Over the past decade, globalisation and Asia’s impressive economic performance, driven mainly by strong GDP growth in China and India, have created an unprecedented environment for the growth of intra-regional trade. Pakistan and Bangladesh have also registered impressively high growth rates, accompanied by significant reduction in poverty levels in both countries. All countries of Southasia have attempted – and, in some cases, succeeded – in concluding free trade agreements (FTAs) with each other. Significantly, the Southasian Free Trade Agreement (SAFTA) also took effect last year. Southasia is the world’s fastest-growing region; over the past decade, its GDP growth has exceeded 7.5 percent. The political environment for regional cooperation and integration has improved markedly, and is reflected in SAARC’s Islamabad and Dhaka Summit declarations. In addition, political pronouncements by Southasian leaders, coupled particularly with events of the past year, have raised expectations that the region could finally, to borrow a term from cricket, ‘go for a six’.
While such are the expectations based on realistic appreciation of economic and political trends, there is no doubt that for the moment the economic advance does not touch all, nor is the trade scenario very rosy. While Southasia accounts for 23 percent of the world’s population, its share of global GDP is only around two percent. In 2005, Southasia’s share in world trade was only 1.5 percent, one quarter of Southeast Asia’s share. Exports of goods and services accounted for only 19 percent of the region’s GDP in 2005. Of this, only 6.7 percent was due to services, while the services sector as a whole accounted for more than half of Southasia’s GDP. Foreign direct investment (FDI), meanwhile, is still only one percent of region-wide GDP.
Trade and investment flows have played a crucial role in the economic integration of other regions of the world, and they have the potential to do the same in Southasia. The realities on the ground with respect to trade among the region’s neighbours are, however, still sobering; left to themselves, they could continue to deter regional economic integration. In terms of intra-regional trade and investment in goods and services, Southasia lags far behind other regions. Intra-regional trade here amounts to only 4.9 percent of total trade, compared to almost 24 percent in Southeast Asia. The ratification of SAFTA on 1 January 2006 did mark an important milestone for the SAARC organisation, and it stipulates that SAARC will reduce customs tariffs on goods to 0-5 percent by 2016. However, that the trajectory tariff concessions would take could not be agreed upon ahead of the upcoming 14th Summit in Delhi on 3-4 April has had a dampening effect on the cheerleaders for SAFTA, and on the new ‘spirit’. Notably, even after SAFTA takes full effect, a complex web of obstacles to trade in the form of non-tariff barriers will remain.
There have been several studies on the economic gains that would accrue from SAFTA. Most indicate significant advantages to both India and ‘smaller’ countries, particularly Bangladesh and Pakistan. However, there is much variation across studies in the magnitude predicted for these advantages. Furthermore, these SAFTA gains are not large in either absolute or relative (to total exports) terms, because most models used in the free-trade policy simulations are constrained by the existing parameters – the current small volume of trade among these countries. As such, any computation of the response of trade to rapid GDP growth and liberalisation based on these volumes would not do justice to the potential impact from SAFTA.
The empirical results of such studies are therefore moot. Any serious investigation would consider the long-term, dynamic impacts of trade liberalisation. The evidence from existing regional trading arrangements in different parts of the world, not least within the ASEAN countries of Southeast Asia, clearly demonstrate that strengthening economic integration via freer trade is not a zero-sum game in the long run. A freely trading Southasia, supported by a liberal investment regime, would permit both restructuring of the existing production structures and specialisation along lines of comparative and competitive advantages, and yield significant benefits to most of the region’s countries. In the early phases of implementing such an arrangement, some of the smaller and narrowly based economies, as well as certain economic activities and socioeconomic groups, will need protection. In other words, not only may revenue losses due to tariff drawdown be required, but so too would social protection due to job losses. However, investment flows into those countries could be counted upon to spark growth and employment-creation in the longer term.
As the first step towards the grand vision of a Southasian Economic Union, not only will the present impasse in SAFTA have to be overcome, but much bolder action will need to be taken on a broader front to create a Southasian free trade area.
Deeper integration in trade and investment in goods requires, most immediately, an accelerated phasing out of non-tariff barriers, other than quantitative restrictions such as import restraints, technical requirements, inconsistent and lengthy customs procedures, and complicated documentation requirements – all of which currently prevent the easy flow of goods and services across the frontiers of Southasia. At the moment, trade documentation can take up to 20 days; import or export of goods can take up to 60 days to see fruition; an inordinate proportion of goods shipped in Southasia are inspected, against a world standard of 5-15 percent; and cumbersome procedures alone can cost 15 percent of the traded goods. Little wonder, then, that here in Southasia, trade-transaction costs, a key determinant of economic efficiency, are the highest in the world, barring a handful of regions such as Africa. High transaction costs distort economic incentives for trade in Southasia, and lower productivity.
The issue of non-tariff barriers is well known; indeed, SAARC’s 2005 Dhaka Declaration emphasises that “parallel initiatives for dismantling of non-tariff and para-tariff barriers” are necessary, and calls for “expeditious action on conclusion of agreements on mutual recognition of standards, testing and measurements with a view to facilitating intra-regional trade.”
The benefits of removing non-trade barriers can be substantial. Preliminary research indicates that the trade benefits of improving port efficiency and the customs environment in Southasia are several times greater than the trade effects from reducing tariff barriers. Improvements in trade-facilitation measures, such as harmonisation of customs procedures and systems, can yield benefits similar in magnitude to those of non-tariff barriers. According to official statistics, while improving port efficiency would increase bilateral trade significantly between, for instance, Bangladesh and both India and Sri Lanka, it would increase by a lesser degree between India and Sri Lanka. This is because the initial port efficiency level of Bangladesh is much lower, and hence the improvement is greater; since the port efficiency levels of India and Sri Lanka are much closer to the world’s average, the improvements are smaller. Similar patterns are seen for improvements in customs environments – increases in trade are greater for countries that initially had lower levels of efficiency. Clearly, therefore, a significant advance can be achieved by simply improving procedures, before even getting into the lowering of tariffs and the removal of non-tariff barriers.
Southasia has a strong comparative advantage in its services sector, which accounts for a substantial and growing share in the region’s total output – 53.3 percent in 2005. However, due to the lack of research on services trade policy and the limited availability of data on international trade in services, policymakers have limited knowledge on how liberalisation in trade in services and investment should proceed. Liberalisation of trade in services is in many ways different from that of trade in goods. Barriers that restrict the crossborder movement of goods are rarely similar to the restrictions on crossborder mobility of services. For instance, many services transactions require physical proximity, and therefore physical mobility of providers and users is essential. Barriers to trade in services are often more complicated than tariffs, and may take the form of regulations, standards, capital and labour restrictions, as well as other policy measures that are difficult to quantify.
Broadening the current SAFTA agreement beyond trade to include investment is equally important. Evidence from other regional groupings shows that investment flows play at least as significant a role as trade in promoting integration of economies. To recall, investments from Japan had a crucial impact on the economic interdependence and integration of ASEAN. Allowing freer flows of investment within Southasia will foster country-specific economies of scale, which can be exploited on a regional scale. As a result, more fundamental structural change of the region’s economies will take place. While free trade alone will yield gains, these are unlikely to be great. However, dynamic long-term effects can be significant, particularly if combined with aggressive trade-facilitation measures, removal of non-tariff barriers and, in particular, liberalisation of the investment regime. The full realisation of the gains of freer trade and investment would also require continuous and massive investment in physical infrastructure to connect the region more efficiently. (Though related to trade, physical connectivity through air, rail and road routes is a subject in its own right, and outside of the scope of this article.)
Cars and textiles
To undertake external sector reforms at a more realistic pace, and to make these more politically feasible, it may be prudent initially to focus on exploring the potentials of priority industries, where more-immediate and specific interventions, such as removal of non-tariff measures, can be implemented more easily. Priority sectors could be selected on the basis of an analysis of comparative advantage and strong potential for long-term economic growth and structural change. Focusing reforms on a limited number of priority sectors could increase the chances of success, permitting the positive results to be used to demonstrate the significant economic benefits of trade and investment liberalisation among Southasian countries. This would be a ‘showing by doing’ approach, and would help to build mutual confidence and trust.
The Southasian textile sector, for example, has strong potential for developing a regional value and production chain. Given that most Southasian countries are large exporters of intermediate and finished clothing and textile goods, the region as a whole could gain greatly if the countries were to cooperate strategically to enhance efficiency, improve product quality and thereby increase value. As India shares borders with most Southasian countries, has proven capability in marketing, and has economic linkages with the major apparel-importing countries, it could become a hub for spurring the growth of intra-industry trade in the region. With its central location and size, India could also serve as an assembly and exit point of high-value Southasian goods (as well as services) for both domestic and international markets. Intra-industry trade could also be boosted by greater crossborder foreign direct investment. For lower-value and specialised textile products, Bangladesh, Pakistan or any of the other smaller countries could become the hub.
The automotive sector also has the potential to develop as a regional priority sector. Several crucial ingredients are already in place for this to happen. Automotive manufacturing is a complex, multi-tiered production process that involves assembly of a large number of components. The assembly complexity spans the entire range, from simple mechanical components to complex electronic parts. Hence, a degree of specialisation for each of the countries is feasible without entering into debilitating direct competition. Furthermore, advances in production technology allow for the geographical spread of assembly of parts and components to locations where economies of scale can be used optimally. Unlike in earlier production technologies, it is no longer necessary to geographically concentrate the entire assembly activity in one geographical location. The current and potential size of the market for automotive products makes it more worthwhile for manufacturers to optimally exploit economies of scale and comparative advantages for each of the countries. Incidentally, in order to fully benefit from scale economies and sub-regional specialisation, it may also be appropriate for Southasian car manufacturers – in the wake of Chinese competition – to broaden the market from the sub-regional to the wider Asian or even global level.
As other successful regional cooperation and integration initiatives have demonstrated, regional cooperation in trade and investment benefits all countries. Focusing on and recognising the longer-term and dynamic benefits of regional integration helps to eliminate the anxiety that Nepal’s gain, for example, would be offset by India’s loss – ie, that there is not much to be gained from such cooperative economic arrangements, or that only the small neighbours would gain. The long-term approach acknowledges that benefits will accrue to all members of the regional group, irrespective of their size. While static benefits for the larger countries in trading with the smaller countries may seem limited, the longer-term dynamic effects from integrating with smaller neighbouring countries are substantial. For smaller economies, exploiting their comparative advantages in specific phases of the regional production chain will yield significant benefits while boosting intra-regional trade, investment and integration with the neighbouring country. Some analysts have also pointed out that regional economic integration, driven by more free trade and investment, could have substantial gains for India’s borders states, some of which are among the poorest in the country.
The peace dividends of a more economically integrated Southasia, as exemplified by the European experience, could be enormous. Peace and stability in the region would spur the ‘neighbourhood effect’ in foreign direct investment; after all, the rest of the world views Southasia as a region, and events in India’s neighbourhood are likely to influence FDI decisions. An economically integrated Southasia that is at the same time open to the rest of the world would not only respond to the aspirations of its peoples for prosperity and peace, but could also be a major anchor for global economic stability. Globalisation is an inexorable process, and the smart thing for Southasia would be to deal with it collectively, as a region.
~ Sultan Hafeez Rahman is deputy director general of the South Asia Department at the Asian Development Bank, based in Manila. The views expressed in the article (p 40) are the writer’s own.