Does the India-EU trade pact make sense for India? - I

  • Blog Post Date 28 April, 2016
  • Perspectives
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During the 13th India-EU Summit in Brussels last month, leaders from both sides welcomed the re-engagement on the stalled India-EU Free Trade Agreement. In this article, Devashish Mitra, Professor of Economics at Syracuse University, argues that this trade pact is not a good idea from India’s point of view, and suggests a few alternatives to the current approach.

Three years ago I wrote an opinion piece in the Indian Express raising concerns about a possible India-EU free trade agreement (FTA). I had argued that such an FTA would not make India’s trade with the rest of the world freer and that the negotiations were taking place in a very asymmetric setting, with India having relatively limited bargaining power in those negotiations. My prediction about such a deal arising from highly unequal bargaining strengths was that the economically stronger of the two, namely EU, would be able to extract significantly greater concessions from the economically weaker country, India than what the latter would be able to get from the former. Some of these concessions could be non-trade such as intellectual property rights (IPR) protection and harmonisation of environmental and labour standards. Such unequal exchange of concessions would have adverse consequences for India and would shrink its policy space. 

India’s low bargaining power

It is important to understand that India’s low bargaining power stems from the fact that it’s aggregate GDP (gross domestic product) is about an eighth of the EU’s. In addition, while India-EU trade is only 2% of the EU´s overall international trade, it is about 20% of India´s. We often hear that India should negotiate much harder and make sure that there is an equal exchange of concessions. A country cannot increase its bargaining power at will, at least not in the short run. In this context, it can be argued that India’s recent history on policy reversals has made its international negotiating position even weaker. One such example of reversal is the withdrawal of 2-G telecom licenses that were given away at throwaway prices, a case of trying to use two wrongs to make a right. The second instance was retrospective taxation on Vodafone. As a result, any country negotiating a trade and/or an investment treaty with India will have a good reason to introduce some stringent rules on investor-State dispute settlement. In the India-EU case there has been an insistence on the part of the EU to introduce a sub-agreement (within the overall agreement) which provides for a European firm investing in India to take the Indian government to an international tribunal in case of actions by the government that reduce the returns on their investment or reduce their profitability. After some pushback from India, there seems to be a move to amend that provision such that the foreign firm will have to first go to an Indian court before taking the matter to the international tribunal. One could argue that Indian firms not having recourse to an international tribunal in case of similar actions by the Indian government is fine since in that case the nationality of the complainant and the judges in Indian courts would be the same, thereby not resulting in the same sort of prejudicial atmosphere as in the case of a foreign firm in India. However, some such provision should exist for Indian service sector firms, especially in information technology (IT) and information technology enabled services (ITES), or for that matter any Indian firm operating in Europe in case they have disputes with EU country governments.

Trade diversion

As I have argued in the past and is well understood by trade economists, an FTA discriminates against countries that are not its members since the tariffs on the imports from non-member countries are not reduced. After the signing of the FTA, the imports by FTA member countries from non-member countries are replaced by member-member trade. This is called trade diversion and can offset the gains from trade creation within the FTA. In the India-EU FTA context, this means that some products India was importing from non-EU countries will now be imported from the EU, where the costs of production and the prices of those products (exclusive of import duties) may be higher. For example, some of the imports of American, Japanese and Korean automobiles and auto parts could be replaced by imports from Europe. Also imports of agricultural and dairy products from low-cost countries like Australia and New Zealand will be replaced by highly subsidised food products from Europe. These high EU subsidies would also prevent establishing a level playing field for Indian producers of agricultural and dairy products. Thus, in the end, consumer gains might not be large enough to offset the losses in domestic profits and tariff revenues.

Non-trade concessions

As I mentioned at the outset, the EU’s and India’s asymmetric bargaining strengths could lead to some important non-trade concessions extracted by EU from India. While details on these negotiations are not really public there is the fear that the FTA might go beyond WTO’s (World Trade Organization) IPR protection provisions which, at least, allow for some exemptions for developing countries. For example, under the WTO provisions, pharmaceutical companies in developing countries are allowed to produce generic versions of certain costly medicines for diseases with relatively high incidence in these countries without seeking permission from the patent holder. Indian pharmaceutical companies have been able to take advantage of these exemptions. Not only have Indian consumers benefited, consumers in other developing countries have also gained from the availability of cheaper imported medicines from India. Through the availability of affordable antiretroviral treatments the lives of millions of HIV/AIDS patients in many developing countries have been saved and at the same time the spread of this virus has been kept in check. Making the IPR regulations in India more stringent through the India-EU agreement would cause great harm to the entire developing world.

Furthermore, the agreement could seek parity or, at the very least, convergence in labour and environmental standards between India and Europe. These standards and the ability to implement them are a function of a country’s level of development, and when developed country standards are imposed on developing countries it is expected to drive up production costs in the latter. These increase in costs in India´s manufacturing sector - especially when tariffs on the imports of European manufactures are eliminated (as believed to have been demanded during these negotiations) - will push several Indian producers out of business, and, in turn, many poor workers there out of employment.

Lack of reciprocity

Reciprocal tariff reductions leading to the exchange of equal amounts of market access are normally desirable if they don’t have non-trade concessions tied to them. However this India-EU trade deal that is being negotiated does not seem to be characterised by the principle of reciprocity. Given India’s much higher current tariffs on manufactures than EU’s, elimination of tariffs in both EU and India provides EU manufacturing firms a market access gain in India in exchange for much less for Indian businesses in Europe. In addition, the EU is believed to have been demanding greater market access in India for its services sector, especially banking, retail trade, telecommunications, retail and accounting services etc. However, the EU seems to be quite reluctant to provide the conditions required for India’s IT and ITES producers’ desired expansion of market access in Europe. It seems unlikely that India will get its requested increase in the number of work visas for its IT and ITES workers, which is essential for that market access expansion. It also does not seem likely that the restrictions on free mobility within the EU of these IT and ITES workers will be lifted, at least not close to the extent India wants. The main reason to be pessimistic on these fronts is the high youth unemployment rate in Europe. Thus this seems to add to the unbalanced nature of the exchange of concessions.

Alternatives to the current approach

So, from India´s point of view, this FTA is not a great idea. Since the EU is a collection of several much richer nations, India is not in a position to take them on in these negotiations single-handedly. There are a few alternatives to the current approach. In WTO negotiations, often large developing countries collude and form a formidable negotiating block with considerable bargaining power. The first approach, therefore, is multilateral negotiations under the WTO but the problem is that for over a decade these negotiations have not been going anywhere. The other alternative could be a BRICS (Brazil Russia India China South Africa)-EU FTA with the BRICS coalition on one side trying to negotiate with the EU on the other. This might appear to be a wild idea but it does illustrate the point that the FTA negotiations with the EU need to expand to include more developing countries that can form a common-interest block with India. Another alternative would be for India to negotiate with one country at a time for an India-UK or India-Germany bilateral trade and/or investment agreement, if possible. Finally, the Indian government should also realise that there is still room for further non-discriminatory unilateral trade reform.

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