Trade

RCEP trade agreement: The road not taken?

  • Blog Post Date 15 November, 2019
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Prime Minister Modi recently announced that India would not be joining the Regional Comprehensive Economic Partnership (RCEP) agreement between Southeast Asian Nations and its free-trading partners. It is mainly due to concerns on the impact that it would have on Indian agriculture and industry because of increased imports from some RCEP countries. Using rigorous academic evidence, Agrawal and Malhotra discuss what the government should reflect on, if it were to reconsider its stance.

As the long and winding negotiations for the Regional Comprehensive Economic Partnership (RCEP) reachedtheirfinal stages this week, many countries in the 16-nation group were eager to conclude a deal by the end of the year. The most optimistic of these were hoping for a positive outcome on 4 November, the final day of the summit of RCEP members’ respective Heads of State, held in Bangkok. However, Prime Minister Narendra Modi announced that India would not be joining this agreement, mainly over concerns on the impact that it would have on Indian agriculture and industry because of increased imports from some RCEP countries, in particular, China. That India already has a significant trade deficit with China and 10 of the other 15 members only added to its apprehension. The RCEP agreement, seven years in the making, was proposed by the Association of Southeast Asian Nations (ASEAN). It was intended to include all its free-trading partners– India, China, Japan, South Korea, Australia, and New Zealand. These countries together account for almost a third of the world’s total GDP (gross domestic product) and around half of the world’s total population, which would have made this the world’s largest trade deal.

India’s key concerns on the RCEP deal

Through the course of negotiations, India had expressed disagreements over various chapters in the draft agreement, prompting frustration among other members, which reportedly issued an ultimatum and signalled their willingness to go ahead without us if needed. Unfortunately, this ultimatum shifted the domestic discourse to whether or not India should join this partnership, without sufficient understanding of what the decision to join entailed. This was further propounded by the ambiguities surrounding the clauses in the RCEP framework since the agreement was negotiated under absolute secrecy. Now as the trade deal is set to be signed in 2020, member countries are divided on whether a workaround is required to accommodate India’s concerns. Weprovide some insight consultingrigorous academic evidence on what the government should reflect on, if it were to re-consider its stance. We limit our attention primarily to trade in goods, and to a lesser extent, trade in servicesas the body of research we can delve into is much larger for the former. Following this, we summarise why incentives may not align for ushering in trade reform, especially in the context of Indian politics, and how despite this, the government should not remain closed to the idea.

What does research evidence on trade liberalisation tell us?

International trade is a topic where economic research and public opinion diverge sharply. A recent study found that although most prominent academic economists believe that US tariffs on imports of steel and aluminium (announced by President Donald Trump last year) would have an adverse impact on Americans’ welfare, just a third of the sample of average Americans agreed with this view. Clearly, there seems to be a general sense of pessimism, not unique to India, surrounding trade. In India, there is fearabout the avalanche of imports from China, and to a lesser extent in the dairy industry, from Australia and New Zealand, post the signing of the RCEP which could potentially cripple Indian industry. How does one reconcile this sentiment with that of the academic community?

Over the last two decades a rich academic literature examining the removal of trade barriers in developing countries has emerged, enabled largely due to widespread trade reform across the developing world. This research has shown that trade liberalisation increases aggregate domestic productivity and welfare by reallocating market share from the least to the most productive firms, with the former, exiting the market, and the latter, expanding their businesses (Pavcnik 2002, Goldberg and Pavcnik 2016). Competition also reduces slack within firms and induces firms to adopt better managerial practices. As a result, consumers are also able to get more variety and cheaper final goods (Melitz and Trefler 2012). Finally, and this point is commonly understood, trade agreements often expand export markets for host countries by lowering reciprocal barriers to trade. However, some caveats are in order. The literature referred to above primarily studies instances of unilateral tariff reductions and not the effect of trade agreements. Deals such as RCEP have an important trade diversion effect, that is, they divert trade from the most productive countries to those covered under a Free Trade Agreement (FTA). Thus, it may be incorrect to extrapolate the gains from importing to the context of the RCEP.

Secondly, post the 1991 reforms in India prices relative to costs did not fall by much in the short term since firms pocketed the extra gains accruing from imports of cheaper inputs (Loecker et al. 2016), so consumers may not always be better off immediately post reform. Thirdly, the reallocation of labour from import-competing to exporting sectors as an outcome of trade liberalisation can be a long and painful process (Dix-Carneiro and Kovak 2017), which can lead to joblessness, increased crime, and even an increase in child labour. Research also finds that in Indian districts that were more exposed to competition post trade reforms, poverty declined at a slower rate (Topalova 2010). In conclusion, although there are gains from trade, they are unevenly distributed. The unequal effects of trade liberalisation become more severe with policies that restrict reallocation of labour and capital across sectors. In the Indian context, our rigid labour policies and an increasing trend of state governments reserving jobs for locals is undesirable insofar as it makes these necessary shifts much harder.

India’s past experience

An additional argument ─ that of the ‘infant industry’ ─ has been commonly used in the Indian context. It states that industries are in the stage of infancy and require some protection to develop before they can compete globally. Such policies were used strategically in East Asia in the mid-to-late 20th century, and have been credited for the success of multinationals like Samsung and Toyota. The difference is that this justification seems to have been used in India since independence in perpetuity, without any adequate indication of its effects. One could argue that there is a considerable difference between State support offered in East and South Asia, but then the fault might lie in the inadequate industrial policy reform ─ in particular labour laws and reservations for MSMEs which discourages these firms from scaling up ─ and not trade reform per se (Besley and Burgess 2004, Ahluwalia 2002).

Many authors also argue that India should not join RCEP because we have not benefited from our past FTAs. They cite studies, including one by NITI Aayog, which make a similar point by showing how our imports have outpaced exports after signing trade agreements. However, equating benefits from an FTA only with its impact on exports is fallacious. Economic policies are often designed to increase national welfare and there is no evidence that India’s trade agreements have had a perverse impact on our national income (but plenty of evidence from other countries of trade increasing GDP) (Fearer 2019, Bernhofen and Brown 2005).

Reports suggest that India negotiated hard on gaining access to markets of RCEP member countries in the services sector, where it possesses a comparative advantage, and thus can rely on gains accrued from exporting. While there is limited research to reflect on in the discussion surrounding the ‘intangible’ economy, services like telecommunication, financial and business services or IT (information technology) are increasingly tradable across borders, and organised in a way that strongly resembles the manufacturing sector, where economies of scale can be exploited. The government’s intent is laudable, but its approach may require a second thought.Trade in services is often distinguished by four modes of supply as defined by the World Trade Organization (WTO). The government’s focus has been primarily on Mode 4 the movement of natural persons as this would include the movement of skilled professionals to other RCEP countries, a higher value-added services export. However, in light of recent debates on immigration across the world, this is also the mostlikely to face considerable resistance. Further, domestic company laws in some countries like Thailand and Singapore, place quantitative restrictions on the hiring of foreigners. It is unclear how far-reaching RCEP rules will be in dismantling these. While the RCEP framework could provide a starting point to create common regulatory framework and harmonise standards (which itself is a tall order given the heterogeneity across members), perhaps unilateral initiatives to facilitate trade in services across modes of supply with a particular emphasis on tourism, education and healthcare may be more fruitful.

Main takeaways

The takeaway from this literature is that conditional on certain domestic reform, easing the re-allocation of labour and enabling industries to operate in a particular way in principle there might be sufficient room for the government to mitigate the adverse effects, and capitalise on the pro-competitive effects, of joining the RCEP.

However, although the size of the economic pie increases with trade, reform is particularly hard because the winners from trade liberalisation are usually dispersed while the losers remain concentrated, and thus their voices, more vociferous in opposition. In 1991, reforms were seen as inevitable in response to the economic crisis, rather than strategic and intentional. Even the then Prime Minister, PV Narsimha Rao, and the ruling Congress party, went into the 1996 Lok Sabha elections downplaying the government’s role in the liberalisation that ensued. More immediately, elections for the important Uttar Pradesh (UP) legislative assembly are due in early 2022. UP is the largest milk producer in the country and cheap imports from Australia and New Zealand would have invariably put pressure on millions of dairy farmers, already suffering the consequences of the state government’s cattle policies. The political economy of populism is a study in sharp contrast to that of trade reform. The winners from the so-called ‘freebies’ delivered by populist politicians usually belong to a select group while the expenses are borne by the taxpaying public who do not have a coherent union to protest and strike on their behalf (yet). It is also not clear if those who benefit from cheaper imports post reform are able to credit their increased purchasing power to specific actions of the government, such as signing trade agreements.As a result, we see much more populism than desirable and much less of trade reform than what is needed.

Politics privileges the immediate over the future but visionary leaders arecapable of seeing their country through short-term discomfort for greater gains in perpetuity. This government has shown some willingness to take tough decisions that will supposedly reap dividends over the long term. In doing so, the ruling party, and in particular the Prime Minister, have tried to portray themselves as being aloof from the compulsions of electoralpolitics, and single-mindedlydevoted to the national interest. The RCEP was a good and timely test for this claim; the question is did the government pass?

Further Reading

  • Ahluwalia, Montek S (2002),“Economic Reforms in India Since 1991: Has Gradualism Worked?”, Journal of Economic Perspectives, 16(3):67-88.
  • Bernhofen, Daniel M and John C Brown (2005), “An empirical assessment of the comparative advantage gains from trade: Evidence from Japan”, The American Economic Review, 95(1):208-225.
  • Besley, Timothy and Robin Burgess (2004), “Can Labor Regulation Hinder Economic Performance? Evidence from India”, The Quarterly Journal of Economics, 119(1):91-134.
  • Dix-Carneiro, Rafael and Brian K Kovak (2017), “Trade liberalisation and regional dynamics”, American Economic Review,107(10):2908-46.
  • Feyrer, James (2019), “Trade and Income—Exploiting Time Series in Geography”, American Economic Journal: Applied Economics, 11(4):1-35.
  • Goldberg, P and N Pavcnik (2016), ‘The effects of trade policy,in K Bagwell and R Staiger (eds.), Handbook of Commercial Policy, Volume 1A, Chapter 3.
  • Goldberg, P and N Pavcnik (2017), ‘Trading up: Globalisation and developing countries’, VoxDev, 21 June 2017.
  • Goldberg, P and N Pavcnik (2018), ‘Integrated and unequal? The effects of trade on inequality in developing countries’, VoxDev, 30 April 2018.
  • Loecker, Jan De, Pinelopi K Goldberg, Amit Khandelwal and Nina Pavcnik (2016), “Prices, Markups, and Trade Reform”, Econometrica, 84(2): 445-510.
  • Melitz, Marc J and Daniel Trefler (2012), “Gains from Trade When Firms Matter”, Journal of Economic Perspectives, 26(2):91-118.
  • Pavcnik, Nina (2002), “Trade Liberalization, Exit, and Productivity Improvements: Evidence from Chilean Plants”, The Review of Economic Studies,69(1):245-276.
  • Topalova, Petia (2010), “Factor immobility and regional impacts of trade liberalisation: Evidence on poverty from India”, American Economic Journal: Applied Economics,2(4):1-41.
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