One of the major factors determining the economic growth of a country is the rate of capital formation, or in other words, the ratio of investment to income. A high rate of growth of an economy depends, other things remaining the same, upon the maintenance of a high proportion of investment goods in the income structure. Import of capital goods therefore stimulates economic growth only in so far as it helps the maintenance of a high investment ratio in the economy.
If, on the other hand, the process that brings capital goods into the economy is also a process that provides incentive to increased consumption within the country, then there is leakage. And to the extent that such leakages take place growth is retarded. This consideration is of the utmost significance for the relation of commercial policy to economic growth. However well-designed a country’s commercial policy may be, whatever the external surplus that it succeeds in creating, it goes awry unless the internal production policy is also adjusted to the requirements of growth. So economic growth is important.
Suppose, for example, an under-developed country decides to restrict the import of luxury and semi-luxury goods in order to acquire foreign exchange for the purchase of plants and machinery to aid economic development. The procedure is a perfectly legitimate one signifying, as it does, just a shift in the consumption pattern of the people over time; and there is nothing in our economic categories to suggest precisely how far such shifts might be permitted, the diehard free-traders notwithstanding. Now in so far as the internal production structure helps maintain the investment ratio implicit in the external trade policy, the economy secures a higher rate of growth. If on the other hand the shelter of import restrictions is permitted to create industries within the economy producing just those good whose imports are restricted, then the objective of growth is frustrated; the economy surrenders through the back-door what it secures by the front-door. So economic growth is important.
Perhaps even more. And here the free trade argument based on differences in comparative costs comes into its own. It is one thing to conserve foreign exchange for the import of plant and machinery designed to help economic growth; it is an entirely different thing to use import restrictions as a device for stimulating domestic manufacture of ‘protected’ goods. Industrialization is not synonymous with economic growth. While a judicious process of industrialization helps economic growth, a wrong process of industrialization retards it. The goods whose imports are restricted with a view to the saving of foreign exchange in the context of growth are not necessarily goods in whose production the economy has a potential advantage. The so-called ‘infant industry’ argument may not apply to these cases. And in so far as it does not, to use resources for the production of such goods is waste which a developing economy cannot surely afford. So economic growth is important.
This is simple logic, and yet it is so often ignored. In our own country, for example, while import of luxury goods such as cars, refrigerators, air-conditioners etc., are virtually prohibited, their production is permitted, even though their internal cost will often be more than double the international price. This is waste, and when account is taken of the fact that a considerable proportion of the resources needed for their production consists of imported parts, which involve the use of foreign exchange anyway, the waste comes out particularly conspicuously. In case the supply of these goods is considered urgent at all, economic considerations would justify a straightforward policy of import preferably of course through State trading, so that the supply may be kept within a prescribed limit and the shortage-induced excess profit may not go into the hands of a few favoured importers.
It is true, as one may argue, that in view of the scarcity of foreign exchange higher weightage must be given to foreign resources as against domestic resources in cost calculation in a developing economy. It is surely arguable that the difference between domestic costs and international prices of these goods is partly nominal and that it would narrow down to the extent that saving of foreign exchange is given higher weightage. Yet on any reasonable assumption concerning the relative weight of foreign and domestic resources it would appear that the domestic production of most of the luxury goods in an under-developed economy is wasteful even if the growth criterion is waived.
If, for example, the cost of an ‘Ambassador’ car produced in India is twice as high as the price of an imported car of comparable quality, and if the domestic car is manufactured entirely out of domestic resources, then its production has economic justification only so long as a rupee-worth of external resources is considered at least twice as important as a rupee-worth of domestic resources. In the more realistic case where a part of the cost of domestic production consists of expenditure on imported materials, the weight given to external resources has to be higher still if domestic production is to be justified in economic terms.
Domestic production of luxury and semi-luxury goods that flourishes under the shelter of import restriction is not only inimical to growth, it is also in most cases uneconomical, judged by the criterion of current income maximization. So economic growth is most important.