After negotiating for about seven years, India decided to opt out of the Regional Comprehensive Economic Partnership (RCEP) earlier this month. One argument used to justify the pull-out is that free trade agreements (FTAs) don’t amount to free trade.
Unlike unilateral trade liberalisation that results only in trade creation, an FTA leads to both trade creation and trade diversion, the latter being diversion of imports from more efficient FTA non-members to its members that now face lower tariffs within this group. This latter element is the protectionist part of an FTA, while the former is the free trade component.
Overall, an FTA will lead to freer trade if trade creation is greater than trade diversion. When initial tariffs are low, with the exception of a small number of industries, trade diversion should be relatively small.
RCEP, Biceps, Triceps
India already has bilateral trade agreements with Japan, Malaysia, Singapore, Thailand and South Korea, as well as an FTA with Asean. Thus, Malaysia, Singapore and Thailand have trade agreements with India individually as well as through Asean. Clearly, then, nothing would have changed between India and 12 of the RCEP member countries after India’s inclusion in RCEP.
As a result, for India, trade barriers would have been lower with only three countries: China, Australia and New Zealand. There was a fear that there would be a surge in imports of manufactures, primarily labour-intensive ones, from China.
Such a surge, it was feared, could wipe out India’s manufactures. There is a problem with this argument. Any standard FTA has a safety valve, in the form of an escape clause, built into it. This means that any import surge that causes injury in the form of losses in output, profits and employment, immediately allows the triggering of temporary protection.
During this period of protection, restructuring of the injured industry will take place, so that it is ready for international competition after some time. We don’t know the specifics of the RCEP agreement, as the negotiations were carried out behind closed doors. But if India was not able to get the standard escape clause into the agreement — which I really doubt — then this would show the failure of India’s trade negotiators.
There was also the fear that Indian dairy farmers would be seriously hurt by competition from New Zealand’s dairy products. Given that we expect the average Indian citizen to be a net consumer (not a net producer) of dairy products, and that milk and milk products are important sources of many essential nutrients, a reduction in the prices of dairy products would have benefited hundreds of millions of Indians.
In other words, the effects of RCEP on dairy farmers would have clearly been trumped by the effects on consumers, including those in poverty. But the dairy farmers’ interests seem to have prevailed. Reciprocity is considered to be an important principle in most FTAs. This means that reductions in trade barriers take place in a way that leads to equal exchanges of market access.
Clearly, China, a major exporter of manufactures, has an advantage in such negotiations, as tariff reductions, especially all the way to zero, are easy to figure out. However, what the barriers are to trade in services, in which India has the comparative advantage, is much more difficult to determine.
Block the Barricade
Reductions in barriers to services trade involve granting of licences and permits, as well as allowing freer movement of professionals, in these tradeable service industries across member countries.
But to what extent any such barriers need to be removed, and how such removal translates into market access and to what extent, can’t be determined by simple calculations. This can, therefore, be a source ofdisagreement between negotiating countries. However, if this liberalisation is agreed to be slowly done in phases until the desired market access is reached, the problem gets simplified considerably.
An agreement like RCEP, with liberalisation (both in manufacturing and services) carried out in phases, has considerable potential for India’s services sector, especially for software and ICT.
Since the beginning of India’s big trade reforms in 1991, economic growth has been 6% a year in 17 of the last 28 years. In 12 of those years, growth has been close to 8% or higher. This is impressive by any standards, but especially by the standards of the 1960s-70s when growth was in the range of1-3%. Not only has growth been high since the 1991reforms, but also the proportion of people below the poverty line has gone down from almost 50% to 20%, using the World Banks $1.90-aday poverty line.
So, it does not make sense to retreat to protectionism, as seen in the RCEP pull-out or in the few tariff hikes India has seen over the last five years. Protectionism clearly failed in a big way during 1960-85. I sincerely hope that remembering these sharply contrasting experiences, India will soon decide to join RCEP at a future date, when it is also able to obtain better terms. Indeed, such a decision will provide an impetus to the next generation of reforms —those related to land and labour.
The writer is professor of economics, Syracuse University, New York, US