RCEP pullout: Innovation and productivity key to benefiting from FTAs

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Published: December 2, 2019 12:47:55 AM

Given this context, India’s decision to withdraw from RCEP, designed to be the world’s largest trading bloc, was a landmark decision, notwithstanding official comments that we will rejoin if our concerns are addressed.

The opposite logic put forth is that by withdrawing, we would actually be disadvantaging Indian industry in terms of preferential access to the largest and the fastest growing markets.

Trade is the life-blood of the world economy. We all know that. The share of global trade grew from around 10% of global GDP to close to 60% by the 2010s. And, those countries which grew their share of the global trade benefited from the huge multiplier effect on their economy. Given this context, India’s decision to withdraw from RCEP, designed to be the world’s largest trading bloc, was a landmark decision, notwithstanding official comments that we will rejoin if our concerns are addressed.

This decision has both passionate supporters and sceptics; the former group agrees with the government’s ‘strong’ decision based on the rationale that the conditions being negotiated for joining RCEP would have been detrimental for Indian industry. The opposite logic put forth is that by withdrawing, we would actually be disadvantaging Indian industry in terms of preferential access to the largest and the fastest growing markets. So, who is right?

To answer this question, let us look at the data from past FTAs and their impact on competitive positioning of Indian industry in global trade. In the last decade and a half, India has signed three regional FTAs—with South Asian, ASEAN, and Mercosur (the trading bloc of Latin American) countries. The other FTAs have been bilateral agreements with individual countries.

Of the three regional FTAs, in only the South Asian FTA (Afghanistan, Bangladesh, Bhutan, India, Nepal, Sri Lanka, Pakistan, and Maldives) did India increase its exports faster than imports; this is understandable given the member countries. In case of both, the ASEAN and Mercosur FTAs, India’s trade deficit with these two regions increased post signing.

For example, post signing of the India-ASEAN FTA in 2010, trade between India and ASEAN increased from $52.6 billion to $64.6 billion in 2016. However, ASEAN countries benefited more, with India’s trade deficit increasing from less than $8 billion in 2009-10 to about $22 billion in 2018-19.

Similarly, post signing of the India-Mercosur FTA in 2009, India’s exports grew from $2.31 billion in 2009 to $3.14 billion in 2016, but its imports grew faster, from $5.34 billion to $11.46 billion in the same period. This data, thus, supports the government’s view that RCEP will be harmful to India’s interests unless carefully calibrated and negotiated.

Now, let us look at data supporting the logic of the critics of the RCEP pullout, who claim that this will disadvantage Indian exporters by denying them preferential access to large markets. Let us use the example of apparel exports, which has been a focus industry for Indian policymakers for many years given the potential of its high labour intensity to generate millions of new jobs.

While India’s share of global apparel trade has stagnated around 4%, that of competing countries like Bangladesh, and even Vietnam, which entered the global market much later, has leapfrogged ahead of India’s. This, despite the potential advantages India has in terms of higher scale from larger local market, domestic supply of cotton and synthetic yarn, and large pool of labour.

In a BCG study of India’s competitive position in the sector, we found that Indian exporters face a cost disadvantage of 14-15% for exports into the EU, compared to Bangladesh. What is interesting to note is that over 60% of this gap is explained by preferential access to the EU market basis Bangladesh’s FTA with the EU (India has not signed one). The balance cost gap is driven by a variety of domestic structural, regulatory/policy, and productivity factors.

For example, the scale of an average Indian clothing plant is much smaller than that in Bangladesh due to our restrictive labour laws (to be fair to the NDA government, they have tried to partially address the labour issue for the textile industry, but much more needs to be done); this gives a cost penalty to the average Indian apparel exporter. India has tried to incentivise exports to overcome some of these structural gaps with several export promotion schemes, but the recent ruling by WTO against India on a complaint by the US has put the future of many of these incentives in doubt.

So, basis the data, the views on both joining and quitting RCEP have a strong rationale. And, one can argue that the government took a pragmatic decision as it did not want a similar increasing-deficit story repeated with the new regional treaty, especially given the fear of being swamped by exports from China.

Unfortunately, this decision also highlights the lack of global competitiveness in many sectors of Indian industry—even with smaller developing countries, given the experience post ASEAN and Mercosur FTAS. India has rightly been focusing on ease of doing business (EoDB) as critical to build competitiveness and attract FDI.

It is equally critical, if not more so, to focus and improve the high cost of doing business (CoDB), which broadly has three components: higher factor costs (land, industrial power, productivity linked labour, financing), higher cost of compliance with government regulations, and high logistics costs from both hard and soft infrastructure (e.g., time taken by processes at ports). And, unless we annually benchmark and improve the CoDB as we are doing for EoDB, our manufacturing industry, especially compared to our peer developing countries, will continue to be threatened by FTAs rather than seeing them as windows of opportunities.

Clearly, FTAs are a double-edged policy sword for India. If wielded right, it can open large markets and drive growth of exports (and push up GDP). It also puts pressure on the domestic industry to become more globally competitive. If wielded badly, i.e., without the policies to improve CoDB, it can be equally harmful to the domestic economy.

Countries that have done it right have ensured that their trade policy, investment policy, and industrial policy are well-aligned. They calibrate the opening of the domestic market with the right industrial and investment policies to structurally improve the competitiveness of the domestic industry.

The industry, in its turn, has to match these enabling policies with a strong effort to improve productivity, and invest in innovation to increase global competitiveness, rather than complaining of cheaper imports flooding the country. Otherwise, we will continue to be ambivalent about FTAs, and struggle to become the next highly competitive manufacturing engine of the world.

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