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The great spaghetti tangle

Financial Express, India

The great spaghetti tangle

India must take a more pragmatic approach to regional trade arrangements

By Rohit Pandit

28 June 2007

The World Trade Organization (WTO) lays down parameters for the conduct of international trade among its 150 member countries. The basic objective, as stated more than implemented, is to provide a fair, transparent, non-discriminatory, rule-based multilateral trade environment. The two basic rules:

1) The most favoured nation (MFN) rule, which translates into a principle of non-discrimination, prohibiting WTO members from discriminating among goods originating in different countries. All tariffs and regulations should be applied equally to exported/imported goods of all countries.

2) The national treatment rule, which prohibits WTO members from discriminating between imports and equivalent locally produced goods.

Given this framework, why is the world seeing a discernible and increasing trend towards regional trade arrangements (RTAs)? By providing preferential tariff access, these deals favour goods manufactured in sign-on countries, leaving others out in the cold.

There are varied reasons for this trend. Even in the absence of RTAs, goods imported from neighbouring countries, ceteris paribus, enjoy greater cost competitiveness on account of geographical proximity and lower freight costs. Since one can’t change geography, neighbours tend to come together to promote regional cooperation in such areas as economic progress. Impatience with the slow progress of multilateral trade talks has also led to the acceptance of smaller regional groupings engaging in mutually beneficial give-and-take. What might take ages to push through the WTO-which requires consensus-can be done sooner through such deals.

Under Article 24, the WTO allows tariffs and other barriers to be reduced on a preferential basis by countries under regional arrangements, as a special exception to the MFN rule-subject to member countries of an RTA removing tariffs and other barriers to trade affecting substantially all trade among themselves, and the agreement not resulting in the imposition of new trade barriers with other countries. While trade between members of the regional arrangement may be duty-free, trade with other countries should be subject to MFN tariff rates.

According to the WTO, which has almost 400 RTAs notified with it, only three of its members are not party to any RTA at all. More than two-thirds of world trade today is done on a preferential basis, by WTO estimates.

Agreements between countries differ, and so do RTAs. The basic kind would be a preferential trade agreement (PTA), in which each member extends import tariff concessions to a mutually-agreed list of goods made in all member countries. Next would be a free trade agreement (FTA), by which there are no internal tariff barriers between member countries and individual external tariff barriers. Next would be a customs union (CU), in which there are no internal tariff barriers and common external tariff barriers. The next stage of evolution would be a common market (CM)-in addition to a CU, there is free mobility of the factors of production. Next would come a monetary union, which is a CM plus common currency and common central bank-which implies a unified monetary policy. Lastly, an economic-cum-monetary union, which is a CM plus unified monetary, fiscal and social/labour policies.

By WTO data, around 90% of notified RTAs are either PTAs or FTAs, and the rest are CUs. According to economic theory, duty-free trade among member countries has two major economic effects. The first is trade creation, which involves the substitution of domestic production in a member country by imports from other members, thereby resulting in specialisation and re-allocation of resources so as to maximise efficiency within a larger framework. The second effect is trade diversion, which involves the substitution of imports from non-members by imports from member countries, thereby harming the cause of efficiency. The balance of these two effects would determine whether a particular RTA delivers economic benefits or harms the world as a whole.

India has been left far behind other large countries in this race for regional integration. South Asia’s natural RTA, Safta, though conceived much before other RTAs, was operationalised only a year ago, though Pakistan has still not given MFN status to India. The Indian government has adopted an aggressive RTA policy only in the last four years, but headway has been hard to make.

The government seems to favour comprehensive economic cooperation agreements-an FTA plus deals on FDI, services and so on. It also seems keen on taxation treaties and bilateral investment promotion and protection agreements. Rules-of-origin have entanglements of minimum value addition/domestic content prescriptions and insistence on manufacturing facilities. Agricultural products, of course, are to be kept away from all this.

It is complicated. With the Doha Round stuck, and RTAs proliferating, we need clarity on trade policy.

- The author is joint secretary, PHDCCI. These are his personal views