Free trade, regional integration and South Asia

The proliferation of free trade areas in the world poses a challenge to multilateral trade agreements. There were only a few physical regional free trade agreements in the early 1990s before the World Trade Organisation (WTO) came into force, but their number exploded in the next two decades. Currently there are 284 physical regional trade agreements in force, which perhaps played an important role in stalling the Doha Round of multilateral trade negotiations. Strictly speaking, free trade areas are directly contradictory to the Most Favoured Nation (MFN) rule which is enshrined in the very first article of General Agreement on Tariffs and Trade (GATT). However, ground reality forced the exemption.

South Asian countries were latecomers in the race to form a free trade area (FTA). Encouraged (or alarmed) by the phenomenal growth of the FTAs all around, South Asian countries also decided to form their own FTAs. South Asia Free Trade Area (SAFTA) was formed with all South Asian Association for Regional Cooperation (SAARC) member countries in January 2004 after lengthy negotiations, and it became operational in 2006. All South Asian countries except Afghanistan, Maldives and Pakistan are also members of Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Co-operation (BIMSTEC) which also includes Myanmar and Thailand. In its current dispensation it came into force in 2004. Individual countries of SAARC are also members of other preferential or free trade agreements.

SAFTA was not very successful in increasing trade in this region. Many thought this was due to the rivalry between India and Pakistan that prevented a unified approach to various issues. Some even thought of forming a group without Pakistan to achieve greater co-operation and success. This line of thinking perhaps confuses correlation with causation. If this were true then the FTA formed without Pakistan, i.e. BIMSTEC, should have been successful, but it has not fared any better. Obviously the main reasons for the poor performance of SAFTA and BIMSTEC even after more than a decade of coming into force have to be sought elsewhere.

The first best option in trade policy is of course free trade with all. However, economist's case for free trade does not always have many takers among business people and policy makers; but they are usually more receptive to the idea of free trade areas. While universal free trade does not give them any special advantage not given to others, membership of a regional FTA gives them some advantage over the non-members. Hence, it is easier to push through a free trade deal.

Free trade is not necessarily beneficial to all member countries. For some countries trade creation effects may be offset by trade diversion effects resulting in a net loss of welfare. Furthermore protection afforded by FTA may engender inefficiencies and a lack of dynamism that could make the FTA members less competitive in the world market than the countries that operate under more liberal trade regimes. Future losses may outweigh current gains. Some times FTAs are politically motivated and economic questions are often swept under the carpet. FTA may lead to overdependence on a large partner which may at times give rise to knotty situations.

One reason why FTAs have not resulted in greater trade in South Asia is that each country excluded, under pressure from business groups, a large number of products from trade liberalisation. These were precisely the products that these countries produced in significant quantities. By putting these in the so-called 'sensitive' or 'negative' list these countries essentially prevented comparative advantage from determining the production and trade structure. The result was that trade between SAARC counties did not blossom in a manner of some other free trade areas. Intra South Asian trade is only about 5 percent of its global trade.

The South Asian FTAs gave tariff concessions to products that were mostly imported. Hence, preferential trade frequently substituted cheaper imports from non-member countries by dearer products of member countries. No wonder that a World Bank study concluded that a free trade agreement between Bangladesh and India would be harmful to Bangladesh as trade diversion effects would outweigh trade creation effects.

Cross-border investment was also discouraged by the poor state of infrastructure, awful bureaucratic red tape problems and severe governance issues. South Asian countries did not fully exploit either the static or the dynamic gains from freer trade. A World Bank study on Indo-Bangla free trade stated: "FTA will bring large welfare gain for consumers in Bangladesh provided there is adequate expansion of infrastructure and administrative capacity at custom borders. Yet the benefits of such a FTA to Bangladesh could be wiped out if it has the effect of keeping out cheaper third-country imports... Such trade diversion costs can be huge and the only way to minimise them is through further unilateral liberalisation." Perhaps such warnings put a damper on the efforts to form an India-Bangladesh FTA.

An additional problem is that trade policies can succeed only if they are supplemented by appropriate policies in other areas. A liberal trade regime will not yield full benefits if the exchange regime is distorted, foreign investment is discouraged by formal or informal barriers, infrastructure is inadequate or the labour force is unskilled. Macroeconomic stability is also essential for trade as it is for economic growth. Most of the South Asian countries are notorious for their miserly attitude toward spending on education and health to develop human capital. Budget allocations for education and health in these countries are among the lowest in the world. The poor quality of the labour force works as a deterrent to not only foreign investment but also domestic investment. Without addressing these basic problems there is little chance that more free trade will yield the desired results.

Curiously some economists on both sides of the barbed wire border have of late floated the idea of regional integration among at least some of the countries of South Asia. The scope of this integration is apparently far wider and deeper than a free trade area, and approaches the concept of an economic union. It is not clear how a region that has not yet successfully taken even the first step in the economic union process (i.e. free trade), could skip the intermediate steps and jump to the last step that requires not only a single economic zone encompassing the entire region but also a monetary union with effectively a single currency, intense fiscal co-ordination and perfect mobility of all factors including labour. Only one highly developed region of the world, viz. Europe, has successfully formed an economic union after many decades of study and preparation, and yet this union is unravelling on the question of the sovereign right of members to decide on such minor issues as refugees and immigration.

South Asia need to focus efforts on developing their countries such that they can responsibly handle the massive changes in their material, intellectual, social and cultural attainment that will be required if and when they decide to move toward such a union. It is unlikely that any SAARC country will achieve such a transformation in the next half a century. It is not very useful to raise these difficult issues now which could deflect or reduce efforts to raise the level of productive economic, political and social engagement in South Asia.

India and Bangladesh share the same history culture and tradition. One country is the natural trading partner of the other. Unless barriers are erected deliberately trade should occur according to market fundamentals. Each country has very significant advantages in trade with the other relative to the rest of the countries of the world. The main advantage is owed to proximity. Products can be exported between the two by road in hours or days at modest costs. But exports from other countries such as China or UK take weeks to reach their ports. The relative money and time costs of export translate into a significant price advantage for India and Bangladesh. This is also attested to by the fact that most of the Indo-Bangla bilateral trade is done through land ports.

History, culture and language also make it easier to access each other's market. If Bangladesh (India) is unable to trade more with India (Bangladesh), it can only mean that it is not competitive enough relative to other countries despite these advantages. Unless there is some compelling reason not spelt out clearly, it is not advisable to artificially prop up export from a neighbour which may lead to trade diversion. The goal should be to provide unfettered access to competitive exports from each to the market of the other, and each must ensure that it is the source of the most competitive exports. Neither should seek unfair advantages to elbow out more competitive exporters since the economic losses could become a source of friction in future, and it will not be ultimately sustainable. It may be pointed out that despite the existing problems, trade between the two neighbours have grown steadily with India now accounting for about 9 per cent of Bangladesh's total trade making it the third largest trading partner of Bangladesh (2015-16) behind only the trade behemoths China and the USA.

There are two perceptions about SAARC trade that merits attention. On the Bangladesh side of the barbed wire there is a widespread perception that India is dumping too much in our market but taking in too little such that our trade deficit is ballooning. India should take effective steps (i.e. increase import from Bangladesh) to reduce the trade gap. The only way the Indian government could influence the trading decisions of numerous individuals and firms located in India is through some trade policies. India has already given duty-free and quota-free access to all least developed countries, and hence, Bangladesh is automatically a beneficiary. It cannot complain too much about tariff barriers. Most of the complaints now are about non-tariff barriers, exclusion list, punitive taxes and infrastructure inadequacies, some of which are not really the subjects of trade policies.

Bangladesh needs to do more on the domestic front to raise the competitiveness and diversify the domestic production which are essential to raise its profile in the Indian market. Apparels alone may not suffice as India is itself a competitive producer unlike the EU or the USA. Although India may appear to export a great deal to Bangladesh (US$6.8 billion in 2016), the fact is that its export to Bangladesh is only about 2.5 per cent of its total export. Bangladesh's export to India also constitutes a bit over 2 per cent of its total export. Economists should not worry too much about trade deficits with individual countries as the politicians do, but focus on total deficit which has implications for the exchange rate and macro outcomes. It is noteworthy that as our trade deficit with India soared during the last decade, the taka exchange rate with India became much stronger (from Tk 1.71/Rs in 2007-08 to Tk 1.19/Rs in 2016-17) due to the robust overall surplus in the balance of payments of Bangladesh. This also discourages more balanced trade with India.

On the Indian side of the barbed wire there is a perception that regional integration has not progressed much among SAARC countries and we are missing out on the bonanza of integration. The ratio of intra-SAARC trade to global trade of SAARC is often presented as an index of regional integration and used for comparison with other regions. This is incorrect since the value of this index does not reflect the intensity of relative integration of trade blocks. This depends very much on the relative size of the trading partners in the regions being compared. Contrary to the perception, some countries viz. Afghanistan, Bhutan, Maldives, Nepal and Sri Lanka are already well integrated having a relatively large proportion of their trade with SAARC, especially India, with their index value ranging from 16 to 61 per cent (ITC data). India is the least integrated by this index with a value of 3 per cent, followed by Pakistan and Bangladesh (7 and 9 per cent respectively). The low regional index value is driven essentially by India which does nearly half the trade of the region.

Bangladesh imports a lot but exports little to SAARC countries. Any large increase in trade will require further development and diversification of its economy. It will not be helpful to put the carriage before the horses in an over-enthusiastic drive for regional integration. Bearing in mind the very old snippet "Nations have no permanent friends or allies, they only have permanent interests", South Asian nations should frame their long term trade policies on permanent interests of one another rather than immediate gains or the warmth of the current relationship.

Countries of South Asia should focus on all round economic development and pursue policies that ensure rapid and sustainable economic growth. To the extent such growth requires a greater volume of intra-SAARC trade, efforts should be made to encourage more free trade in the region. This should be achieved by exploiting the relative static and dynamic advantages of freer trade in the region rather than restrictive or exclusionary policies.

The writer is a professor of Economics, University of Dhaka.

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