The Hindu BusinessLine | 1 December 2022
The bare truths about FTAs
BY AJAY SRIVASTAVA
The WTO database says that world over 355 FTAs (free trade agreements) are in force. Such a large number is partly due to the belief that FTAs are win-win deals and a country must do them to increase trade or become part of global value chains (GVCs).
Global Trade Research Initiative (GTRI), a new think tank on trade, finds that most such beliefs are just myths. Here are GTRI’s findings on the eight common myths surrounding FTAs, and the true picture.
One, most world trade happens through FTAs. Not true. Estimates suggest that just 15-17 per cent of world trade occurs through the preferential route. Why do experts overestimate the trade taking place through FTAs? They take total trade between two FTA partners, even though most of the bilateral trade may happen at MFN zero duty.
MFN or ‘Most Favoured Nation’ is a WTO term indicating that a country must charge the same import duty from all countries for a product. For example, of the $12 billion of India’s exports to Singapore, only 6 per cent is preferential. India’s 70 per cent exports to ASEAN enter at zero MFN duty. But most economists choose to forget this. Are they ignorant? No.
Two, FTAs are building blocks of the WTO. Not true. Developed countries are currently using FTAs to get developing countries to take WTO-plus obligations on new issues including intellectual property, environment, gender, labour, and sustainability. The new FTA obligations will be WTO-plus, leaving the WTO weak and irrelevant. These provisions will act as non-tariff barriers preventing developing country exports.
Three, countries are rushing to do FTAs. Not true. FTAs are enthusiastically embraced mainly by East Asian economies or countries that have lowered their MFN tariffs close to zero. Major industrial countries/regions do FTAs selectively.
For example, the US has no FTA with significant economies like the EU, China, Japan, ASEAN, or India. Most of EUs FTAs are with raw material suppliers and small countries. It has no FTA with the US, ASEAN (barring Vietnam), Russia, or China (except on investment)
Four, FTAs lead to an accelerated increase in exports. Not true for India. Chances of an increase in exports due to the signing of FTAs are low if import duties in the partner country are low. FTAs with Malaysia, Japan, Australia, New Zealand, Brunei, etc., benefit a few product groups only as most imports into these countries happen at zero MFN duty for all countries.
Five, FTAs promote domestic manufacturing. Zero-duty import of finished goods through the FTA route may disrupt many domestic manufacturing programmes. The US, in the new IPEF (Indo-Pacific Economic Framework) agreement under negotiation with India and others, did not include tariff elimination to protect its industry.
Six, FTAs lead to enhanced participation in GVCs. No conclusive evidence. Zero MFN duties provide the best conditions for the free movement of goods across countries. FTA duties must satisfy complex rules of origin and are the second-best option.
The WTO’s Information Technology Agreement (ITA-I), signed in 1996, with zero MFN duties and no rules or origin requirements, contributed more to developing GVC trade in electronics and computer products than any FTA.
The China-ASEAN-Japan-South Korea region developed an integrated GVC mainly after implementing the ITA agreement and before FTAs were signed. FTAs only provided top-up effects.
Overall, the critical reason for GVC growth was countries making MFN duties zero on essential sectors. But most economists ignore this fact and link the increase in trade with the subsequent signing of FTAs in the region.
ASEAN, Japan, and South Korea constitute the core of the Asian regional value chain. Despite FTAs with these countries, India has a weak presence in the electronics, machinery, or apparel value chains.
Seven, FTAs promote investment. Evidence is mixed. The examples of the automobile industry in Australia and India provide some clues.
Australia, in 1987, produced 89 per cent of the cars it used. It protected the car industry through a high 45 per cent import duty.
But the share of locally produced vehicles decreased as Australia reduced the duties gradually. Today, Australia imports nearly all cars as tariffs reach a 5 per cent level. Most manufacturers, such as Nissan, Ford, General Motors, Toyota, Mitsubishi, etc., which produced vehicles in Australia shut shop. The Australian auto industry got wiped out due to inadequate import tariff protection.
On the other hand, India could attract significant car sector investments due to high import duties (60-125 per cent). This resulted in the development of an indigenous car and auto component industry. Today, the automobile sector provides for a third of the manufacturing GDP of India.
If a country is not the most efficient economy, some import wall level helps get external investments. Without an import wall, many firms may shift production to the more efficient FTA partner countries for exporting back to the home market.
The quality of investments increases as a country moves towards becoming a more efficient economy. Such countries are in an ideal position to become manufacturing and services hubs.
Eight, FTAs lower prices. Rarely. More evidence is needed. The immediate visible effect of an FTA is the transfer of money (otherwise charged as duty on imports) from importing country (India) customs to partner country exporters, with no gains to Indian consumers.
In products where FTA imports face competition from domestic firms, the FTA supplier may offer better terms to importers or reduce prices just enough to have the upper hand in the market. Full margins arising out of duty elimination are not passed to consumers.
Myths generally take a long time to develop. Yet, FTA myths developed in less than two decades. Thanks to experts who spread these without facts or data. Countries must do due diligence based on their economic needs and not blindly follow ideology-driven advice.
The writer is co-founder of Global Trade Research Initiative