Context: Free Trade Agreements and myths about its impact in reference to RCEP.
More in news:
- On November 4, 2019 India decided against joining the 16-nation Regional Comprehensive Economic Partnership (RCEP) trade deal.
Regional Comprehensive Economic Partnership (RCEP):
- The Regional Comprehensive Economic Partnership (RCEP) is a so-called mega-regional economic agreement being negotiated since 2012 between the 10 ASEAN (Association of South-East Asian Nations) governments and their six FTA partners: Australia, China, India, Japan, New Zealand and South Korea.
- The stated goal of the negotiations is to “boost economic growth and equitable economic development, advance economic cooperation and broaden and deepen integration in the region through the RCEP”.
There are several stages in the process of economic integration, from a very loose association of countries in a preferential trade area, to complete economic integration, where the economies of member countries are completely integrated.
A regional trading bloc is a group of countries within a geographical region that protect themselves from imports from non-members in other geographical regions, and who look to trade more freely with each other. Regional trading blocs increasingly shape the pattern of world trade – a phenomenon often referred to as regionalism.
- Preferential Trade Agreement (PTA): In a PTA, two or more partners agree to reduce tariffs on agreed number of tariff lines. The list of products on which the partners agree to reduce duty is called positive list. India MERCOSUR PTA is such an example. However in general, PTAs do not cover all trade.
- Free Trade Agreement (FTA): A free trade agreement is a pact between two or more nations to reduce barriers to imports and exports among them. Under a free trade policy, goods and services can be bought and sold across international borders with little or no government tariffs, quotas, subsidies, or prohibitions to inhibit their exchange.
- Comprehensive Economic Cooperation Agreement (CECA) and Comprehensive Economic Partnership Agreement (CEPA): These terms describe agreements which consist of an integrated package on goods, services and investment along with other areas including IPR, competition etc. The India Korea CEPA is one such example and it covers a broad range of other areas like trade facilitation and customs cooperation, investment, competition, IPR etc.
- Custom Union: In a Customs union, partner countries may decide to trade at zero duty among themselves, however they maintain common tariffs against rest of the world. An example is Southern African Customs Union (SACU) amongst South Africa, Lesotho, Namibia, Botswana and Swaziland. European Union is also an outstanding example.
- Common Market: Integration provided by a Common market is one step deeper than that by a Customs Union. A common market is a Customs Union with provisions to facilitate free movements of labour and capital, harmonize technical standards across members etc. European Common Market is an example.
- Economic Union: Economic Union is a Common Market extended through further harmonization of fiscal/monetary policies and shared executive, judicial & legislative institutions. European Union (EU) is an example.
Impact of Free Trade Agreement (FTA):
- Market Access: By eliminating tariffs and some non-tariff barriers FTA partners get easier market access into one another’s markets. Countries negotiate Free trade Agreements for a number of reasons.
- Preferential treatment for exports: Exporters prefer FTAs to multilateral trade liberalization because they get preferential treatment over non-FTA member country competitors. For example in the case of ASEAN, ASEAN has an FTA with India but not with Canada. ASEAN’s custom duty on leather shoes is 20% but under the FTA with India it reduced duties to zero. Now assuming other costs being equal, an Indian exporter, because of this duty preference, will be more competitive than a Canadian exporter of shoes. Secondly, FTAs may also protect local exporters from losing out to foreign companies that might receive preferential treatment under other FTAs.
- Increased Investmet: Possibility of increased foreign investment from outside the FTA. Consider 2 countries A and B having an FTA. Country A has high tariff and large domestic market. The firms based in country C may decide to invest in country A to cater to A’s domestic market. However, once A and B sign an FTA and B offers better business environment, C may decide to locate its plant in B to supply its products to A.
- Such occurrences are not limited to tariffs alone but it is also true in the case of non-tariff measures. Especially when a Mutual Recognition Agreement (MRA) is reached between countries A and B. Some experts are of the view that slow progress in multilateral negotiations due to complexities arising from large number of countries to reach a consensus on polarising issues, may have provided the impetus for FTAs.
Myths around FTAs:
- Impact on Exports:
- India has FTAs with ASEAN, Japan and South Korea. India also has a small PTA with China. Three-fourth of the bilateral trade of India already happen zero duty.
- Mere signing of an FTA doesn’t guarantee an increase in exports. If import duty in a partner country is high, there is likelihood of an increase in exports by 10% when this duty becomes zero. But if the import duty is already low at 1-3%, the chances are very low. In this regard, signing the FTA with Singapore and Hong Kong is of no use.
- 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. Some of the other non tariff measures are:
- Custom procedures
- import licencing procedures
- trade documentation
- pre-shipment inspections
- special sourcing equirements
- It can be said that FTAs cut import duties, but this is only one of many factors that decide if exports will increase.
- Investment flow:
- 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 duty wall helps in external investments.
- For example, India could attract significant investments in car sector on account of high import duties. This resulted in the development of an indigenous car and auto component industry.
- Without an Import duty wall, many firms may shift production to the more efficient FTA partner countries for exporting back to the home market.
- Global Value Chain:
- 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.
Conclusion: An FTA’s possible impact on the economy or exports is subject to many conditions. The FTA can ensure market access to only the right quality products made at competitive prices. Critics have called India being inward. However, India ranks higher than the US, Japan and China in the trade openness ratio. The ratio is the sum of all the imports and exports as % of GDP. India rank 43 is more open than US (27), Japan (35) and China (38).