Who Pays for Trade Liberalisation? The Domestic Producers Behind India’s FTA Bargains

A free trade agreement is usually presented as a bargain between countries. Tariffs fall, markets open, exports rise, and both sides are expected to gain.

But an economy is not a single actor.

The same tariff cut that makes an imported product cheaper for a consumer can make competition harder for a domestic producer. A cheaper imported machine may help one Indian firm become more productive while reducing the market for an Indian manufacturer of that machine. An agreement that opens India’s market to foreign automobiles may benefit buyers and foreign brands while requiring domestic manufacturers to adjust to a new competitive environment.

The important question, then, is not simply how much trade increases. It is who gains from the new trade, who bears the adjustment, and how the tariff structure determines the answer.

Trade liberalisation creates a distributional map inside the domestic economy. Consumers, exporters, importers, manufacturers, downstream firms and small enterprises do not experience the same FTA. The benefits may be widely dispersed while the adjustment costs are concentrated in particular industries.

The same tariff cut can create two very different economic effects

Consider a domestic product that competes with imports.

If the tariff on the imported product falls, the foreign product becomes more competitive in the Indian market. Consumers may get more choice or lower prices. Firms that use the imported product as an input may also benefit if their costs fall.

The Indian producer competing directly with that import faces a different reality. Its selling price may come under pressure, its market share may shrink and its margins may narrow. It may have to invest in technology, reduce costs, change its product or move into a higher-value segment.

The economy as a whole can therefore become more competitive even while a particular producer becomes less competitive. Adjustment does not occur at the level of an abstract “Indian economy”. It occurs inside factories, supply chains and firms.

That is also why trade liberalisation cannot be understood simply through the value of imports and exports. A country can gain from cheaper inputs and greater consumer choice while some domestic industries face significant adjustment pressure. The distributional question is built into the tariff itself.

Consumers gain from openness—but not every gain is identical

The most immediate effect of tariff reduction is straightforward: imported goods become cheaper relative to what they would have been behind a higher tariff wall.

India’s recent FTAs illustrate the range of products involved. Under the India-UK agreement, the official Indian tariff schedule provides for highly differentiated treatment of passenger cars, including a high base duty, preferential in-quota rates and phased reductions. For specified vehicles, the schedule moves from a 110% base rate toward lower preferential rates, with tariff-rate quotas controlling the volume receiving those concessions. The agreement similarly phases the treatment of Scotch and other alcoholic beverages rather than removing the tariff in a single step. (commerce.gov.in)

For consumers, greater access to imported cars, whisky, chocolates, cosmetics and sporting equipment can expand choice and potentially reduce prices. But the effect is not automatic. Final prices also depend on exchange rates, margins, local assembly, distribution costs and the structure of the agreement.

A tariff cut therefore changes the competitive environment; it does not guarantee an equal reduction in the price paid at the checkout counter.

The producer sees the same agreement from the other side

For an import-competing producer, the starting point is different.

Before liberalisation, the tariff creates a degree of protection from foreign competition. Once that tariff falls, the domestic producer must compete more directly with foreign suppliers.

That does not necessarily mean the domestic producer loses. It may become more efficient, adopt new technology, improve quality, specialise, integrate into global supply chains or shift toward products where it has a stronger advantage.

But adjustment has costs. Capital has to be redeployed. Workers may need new skills. Suppliers may have to meet different standards. Firms operating on thin margins may have less capacity to make these investments.

This matters particularly for smaller firms. A large company may be able to absorb the cost of certification, technology upgrades, supply-chain restructuring and market development. A small manufacturer may face the same competitive pressure without the same financial or organisational capacity to respond.

The Ministry of Commerce has explicitly recognised this distributional concern. In a 2025 parliamentary answer, the government said FTA impact assessment is a continuous process, that proposed agreements are examined for their impact on domestic industry, especially small and medium enterprises, and that stakeholders are consulted. It also noted that FTAs can contain sensitive, negative or exclusion lists and allow trade-remedy measures when import surges injure domestic industry. (commerce.gov.in)

The tariff is removed at the border, but adjustment takes place inside firms—and firms do not have equal capacity to absorb it.

This is where the inverted-duty problem becomes important

Trade policy becomes especially complicated when tariff treatment differs across different stages of the same production chain.

An inverted duty structure arises when an imported raw material or intermediate input faces a higher duty than the finished product made from that input. The domestic manufacturer can then find itself paying more to bring in the components or materials it needs while competing with a finished product that enters India under a lower preferential duty.

The result is a distortion in the economics of domestic production. The Indian manufacturer is not necessarily inefficient in making the final product; part of its disadvantage can originate earlier in the production chain.

Industrial examples in India’s trade-policy experience have involved metals, chemicals, plastics, rubber and other manufacturing inputs. The Department of Commerce has also distinguished between inversions arising from the broader MFN tariff structure and those specifically associated with FTAs, noting that most reported cases were linked to the former, although some FTA-related cases have been identified and corrected. The government has said these issues are examined both during negotiations and afterwards. (commerce.gov.in)

The distinction matters because the problem is not simply “FTAs create inverted duties”. It is that different layers of the tariff system can interact in ways that change the cost of producing inside India.

Where an input carries a relatively high tariff while a competing finished product receives preferential treatment, the resulting cost gap can affect both pricing decisions and investment decisions.

When an FTA changes where production happens

Consider a firm deciding whether to manufacture a product domestically or source the finished product from abroad.

If producing in India requires paying duties on important inputs, while an equivalent finished product can enter from an FTA partner at a substantially lower duty, the relative economics of the two locations changes.

The firm can respond in several ways. It can absorb the additional cost, invest in productivity, seek changes in the tariff structure, redesign its supply chain or shift some stages of production to another location.

That does not establish that an FTA is responsible for every decision to manufacture outside India. Labour costs, infrastructure, logistics, access to suppliers, market conditions, investment policies and technology all influence where firms produce.

But tariff architecture can become one of those variables.

The relevant policy question is therefore broader than whether imports have increased. It is whether the agreement is encouraging cross-border trade while also creating conditions in which domestic production remains commercially viable.

An FTA can make importing a finished product easier without necessarily making the domestic production of that product equally competitive.

MSMEs face the adjustment differently

The distributional consequences become sharper when the domestic production base is fragmented.

India’s manufacturing ecosystem includes large integrated firms as well as smaller enterprises operating as suppliers, subcontractors and specialised producers. For a small firm, even a modest tariff preference can matter if it changes the competitive price of an imported product.

At the same time, the same firm may find that using an FTA preference on its own exports is less attractive when the foreign tariff advantage is small relative to the cost of complying with rules of origin, certification and paperwork.

This creates a double challenge. A domestic MSME can face greater import competition at home while lacking the scale, capital or administrative capacity required to capture equivalent opportunities abroad.

That does not mean MSMEs are uniformly harmed by FTAs. Some can gain substantially as exporters, suppliers to larger firms or users of cheaper imported inputs. The important variable is firm-level capability: the tariff agreement creates an opportunity, but it does not distribute the ability to use that opportunity equally.

This is why India negotiates with thresholds, quotas and phases

If liberalisation produced only aggregate gains, trade negotiations would be much simpler. In practice, governments rarely treat every product identically.

Sensitive sectors can receive longer transition periods, tariff-rate quotas, exclusions or partial reductions. The logic is adjustment management: competition is introduced, but its speed and scale can be controlled.

The India-EU agreement illustrates the approach. According to the Department of Commerce’s official factsheet, India has received preferential access across 97% of tariff lines covering 99.5% of trade value. Of those concessions, 70.4% of tariff lines covering 90.7% of India’s exports receive immediate duty elimination; 20.3% of tariff lines covering 2.9% of exports receive zero-duty access over three or five years; and another 6.1% of tariff lines covering 6% of exports receive preferential treatment through tariff reductions or tariff-rate quotas, including for products such as cars and steel. (commerce.gov.in)

The numbers matter because they show what an FTA looks like in practice. Liberalisation is not a single switch. It is divided across products, timelines and conditions.

The automobile and wine arrangements are particularly revealing because sensitive products can be placed under quota-based systems rather than exposed immediately to unrestricted competition. The India-UK tariff schedule follows the same broader principle through staged reductions and tariff-rate quotas. (commerce.gov.in)

These arrangements are part of the mechanism through which governments reconcile market opening with domestic adjustment.

Exclusions are therefore economic instruments, not merely political concessions

Once the distributional structure becomes visible, another feature of FTAs makes more sense: exclusions.

A product may be politically sensitive because its domestic production base is important, employment-intensive or vulnerable to sudden import competition. The government then faces a trade-off.

Open the market completely and consumers may gain faster, but domestic producers may face sharper adjustment. Protect the producer indefinitely and competition, efficiency and consumer choice may suffer.

The compromise is often calibrated liberalisation. Tariffs fall gradually. A quota limits the initial volume of imports. A product receives partial rather than complete tariff reduction. Or liberalisation is delayed for several years.

India’s own official explanation of FTA policy makes this explicit. The Department of Commerce has said that sensitive or negative lists are used to protect domestic industry and agriculture, while import surges causing injury can trigger trade-remedy measures. The government has also described FTA assessment as a continuing process rather than a one-time exercise. (commerce.gov.in)

The structure of the India-UK and India-EU agreements therefore illustrates a broader point: an FTA is not simply a decision to liberalise or not liberalise. It is a decision about the speed, depth and sequencing of liberalisation across thousands of products.

The real policy question is therefore not “protection or free trade”

That framing is too crude.

The more useful question is what kind of domestic production structure is being exposed to competition, and in what sequence.

A tariff on a final consumer good and a tariff on an industrial input do not have the same economic consequences. A tariff reduction on a luxury automobile affects a different group from a tariff reduction on machinery used by thousands of manufacturers.

A tariff cut on an intermediate chemical can lower costs for downstream firms even as it hurts the domestic producer of that chemical. The same agreement can therefore produce opposite effects at different points in the production chain.

This is why tariff design matters.

A government may maintain a tariff on a basic input in an effort to support domestic production. But if the result is that downstream manufacturers become less competitive against imported finished goods, the protection can work against the broader objective of domestic value addition.

Conversely, removing every tariff immediately can expose industries before they have the capacity to adjust.

The challenge is to design a tariff structure in which competition pushes firms toward greater productivity without making domestic production structurally more expensive than imported production.

Trade liberalisation is therefore a redistribution of adjustment

The phrase “free trade” can make the process sound universal. It is not.

Trade liberalisation changes relative prices. Once relative prices change, the position of different firms, workers, consumers and sectors changes with them.

Some firms gain access to cheaper inputs. Some exporters gain access to new markets. Some consumers gain greater choice. Some import-competing producers lose part of their protective barrier. Some downstream manufacturers benefit from cheaper inputs while others are squeezed by cheaper finished imports.

The aggregate outcome depends on how these changes interact.

That is why the success of an FTA cannot be judged only by the volume of trade it creates. A more revealing question is whether the agreement is restructuring India’s production base in a direction that raises domestic value addition and productive capability.

If imports consist substantially of productive machinery and intermediate goods that help Indian firms become more competitive, their economic meaning is different from a persistent increase in finished goods that displaces domestic production without generating comparable productive gains.

Likewise, a tariff concession that opens a foreign market for Indian labour-intensive exports can have a very different domestic effect from one that simply increases competition in a sensitive manufacturing sector.

The distribution matters because the structure of the gains matters.

The deepest issue lies beneath the tariff

An FTA is negotiated between governments, but its consequences are experienced by firms.

That makes tariff schedules more than diplomatic documents. They are maps of future competitive conditions.

Where tariffs fall determines who faces new competition. Where tariffs remain determines who receives adjustment time. Where quotas are introduced determines how quickly competition arrives. Where exclusions are negotiated determines which domestic production systems are considered too vulnerable for immediate exposure.

And where input tariffs remain higher than finished-product tariffs, the structure can influence where firms choose to manufacture.

This is why the question “Who pays for trade liberalisation?” has no single answer.

Consumers may pay less. Exporters may gain more. Import-competing producers may bear adjustment costs. Downstream manufacturers may gain from cheaper inputs or lose from tariff distortions. MSMEs may find new markets—or face competition they are less equipped to absorb.

The purpose of trade policy, therefore, cannot simply be to maximise the number of tariff lines liberalised. It has to consider how liberalisation changes the domestic production system.

The defining lesson is simple: trade liberalisation does not distribute its effects evenly because an economy does not enter an FTA as a single unit. It enters with existing industries, supply chains, cost structures and differences in productive capability.

The real question is not whether India opened its market. It is what that opening does to the productive system behind the market.

A trade agreement can give consumers access and exporters opportunity while still imposing adjustment on domestic producers. The quality of the agreement therefore depends not only on how much it opens, but on how the opening is sequenced, where the adjustment falls, and whether domestic firms have the capability to respond.

That is the difference between opening an economy and restructuring an economy through trade.