Callaway

Trade Liberalization and Firm Productivity:

The Case of India

International Business (MBA Ð'- FS)

Dalhousie University

Mukta Verma

Table of Contents

Topic Page

Executive Summary 3

Introduction 5

INDIA Ð'- an Overview 6

 Why is trade so important to India

 What makes India so unique

Development since Independence 7

 1951-1956

 1956-1961

 1961-1985

1991 Onwards 12

 India's Trade Liberalization

 Reforms Impact on India

Trade Liberalization and India's Manufacturing Sector 15

Conclusion 18

Appendix 20

Figures 24

References 30

EXECUTIVE SUMMARY

India is the largest Democracy in the world and the second most populous country. Beside other things it has high levels of poverty, illiteracy, unskilled labour, low capital equipment, macro and micro instability, lack of infrastructure, red tape and transparency and ineffective court system. Last but not the least, its decision making is done by unstable governments and motivated by political considerations. The Indian government was prompted to introduce important reforms in early 1990s as a result of serious balance of payment crisis. These reforms opened the economy to international trade and investments, abolished industrial licensing, floated the exchange rate and increased domestic and foreign private participation in financial markets. Such significant structural reforms helped India become one of the world's fastest growing emerging economies, boosting living standards and reducing poverty. (Australian Government department for foreign affairs and trade, 2001)

This paper highlights the journey of this Indian adventure into the reforms process with special emphasis to the 5 Year Plans and the structural policies of the government. It then looks at India's trade reforms from its independence onwards with detailed discussion on reforms of the 1990's. Further, how these reforms impacted the firm productivity in the manufacturing sector and the effect of tariffs on trade. The impact of trade liberalization on productivity increase is still an empirical issue; this paper examines the impact on various sectors, studies done by various economists. Data from various sources has been collected and examined and an attempt has been made at establishing a link between trade reforms and tariffs on firm productivity in the manufacturing sector. It is further researched on how India has moved towards undertaking major economic reforms aimed at increasing trade; Foreign Direct Investment (FDI) and creating a favourable business environment which in turn, will have favourable impact trade and productivity.

As stated by the World Trade Organization (2002), the Indian economy has grown rapidly over the past decade, with real GDP growth averaging some 6% annually, in part due to the continued structural reform, including trade liberalization. The report acknowledges that identifying the important linkages between trade and economic growth has led the Indian government to simplify tariff, eliminate quantitative restrictions on imports, and reduce export restrictions. The future plan is to continue to further simplify and reduce the tariff. However, the level of protection through the tariff remains relatively high and the anti-export bias inherent in imports and other constraints still remains. The paper analyses the shift in trade strategy from an import substitution to trade liberalization for the Indian sub-continent.

INTRODUCTION

Over the past few decades trade liberalization has been recognized as an integral part of almost all countries development strategies. Trade liberalisation means reducing the limitations on trade that countries around the world have erected over a number of years. Protectionism is a means of attempting to ensure that domestic industries are protected from competition from foreign producers. This can be carried out through a variety of means Ð'- through tariffs, which raise the price of goods coming into a country (imports). Quotas - a physical limit on the number of goods that can be brought into a country; and other non-tariff barriers (NTBs), such as regulations and legislation that make it very hard for foreign competitors to sell goods into another country. Trade is the wonder word associated with development. Almost all developed countries have one thing in common - they are strong believers in free trade, although how free is the trade really, well that is open to discussion. There are two school of thoughts associated with liberalization. The one in favour argue that opening up of local market to foreign competition and FDI can be the path to improving productivity of the domestic sectors as a result of maximum resource allocation. The second school of thought does not agree with this view as according to them the local firms will not be able to compete with foreign firms since they may not be able to adapt and cash the technologies brought in by foreign firms. (Topalova, 2004)

This paper is a study of corporate India and the various stages this corporate has gone through since independence from British rule. This highlights the role played by trade liberalisation in firm productivity and in turn defining India's path towards progress and development. India has been for the longest time under the influence of the then communist Russia and has been a firm believer in "self reliance". This means that a country should indulge in import and/or export to a minimum level and that all goods and services needed by the people