India’s abstinence from RCEP: Free marketeers getting it surprisingly wrong
FTAs, by definition, are about countries swapping market access in areas where they have respective comparative advantages in place.
India’s somewhat spectacular pause on signing up on the RCEP (Regional Comprehensive Economic Partnership), after years of hard negotiations (and recent indications suggesting the government might sign on) has been almost uniformly criticised by the free market commentariat. The critique was standard, almost at déjà vu levels – keeping off a large regional trading bloc indicates a “protectionist” India and signals an unwillingness to undertake “hard reforms” needed to make industry more competitive. At a geoeconomic praxis, keeping off RCEP gives China a free-run on a large regional platform.
There is an old chestnut – “where one stands depends on where one sits”. The passionate advocacy of FTAs (like RCEP) is puzzling, coming from selfproclaimed votaries of free markets. At a first principles basis, as well as from India’s lived-experience basis, there are questions on FTAs that are far from the panacea that they seem to be posited to be.
Professor Jagdish Bhagwati, the exemplar-evangelist of the benefits of free trade and market economy, memorably described preferential trade agreements (PTAs) as Termites in The Trading System, in an eponymously titled book published in 2008. Bhagwati’s thesis was intuitively simple – in an FTA (or PTA), two or more countries agree to lower/eliminate tariff and non-tariff barriers on trade between each other. Superficially, this is good for the member countries of the FTA, but practically creates multiple distortions in free trade and its benefits to consumers/ economies.
This is explained by a simple example, say, of manufactured cheese. Consider 3 trading entities – India, New Zealand and the EU – each manufacturing cheese at different price points (say 110, 105 and 100, respectively). Before a possible Indo-NZ FTA, the import duty on cheese was 10%. Which meant that landed price in India of the EU cheese was 110 and NZ cheese was 115.5, respectively. Post an Indo-NZ FTA, which eliminates import duty on NZ, the landed price changes to 105 for NZ and 110 from the EU.
Consequently, India would divert all its imports of cheese from the EU to NZ, even though EU is a lower cost source of the product. Further, with NZ cheese available at a price point lower than Indian (105 versus 110), consumers would gradually move completely to NZ-sourced cheese – thereby creating trade where none existed and shutting down large numbers of Indian factories making cheese. While the example is illustrative, it isn’t entirely hypothetical. Post the RCEP pullout, Amul’s iconic ad-strip showed the Amul girl leading a farmer couple carrying milk-buckets with the punchline – “Firm PM, Farm PM”.
The distortion isn’t limited to a priori trade diversion and creation. It persists over time and expresses itself via anti-dumping duties. Prof Thomas Prusa of Rutgers University and Robert Teh of WTO, in a follow-up research of Bhagwati’s hypothesis, wrote in a paper published in 2010 that FTAs proliferate anti-dumping measures taken by FTA members against non-members and likely dampen the efficiency gains that are premised as the key rationale for FTAs.
The puritan theoretical view (as above) apart, there is a practical first principles issue as well. FTAs, by definition, are about countries swapping market access in areas where they have respective comparative advantages in place. In theory, this should mean India would swap market access in areas where we have a comparative advantage (primarily high-end labourintensive services) for market access where we tend to have a comparative disadvantage (primarily capital and manufactured and processed-agri goods). In practice though, most FTAs executed (and those in negotiation, like RCEP) are rather tardy on labour mobility, while getting significant freedom of capital and manufactured goods mobility.
Beyond the first principles, and more pertinently for India’s trade negotiators, is the point of India’s “lived experience” with FTAs. Most of India’s highest profile FTA in the last decade have had underwhelming results, especially if balanced trade is taken as a key parameter of success. The Indo-ASEAN FTA, post its signing in 2010, has resulted in India’s trade balance deteriorating from $8 billion in 2010 to $22 billion in 2018. This was a result of not just imports from ASEAN outpacing exports to it, but also of ASEAN outpacing the rest of the world in India’s import basket. Indo-Korea FTA entered at the same time had a similar experience. Trade deficit has widened from $5 billion in 2010 to $12 billion in 2018. The experience has again been similar with the Indo-Japan FTA, where Indian exports have stagnated (even declined), while imports from Japan have surged. In a nutshell, India is coming off a decade of empirical evidence that militates against an original premise of FTAs, i.e., balanced trade.
Last, but far from being the least, is the elephant (or rather the dragon) in the room, China. India’s current trade deficit with China runs at $53 billion, by far the largest share in India’s trade deficit pie. Membership of RCEP, a conglomerate where China has been historically, socially and politically embedded, sans very high safeguard walls, present more risks than rewards in the Indo-China equation.
That is because an FTA imposes near-tautological restrictions for punitive (or partial) deal-making between two member-countries facing unique bilateral issues. India’s plate of bilateral issues with China is very full, and the burgeoning trade deficit is a large piece there. Arguably, India’s best chances on deal-making with China would be when several pieces in the plate are simultaneously at play. RCEP would substantially tend to make trade a very circumscribed piece.
All in all, the critique of India’s RCEP stance stands on contradictory grounds, going by the critics’ own praxis and expectations. The policymakers, yet again, are likely to have taken the right call, notwithstanding the critique.
(The author is managing partner, ASK Wealth Advisors. Views expressed are personal.)