Insights into Editorial: The myths around free trade agreements
Context:
India’s decision not to join the Regional Comprehensive Economic Partnership (RCEP) has led to an avalanche of write-ups, editorials and interviews.
Most looked at the effect of the decision around four issues: exports, investments, integration into the global value chain (GVC) and domestic industry.
Let us use another source for insights experiences countries have had with free trade agreements (FTAs).
A few examples of FTAs from the past:
- So far, India has signed 14 FTAs. The impact of all these FTAs on the economy, and especially on the agriculture sector has been disastrous.
- Among these, the India-Sri Lanka and ASEAN-India FTAs had the greatest negative impact on the Indian agriculture sector.
- The India-Sri Lanka FTA’s impact was high on spice farmers. Pepper started coming from Vietnam through Sri Lanka. In 1999, the price of pepper was 720 per kg, which has now reduced to 330 per kg.
- Another sector impacted was tea plantations. Indian green raw tea leaf price was Rs 16 per kg before the agreement, but it reached Rs 6 per kg in 2004.
- The import quota allowed in the agreement from 2000 was 11,250 tonnes. Actual import of tea was much less than the import quota.
- And in 2002, it was 448 tonnes or 2.9 per cent of quota according to The Impact of the Indo-Sri Lanka Free Trade Agreement on the Sri Lankan Economy by Sumudu Perera, University of Sri Jayavardanapura.
- This statistic proves that not only actual import but also chances of import have a big impact on domestic tea prices. Prices of most spice products also came down heavily after the Indo-Sri Lanka FTA.
Does a lower import duty regime help in getting significant investments?
- For Instance, let us look at evidence from the automobile industry in Australia and India.
- Australia, in 1987, produced 89% of the cars it used. It protected the car industry through a high 45% import duty. But the share of locally produced vehicles came down as the duties were reduced.
- Today, Australia imports nearly all cars as tariffs came further down to a 5% level.
- Most manufacturers such as Nissan, Ford, General Motors, Toyota, Mitsubishi, etc. which produced cars in Australia shut shop.
- But India could attract significant investments in the car sector on account of high import duties. This resulted in the development of an indigenous car and auto component industry.
- Now, with the car industry maturing, India can think of lowering import duties to promote competition.
- Most investments are a result of the package such as tax cuts, cheap land, power, etc. offered by the host country.
- If a country is not the most efficient economy, some level of an import wall helps in getting external investments.
- Without an import wall, many firms may shift production to the more efficient FTA partner countries for exporting back to the home market.
- But the quality of investments increases as a country moves towards becoming a more efficient economy. Such countries are in an ideal position to become manufacturing and services hubs.
Do FTAs ease entry into GVCs?
Most commentators have lamented that by not signing RCEP, India will miss becoming part of GVCs. It is not so simple. Actual value chain activities are time critical.
And a country cannot become a significant part of such value chains unless it has efficient ports, customs, shipping, roads and a regulatory compliance infrastructure. GVC production also requires harmonisation of product and quality standards.
For these reasons, FTAs alone do not make a country part of a value chain, which will be disrupted if a shipment is delayed or is of non-standard quality.
ASEAN, Japan and Korea constitute the core of the Asian regional value chain.
But despite FTAs with these countries, India has a weak presence in the electronics, machinery or apparels value chains.
Do FTAs lead to an increase in exports?
Few economists have argued that by not signing the RCEP, Indian exporters would miss on exporting to RCEP countries.
They forget that India has FTAs with the Association of Southeast Asian Nations (ASEAN), Japan, South Korea, and three-fourths of the bilateral trade already happens zero duty. India also has a small preferential trade agreement with China.
The mere signing of an FTA does not guarantee an increase in exports. If import duty in the partner country is high, there is a likelihood of an increase in exports by 10% when this duty becomes zero. But chances of exports increasing are low if import duty of the partner country is low at 1-3%.
Is Indian industry protectionist?
Consider the impact of reducing import duty on an engine from 20% to zero for an FTA partner. Cheaper imports may replace products from domestic industries.
But, if the duty on a product is low at say 3%, the local industry may not care much about the duty elimination through any FTA.
Countries that have reached this stage are comfortable doing FTAs with fewer worries.
Global Value Chain system:
- To become a significant partner in global value chain system, it is required to have efficient ports, customs, shipping, roads and a regulatory compliance infrastructure.
- It also requires harmonization of product and quality standards. Therefore, FTAs alone cannot make a country part of global value chain system.
- Despite FTAs with ASEAN, Japan and South Korea, India has a weak presence in the electronics, machinery or apparels value chains.
- It is not always true that if the high import duties are reduced to zero, it will increase exports.
- For example, Japan reduced duty from 10% to zero for Indian apparels through an FTA in 2011.
- But even after the FTA, India’s apparel export to Japan reduced from $255 million in 2010 to $152 million in 2018. This is primarily because of non-tariff barriers.
Conclusion: Steps to have an effect:
An FTA’s possible impact on the economy or exports is subject to many caveats.
The FTAs can ensure market access to only the right quality products made at competitive prices. Improvement in firm-level competitiveness is a must.
The government can help by ensuring lower duties on raw materials and intermediates than on the concerned finished products.
It can set up an elaborate quality and standards infrastructure for essential products.
Most countries regulate imports through such requirements and not through tariffs.
Finally, about India turning inward. India ranks higher than the U.S., Japan, and China in the trade openness ratio, the globally accepted measure.
The ratio is the sum of all imports and exports as % of GDP: India (43) is more open than the United States (27), Japan (35), and China (38).
