Abstract
The World Trade Organization (WTO) recommends all members to phase out their export subsidies. While this may render export-oriented industries susceptible to tighter competition in their import markets, productivity improvements could help offset such disadvantages. This article explores the interaction between these two different aspects to evaluate the economy-wide impact of export subsidy reforms and productivity improvements in the Indian textile and clothing sector. Our analysis stands on various policy simulations applying the general equilibrium model of the Global Trade Analysis Project (GTAP; Hertel, 1997). The welfare impacts of the removal of Indian textile and clothing subsidies in terms of equivalent variation shows that India is expected to encounter a loss of about 71.5 million US$, while other Asian countries may gain about 218 million US$. In a different scenario, we simulate the impact of a complete phase-out of subsidies provided to the textile and clothing industry of India and a simultaneous increase in total factor productivity growth to 3.5 per cent. This leads to a net positive welfare change and an expected gain of about US$ 13.17 million in terms of allocative efficiency. We conclude that merely removing subsidies is not enough, as is often argued by Indian policymakers that such a policy reversal might result in contraction of the sector. Investments in total factor productivity should come about simultaneously, probably by employing surplus funds from saved subsidy payments in areas like research and development and infrastructure. This conclusion may be qualitatively generalised for any sector in the world, which is examined for export subsidy reforms, but similar economy-wide studies are recommended for specific cases.
JEL Codes: F00, F13, C68, L670
INTRODUCTION
According to World Trade Organization’s (WTO’s) Subsidies and Countervailing Measures rules, a developing country with per capita income below US$ 1,000 can provide export subsidies to its exporters till the time it reaches the export competitiveness threshold. This threshold is reached when a country attains a share of 3.25 per cent of world trade in two consecutive years. India, for example, has long crossed that threshold (in 2007) according to WTO data. 1 In 2008–10, the country’s share in world textile trade was 3.5, 4 and 4 per cent, respectively. Since, a country has eight years to remove subsidies after crossing the threshold India has till 2015 to phase out subsidies.
India has faced enormous external pressure to reform export subsidies in recent years. The European Union (EU) and Japan in particular have joined hands with the US and Turkey to demand that India stop giving fresh subsidies and gradually phase out existing ones as the textiles sector has already achieved export competitiveness. The issue came up for discussion at a recent meeting of the WTO Committee on Subsidies and Countervailing Measures (2012–13). New Delhi is keen on further talks to temper the phase-out and ensure that the key export sector is not stripped of all support. While the government agrees in three years it will have to reduce some export subsidies given to the textile industry as the threshold level for qualifying for such sops has been breached, it will be careful to ensure it removes only those that are necessary.
The Indian textile industry has an overwhelming presence in the economic life of the country. Apart from providing one of the basic necessities of life, the textile sector 2 contributes to 14 per cent of industrial production, which is 4 per cent of GDP, employs 45 million people directly and indirectly and accounts for about 11 per cent share of the country’s total exports basket. 3 The Report of the Working Group constituted by the Planning Commission on boosting India’s manufacturing exports during the Twelfth Five-Year Plan (2012–17) envisages India’s exports of textiles and clothing at US$ 64.11 billion by the end of March 2017. 4 In 2011–12, about 10.7 per cent of India’s total exports were constituted of textile and apparel products. 5
With the downturn in global trade reducing the demand for exports, the government has been providing several incentives to exporters, in the face of objections from Turkey, Japan and the EU. India, however, maintains that many of the subsidies identified by the US and others are not subsidies and merely a reimbursement of input duties. It claims that before phasing out subsidies, there has to be a common understanding on what the subsidies are. Also, since countries are given eight years to remove the subsidies, India has till 2015 to do so. There is ambiguity over the definition of a product in the WTO rulebook. It does not clearly define a product according to some Indian negotiators. In the WTO rulebook, article 27.6 of the Agreement on Subsidies and Countervailing Measures (ASCM) defines a product as a ‘section heading’ of the Harmonized System (HS) nomenclature. But there is no such term in the product category. The WTO rulebook classifies traded products through the HS of customs classification, which includes section (Roman 2 digit), chapter (numerical 2 digit), heading (2 digits) and subheading (2 digits). While textiles as a sector are covered under Section XI of the HS system, different products are defined under 14 chapters (50–63). These products are further classified under headings and subheadings.
While India has surpassed the export competitiveness threshold on section-based calculations, if we calculate on the basis of the 14 chapters, not many Indian products are likely to fall in the competitive category. Indian negotiators are depending on Article 3 of the ASCM, which talks about ‘subsidies contingent, in law or in fact, whether solely or as one of several conditions, upon export performance’. India runs many other schemes, such as special economic zones (SEZ), export-oriented units (EOU) and focus market schemes (FMSs), which may be interpreted as prohibited export subsidies.
These recent discussions can have major implications for the Indian economy and therefore this issue needs to be understood and opportunities need to be exploited to make the most of the current state of the economy. Several studies have focused on phasing out of MFA quotas and other trade policy reforms in the South Asian textile and apparel sectors (Elbehri and Hertel, 2003; Lips et. al., 2003; Narayanan, 2008), while a few others describe and analytically examine the issue of export subsidies in India (Ahuja, 2001; Hoda and Ahuja, 2002); however, no study has made an attempt to rigorously and quantitatively understand the issue of the removal of export subsidies in the Indian textile and clothing (T & C) industry. We aim to address this gap in this study.
The main focus of the article is an understanding of how the phase-out of subsidies will shape the Indian textile and clothing industry and its implications for India’s major trading partners. In investigating this issue, we first attempt to understand the subsidy mechanism in the Indian textile and clothing industry, specifically the variety of schemes, and the compatibility of current schemes with WTO mandates. Based on this background, we conduct a quantitative analysis to understand how the removal of subsidies affects exports, imports, prices, input requirements and mainly overall welfare in a multi-region and multi-sector, general equilibrium framework using the Global Trade Analysis Project (GTAP) model (Hertel, 1997) and its latest dataset, named GTAP Data Base version 8.1 (Narayanan et al., 2012).
Our results indicate that the economy-wide welfare gains are negative for India when the export subsidy reforms are carried out without any change in productivity. However, a 3.5 per cent growth in total factor productivity is sufficient to ensure positive gains from export subsidy reforms. This result suggests that the government could help the industry by using the saved subsidy expenditure to enhance productivity by developing better infrastructure, enhancing R&D investments, etc. While this result can be generalised qualitatively for any sector in the world, the extent of productivity growth needed to ensure positive gains from export subsidy reforms can vary across countries and sectors.
This article is organised as follows: Section 2 throws light on India’s recent export performance and on the subsidies in textiles and clothing; Section 3 proposes the methodology of analysis and data sources; Section 4 presents the results and Section 5 concludes.
EXPORT SUBSIDIES IN THE INDIAN TEXTILES AND CLOTHING INDUSTRY
Exports of textiles and clothing products from India have increased steadily over the last few years, particularly after 2005 when the textiles exports quota was discontinued. These exports registered a growth of 25 per cent (US$ 3.5 billion in value terms) in 2005–06 over 2004–05, reaching a level of US$ 17.52 billion. Growth of these exports, although a bit slower, continued until a decline by over 5 per cent in 2008–09, with subsequent recovery thereafter, touching US$ 33.31 billion in 2010–11. However, in 2012–13, exports fell by 4.82 per cent in dollar terms, despite growing at 8.10 per cent in rupee terms. In 2012–13, readymade garments accounted for almost 39 per cent of total textiles exports and 74 per cent when combined with cotton textiles products. The US and the EU account for about two-thirds of India’s textiles exports. The other major export destinations are China, the UAE, Sri Lanka, Saudi Arabia, the Republic of Korea, Bangladesh, Turkey, Pakistan, Brazil, Hong Kong, Canada and Egypt. 6
The government, both central and state, plays a major role in the development of the textile sector. Its role extends to a range of activities such as price support to cotton and jute, incentives for investment in technology up-gradation and modernisation, setting up of integrated textile parks and a Technology Mission on cotton, jute and technical textiles, development of mega-clusters for power looms, handlooms and handicrafts, development of the sericulture and wool sub-sectors by implementing a number of schemes, welfare schemes for handloom weavers and handicrafts artisans and promoting skill development of textile workers in collaboration with the industry. The government also provides a number of incentives for the export of textile products. A large network of government offices, public sector enterprises, textile research associations, textile design and education institutions such as the National Institute of Fashion Technology (NIFT), various textile industry associations, Export Promotion Councils and so on, provide a robust institutional framework for the development of the textile sector.
Export promotion schemes 7 can play an important part in the development strategies of a country, especially a developing country like India that seeks to make exports an engine for economic growth. Membership in the WTO is a critical tool for participation in the multilateral trading system. It requires opening domestic markets to international trade, where exceptions and flexibilities have not only been negotiated but also provides huge market opportunities for domestic producers. To design successful export development strategies, it is fundamental that governments and private exporters have a clear understanding of the applicable WTO rules and their implications for their specific individual characteristics.
Subsidies are one of many policy instruments subject to rules in the multilateral trading system, but they present more complex issues for policy-makers than many other instruments subject to GATT/WTO rules. One reason for this is that subsidies can be defined in different ways. Another is that that they are used in pursuit of a wide array of objectives. Even where they are not aimed at trade, they can affect trade flows. The challenging task of determining which sorts of subsidies are problematic from the perspective of the trading system, and what can be done, has occupied an important place on the agenda of almost all countries as well as the WTO/GATT system.
In order to analyse existing data on subsidies it is necessary to understand the definition used for subsidies and their economic effects. 8 Data on the use of subsidies are scarce in general and difficult to compare across countries and sectors because of methodological differences and data gaps. Nevertheless, the limited evidence available indicates that subsidies may have a significant impact on trade flows. According to some estimates global subsidies may amount to more than a trillion US$ per year, or 4 per cent of world GDP. Other estimates indicate that subsidies represent on average around 6 per cent of expenditure by governments and 1 per cent of their GDP. These values vary significantly across countries and sectors. The economic inefficiencies created by subsidies are also potentially significant. Both developed and developing countries could benefit from reducing those subsidies that are not necessary to correct for market failures or to pursue valid policy objectives.
From an international trade perspective, concern among trading partners about subsidy practices rises to the extent that they are perceived to impart an advantage to beneficiaries, which constitutes a competitive threat in an internationally contested market. Whether or not such subsidies could be justified in terms of national welfare, the fact remains that if their trade effects are perceived as being too severe in the marketplace, they will likely attract a reaction that would nullify any value from granting subsidies. The WTO subsidy rules attempt to balance the potential tension between the right to use subsidies and the imperative that such subsidies are not too disruptive or distorting in terms of international trade. 9
Subsidies may involve budgetary outlays by governments. They might rely on regulatory interventions with no direct financial implications for the government budget. They could constitute public provision of goods or services at lower than market prices. Or they may simply be thought of as the consequence of any government intervention that affects relative prices. Definitions used in the literature and by national and international authorities tend to be determined by the purpose at hand. Most definitions of subsidy, however, entail a transfer from the government to a private entity that is ‘unrequited’, that is, no equivalent contribution is received in return. Subsidy definitions often distinguish between categories of recipients, such as producers and consumers, or nationals and foreigners as recipients. Subsidy programmes might also limit subsidisation to certain sub-groups within these categories. The more narrowly defined the group of (potential) beneficiaries, the more ‘specific’ a subsidy programmes is considered to be. Subsidy programmes with a wide range of (potential) beneficiaries, instead, is often referred to as ‘general’ subsidies. The WTO Agreement on Subsidies and Countervailing Measures defines a subsidy to include a public financial contribution that confers a benefit to the recipient. It takes a broad approach on the possible forms of subsidy, including direct payments, tax concessions, contingent liabilities and the purchase and provision of goods and services (with the exception of the provision of general infrastructure). The definition excludes regulatory measures or other policies, like border protections that do not consist of government resource transfers. Another key feature of the WTO subsidy definition is the notion of ‘specificity’, that is, only subsidies with a limited beneficiary set are subject to the WTO subsidy rules.
The effect of a subsidy is to shift the supply curve downward by the amount of the subsidy. Effectively this is an increase in supply. The impact of the subsidy is to lower prices for consumers but to increase the price received by producers. The benefit of the subsidy is shared by consumers and producers in a proportion that depends upon the relative slopes of the demand and supply functions. The deadweight loss of the subsidy is the amount by which the cost of the subsidy exceeds the gains in consumers’ and producers’ surpluses. The magnitude of the deadweight loss of a subsidy depends upon the amount of the subsidy and change in production that results from the subsidy.
With the help of WTO, the Indian government, Ministry of Textiles and Textile Committee reports, press releases and circulars, and notifications to the WTO under the ASCM this study aims to get the required information on Indian subsidies currently provided, the rules and regulations governing the provision of subsidies in the international scenario and so on. 10
METHODOLOGY AND DATA SOURCES FOR MODELING
From 2007, the WTO has asked the Indian government to phase out textile and clothing subsidies as the country has reached export competitiveness in this sector. Trade ministers, however, are behind in negotiations, lacking consensus on key elements such as subsidy cutting modalities. Still, years of negotiations have indicated the direction of a potential deal. This section of the article explores one such direction, that is, the phase-out of subsidies and its implications for India’s economy. Specifically, we consider analysing the impact of the removal of export subsidies on textiles and wearing apparels in India. Our analysis stands on various policy simulations applying the general equilibrium model of the GTAP (Hertel, 1997).
Computable general equilibrium (CGE) models bring together economic theory and empirical data to create a practical tool for exploring economic policies, such as changes in subsidies or taxes and their effects on economic systems. CGE models use mathematical formulas to represent the behaviour of numerous economic agents (producers, consumers and governments), sectors (industry, agriculture and services) and factors of production (labour, capital and land). These economic structures are then married to a rigorous accounting system, which ensures that all resource constraints, such as available land, capital and labour, are accounted for because a CGE model gathers all the significant elements of an economy, it can account for, in theory, all the flow-through and feedback effects of policy changes. CGE models are therefore well suited to exploring the implications of multilateral trade agreements whose policies cut across many sectors and regions.
The CGE model employed here is the GTAP. The global CGE modeling framework of the GTAP (Hertel, 1997), is the best possible way for the ex ante analysis of the economic and trade consequences of multilateral or bilateral trade agreements. The GTAP model is a comparative static model, and is based on neoclassical theories (Hertel, 1997). The version of the GTAP model used in this study is a relatively standard model and is a multi-region and multi-sector model. Because the GTAP model is a comparative static model, and it does not model the dynamic effects of policies, its results must be seen as somewhat conservative. Even so, the model can provide powerful insights into the underlying data and mechanisms of economic change resulting from policies being negotiated at the WTO.
A global CGE model requires an enormous amount of data on topics from trade flows, border protection and industry cost structures to consumption and investment, and the GTAP database models these. In a GTAP model, regional production is generated by a constant-return-to-scale technology in a perfectly competitive environment, and the private demand system is represented by a non-homothetic demand system (a constant difference elasticity function). 11 The GTAP model employs the Armington assumption, to distinguish imports by their origin. Following the Armington approach import shares of different regions depend on relative prices and the substitution elasticity between domestically and imported commodities. The bilateral trade flows and foreign trade structure is characterised by this assumption implying imperfect substitutability between domestic and foreign goods.
The study applies the GTAP database, Version 8.1 that refers to the base year 2007 and is the latest database released in May 2013. In this GTAP 8 Data Base (Narayanan et al., 2012), and there are 57 commodities and 134 regions. To sharpen the focus to our objectives, we aggregated up to a level that highlights sectors and countries of interest for this particular study. For the analysis the study employs an aggregation with 134 regions and 57 sectors. They are presented in the Tables 1 and 2, respectively.
Regions in the GTAP Database
Regions in the GTAP Database
Sectors in the GTAP Database
The global database combines detailed bilateral trade, transport and protection data characterising economic linkages among regions, together with individual country input-output databases which account for inter-sectoral linkages within regions (Walmsley et al., 2012).
In our analysis, to study the effects of the removal of export subsidies from the Indian textile and clothing industry, only the relevant countries, that is, India’s major trading partners and competitors in the textile and clothing industry are considered. Countries not directly relevant for the purpose of this study are grouped as ROW. The choice of these countries is governed by the export trade statistics from DGCI & S, Kolkata, the UN Comtrade Data (HS 2007 classification) from WITS and the Ministry of Textiles. The study considers top export partners which account for about 80 per cent of Indian textile exports and other major players in this industry which pose a competition to India’s exports.
For our analysis, all textile-related sectors like plant-based fibres (Agri), textiles, and wearing apparels (TextWapp) sheep and wool products (livestock) are crucial. The sector ‘Machines’ includes machinery, manufactures and electricity required for mechanised segments of the Indian textile and clothing industry. All trade and transport are in the sector ‘Transcom’. The last sector ‘Others’ includes the remaining sectors in the economy, cutting across agriculture, manufacturing and services. Our choice of sectors reflects a multi-region world, the relation between the textiles and clothing (wearing apparel) sector and other sectors that share forward and backward linkages with it.
Version 8 of the GTAP database has 2007 as the base year. Several pre-simulations were conducted to update the base year to reflect the situation in 2007 using updated national, economic and trade data and updated protection data. The model is solved using GEMPACK software (Harrison and Pearson, 1996).
For the research presented in this article, the authors updated the 2007 database to include the subsidy in 2012, by modifying the GTAP database to include updated information on export subsidies (2.5%). 12 The GTAP database consists of observed trade data and macroeconomic data, combined with the best available data on the domestic economy and policy settings. The latter are adjusted to represent a common base year, and to be consistent with the former. Textile export subsidies in the original database are unsuited for our analysis because we have better information than that used to construct the original GTAP database. It is therefore useful to change these subsidies in the initial, pre-simulation database.
For introducing new tax rates in the GTAP database, we use the Alter tax procedure (Malcolm, 1998). The aim of this procedure is to maintain the internal consistency of the database while minimising the impacts of the tax change on the value flows in the database. In order to maintain the overall balance of the database, this procedure allows us to change the tax in question, and lets other flows in the database adjust to maintain consistency. A general equilibrium closure ensures that internal consistency is maintained. It should be noted that the aim of this procedure is to improve the quality of base year data, where improved information becomes available. We update the database with latest information on subsidies in the textile and clothing sector.
We define two scenarios (Table 3). In the base scenario, we simulate a reduction of export subsidies to 0 per cent for the textiles and clothing industry in India, as it is a possible outcome of on-going negotiations at the WTO. It includes a complete phase-out of export subsidies on textiles, clothing and wearing apparel. We simulate the potential impacts of removing all the export subsidy programmes for textile industry on the Indian textile and clothing sector as well as on sectors with forward and backward linkages with textiles and clothing, using the standard multi-region GTAP applied general equilibrium model (Hertel, 1997). The analysis focuses on the likely impacts of the policy on textile production, prices, exports and imports, intermediate input demand and the welfare impacts in India, its trading partners, export destinations and other major producers.
The new scenario is created with a view to suggesting a policy prescription to deal with the welfare loss due to the removal of subsidy as we see later. We do this by increasing the total factor productivity to 3.5 per cent. This scenario also includes all the changes that we incorporated in the base scenario. This will suggest to us a possible policy option to protect the textile industry from the shock.
Scenarios in GTAP Modeling
A CGE model summarises impacts across an entire economy, netting out positive and negative implications of policy changes for agents (consumers, producers and governments), and the movement of resources from one sector to another. In contrast, partial equilibrium models frequently focus on impacts within a sector or group of sectors without accounting for limited resources such as capital, land, or skilled labour. Because CGE models at least in theory represent an entire economy, they also provide a meaningful perspective for such figures as millions of dollars and thousands of jobs. In the next section we examine the likely effects on general welfare and trade and production of two possible scenarios.
The simulation results of the removal of textile and clothing subsidies on output prices of textiles are reported in Table 4. All of this comes from a 1.77 per cent increase in export prices due to subsidy reduction. Accordingly, the Indian textile and wearing apparel output is expected to fall by 4.1 per cent; the effects are economy-wide as they affect other sectors as well. The decline in Indian textile and clothing output is expected to increase the export price of TextWapp by 1.77 per cent. Consequently, output in the Agri sector in India, which shares forward linkages with TextWapp, is expected to fall by 2.6 per cent. However, as factors released from textile and clothing production move to other sectors, output is expected to increase slightly in the machines and related sectors. Also, the fall in TextWapp output in India is accompanied by a rise in TextWapp output in all the other regions by about 0.2–0.3 per cent (Table 4).
Change in Industry Output (per cent)
Change in Industry Output (per cent)
As Textwapp production in India decreases, the demand for imports of inputs in the TextWapp sector is expected to decrease by about 4–5 per cent, contracting even the demand for TextWapp imports, which includes unfinished yarn and fabrics (Table 5). Similarly, TextWapp industry’s demand for domestic inputs is expected to decrease by about 4 per cent (Table 6), while this rises a bit elsewhere in the world, particularly for Agri, Transcom, Machines and Livestock. The self-consumption of TextWapp falls as a result of the contraction in India’s TextWapp exports (Table 7).
Change in Import Demand for Textile and Clothing (per cent)
Change in Industry Demands for Domestic Inputs by T&C Industry (per cent)
Change in Aggregate Exports 13 (per cent)
Change in Export Sales of Textile and Wearing Apparel (per cent)
Change in India’s Aggregate Imports 14 (per cent)
The elimination of India’s subsidies is expected to lead to a drastic decline in India’s TextWapp export as prices are expected to increase. The model predicts that India’s export of TextWapp decreases by about 11 per cent (Table 7) as export prices rise by 1.7 per cent. Other large producers respond by increasing their exports to fill the void left by India. An interesting result obtained here is that aggregate export sales of TextWapp from other regions to India are also expected to fall (Table 8), probably because India’s input requirement of unfinished yarn and fabric falls. This is due to lower overall imports (Table 9). The lower overall imports are in fact driven by the lower demand for inputs due to a fall in production (Tables 6 and 7).
The market price of textile imports is expected to rise in all regions except India and Asia. India’s share in the MEA market is about 11 per cent (Table 10) while in other regions it is less than 5 per cent. We observe that the market price of TextWapp in the MEA is expected to increase by 0.2 per cent while in other regions it is expected to increase only by 0.1 per cent. India’s share is particularly low in Asia, resulting in no effect on aggregate import prices. India’s share is just 1.5 per cent of their total imports probably because Asian economies are more likely to be our competitors than trading partners in terms of the textile and clothing industry. 15
Relative Share of India in Different Markets (per cent)
The welfare impacts of the removal of Indian textile and clothing subsidies in terms of the equivalent variation (EV) of millions of US$ are presented in Table 11. It is expected that India will encounter a loss of about US$ 71.5 million, and the major beneficiary from the removal of the subsidy programmes will be Asia whose gain is estimated at about US$ 218 million. When we look at the decomposition into the sources of the welfare, for India, the loss comes mostly from inefficiency in resource allocation in the textiles and clothing sector although there are some gains in the agriculture sector, and modest gains from export taxes (xtax); all the other losses stem from reduced output.
The US, the EU, Middle East and other textile importers lose from this policy. While losses to importers are from terms of trade effects as the world price of textiles rises, losses to India are mostly a result of inefficient resource allocation as textile producers probably try to lure resources from other efficient sectors and attempt to expand output in textile production in order to remain cost effective. Although there exists some allocative efficiency gain due to the removal of export subsidies in terms of increased export taxes, the loss from reduced output of TextWapp arising from higher export prices far outweighs the benefits. Also, the gain in terms of trade is mostly driven by higher export prices.
Therefore, the removal of subsidies is not beneficial till we figure out a way to minimise lost output by preparing the industry to deal with the phase-out.
In the new scenario, we simulate the impact of a complete phase-out of subsidies provided to the textile and clothing industry of India and a simultaneous increase in total factor productivity growth to 3.5 per cent. This leads to a net positive welfare change and an expected gain of about US$ 13.17 million in terms of allocative efficiency although the terms-of-trade (TOT) effect turns out negative as expected with the fall in export prices arising from productivity gains (Table 12). Despite a huge TOT loss, in the new scenario the net gain is positive since other sectors benefit from forward and backward linkages with a more productive and less distorted textile and apparel sector. 16
Equivalent Variation (million US$)
Merely removing subsidies is not enough and investments in total factor productivity should take place simultaneously. Also, once the government undertakes a phase-out of subsidy-related schemes, it will have a pool of surplus funds that can be deployed into research and development in enhancing total factor productivity and other areas to provide the textile and clothing industry a cushion to mitigate the effects of the shock (of the removal of subsidies on which the industry is currently highly dependent).
Allocative Efficiency and TOT Effects in the TexWapp Sector: Commodity Summary (million US$)
The welfare impacts of the removal of Indian textile and clothing subsidies in terms of the EV of millions of US$ show that India is expected to encounter a loss of about US$ 71.5 million. And the major beneficiary from the removal of the subsidy programmes is Asia whose gain is estimated at about US$ 218 million. When we look at the welfare loses for India, the loss comes mostly from inefficiency in resource allocation in the textiles and clothing sector although there are some gains in the agricultural sector, and modest gains from export taxes. All other loses stem from reduced output.
The US, the EU, Middle East and other textile importers lose from this step. While the losses to importers are from the terms-of-trade effects as world price of textiles rises, losses to India are mostly a result of inefficient resource allocation as the textile producers probably lure resources from other efficient sectors and attempt to expand output in textile production. Although there are some allocative efficiency gains from the removal of export subsidies in terms of increased export taxes, the loss from reduced output of TextWapp arising from higher export prices far outweighs the benefits. Also, the gain in terms of trade is mostly driven by higher export prices. Therefore, the removal of subsidies is not beneficial till steps to prepare industry to deal with the phase-out accompany it.
In the ‘new’ scenario, we simulate the impact of a complete phase-out of subsidies to the textile and clothing industry of India and a simultaneous increase in total factor productivity growth to 3.5 per cent. This leads to a net positive welfare change and an expected gain of about US$ 13.17 million in terms of allocative efficiency, although the TOT effect turns out negative as expected.
Some prerequisites for India to remain a major player in the global textile industry are imbibing global practices, adopting rapidly changing technologies and efficient processes, innovation, networking and better supply chain management and linking-up with global value chains. We explore a few alternative uses of resources that shall be freed up upon the removal of subsidies. Investments in productivity improvement should happen simultaneously with the removal of subsidies.
Apart from ginning and spinning, India is largely dependent on imported technology for machineries. Productivity improvements simulated in the ‘new’ scenario, introduced in this article, may come from investment in research and development in the textile machinery sector, so that the costs of such machineries may fall due to their domestic production in the future. Further, the interest subsidy for spinning offered under the TUFS scheme could be extended to weaving and knitting, including a requirement for matching investment in these sectors when a loan is offered for spinning machinery. Labour development is another area of productivity improvement. Until 2000, most of the Indian apparel industry was reserved for the small-scale sector; this policy has a residual effect on the structure of this sector even today. Scaling up, therefore, is a way to improve productivity, by exploiting economies of scale.
Infrastructure bottlenecks remains a serious handicap affecting the development of textile industries in India. Some of the subsidy expenditure saved may be directed towards reducing these infrastructure constraints faced by the textile industry. The roads and power sectors need special attention. Product diversification from cotton-oriented textile industry to one with a more dominant man-made fibres sector, and from apparel-focused industry to one that ventures into technical and industrial textiles, is required. This is already happening, based on government initiatives. Some of this expenditure may be funded by the saved export subsidies. We therefore conclude that merely removing subsidies is not enough and should be accompanied by investment in total factor productivity, some of which may be funded by resources freed by reduced subsidy expenditure.
In this article, we have made a fresh attempt to quantify the effects of removing export subsidies in the Indian textile and apparel sector. However, there are several possible research extensions to this work. First, it will be an interesting and useful exercise to econometrically estimate the past effects of export subsidies on the exports of these commodities. In other words, we do an ex-ante analysis in this study, while the ex-post analysis has not yet been attempted in the literature. One reason for such a gap is the lack of sufficient policy variations in the past to help infer such effects. This issue may be addressed by choosing a sector that has seen continuous changes in export subsidies over the years. Second, a study that considers multilateral reduction of export subsidies across the world may give a more realistic picture of winners and losers if ASCM is strictly enforced. This would, in turn, involve enormous data requirements on policies in many countries, although the framework employed in this article is well suited for such a study.
Footnotes
Acknowledgements
The authors are grateful to Dr P. Nayak and Mr T.K. Rout from the Textiles Committee, Mumbai, for their support and resources provided. They also thank Professors P.G. Babu and Ganesh Kumar at the Indira Gandhi Institute of Development Research, Mumbai, and the anonymous referee for their valuable comments.
OVERVIEW OF EXPORT SUBSIDY SCHEMES IN THE INDIAN TEXTILES AND CLOTHING SECTOR
The following is an overview of 41 schemes promoting textile and clothing exports by the Indian government:
Technology oriented: [Technology Upgradation Fund Scheme (TUFS)
17
, Scheme for Integrated Textile Parks (SITP)
18
, Technology Mission on Technical Textiles (TMTT)
19
, Technology Mission on Cotton]
20
and Development Schemes [Integrated Scheme for Powerloom-cluster Development
21
, Comprehensive Powerloom Cluster Development Scheme (CPCDS)
22
, Comprehensive Handicrafts Cluster Development Scheme (CHCDS)
23
, Comprehensive Handloom Cluster Development Scheme (CHCDS)
24
, Revival, Reform and Restructuring Package for handloom sector
25
, Integrated Handloom Development scheme (IHDS)
26
and Scheme for Growth and Development of Technical Textiles (SGDTT)]
27
; Welfare (labour-oriented) schemes: [Textile Worker’s Rehabilitation Fund Scheme (TWRFS)
28
, Integrated skill Development Scheme (ISDS)
29
, Scheme of Fund for Regeneration of Traditional Industries (SFURTI)
30
, Group Insurance Scheme for Powerloom Workers
31
and Apparel Training and Design Centres]
32
; Market oriented: Focus Market Scheme (FMS)
33
, Focus Product Scheme (FPS)
34
, Market Linked Focus Product Scheme (MLFPS)
35
, Utilisation of Duty Credit Scrip
36
and Market Access Initiative (MAI)
37
; Reimbursement of import duties: Duty Free Import Authorization (DFIA)
38
, Advance License/Advance Authorisation scheme
39
, Duty Entitlement Passbook
40
, Duty Drawback Scheme
41
, Duty-Free Import for Garment Exporters; adopted by the Ministry of Commerce & Industry
42
and Refund of CENVAT Credit (Excise Duty)
43
; Direct export promotion: SEZ
44
, Export-oriented units (EOU)
45
, Zero Duty Export Promotion Capital Goods (EPCG)
46
, Post-Shipment Export Financing
47
, Pre-Shipment Export Financing
48
, 2 per cent Interest Subvention Scheme on rupee export credit is available to certain specific export sectors.
49
, Incremental Export Incentivisation Scheme
50
, Market Development Assistance Scheme
51
and Marketing & Export Promotion Scheme (2007–08 to 2011–12)
52
; Input related: Mill Gate Price Scheme
53
, 10 per cent subsidy on Hank yarn
54
and Subsidy Scheme for Distribution of Certified Seeds
55
In addition, there is a plethora of state-level schemes by the governments of Gujarat 56 , Maharashtra 57 , Jharkhand 58 , Bihar 59 , Karnataka 60 , Punjab 61 and Andhra Pradesh 62 . Of the several schemes provided by the government to support the textile and clothing industry, only a few are aimed at promoting exports. Since subsidies aimed at export promotion are prohibited in light of the textiles and clothing industry achieving export competitiveness, we identify the following schemes as pertaining to exports.
INDIA’S TEXTILE AND CLOTHING SUBSIDIES IN THE WTO CONTEXT
Since subsidies can distort international free trade, they are regulated by WTO agreements and only permitted under limited and strict conditions. Rules on subsidies were first laid down in the GATT and then further developed for industrial goods in the Agreement on Subsidies and Countervailing Measures (ASCM) and for agricultural products in the Agreement on Agriculture (AOA). Both agreements, which are part of treaties setting up the WTO in 1995, provide some specific rules applicable only to developing countries. The latter are known as special and differential treatment. The Uruguay Round ASCM was a major step forward in rule making. A definition of subsidies was introduced, along with the concept of specificity. The new Agreement applied to all Members, with far-reaching consequences for many countries that hitherto had effectively been exempt from most subsidy disciplines. The approach in the legal texts towards ‘specificity’ reflects the expectation that subsidies carry the potential to be more trade-distorting the more specific they are. Indeed, in economic terms the more closely targeted a subsidy towards its intended beneficiaries, the more concentrated its relative price effect will tend to be. In many circumstances, this could be taken to imply a higher probability that the subsidy is distorting. A subsidy to a single industry, for example, rather than too many industries could impart a narrow advantage. The more broadly based subsidy recipients are defined, then, the more ‘spread out’ and shallower will be the likely subsidy impact.
The extent and form of export incentives vary from country to country. Within its overall budget constraint, each WTO member country must decide how best to structure its export incentives so they are consistent with WTO rules and at the same time achieve the objective of export promotion. Not all export incentives are regarded as subsidies under the WTO Agreement. The Agreement on Subsidies and Countervailing Measures (SCM Agreement), framed in the most recent round, namely Uruguay Round (1986–94) governs the conduct of member countries with respect to all subsides. The SCM Agreement clearly specifies what export incentives constitute a subsidy and hence, subjected to the disciplines of the SCM Agreement. This Agreement is a considerable improvement over the plurilateral ASCM agreed in the Tokyo Round (1973–79).
In the SCM Agreement, the disciplines over subsidies and countervailing duties were made stronger and clearer, and the term ‘subsidy’ was clearly defined. A measure is defined to be a subsidy if it contains the following three elements (i) it is a financial contribution (ii) the contribution is by a government or any public body within the territory of a Member and (iii) the contribution confers a benefit. A financial contribution could take the form of direct transfers or of income or price support. Direct transfers could take the form of grants, loans and equity infusion or could also be in the potential sense when government provides for loan guarantees. Government is deemed to have made financial contribution if revenue otherwise due to government is not collected. For example, fiscal incentives such as tax credits or where government provides for goods and services other than general infrastructure, or purchases goods on favourable terms. A government may either itself carry out these functions or may entrust these to any private agency. The Agreement provides examples of a number of measures that represent a financial contribution. It is important to note that remission or drawback of duties on the inputs used in the production of exports is not considered a financial contribution, and so also government’s financial contribution for general infrastructure such as rail, roads and ports. Hence, these do not qualify as subsidy. However, excess of remission or drawback is considered to be a financial contribution, and is also considered a subsidy. The Agreement categorically mentions:
… the exemption of an exported product from duties or taxes borne by the like product when destined for domestic consumption, or the remission of such duties or taxes in amounts not in excess of those which have accrued, shall not be deemed to be a subsidy.
All subsidies have been categorised into the following three types:
Prohibited Subsidies: these are subsidies that are contingent upon export performance (or export subsidies), or upon the use of domestic over imported goods (local content subsidy). Actionable Subsidies: Most domestic subsidies come under the category of actionable subsidy if they are specific to an enterprise or group of enterprises. These subsidies although not prohibited, can be challenged, either through multilateral dispute settlement or through countervailing action, if such subsidies cause adverse effects to the interests of another member. Non-actionable subsidies: These subsidies relate to research subsidies, assistance to disadvantaged regions and environmental subsidies. These subsidies are either unlikely to cause adverse effects or are considered to be of some merit and thus not to be discouraged. However, five-year period, under which the subsidies were to be reviewed and further decision taken, lapsed on 1 January 2000. So, now only non-specific subsidies are non-actionable. The basic idea here is that such subsidies should not be seen as being given to any particular product. For example, investment subsidies and tax subsidies given to small-scale industries, defined in terms of its investment in plant and machinery, could be given without inviting any CVD action because the term ‘small-scale industry’ is objectively defined.
The following part of this annex examines the status of export incentives within the SCM Agreement.