Thursday, January 31, 2008

Are regional trade agreements the right strategy?

This is one question you can expect to be asked either in Mains or in an interview. You can’t get a better answer for this question than from today’s op-ed by Prashant Goyal. Take a look at it here. But Some excerpts worth our noting follow.

Today 50% of world trade is under 200 RTAs and for countries like Mexico and Singapore almost 85% and 63% respectively of their global trade is under RTAs. In contrast, only around 30% of India’s global trade is under RTAs.

Today when our exports are around 14% of GDP and the trade-GDP ratio is almost 33%, our economy cannot afford this trade diversion. The effects of such diversion would be traumatic if India’s competitors were to conclude RTAs with India’s major trading partners.

The WTO negotiations are meandering. Even if the Doha round gets concluded, trade liberalisation is unlikely to be as ambitious as under RTAs owing to the divergent views and positions of 151 nations. RTA negotiations, in contrast, are faster, afford opportunity to seek tariff reduction in specific products of interest and also allow country-specific shielding of sensitive sectors.

Static benefits from RTAs include:

  • Trade creation through reduction in tariffs
  • Replacement of some domestic production from cheaper imports
  • Increased specialisation and division of labour in areas of comparative cost advantage
  • Increased consumer welfare because of reduction in prices

Dynamic benefits include:

  • Increased competition
  • Economies of scale
  • Stimulus to investment
  • Better utilisation of economic resources
  • Development and use of new technology
  • Increase in GDP because of efficient allocation of resources

Downside with RTAs:

The benefits, however, would be reduced to some extent due to trade diversion, lower-cost imports from efficient third country suppliers would be replaced by higher-cost goods from RTA members due to tariff preference for the latter. This reduces welfare by shifting production away from areas of comparative cost advantage.

A wider sweep of RTAs would help minimise this trade diversion impact. But, the Rules of Origin can never be perfect and the consequent trade deflection from non-members would to some extent neutralise the negative impact of this trade diversion.