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[oped of the day] The myths around free trade agreements

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Trade openness ratio

Mains level : RCEP and FTAs - effectiveness

Context

India decided not to join the Regional Comprehensive Economic Partnership (RCEP). This decision can be seen in the lens of experiences countries have had with free trade agreements (FTAs).

Impact on exports

    • Some have argued that by not signing the RCEP, Indian exporters would miss on exporting to RCEP countries. 
    • FTAs – India has FTAs with the ASEAN, Japan, South Korea. Three-fourths of the bilateral trade already happens zero duty.
    • PTA – India also has a small preferential trade agreement with China.
    • FTA not enough – The mere signing of an FTA does not guarantee an increase in exports. If import duty in the partner country is high, there is a likelihood of an increase in exports by 10% when this duty becomes zero. But the chances of exports increasing are low if the import duty of the partner country is low at 1-3%. 
    • Zero duties – FTAs are of no use for exporting to Singapore, Hong Kong as regular import duties are zero.
    • Few products benefit – FTAs with Malaysia, Japan, Australia, New Zealand, Brunei, etc. benefit few product groups only as more than 60% of imports into these countries happen at zero duty for all countries.
    • Even zero duty no guarantee – even the high import duties coming down to zero through the FTAs do not guarantee exports. Japan reduced duty from 10% to zero for Indian apparels through an FTA in 2011. But India’s apparel exports to Japan have nosedived from $255 million in 2010 to $152 million in 2018.
    • Non Tariff Barriers –non-tariff barriers to trade (NTBs) such as special sourcing requirements are generally not negotiated in FTAs. Countries have to resolve these bilaterally.

Investment flow

    • Many argue that a lower import duty regime help in getting significant investments.
    • A case – Australia, in 1987, produced 89% of the cars it used. It protected the car industry through a high 45% import duty. But the share of locally produced vehicles came down as the duties were reduced.
    • Today, Australia imports nearly all cars as tariffs came further down to a 5% level. Most manufacturers such as Nissan, Ford, General Motors, Toyota, Mitsubishi, etc. which produced cars in Australia shut shop.
    • Higher duties – investment – India could attract significant investments in the car sector on account of high import duties. This resulted in the development of an indigenous car and auto component industry. 
    • India can think of lowering import duties to promote competition.
    • Other reasons for investments – Most investments are a result of the package, such as tax cuts, cheap land, power, etc. offered by the host country.
    • Need for an import wall – If a country is not the most efficient economy, some level of an import wall helps in getting external investments. Without an import wall, many firms may shift production to the more efficient FTA partner countries for exporting back to the home market.
    • Need for efficiency – the quality of investments increases as a country moves towards becoming a more efficient economy. Such countries are in an ideal position to become a manufacturing and services hub.

Entry into Global Value Chains(GVCs)

    • Reforms – A country cannot become a significant part of such value chains unless it has efficient ports, customs, shipping, roads, and regulatory compliance infrastructure.
    • Standards – GVC production also requires harmonization of product and quality standards.
    • GVCs will be disrupted if a shipment is delayed or is of non-standard quality. 
    • ASEAN, Japan, and Korea constitute the core of the Asian regional value chain. Despite FTAs with these countries, India has a weak presence in the electronics, machinery or apparel value chains.

Indian industry protectionism

    • Cheaper imports may replace products from domestic industries.
    • If the duty on a product is low, say, at 3%, the local industry may not care much about the duty elimination through any FTA.
    • Countries that have reached this stage are comfortable doing FTAs with fewer worries.
    • Trade openness – India ranks higher than the U.S., Japan, and China in the trade openness ratio. The ratio is the sum of all imports and exports as % of GDP — India (43) is more open than the United States (27), Japan (35), and China (38).

Steps to have an effect

    • The FTAs can ensure market access to only the right quality products at competitive prices. 
    • Competitiveness – Improvement in firm-level competitiveness is a must. 
    • Duties – The government can lower duties on raw materials and intermediates than on the concerned finished products.
    • Standards –  It can set up an elaborate quality and standards infrastructure for essential products.

Back2Basics

Trade openness ratio

The ratio is the sum of all imports and exports as % of GDP

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