Should India be cautious on free trade?

Ever since India opened up its economy in 1991, its trade to GDP ratio has risen steadily. This is the ratio of imports plus exports divided by national income. It used to be less than 20 per cent, and presently it is above 50, and higher than that of USA, China and Japan. It indicates the extent of globalisation and the degree of openness of an economy. By this count, India has embraced globalisation. Of course, the ratio could be lower, not because an economy is isolated or low in trade, but because it has much higher GDP in the denominator, as is the case with USA, China and Japan. If the ratio is too high, then it signifies over-dependence on global trade. For instance, Singapore’s trade to GDP ratio was close to 400 per cent in the last few years. Obviously, for a large economy like India, with a large domestic consumer base, the optimum ratio is between 40 to 50 per cent, which is where it is. That does not mean we need to be complacent, or start shutting off exports and imports.

Our experience with its various free trade agreements (FTAs), including the one with ASEAN is cause for some concern. Almost in all cases, the bilateral trade deficit has widened after the FTAs came into force.

The opening up since 1991 has meant that import tariffs have come down from greater than 50 per cent to single digits now. Most industrial goods made in India today face stiff competition from imports, especially from countries like China and hence are priced very competitively. Competition has forced Indian industry to improve domestic efficiency and productivity, as well as technology and quality. This has been done despite domestic handicaps such as high cost of capital, relatively poor infrastructure, high taxation (like excise) and clumsy logistics. All of these handicaps are absent in our trading partners from East Asia or China. The fact that Indian industry has been able to hold its own despite the disadvantages is a testimony to the genius of Indian entrepreneurs.  This is also not to deny that economic reforms have also helped industry (for instance the dismantling of the licence raj), and these reforms have definitely improved the domestic investment climate.

Twenty years after the birth of the World Trade Organisation, the body that promotes free trade, we are in a new age, called the “Trump Era”. The ascent of President Donald Trump has meant a new language of protectionism. He says put America first, implying make and buy in America, and shun imported items. Imports are stealing domestic jobs, and hence need to be stopped, so goes the logic. There is a proposal to hike import duties steeply to discourage imports, especially of automobiles and other industrial and consumer goods. He is even proposing a “border tax” that will penalise imports by not allowing the cost of cheap imported components to be deducted, and conversely he also proposes to make export income tax free.  Before Trump’s call for protectionism was the Indian Prime Minister Narendra Modi’s call for ‘Make in India’.  But the latter did not have any protectionist angle. In fact, the PM made it clear that ‘Make in India’ meant make Indian industry so much more competitive that it becomes a hub not just to serve India’s domestic market but also the global one. 

President Trump’s initiative might lead to a domino of protectionist actions. He promptly cancelled the mega free trade pact called Trans Pacific Partnership (TPP). The TPP was between twelve countries, the notable exclusions being China and India. The response to TPP was RCEP, the Regional Comprehensive Economic Partnership.  This was the ASEAN grouping of ten countries plus China, India, Japan, Korea, Australia and New Zealand. RCEP is perceived as Asia’s (read China’s) response to TPP. Since TPP is off, then may be the RCEP, too, will be off? No way, since the latter group is going full speed in concluding the agreement.

It may be recalled India already has a prior free trade agreement with ASEAN, which will now be expanded to RCEP. But our experience with its various free trade agreements (FTAs), including the one with ASEAN is cause for some concern. Almost in all cases, the bilateral trade deficit has widened after the FTAs came into force. Industrial goods imports, especially of chemicals, metals and textiles have surged. In the case of ASEAN FTA, it was expected that India’s export of services to those ten nations would increase. This has not happened to a satisfactory extent. In the case of some of the ASEAN countries, it is also suspected that free entry under the FTA is happening by flouting some conditions of the “rules of origin” in the FTA itself.

That means, say Chinese goods are coming via an ASEAN country, masquerading as if it’s not coming from China. By signing the RCEP, India will have a de facto free trade agreement with China, a fact that worries Indian industry. That’s because there is already a huge overhang of excess capacity in China, making it easier to “dump” their goods into countries like India, at lower cost. Besides there is also worry of government subsidies, which benefit Chinese exports, and hence provide a less than a level playing field to Indian industry. In an era of increasing protectionism in the West, it seems prudent not to rush headlong into an absolute zero tariff regime under RCEP. Both India’s government and industry are vigilant about phenomena like dumping or unfair subsidies, and have taken this up with the WTO. Even the terms of negotiations in RCEP pay heed to domestic concerns. And it is nobody’s case that we can put the genie back in the bottle, of reversing the free trade path.

Opening up and lowering barriers must continue, the Trump doctrine notwithstanding. Economists cry hoarse in pointing out that low cost dumping helps the consumer (cheap goods), and hurts the seller (the one who is dumping). But this argument ignores the impact on jobs and the domestic industry in the longer term. There’s always a thin line between “excessive coddling” and providing a “fair tariff protection” to ensure a level playing field. Hence a slower, more nuanced, prudent approach to free trade should be the order of the day for India.

(The author is a senior economist based in Mumbai)