy. I won’t use my trade models to apply through . . . but still, first, to have the respect of your peers—very important, so you have to do that.

Also, when you go into these debates with others, in policy field, that is, if they got a doctorate and they’re famous economists, and you’re not, you are left at a disadvantage. Therefore, all these things are really important, but at the same time, I also feel that at least my field is international trade -This also, to some degree, comes from Jagdish Bhagwati, who has been always my mentor for life. He always says - “Look, trade is an applied field in the end, so we have to think in terms of policy also.”

His own trajectory has been like that, of course, although he never actually worked in the government. But certainly, he saw and advised many people, certainly the eminent policymakers and so forth. All of us got influenced by his writings. There is no doubt about that. He always said, “Look, in the end, we have to translate this into policy.” That’s how I came about.

What I think a little bit different in my case, than Jagdish’s was that I’ve written very regularly for more than 20 years now in the Indian press, and I think that was very helpful actually. I started, and more or less remained, once a month. Occasionally, I’ll do twice, but usually once a month, and that I took very seriously. Even now, sometimes I end up spending two days, three days looking through, researching, writing, rewriting the columns.

I don’t take it like, “Ah, this newspaper requested, so quickly, one hour, I’ll write it out and all. What is it on my CV? Nothing.” That’s not how I take it. I take it very seriously because that is where you are influencing the wider audience. That is also where you may influence some policymaker. We’ll never see this connection that because you wrote something, something happened. That connection, for us academics, is impossible to see.

RAJAGOPALAN: Exactly.

PANAGARIYA: But at the same time, if you believe in the cause, then it’s a very long drawn, long battle for ideas, and you have to really keep doing it. One thing I often say is—and that’s reflected in all my policy writings—is that in policy, repetition is not a vice. It’s a virtue. You have to keep saying the same thing in different ways in different contexts.

RAJAGOPALAN: It’s so funny you say this because Frank Knight at University of Chicago—he would say, “It takes varied reiterations to force alien concepts upon reluctant minds.”

PANAGARIYA: [laughs] How beautifully said. He being cleverer, he obviously said it so much better than I could.

RAJAGOPALAN: Speaking of writing, you are really prolific. I had scheduled a panel conversation with Arvind on this book last year, to happen sometime in March, which, of course, we couldn’t do because of COVID. We kept postponing, hoping that one day, we will be able to do it in person.

In the meanwhile [laughs], Arvind has already come out with another book on India, which I really hope, Arvind, you will come back on our show, and we’ll talk about that book and India’s reform story and have a detailed conversation on that.

You write a book every year or every other year, and lots of papers, and of course, your columns in the popular press. What is your writing process?

PANAGARIYA: Really, in a way, you have to like it, right? For me, my energy really comes from writing. I do try to do writing almost every day, but not necessarily because reading is also important. A lot of my reading, by the way, for the last several years, actually happens as a part of writing process.

You want to write something, then you have to know a lot more than the audience for which you are writing. In terms of policy also, one of the things is that—this is going back a little bit to what we were talking about earlier—is that you often need to know the facts and all, what the policies are, what the particular context of the discussion in debate is, and all.

One of the problems our academics often have is, “I did this research, so implement it.” It doesn’t work that way. Effectively, those who won the elections, those who got the people’s mandate are the ones who have their policy agenda laid out. There is a manifesto on which they won the elections and all, so you’ve got to embed yourself in that and see that, as a part of that agent, that they do the right things. If you will say, “Oh, this is fantastic, randomized control trial that I did, why don’t you do that?” It will never happen.

Your main question of, what my own process is, is basically, my energy comes from writing, and nowadays, I’m not doing almost any of the technical writing. Mostly, even my policy writings are basically trade in India. That’s the area in which I’m working. But I like to write.

When people say, “I’m a one-draft person,” I find it hard to believe, I do a lot of redrafting, particularly if it’s a difficult subject. Occasional subjects are easy, in which case, you can write it in three–four hours, and the next day, look at it and clean it up. When it takes longer, then it is also good practice to let it sit for two or three days if you can, if you have the time, and then come back to it with a fresh mind.

Then you read as a reader what you wrote. Then you know that you haven’t written it cleanly enough, and so you go back and clean it up a bit more. The cleaning-up process is very, very important. I think that’s very, very important because, in the end, you try to see it from the viewpoint of the reader.

I tell you, this is not to praise myself, but because of the podcast we had, I thought at least take a quick look at something in the book and read the preface and then some of the earlier portion. It felt really good. I said, “Well, it got written clearly.”

RAJAGOPALAN: The book is actually, excellently written. It is not technical, but it incorporates every important economic insight very simply and beautifully, and every single person must read this book. It’s literally boiling down the knowledge of 500-odd papers on international trade into—I won’t say a popularly written book, but a very easily accessible book in that sense. I tremendously enjoyed it.

In fact, the way I came about the book, I’m almost embarrassed because I know you, Arvind. I’ve read your other books. I didn’t even know you had written this book, and it’s actually my colleague at Mercatus, Don Boudreaux, who told me, “Oh, haven’t you read Arvind’s book? It’s a love letter to free trade.”

PANAGARIYA: What a lovely compliment. [laughs]

RAJAGOPALAN: I said, “I’ve never heard anyone describe a book like that. Let me read that immediately.” Then I found the book, and I read it. It really is written as accessibly as a love letter to free trade.

What are you currently reading?

PANAGARIYA: Well, I finished reading one autobiography, which is of a friend N.K. Singh, who also played a very important role, particularly during Atal Bihari Vajpayee years. I read that book, and currently a book I’m reading by two young Indian scholars. It’s called A New Idea of India.

RAJAGOPALAN: This is Rajeev and Harsh?

PANAGARIYA: Yes.

RAJAGOPALAN: Most important question during the COVID pandemic, without which I cannot let you go: what are you binge-watching?

PANAGARIYA: [laughs] My wife and I are both into Korean dramas.

RAJAGOPALAN: Do you understand Korean at all? Or do you use the subtitles?

PANAGARIYA: No, these all have subtitles. I’ll tell you, the acting and everything, the storyline and all. Nobody can beat Koreans. It’s so fantastic.

RAJAGOPALAN: Is there a recommendation that you have of a particular show or a movie?

PANAGARIYA: Well, if you have Netflix, these are longer things, 20 episodes or so. Watch Mr. Sunshine.

RAJAGOPALAN: I’ll make a note of that.

This was so enjoyable, Arvind. Thank you so much for being so generous with your time and discussing the book. I do hope you will promise to come back and discuss the other book.

PANAGARIYA: Thanks, Shruti. It’s been a great conversation. You are incredible.

RAJAGOPALAN: Thanks for listening to Ideas of India. If you enjoy this podcast, please help us grow by sharing with likeminded friends. You can connect with me on twitter @srajagopalan. In the next episode of Ideas of India, I speak with Chandra Bhan Prasad on the meaning of Ambedkarism, Dalit capitalism and entrepreneurship.