South Asia Means Business

South Asian governments should lift trade barriers, get out of the way, and let markets grow smoothly.

Despite the dangers of generalisation, it is fair to assert that most countries in the South Asian region had, until recently, followed development paradigms based on import-substituting industrialisation. Since the 1980s, and particularly in the 1990s, this has been replaced by a greater degree of outward orientation with accompanying emphasis on export promotion. Bangladesh, India, Pakistan and Sri Lanka have all been engaged in such unilateral and autonomous liberalisation attempts. These reforms involve a domestic as well as external sector component, and the two cannot really be delinked. In the external sector, most reforms have involved four distinct strands: a reduction in tariffs, an elimination of quantitative restrictions on imports, a transition to realistic and market-determined exchange rates and elimination of exchange controls so that there can be a transition to current account convertibility and a more open and liberal policy regarding foreign direct investments (FDI)..

By and large, the reforms reflect an innate dissatisfaction with the GDP (gross domestic product) growth rates achieved under the earlier development model.

In many cases, the scope for further growth based on import substitution had exhausted itself. In addition, the effects of historical growth rates on welfare indicators like the percentage of population below poverty line, life expectancy, adult literacy and infant mortality had been less than satisfactory. Such dissatisfaction has existed even when reforms have been precipitated by an economic crisis.

The point to note is that the success of such outward-oriented reforms depend crucially on the continued existence of an open multilateral trading system. Reforms therefore would have been easier had South Asia opened up in the 1970s. Despite the successful conclusion of the Uruguay Round of multilateral trade negotiations and the entry into force of the World Trade Organisation (WTO) in January 1995, the multilateral trading system continues to face the threat of bilateralism and protectionism as manifest in regional trading agreements. For example, such regional trading agreements are governed by Article XXIV of the erstwhile General Agreement on Tariffs and Trade (GATT). Under Article XXIV requirements, such regional agreements have to be notified and to date, exactly 63 such agreements have been notified to gatt/wto. The span of these agreements covers free trade areas, customs unions, common markets and economic unions.

Advance or Retreat
How does one react to the proliferation of these regional agreements? Two lines of reasoning are possible, with the implications diametrically opposed. On the one hand, one can argue that the goal of global free trade is not directly attainable and regional free trade is a stepping stone towards that eventual goal. Viewed thus, regional agreements are desirable. On the other hand, regional agreements can reflect a dissatisfaction with the goal of global free trade and thus represent a retreat from multilateralism. Viewed thus, regional agreements are undesirable.

Had the Uruguay Round of negotiations collapsed, the second interpretation would have been more plausible. As things stand, the integration of regional trade policies within the multilateral system is not impossible and the wto´s Committee on Regional Trade Arrangements has the task of reconciling the two principles.

The 63 agreements cover the regions of Western Europe, Eastern Europe, North America, Central America and West Asia. In addition, if one includes agreements notified under the enabling clause of Article XXIV, South-East Asia and Latin America are also covered. Thus, despite the successful conclusion of the Uruguay Round, the international trading system seems to be in danger of splitting up into a tri-polar world, with the three poles centred in Europe, North America and South-East Asia. The only geographical regions of the world that are not covered by an existing or potential major trading bloc are Africa and South Asia.

Regional agreements can have positive or benign effects on the rest of the world. Examples of positive effects are trade creation, investment creation, reduced protectionism (because of greater employment opportunities), harmonised marketing standards and decreased import costs for the rest of the world as exploitation of economies of scale brings down costs of production within the bloc. But there are also negative effects, and examples of these are trade diversion, investment diversion, enhanced protectionism (due to frictional unemployment) and mergers and acquisitions within the bloc that lead to reduced bargaining clout of individual firms in the rest of the world. The paranoia among non-members about regional agreements reflects the belief that the negative effects may more than outweigh the benefits.

Not being a member of a major trading bloc, South Asia has to accept that the inhibiting effects on market access can be fairly serious. There are four possible courses of action which are, of course, not mutually exclusive. First, one can contest the issue of bloc formation at multilateral fora like the WTO. The disciplines of Article xxiv are so mild that regional agreements have the implicit sanction of the WTO and this option is therefore not viable.

Second, one can attempt to join an existing or potential bloc. For South Asia, the obvious choices are a trading bloc that may emerge in the Asia and Pacific region centred on ASEAN (Association of South-East Asian Nations) or in the Indian and Pacific Ocean Rim, involving South Africa and Australia. But the prospects of such a large and disparate group of countries achieving any concrete economic results is not too bright.

Third, one can try to form a bloc of one´s own and this is where the concept of a South Asian Preferential Trade Agreement (SAPTA) becomes important. Apart from anything else, an entity like SAPTA enhances the collective bargaining strength of individual member countries. For example, the outcome of the textiles and garments negotiations in the Uruguay Round might conceivably have been different had SAPTA negotiated as a group. Fourth, one can negotiate bilateral agreements with existing or potential trading blocs so that market access does not constitute a problem. But even here, the countervailing force is considerably more with an entity like SAPTA. Thus, whichever way one considers the question, there is some urgency in making SAPTA take off.

Small Country, Large Gain
Historically, this urgency has been missing. SAARC has been in existence since 1985, but concrete measures on economic cooperation were non-existent before the Eighth Summit, in 1995. More accurately, the beginnings of economic cooperation can be traced to a 1991 study which analysed the existing status of intra-SAARC trade and sought to identity constraints for further trade expansion. Eventually, the agreement on SAPTA was signed in 1993 and SAPTA became operational in December 1995.

Economic analyses show that in any process of bloc formation, relatively larger gains accrue to weaker and smaller countries which in the SAPTA context means the least developed economies of Bangladesh, Bhutan, the Maldives and Nepal. Conversely, relatively smaller gains accrue to stronger and larger countries. In the SAPTA context, this means India, Pakistan and Sri Lanka.

Any process of bloc formation therefore has to be subsidised by the larger countries. The extent to which SAPTA succeeds is a function of the extent to which India, Pakistan and Sri Lanka are prepared to subsidise the process. This is under the assumption that bloc formation implies more than trade liberalisation, and that required structural adjustments are also carried out. If bloc formation is restricted to the limited area of trade liberalisation, relatively larger gains often accrue to the larger countries.

Intra-SAARC trade levels have never been very high historically. As a percentage of trade turnover with the entire world, it is about 2.5 percent. But this is an aggregate figure, and intra-regional trade has been much more important for smaller countries like Bhutan, Maldives and Nepal. Many reasons have been cited for this low level of intra-regional trade. For instance, intra-regional trade flows are not determined by economic factors alone, but are a function of various social, political and historical factors. The India-Pakistan relationship is a case in point.

There are also issues such as the absence of a proper financial and institutional framework such as a bank for the countries of the region or the establishment of capital markets of regional importance. For example, the settlement of India´s trade surpluses with the other countries (barring Pakistan) is a problem. This is linked with a centre-periphery or North-South perception vis-a-vis India and other SAARC countries.
In the context of conventional trade flows, as opposed to cross-border investments, the competitive and non-complementary nature of the economies is a constraint. One can also cite the inadequate quality of goods that can be imported from within the region as compared to the quality of goods that can be imported from outside the region. This last factor is coupled with a certain amount of prejudice and lack of credit facilities in general. It is also true that concessional aid and credit often bind trade flows to donors who come from outside the region.

Uncustomary Duties
Since SAPTA became formalised in 1995, individual countries have offered SAARC countries preferential rates of customs duties. Are these likely to boost intra-SAARC trade significantly? If one scans the national schedules, one finds that Bangladesh has offered a 10 percent reduction on existing customs duties for 12 tariff lines. The Indian offer covers 106 tariff lines. Duty reductions range from 10 to 90 percent, with a range of 10 to 100 percent for the least developed economies of the region. Maldives has an offer on 17 tariff lines, with reductions of 7.5 percent. The Nepali offer covers 14 tariff lines, with reductions of 7.5 or 10 percent. On 35 tariff lines, Pakistan has reductions of 10 percent, with 15 percent for least developed economies. The Sri Lankan offer, on 31 tariff lines, involves duty reductions that range from 10 percent to 20 percent.

These reductions, achieved through the first round of trade negotiations, are not substantial enough for there to be a major impact on intra-SAARC trade. Part of the problem lies with the way tariff concessions have been negotiated, on a product-by-product basis. Such negotiations inevitably lead to offers on items that are not traded much.

In the second round of trade negotiations, the negotiators ought to switch focus to across-the-board tariff reductions, when the impact on trade flows is likely to be much more significant. In addition, they could adopt a two-track approach to tariff reductions. That is, apart from the track adopted for reductions throughout SAARC, there can be a faster track of tariff reductions, negotiated bilaterally among the relatively more advanced countries. While the initial round of tariff reductions is significant as the driving of a wedge, the transition from SAPTA to a SAARC. Free Trade Area (SAFTA) cannot take place until the tariff reductions are speeded up.

In global trade flows, non-tariff barriers (NTBs) are far more important as constraints to trade flows than tariffs. Intra-SAARC trade is no different. India-Pakistan trade flows provide innumerable examples of such NTBs. Negotiations on NTBs are more messy than those on tariffs, since NTBs are difficult to pin down, quantify or police. Therefore, the relatively more tractable business of tariff reductions and tariff eliminations needs to be completed fast, so that one can move on to the NTBs.

More importantly, trade flows are a function of cross-border investment flows. In global trade, a large chunk of trade flows consists of intra-industry trade of which a significant segment consists of intra-firm trade. The goal of increasing trade flows cannot therefore be delinked from the objective of increasing cross-border flows of investment. Joint ventures are possible in sectors such as jute, tea and textiles and garments.

The transition from conventional trade flows to investment flows has the added advantage of tapping synergies and complementarities and exploiting economies of scale, since competitive economic structures become relatively less important. Joint ventures need not be confined to manufacturing, but can extend to services sectors and even to non-tradeables. The point, however, is that such joint ventures often involve structural adjustments within the individual countries. Not a single one of the SAARC countries is presently prepared to accept such structural adjustments.

The future of SAARC lies in the standard transition from a free trade area to a customs union, and from that, to a common market and an economic union. But given the lack of political will, even the free trade area is a long way off. Not surprisingly, intra-regional investments have been far less significant than intra-regional trade.

The examples of the most successful regional blocs illustrate that they do not succeed because of what governments do. At best, governmental announcements merely provide formal sanction to what has already been taking place at ground level, because of commercial decisions. SAFTA, or a South Asian Economic Union, will not emerge because the governments decree it. The most that governments can do is to provide an enabling framework and remove constraints in the way of commercial decision-making. Most political and other constraints that exist in the region can be directly attributed to state interference in commercial decision-making.

The greatest stimulus to intra-regional economic cooperation thus lies in the reform process, which almost tautologically, involves a diminished role for the state. Therefore, the faster liberalisation proceeds in the individual countries, the better the prospects for South Asia as a whole. That is the road map to SAFTA.

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