Much is made of the inverted duty structure by federations and confederations of industries, not just this year but for several years now. What these associations are saying is that the duty on inputs should be lower than that on output. This logic is nothing but a fallacy.

Let us begin with the example of tyres. The media have reported on representations by the Indian tyre industry beseeching the reduction of the rate of duty of natural rubber (which is the raw material) from 20 per cent to 10 per cent (which is the rate of duty for finished tyres).

A higher duty for inputs is an inverted duty structure, according to the tyre industry. Therefore, the logic goes, the raw material duty should be brought down to the level of or lower than the level of output duty. But this logic has a hole that is as big as the hole of the tyre. The reasons are as follows:

• Most of the rubber used in the manufacture of tyres these days is synthetic rubber -- a copolymer of butadiene and styrene, which have far more resilience and strength than natural rubber. Synthetic rubber has high resistance to heat and hydrocarbon oils, and thus, is superior to natural rubber for use in tyres and hoses. The best areoplane tyres that go to great heights and which can land at great speeds with weight, are made of artificial rubber. A much larger quantity of artificial rubber is imported in India than natural rubber.
• The duty on artificial rubber is only 10 per cent. So, the maximum amount of duty paid on raw materials on account of rubber is at the same rate as on tyres.
• The other very important raw materials in a tyre are steel radials, resins, carbon black and rubber chemicals that act as retarders or accelerators. These also bear a 10 per cent duty. So, the element of duty difference of 10 per cent (20 per cent minus 10 per cent) on natural rubber used on a per-tyre basis will be a negligible amount that cannot affect the competitiveness of tyres made in India.
• There is a natural rubber industry in India which also needs protection. It is not so well organised to vociferously propagandise about the protection it needs. The customs duty is basically a protective duty. It needs to protect the natural rubber industry in India.
• It is the value addition of all raw materials put together which makes the difference. The value addition on machinery, rubber, resin, steel, chemicals and all raw materials when manufactured adds up to a value which is far greater. This is because they fetch a much higher price on the basis of which they pay the Cenvat and VAT. So long as they pay these two taxes, it is proved beyond doubt that there is a positive value addition. Otherwise there would be no tax at all.
• Last but not the least, it is the Effective Rate of Protection that matters and not the Nominal Rate of Protection.

The next example is that of toys.  Toys are imported from China mostly. Arguments are made that the cloth which is used in toys bears much higher rates of duty compared to the final duty on toys which is 10 per cent. Many of the duties on fabrics are in quantitative terms and, therefore, often come to much more than 10 per cent, which is the duty levied on toys.

But it is not logical to argue that the duty on fabric should be lower than that on toys. Very little cloth is used in a toy in any case, and this makes very little difference to the cost of toys. If the duty on fabric is brought down to lower than 10 per cent, the indigenous textiles industry will become uncompetitive.

From the macro-economic point of view, tariff determination is not just a simplistic decision to make input duty lower than output duty. It is a much more complex and multidimensional issue involving the competitiveness of Indian industry, revenue, exemptions, simplification, subsidisation, contradictory interests between users and manufacturers, anti-inflationary intervention on domestic prices, and so on. The rate of customs duty is a potent instrument of economic dirigisme.

The thesis that raw materials should attract a lower rate of duty is practically impossible to implement since a large percentage of items are both finished products as well as raw materials. All chemicals, for example, are raw materials as well as finished products.

Steel is both an intermediate as well as a finished product. The 'intermediate' as a concept is easy to understand, but to identify some products as intermediate is practically impossible. The Arvind Virmani committee had submitted a report in 2001 with this conclusion. The relevant conclusion that the committee arrived at is reproduced below:

"The division of all goods into these two categories (intermediates and finished goods) may, however, be quite difficult in practice. In addition to the problem of dual use, there is also the problem of drawing a line between the final, finished consumer good and its sub-assemblies."

I agree with Virmani's conclusion that it is extremely difficult to draw a line of distinction between raw materials, intermediate products and finished goods.

Coming to protection, it should be well understood that the most relevant concept is not nominal protection but the effective rate of protection. ERP expresses the margin of protection on value added during the production process rather than on the product price.

It is the percentage excess of domestic value added, obtainable by the introduction of tariffs on the product and its inputs over the foreign or world market value added. An available computation of import-weighted average ERP (Protection in Indian Manufacturing by H Nouroz, Macmillan, 2001) is shown in the table.

The latest figures are not available but judging from the high rates of the past, it does look likely that it is still positive. It is not easily calculable since industry does not make the value addition figures available easily.

It is quite clear that industries do not develop just because of high protection. On the contrary, studies by Aksoy and Ettori (1992) and by Nouroz (2001) show that import protection by tariff has caused a significant bias against exports.

To conclude, as long as the ERP is positive, it is incorrect to argue that the duty structure is inverted.

The writer is Member (retd), Central Board of Excise & Customs.