A bird’s eye view of containers stacked at Port of Napier, which is a major trading hub in New Zealand. Currently, the country is aggressively negotiating a FTA with India
In the post-GFC world, policymakers are leaving no stone unturned to jumpstart growth. Be it negative interest rates, or trillions of dollars of QE, every trick in the book, and many beyond it, are being used to create demand. One such attempt are free trade agreements, which, suddenly, are on the tip of every policymaker’s tongue. But do they bring anything to the table? The Dollar Business presents a detailed analysis
Sisir Pradhan | May 2015 Issue | The Dollar Business
Trade and commerce have always been part and parcel of human society. There’s enough evidence to suggest that even in pre-historic times, trade used to take place across the then existing borders. But for centuries, there was nothing in place to regulate it. Goods used to move across borders rather freely. With the formation of modern nation states and thanks to rising competition among them, however, the need was felt for a mechanism to monitor trade. This need got standardised, when the post-World War II world order got the General Agreement on Tariffs and Trade (GATT) – the first concrete step towards promoting and regulating global trade. Later, in 1995, GATT was scrapped, when 123 countries came together to form a global regulator – the World Trade Organisation (WTO).
Escape route
One of the primary principles of the trading system under WTO is to provide a level playing field to both local goods and services, as well as, those from other member countries. Its aim is to eliminate all sorts of discriminations and remove tariff and non-tariff barriers. To ensure this, WTO mandates each member to treat all other members equally. In other words, it wants each member to treat all other members as a Most Favoured Nation (MFN). But, thanks to geo-politics, since this was always going to be a herculean task to achieve, the WTO kept some window open for regional trade agreements, as per which, any two or more countries are free to form trade partnerships based on mutual consensus.
One variety of such agreements is a Free Trade Agreement (FTA), which allows two countries/ blocs to make rules that apply only to their goods/ services/ investment. Although it’s a deviation from the basic fundamentals of WTO, it is, today, considered an integral part of global trade integration.
Reality bites
Though free market principles sound great in theory and there’s no dearth of advocates for them, they are a distant mirage in the world of international trade. More often than not, they are overshadowed by socio-politics; a division between us and them; and of course, a division between insider and outsider. On the pretext of protecting domestic economies, policymakers create tariff and non-tariff barriers, many a time to serve vested interests, mostly to serve themselves, all at the expense of the end-consumer. And while adhering to MFN would mean each time a country lowers trade barriers for one country, it needs to do the same for all WTO members, under FTAs things boil down to choices, negotiating skills and bargaining powers. Hence, they are becoming increasingly popular. For, a FTA allows one to pick and choose – a tool that the powers that be always prize.
All equal, some more
All animals are equal, but some animals are more equal than others – the famous line from George Orwell’s satirical classic, Animal Farm, best fits the WTO. For, while political bosses make headline grabbing statements that they are all for a free world, without discrimination, reality cannot be further from that. Is trade between two countries only based on market dynamics? Why is trade the first thing that is targetted when the West imposes sanctions on an Iran, a North Korea or even a Russia? If everyone is for a free and fair world, shouldn’t at least the WTO stop countries from unilaterally imposing trade restrictions at the slightest pretext? At the other end of the spectrum, how many of the trade agreements that are signed during state visits are actually implemented? Just what happens post such photo-ops and handshakes can be gauged from the fact that of the 37 FTAs that India has had/ is having trysts with, only South Asia Free Trade Area (SAFTA), India-ASEAN FTA and India-Sri Lanka FTA have seen some kind of logical conclusion. For everything else, ‘negotiations are on’.
Status quo
Having discussed the logic behind FTAs and the reason for them becoming increasingly popular, let’s take a look at the way things change, if at all they do, after the implementation of an FTA. An analysis of trade between India and Sri Lanka, India and other SAFTA members and India and ASEAN members, immediately before and after the respective FTAs were signed, reveals that while deficits never turned into surpluses, or vice versa, trade volumes jumped. And this is, actually, what FTAs should be achieving – more trade, which would trigger higher growth. They should not be looked at only from a trade balance point of view. If that were the case, why would any country, with a deficit with another country, be willing to negotiate an FTA?
Trade experts and economists, however, are not happy with India’s policy vis-à-vis FTAs. They think India trying to sign trade agreements with East Asian countries is illogical. For, since India has higher trade barriers than most East Asian countries, agreements based on just reducing tariff barriers, which has been India’s policy for long, would only mean giving up more and getting less. Similarly, since India’s strength is in the services sector, the fact that it has not been able to negotiate services trade agreements, puts serious question marks over the objectives of the country’s policymakers. The inability to complete mutual recognition agreements (MRAs), which are key to services trade, even 10 years after starting them in case of the India-Singapore FTA, only strengthens this view.
Spaghetti bowl
Another lacunae in India’s FTA policy is the failure in spreading awareness about and the implementation of Rules of Origin (RoO). The same is the case with the overlap of many FTAs. For, India has several trade partners that are part of more than one FTA. For example, while trading with Sri Lanka, an Indian trader can currently opt for any of four FTAs in order to get preferential treatment – India-Sri Lanka Free Trade Agreement (ISFTA), Asia-Pacific Trade Agreement (APTA), SAARC Preferential Trading Arrangement (SAPTA) and South Asian Free Trade Area (SAFTA). Similarly, while dealing with Bangladesh, an Indian trader can opt for either of three FTAs – APTA, SAPTA and SAFTA. Even with Malaysia, Thailand and Singapore, India has two FTAs – individual bilateral agreements, along with the India-ASEAN Comprehensive Economic Cooperation Agreement (CECA).
“This ‘spaghetti bowl’ of FTAs is causing a lot of confusion in the trading community as the rules governing each FTA are different,” Bhaskar Sarkar, Executive Director, Engineering Export Promotion Council (EEPC), told The Dollar Business. Speaking on similar lines, Shintaro Hamanaka, Economist, Asian Development Bank, said, “Empirically speaking, East Asian (Northeast plus Southeast Asia) FTAs have little effect, because trade in East Asia is already nearly free even without FTAs. Similarly, South Asian FTAs also provide very little additional tariff cut.”
Another lacunae of FTAs is that they result in inverted duty structures as under them, even end-products can be imported at zero or significantly lower duties, while inputs/components imported from other countries attract regular rates. This imposes a competitive disadvantage to the Indian engineering industry. FTAs are also prone to misuse, thanks to issues like re-routing through a third country and mis-declaration of value addition.
Eradicating Myopia
Despite their limitations, FTAs, if meticulously negotiated based on facts, figures and comprehensive research, can be very beneficial to a growing economy like India. But for that to happen, they need to be looked at without the myopic glasses of just deficits and surpluses. “FTAs should be used as a tool for technology transfer and capacity building and not just be looked at on the basis of competition,” Hamanaka told The Dollar Business. Moreover, FTAs don’t just mean more merchandise trade. There can be FTAs in services and investment. For example, despite having a big merchandise trade deficit with China, India can benefit from a FTA with China if services, investment and technology transfer aspects can be negotiated properly.
Explaining such potential benefits of FTAs, Atul Kumar, President, Indian Importers Association said, “FTAs do help the economy of both the countries who have signed this agreement, though, there has been some criticism that they are destroying our nascent domestic industry. This would be true only if a large multinational takes advantage of a FTA and dumps its products in India. Usually, this is not the case as EXIM business is largely between SMEs. Big companies operate on a different level, where brand equity and institutionalised marketing networks are involved, which don’t leave room for dumping.”
On a similar note, explaining the role FTAs play in fostering economic growth, Dr. Ferdinand Rauch, Associate Professor, University of Oxford, told The Dollar Business, “Even if trade deficit or surplus remains constant, and merely volumes increase, there would be huge medium to long run benefits, although there might be short term disruptions.” Explaining the long term benefits of FTAs further, Rauch added, “FTAs lead to lower prices and greater variety for consumers. They lead to higher productivity of domestic producers since they are forced to learn best practices. FTAs also provide firms bigger markets and more competition that can break domestic inefficiencies.”
Give and take
When it comes to FTAs, India, with its billion plus population, has no dearth of suitors. One such suitor, which is currently negotiating a FTA with India, is New Zealand. Trying to explain the motivation for New Zealand looking for FTAs in general, and with India in particular, to The Dollar Business, a spokesperson of New Zealand’s Ministry of Foreign Affairs and Trade, said, “It is New Zealand’s view that trade agreements help open up markets for Kiwi exporters, and exports drive New Zealand’s economic growth. Helping our exporters means creating jobs for New Zealanders. FTAs can complement and enhance the gains from liberalisation under the WTO. For New Zealand, FTAs can help deliver market access gains beyond what is possible in a multilateral negotiation. New Zealand also needs to keep negotiating free trade agreements to ensure a level playing field for its exporters in the face of the FTAs our competitors are negotiating. FTAs are not just about market access and rules. They also contribute to the competitiveness of New Zealand business. FTAs have been a significant contributor to gradually exposing businesses to the pressures and requirements of the international marketplace, enabling businesses to stand on their own feet and to focus on areas of New Zealand’s real comparative advantage.”
Until utopia
There’s no doubt that FTAs are a short-term solution to a long-term problem. They can’t be there forever. Once WTO becomes stronger, they will die a natural death. But in the interim, there’s no reason not to embrace them. If nothing else, they at least lead to higher volumes of trade, which is bound to have a multiplier effect on an economy. To make the most of them, however, a growing economy like India needs to pick and choose its partners, and of course, shouldn’t forget what its strengths and weaknesses are.
“A lot of bullying & arm-twisting takes place during FTA negotiations” – Dr. Swati Dhingra, Assistant Professor, Department of Economics and CEP, London School of Economics
TDB: Don’t you think FTAs are against free market principles, since if two countries sign a FTA, others are at a disadvantage?
Swati Dhingra (SD): Absolutely! This is the reason why most economists are a bit sceptical about RTAs and FTAs, because they essentially divert trade from one country to another. However, there are several broad studies that show that RTAs are likely to create a lot more trade between partner countries, because as trade barriers fall, trade volume rises.
TDB: What is the official stance of the WTO on FTAs? Don’t you think it should prohibit members from signing such agreements?
SD: The official stance of the WTO is that RTAs/FTAs are permitted, but under certain conditions. Most FTAs signed till date have, typically, been signed under the condition that they should cover a significant share of trade between the two partner countries and not be restricted to just a few selected products.
From WTO’s perspective, RTAs are road blocks towards free trade. They favour one country over another, even though, ironically, one of WTO’s basic principles is to give Most Favoured Nation (MFN) status to all member countries. So, in some sense, two entirely disparate ideas have been put together. The only justification for RTAs/FTAs seems to be that when two countries go in favour of each other and away from the MFN status, they trade a lot more with each other and help expand total trade volume.
TDB: Do you think a rise in the number of FTA negotiations in recent years is a function of anaemic global growth post the GFC, which has made policymakers desperate to explore all possible options?
SD: I think that is definitely happening. You see precisely that sort of debate during negotiations on the Transatlantic Trade and Investment Partnership (TTIP) between US and EU. German Chancellor Angela Merkel, one of the more vocal supporters of the trade agreement, has for some time been putting forward the argument that the post-crisis world needs this kind of a trigger to kickstart economic growth.
TDB: In case of TTIP, negotiations are on between two equals. But can the same be said about other FTAs? Don’t you think there is bullying and arm-twisting during negotiations?
SD: A lot of arm twisting does take place when a bigger economy negotiates with a smaller one. A fair amount of research has gone into analysing this aspect of FTAs. Typically, once a FTA comes into effect, one would expect prices to fall in the partner countries and consumers to benefit. This is the argument that is typically given in favour of these agreements.
However, in reality, things are not as simple. Market power matters, and in our recent research, we have found evidence of this. Colombia recently negotiated a FTA with US. After the agreement, US exporters exercised greater market power and as a result, prices of several imported products increased in Colombia. Instead of lowering prices, firms were vertically integrating with the importers and pushing up prices. This is less likely to happen when US negotiates with EU, which is a bigger economy with stronger competition policies. Similarly, there is lot of talk about UK exiting EU. I am sure, if that happens, it wouldn’t have the kind of bargaining power the EU has.
TDB: What do you think of the secrecy that is maintained around FTA negotiations, particularly given the way US President Barack Obama is trying to push through TTIP before the next presidential election?
SD: There is a lot of public concern about trade agreements. I think, there needs to be a lot more transparency as far as FTA negotiations are concerned. More than what happens to goods and services trade, there are concerns over other principles like investment settlement and intellectual property rights that are put into these agreements.
Governments need to give the public full access to the terms of such agreements and open debates and discussions need to happen. If the public doesn’t have access to the terms, the battle to convince them of potential economic benefits is already lost.
TDB: Do you think the WTO’s dispute resolving mechanisms are good enough to take care of FTA disputes?
SD: The WTO has a dispute settlement mechanism that works fairly well. However, in case of FTAs, a lot of the disputes are taken to local courts, which is very problematic when a small and a large country are the partners.
TDB: Don’t you think instead of letting individual countries sign FTAs with their partners to boost trade, the WTO should simply ask all its members to lower tariff barriers?
SD: I wish that could happen! Realistically though, it is very difficult to get all members to agree on reducing trade barriers through the WTO. However, the WTO is experimenting with one more aspect. Under GATT, there were a lot of plurilateral agreements, wherein countries used to only opt for agreements they were comfortable with. Such agreements can be beneficial for smaller countries.
TDB: If negotiations are done meticulously, would you like India to sign more FTAs?
SD: India should focus on going through the WTO, where it has previously influenced global policy. This, largely because it has got great bargaining power. If that’s not an option, then while negotiating FTAs, it should go ahead as long as it doesn’t giving up too much and gets reciprocal market access.
“We should sign FTAs with countries that have high trade barriers” - Dr. Manoj Pant, Centre for International Trade and Development, School of International Studies, Jawaharlal Nehru University
TDB: There is a lot of debate on whether or not FTAs are helpful to India’s economy. Where do you stand on the issue?
Manoj Pant (MP): In my opinion, India still doesn’t know why it is negotiating bilateral trade agreements. There are two reasons why a country negotiates RTAs or FTAs. Other than trade, one reason is that it wants to get politically close to some country or become part of a block which can be used to gain other diplomatic advantages at the global level. For example, let’s talk about BRICS – Brazil, Russia, India, China and South Africa – though it is not an RTA. Now, there is no economic logic for BRICS. India only trades a certain amount with Russia; its trade with China is always under serious stress; and Brazil wants to export its agricultural goods that India doesn’t want. In fact, in the last 8-10 years, BRICS has been driven by only one thing – China’s imports of iron ore and other stuff from everyone else, largely due to the Beijing Olympics. But now that the games are over, China’s import of iron ore has seen a big drop. Hence, BRICS is not a very significant economic grouping anymore (in terms of intra-group trade), but it is certainly a very big political grouping.
The world dynamics are changing. In the next four-five years, there will be a mandatory agreement on climate change. So, India has to decide whether the country needs to sign a FTA to promote trade or to have political closeness with certain partners for other political gains in the international arena. If we look at India’s RTAs, the most successful one is the South Asian Free Trade Area (SAFTA), because it might not have led to high volumes of trade, but has provided political benefits.
TDB: What should India look for while choosing FTA partners?
MP: India should look at signing FTAs with countries that have high trade barriers, so that reduction in tariff will boost exports to those countries. Then again, FTAs are not just about tariff, but also about other aspects that facilitate trade between partner countries. The problem, though, is that India’s tariff barriers are one of the highest in the world, even when compared to ASEAN members. So, when India looks to sign a FTA with these countries, its tariff being already high, if it goes by percentage reduction, the actual reduction promised to the partners is more than what the country gains because their tariff is already low. Let’s take the example of Japan, which has no tariff barrier on any product except for liquor and tobacco. So, an Indo-Japan FTA in commodities cannot confer any serious advantage to Indian exporters. Hence, India needs to have a relook at its FTA policy, because until it goes beyond just tariff barriers, it is not going to gain anything.
TDB: India has never been a strong force in exports of goods, but is a force to reckon with in services. What’s your take on how India has dealt with FTAs in services?
MP: The only effective and well defined services agreement that India has is with Singapore. While negotiating services trade agreements, all service components are taken into consideration and these are negotiated based on non-tariff measures such as mutual recognition agreements (MRAs) that cover regulatory regimes of the partners. However, even in India-Singapore agreement, though there is a mention of completing MRAs within a certain time, no final agreement has yet been arrived at despite negotiations starting in 2005. Even ASEAN members first finalised commodity trade agreements, but are now procrastinating on the services trade ones.
TDB: How strong is the relationship between FDI and trade agreements?
MP: Contrary to popular perception that FDI and trade are different, they, actually, are the two sides of the same coin. This, particularly in today’s world, where 80% of trade is in components (not final goods) and between subsidiaries of transnational corporations.
In the services sector, where India’s export growth has been high, future growth will depend more on investment agreements than on tariff based negotiations. India’s RTA negotiations – be it with ASEAN, South Korea or Japan – is more based on tariff, with not much focus on investment. Negotiating a services agreement is meaningless without understanding the role of FDI.
TDB: How can India use trade agreements to foster sustainable economic growth?
MP: The distinction between trade and commerce, services and foreign direct investment is artificial. The first thing that India needs to do is bring trade and commerce, services and FDI departments under the purview of one single authority. In India, even today, trade and FDI are considered separate entities. While Ministry of Commerce negotiates trade agreements, Department of Industrial Policy and Promotion (DIPP) looks after investments and Ministry of Finance takes the final call. The presence of multiple ministries is diluting the whole purpose of promoting trade and economic growth by delaying the decision making process. We need to restructure our ministries and should have something like what Singapore has – a single ministry that takes care of all trade related matters.
India should look at bigger trading partners like EU, which has a lot of tariff and non-tariff barriers on Indian products. India also needs to relook its agreements with China. India, at present, in no way, competes with China in manufacturing goods. Hence, it should stress on having a services agreement with it. Moreover, though there are security issues, India should look at having an investment partnership with China.
“India should look for FTAs with Eurasian, African & Latin American countries” – Bipul Chatterjee, Deputy Executive Director and Head, CUTS Centre for International Trade, Economics & Environment
TDB: What’s your take on India’s stance on FTAs? How far have FTAs influenced the country’s foreign trade and economy?
Bipul Chatterjee (BC): It is true that imports from countries, India has FTAs with, has increased. But they have increased primarily due to two reasons – lowering of tariffs and a rise in income levels. While many experts agree that lowering of tariffs has increased imports, very few consider the fact that an increase in average income levels of Indians has also boosted consumption and subsequently, an increased demand for imported goods. At the same time, India’s FTAs have also resulted in higher exports to partners. The critical question, though, is how much is India utilising its FTAs. If we go by import data, our utilisation rate is not very encouraging. Even in the case of exports, comprehensive data for services exports to partner countries is not available. India also needs to review how much its FTA partners are utilising their trade agreements.
TDB: Should FTAs be seen as instruments for promoting trade volume or addressing deficits and surpluses?
BC: We need not look at the utilisation of FTAs based on trade deficit/surplus. We should also evaluate FTAs on how they are helping Indian companies increase competitiveness and their efficacy in giving Indian consumers access to better quality products at lower prices. FTAs should be looked at beyond just the numbers.
TDB: Do you think India should look at FTAs with big consumers like US or should India look at partnerships with exporters like China?
BC: As a rule of thumb, India should go for FTAs only with countries that have high tariffs. Tariffs are already low in US. Hence, one needs to examine how much more market access India will gain if we sign a FTA with US.
At present, India is not considering any FTA with China. Only a Regional Comprehensive Economic Partnership (RCEP) is under consideration. It is true that India has a huge trade deficit with China, but from a broader perspective, we must see how much of the imports from China are being used for value addition – both for domestic consumption and exports. Unfortunately, there are no comprehensive studies on this, which is a major concern.
TDB: What have been the biggest hindrances in India not being able to fully utilise FTAs?
BC: Although the situation has improved over the last few years, there is a general lack of awareness among exporters and importers about such agreements and the associated benefits. In some cases, the Rules of Origin (RoO) provision is a bit cumbersome due to which Indian traders prefer to do business based on MFN tariffs, instead of preferential tariffs.
Ministry of Commerce is doing its bit via outreach programmes on FTAs, but much more needs to be done. One encouraging sign, though, is the new FTP, in which the government is stressing on better utilising the existing FTAs, in order to improve the competitiveness of the Indian economy.
TDB: Can you give examples of economies that have been able to fully utilise their FTAs? What should Indian traders learn from their counterparts in such economies?
BC: Singapore and China are two glaring examples of gaining economic success from FTAs. China, in particular, has successfully negotiated FTAs with Australia and ASEAN countries, among others. If India wants to gain to similar extents, it needs to give more importance to conducting studies in these areas. For example, India should commission a study on how FTAs are benefitting the Chinese economy.
Indian exporters, importers and manufacturers have to improve their competitiveness. They need to look at cutting down input costs. This requires reforms. The industry cannot become competitive unless the government works closely with it. This is very important because once an economy opens up, the domestic industry will survive only if it is competitive.
I would also like to add that in my opinion, India should look for FTAs with Eurasian, African, and Latin American countries as their tariffs are still high and FTAs with them will help Indian traders gain better access to those markets, particularly since they are yet to be fully explored by India.
Industry: Foreign Trade
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