Sep 12, 2012

The Phantom Menace

Can there be one 'simple' test for policymakers, that if applied to a trade policy measure, could come up with an answer that tells if the step is good or not? I tried to devise one and failed. However, I believe that one can spot a bad policy decision, after the policy gets implemented. I guess, that can be one of the tests.

It's a personal view, but I believe the measure to give duty exemption on imported luxury cars in the name of Export Promotion is one such bad measure. The Foreign Trade Policy (FTP), under chapter 5, has a policy that's called Export Promotion Capital Goods (EPCG) scheme. EPCG is an excellent scheme by itself, as it is aimed at capacity building of the industry. You can read more about it here and here. In short, one can import capital goods/machinery, without paying any duty on it, and export the manufactured items (ideally from that machine), over a given period of time in lieu of it. That helps the industry to climb up the technology ladder, by helping them invest in capital goods, and also helps exports. Fair enough. 

Under this chapter, 5.2 (h) says that motor vehicles can also be imported as capital goods by certain category of exporters. The category includes the hotels, travel agents, tour operators, transport agents, golf course owners etc. The idea is that vehicles are capital goods for this category, and by using these vehicles, we can serve foreign tourists better, in turn earning foreign exchange. And this is not fiction! This is exactly what FTP believes. And that's why this measure comes under the EPCG chapter. 

And there comes this foreign exchange earner, who owns a chain of hotels, and orders a Rolls-Royce Phantom under EPCG scheme, saving customs duties that run in crores. And there come his followers who are ordering such cars all over India. Of course, they are earning foreign exchange through their hotels or tourism business, but then, the question is, how much of  it is due to this capital good that came duty free. Do they really use it to ferry the foreign tourists, as our FTP assumes? In Phantoms? Really?

 DGFT made it mandatory to register such vehicles as taxis, if they come under EPCG scheme but then, as it goes wink wink nod nod, who checks on the ground? A little shade of yellow on white never hurts, and a traffic constable would never dare stop a Phantom or Ferrari and check for the shade of yellow. And you can see the link above to see how difficult it was to implement the taxi rule. 

That's when I thought again about the simple test to determine if the policy is producing intended effect. The complex one would have all the questions below (and more):

1. Is the export performance directly linked to the incentive? 
2. What will be the marginal change in export performance, if, this incentive 'alone' is withdrawn?
3. What will be the marginal change in export performance, if, this incentive 'alone' is introduced?
4. How does this incentive interact with other variables that effect export performance. 
5. What would the be demand for the incentive itself, if other variables (such as duty structure) is tweaked. In this case, what would happen if the duty on assembled cars is reduced from 180% to say 10% of CIF value. Would the people still queue up for the EPCG? (for sure, they will import more cars, but by paying duty)
6. What is effect of incentive on domestic industry. Does it increase local production or increase imports? 
and so on...

And to make things simple, for this case, I thought of this test:

What is the incremental, direct, foreign exchange earning due to Rolls-Royce Phantom? 

But then, the simple test failed the generalization principle. And I ponder further.


Disclaimer: I would love to own a Phantom myself. And I don't envy who do!