Trade pacts: Why it’s a big deal
Indian Express, India
Trade pacts: Why it’s a big deal
Ila Patnaik
15 September 2006
Does a trade agreement between India, Brazil and South Africa make economic sense? They are geographically apart, are all labour-abundant developing countries without clear gains from trade, and it’s unclear the agreement will result in trade creation and increased welfare. But that’s the beauty of trade agreements: the power they bring to the table isn’t always obvious. ILA PATNAIK looks at trading agreements past and present:
• What are trading agreements?
A trading agreement is an arrangement between countries to reduce tariff barriers. Customs duties on imports are a barrier to international trade, reducing trade and the gains that could be made from trade. Lowering them leads to an increase in trade and business.
• How many kinds are there?
There are multilateral, bilateral and regional trade agreements. There are customs unions and free trade areas.
• What have trade agreements meant for trade and welfare?
While most evidence finds that multilateral agreements help in increasing trade and welfare, it is not clear that regional agreements lead to trade creation (an increase in trade), rather than trade diversion (an increase in trade among member countries without an increase in total trade, the increase coming at the cost of trade reduction with non-member countries). Which brings us to Free Trade Areas, in which countries maintain their own tariffs against non-member countries while having zero tariffs with FTA members. Economists often say FTAs may promote better political ties with neighbours, but are not based on sound economic principals.
• How do FTAs lead to trade diversion, not trade creation?
Under an India-South Africa FTA, for example, instead of importing steel from Europe, a producer would import it from South Africa. This does not help the Indian economy. Moreover, as long as South Africa does not satisfy the entire Indian demand for imported steel, the price of steel in India does not fall. “Rules of origin”, on which FTAs are based, mean that only steel produced in South Africa can be imported under preferential tariffs - zero tariff is only when there is a minimum percentage of value added in South Africa.
• What has been India’s involvement with FTAs?
Over the last few years a number of FTAs have been signed with Asian neighbours, including Sri Lanka and Singapore. Steps are being taken for the creation of free trading areas within South Asia and ASEAN. The benefit to India from entering an FTA is limited when India is dealing with a free-trading country. Since India is a high tariff economy, an FTA gives the partner a clear benefit, but if the partner already has zero or near-zero tariffs, (as is the case with Singapore) Indian exporters do not stand to gain much. The FTA does not give Indian exporters additional market access. While India has an average custom-to-total import ratio of around 20 percent, Singapore is a zero tariff zone, Sri Lanka’s is much lower at 5 percent and Thailand, with whom the next FTA is proposed to be signed, has custom s collections at 3.8 percent of total imports. Indian exporters gain little from preferential tariffs in these countries. It is their exporters who gain. India loses customs duties to be collected on their exports.
• The other implications of Rules of Origin for India?
There is a big cost in terms of creating a bureaucracy which sits at customs points and checks whether goods coming from FTA partners satisfy “Rules of origin”. There is scope for corruption.
• So why India and RTAs?
First, there are political gains of belonging to a group. Second, it is a way of reducing barriers to trade and reduce custom duties which may not be as easy to do in a unilateral manner. Yashwant Sinha, when he was finance minister, had announced that Indian tariffs would be brought down to ASEAN levels. If India is part of a deal to cut customs duties, it becomes easier to do so. While domestic producers may protest, consumers stand to gain when duties are cut. In addition, these agreements can lead to an increase in service exports an area in which there is slower progress in multilateral arrangements like WTO.
