Over the past few weeks policy makers in India have had to cope with the economic impact of the West Asia war, mainly on oil and gas availability and price. The ceasefire softened the impact but the failure of the dialogue between USA and Iran revives the adverse impact. But the withdrawal from cooperation with allies and from the standards set in the UN Charter by USA, the most powerful state in the world, is a signal that inter-state relations are entering a new phase based on power rather than cooperation. The adverse transformation of the global trade, finance and economic system is much deeper than the immediate challenges of the West Asian War.

We have experienced this with the behaviour of the Trump administration on global economic relations. What is at risk is the free and depoliticized flow of trade and finance that has benefited the emerging economies over the past three to four decades. This pattern was threatened by the deep financial crisis in 2008, the growing concern in the developed world about the rising strength of the emerging developing countries, particularly China, and the impact of that on employment in the developed countries.

The big change has come with the explicit politicization of trade policy by the USA. The impact of this on global supply chain investments will lessen the corporate link across countries with the pressure from the Federal Government for domestication of production in USA and constraints on which country to trade with and where to invest.   As the influential US writer Francis Fukuyama said recently: “There has never been a time when the United States was more distrusted, by both traditional friends and by rivals, as at the present.”  In fact, in a variety of ways the USA has become the Unreliable State of America.

There is one more dimension of emerging constraint that needs to be understood and considered in development policy in India. China is best seen not just as an emerging economy but as a manufacturing powerhouse that accounts for 27-29 percent of global manufacturing production and around 20 percent of global manufacturing trade.  It also has demonstrated a willingness to use its domination of production and trade in certain areas like rare earth material as a tool in its political relationship with major states.  Given this reality, India must recognise that the politicization of trade is not limited to USA but also involves China.

Our policy must now assume that the de-facto depoliticization of inter-country trade and finance relations has ended and with heavy politicization of trade by USA no country is pursuing globalisation as an end and all are focusing on priority for their people and enterprises.  Going forward, countries are likely to emphasize bilateral and regional trade agreements, as well as government policy aimed at protecting key industries.  This is already a part of India’s policy framework.

When it comes to finance the imposition of direct controls has not come and the precautions that we experience is more because of concerns about the view of national governments, particularly in USA. However, there is a body of argument in the USA and in some countries in Europe that free movement of capital had contributed to the hollowing out of industry.  Hence FDI and FII flows will become more constrained.

All these developments require substantial policy change.  This has been elaborated very well in Chapter 16 in the Economic Survey 2025-26 (ES 25-26) because, as it says:

“In a world marked by geopolitical fragmentation, contested trade, volatile capital flows, and rapid technological shifts, growth by itself is no longer the binding constraint. What increasingly differentiates countries that merely absorb shocks from those that shape outcomes is the depth and quality of their state capacity.”

Let me focus on the industrial policy changes that we require to cope with the threats to global trade by the possible continuation of the West Asian war and the rising mercantilism in USA and some other states.  In any case this policy change is required to correct the inadequate  growth in manufacturing production, whose proportion in national GVA at current prices has declined from 17.4 percent in 2011-12 to 14.1 percent in 2025-26.

The most important requirement is a more strategic orientation of manufacturing policy. The global politicisation of trade requires us to focus our import substitution policies sharply on products which are critical and whose imported inputs are liable to political controls by supplying countries.  This may also be worth doing for industries that have the potential to become dominant in global markets. In fact, strategic import substitution does not necessarily work against export promotion.  For instance if a policy assessment leads to incentives for greater domestic production of Active Pharmaceutical Ingredients (API), whose imports at present are Rs 39 thousand crores, mostly from China, this domestication of API availability may actually boost pharmaceutical exports, which are a major component of our manufacturing exports. In fact an important objective of our industrial policy has to be on manufacturing rising to a global competitive level and its exports rising from about 2  percent of global manufacturing exports to something closer to China’s share of 20 percent. This will reduce the current account deficit and make us less dependent on inflows of foreign finance.

Raising tariffs to promote domestic production of critical input requirements is not enough an answer.  We need to move our private and public corporations more firmly into becoming enterprises that place a higher priority on being more focussed on being technology innovators and global competitors.  The key requirement here is that policy must emphasise substantially higher spending on research and development by the larger manufacturing establishments.  At present India’s R & D spending as a percentage of GDP is about one-fourth of China’s.  Since China’s GDP is four times higher that India’s, this implies that in absolute term India’s R & D spending is one-sixteenth time that of China. But the most critical difference is that In India only about 35 percent of the national R & D is done by the commercial non-government sector, while in China this sector accounts for about 75 percent of the sixteen-fold higher R & D.  This is one important reason for the sharp difference in the size, evolution and global role of the manufacturing sector between India and China. Hence, a policy that pushes the private sector, mainly in manufacturing, into much more committed R & D is an essential part of the change that we need.

The most important policy change we require is to shift the policy priority of corporations away from focussing on relations with politicians and administration to the standing in global competitiveness. If we do this,  manufacturing production will move closer to the long-standing target of 25 percent of GDP, become more dynamic in a global context and more technologically independent.