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are designed to keep costs of Lnvestment and capital goods clove to international prices, in order to avoid loading production costs with locked-in financial a'nd fiscal charges over the llfe of industrial projects. In all developed cou,.trie9 and practically all developing countr:es, import tariffs and nominal pzotection applied to capital goods are quite low, much lower than tariffs and protection applLed to other tradeables, and capital goods are often exempt from import duties and domestic taxes. For instance, in Brazil which has highly protected its domestic industry, tariff collection rates on machinery in the mid-80L were in the 11-17% range. In Korea, they were about 9% for domestic use, and negligible for ezport production. Even in Pakistan (which has the second highest overall tariff collection rate after India), tariff collection rates on machinery were 15% in 1987/88.

# Corrected Protection under a distQrted price of fixed capital<sup>6</sup>

12. By contrast, India is almost unique in levying high tariffs and taxes on capital goods. Its average tariff collection rate on machinery was about 70% in 1987/88, and this high protection in favor of its domestic capital goods industry (coupled with strict QRs) has led to NPCs averaging about 1.40 for domestic capital goAds. As a result, investment costs of industrial projects in India are, ceteris p4rLbus, about 50% highez on average than investment costs of comparable projects at international prices 16].

13. Under a structure of high protectlon and prices for capital goods, higher investment costs entail impllcitely that: (i) Value Added generated by an industrial project normally include a larger amount of capital remuneration (depreciation, interest, and profit as return on equity); and (ii) thus domestic Value Added VAd exceed Value Added at international prices VAw, with a resulting positive EPR, even if the domestic firm is efficiently operated by international standards. A high price of capital goods and investment, characterlzed by an average NPC for capital goods (NPCk) substantially above 1, generates in the value added at domestic prices a fixed capital cost FRd which is approximately proportionate to NPCk ( depreciation and interest charges are, ceteris paribus, a fixed proportion of the total investment cost). Assuming (for the sake of simplicity) that the labor cost L would not substantially decrease, at least in the short/medium term, if the project were to operate under free-trade, a hlgh NPCk requires a high FKd which thus cuts down profit Pd, in particular when NPCk is higher than the output NPCo. This mechanism is illustrated by the graph 3 where FKd, the projection of FK on the vertical line NPCk, is proportionate to NPCk. When NPCk increases (horizontal arrow), FKd increases, as well as FKd's projection on the VAd vertical line. The portion of VAd other than Ld (fixed) and FKd shrinks (vertical arrow), up to a point where the resldual room left for profit can vanish altogether. X <!-- Start of picture text --> Pes Graph 3 .<br>.<br>Pd<br>.-<br>P<br>.- .-- :<br>- .- - .-...-.-<br>'<br>,.: .<br>-__ ______.'_<br>I N.i NPC. NPCk<br><!-- End of picture text --> 6 The issues associated with a distorted price of financial capital (e.g. interest aubsidies) on EPRs have been extensively analyzed in the litterature. They are not the subject of this paper, and are not addressed herein.

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