Subject: Economics

Context

India’s international trade posture appeared to turn protectionist in the past week, with two indicators the government sent out.

What were the two indicators?

• The first-Signal sent out in the Budget: The first indicator, which played out live on television was contained in the Union Budget.
  • Laying out the Budget for the year, the finance minister made several references to the problems with free trade and preferential trade agreements (FTAs and PTAs).
  • Raise in tariffs, changes in the act: The Budget raised tariffs on the import of more than 50 items and changed the Customs Act provisions substantially to penalise imports suspected to originate from third countries.
• The second- India declined negotiations: The other indicator was that India declined to attend a meeting of trade negotiators in Bali that was discussing the next step in the Association of Southeast Asian Nations (ASEAN)-led Regional Comprehensive Economic Partnership (RCEP) trade agreement.

Issues with the Free Trade Agreement

• What the FM told Parliament: It has been observed that imports under Free Trade Agreements (FTAs) are on the rise.
  • Undue claims of FTA benefits have posed a threat to the domestic industry.
  • Such imports require stringent checks, adding that the government will ensure that all FTAs are aligned to the conscious direction of our policy.
• What could be the consequences of the Govt. policy?
  • Discouragement to imports: While the Govt. motive may be to protect Indian markets from dumping-primarily by Chinese goods-
  • The consequence of the changes will be to put Indian importers on notice and discourage imports in general.
  • Even as the government reserves the right to modify or cancel preferential tariffs and ban the import or export of any goods that it deems fit.

The rise in the trade deficit and decision to walk out of FTA

• The trade deficit with FTA partners: The government’s problem with FTAs was a key theme in its decision to walk out of the RCEP negotiations (of 16 countries) the rise in trade deficits with FTA partners.
• Review of all agreements: The government says it will now review all those agreements and wants to “correct asymmetry” in negotiations with new partners. The agreement that would be reviewed includes-
  • TAs signed with the 10-nation ASEAN grouping (FTA).
  • Japan (Comprehensive Economic Partnership Agreement, or CEPA).
  • And South Korea (CEPA).

Why it would not be easy to negotiate bilateral treaties

• The bilateral agreement would not be a priority for other countries: If India makes a complete break with RCEP, negotiating the bilateral trade agreements (TAs) will not be a priority for the other countries until RCEP is done.
  • The process of legal scrubbing is likely to take most of the year, and any talks with India will probably only follow that.
  • Difficulty in getting better deal: It is also hard to see any of them being able to offer India a better deal bilaterally once they are bound into the multilateral RCEP agreement.

India’s pending talks on bilateral treaties

• Negotiations of CECA with Australia: The case of the Comprehensive Economic Cooperation Agreement (CECA) being negotiated with Australia, will be a difficult task, not the least due to its history.
  • India and Australia began CECA talks in 2011.
  • However, talks hit a dead-end in September 2015. With the focus on RCEP, no progress has been made since then.
• Negotiations of FTA with the UK: A similar scenario awaits the announcement of the India-United Kingdom FTA talks.
  • It is unlikely that the U.K. will actually be able to talk until next year after terms for the K.’s full withdrawal from the European Union (EU) are completed.
• Negotiation of BTIA with the EU: Bilateral Trade and Investment Agreement (BTIA) negotiation are also unlikely to make headway until the UK’s complete withdrawal from the EU.
  • Both sides will have to decide how to revive from where they left off in 2013.
  • Why the negotiations are pending? Making the negotiations harder is the government’s decision to scrap all bilateral investment treaties with 57 countries including EU nations, and bringing in a new Bilateral Investment treaty (BIT) model in 2015.
  • Only Kyrgyzstan, Belarus and most recently Brazil have agreed to sign a new investment treaty based on that model.
• The US-India trade issue: Finally, there is the much-anticipated resolution of U.S.-India trade issues ahead of the visit of U.S. President.
  • The talks in that visit could also include talks on an FTA.
  • At present, there have only been some non-paper talks on the issue.
  • And given that the U.S. has expressed deep misgivings about India’s BIT model, these talks will also take several years to come to fruition.

Why India should rethink its stand on FTA

• First-Prospect of no dispute settlement mechanism: The decline of multilateralism, accelerated by the retrenchment of the U.S. and China’s intransigence have all meant the World Trade Organization (WTO) has lost steam as a world arbiter.
  • This leaves states that are not part of arrangements without a safety net on dispute settlement mechanisms.
• The second-trade deficit of other countries with India: The government has invoked the massive $57-billion trade deficit with China to explain protectionist measures, but it forgets its own trade surpluses with smaller economies.
  • Particularly in the neighbourhood, where Indian exports form more than 80% of total trade with Nepal, Bangladesh, Bhutan and Sri Lanka, respectively.
• Third- The rise of regional agreements: It is clear that most of the world is now divided into regional FTAs, for example-
  • The North American Free Trade Agreement (NAFTA) for North America.
  • The Southern Common Market (MERCOSUR for its Spanish initials) for South America.
  • The EU, the Eurasian Economic Union (Russia and neighbours).
  • The African Continental Free Trade Agreement (AfCFTA).
  • The Gulf Cooperation Council (GCC) FTA in West Asia.
  • And now the biggest of them all, RCEP, which minus India, represents a third of the world’s population and just under a third of its GDP.
• Fourth- Finally, the trend across the world does not favour trade in services the way it does in goods.
  • India’s strength in the services sector and its demand for more mobility for Indian employees, is thus becoming another sticky point in FTA negotiations.

Conclusion

India’s demographic might is certainly attractive for international investors, but only if that vast market has purchasing power and is not riven by social unrest and instability. India’s demographic might is certainly attractive for international investors, but only if that vast market has purchasing power and is not riven by social unrest and instability.

Context

Attempt to formalise the informal sector would not necessarily benefit it as two recent papers reveal.

What do the research papers reveal?

• The first paper-No strong evidence that formalisation improves business outcomes.
  • Published by the National Bureau of Economic Research, economist Seema Jayachandran argues that there is no strong evidence from studies conducted in many developing countries that formalisation improves business outcomes.
• The second article-Formalisation an evolutionary process:
  • In the second article, a background paper for the International Labour Organisation (ILO), economist Santosh Mehrotra calls formalisation an evolutionary process.
  • During this evolutionary process small, informal enterprises learn the capabilities required to operate in a more formal, global economy.
  • He says they cannot be forced to formalise.

The formalisation trap

• Why does the state want to formalise?
  • Easy monitoring and taxation: The state finds it easier to monitor and to tax the firms that adopt its version of formality.
  • Reduced last-mile cost for banks: Formality can reduce the last-mile costs for banks also.
• Problem with the imposed formalisation
  • The added cost outweighs benefits: Ms Jayachandran’s study reveals that most of the formalities imposed from above, add to the costs of the firms that outweigh the benefits of inappropriate formalisation.

How informal sector improves themselves?

• Association with their peers: Small entrepreneurs gain from forming effective associations with their peers.
• Mentoring: They also benefit greatly from ‘mentoring’.
• On job skill development: Skills of small entrepreneurs and their employees are best developed on-the-job.
  • This is because they cannot afford the loss of income by taking time off for training.
• Soft skills to form associations and manage enterprises, matter as much for the success of the enterprises as ‘hard’ resources of finance and facilities.

Problems with connecting to global supply chains-

• There is a desire to connect small firms in India more firmly with global supply chains.
  • Search for lover cost source supply: Mehrotra points out that the primary motivation of multinational companies for expanding their global supply chains is to tap into lower-cost sources of supply.
  • Supply chains compete with each other.
  • When wages and costs increase in their source countries, they look for other lower-cost sources.
  • Informal-the lowest labour cost firms: The lowest labour cost firms at the end of supply chains are generally informal.
  • Thus, the push by the state to formalise firms is countered by the supply chain’s drive to lower its costs.

Way forward

• India’s jobs, incomes, and growth challenges necessitate a reorientation of policies towards the informal sector.
• First-The government and its policy advisers must stop trying to reduce its size.
  • The development of an economy, from agriculture to the production of more complex products in the industry, is a process of learning.
  • Informal enterprises provide the transition space for people who have insufficient skills and assets to join the formal sector.
• Second-Policymakers must learn to support informal enterprises on their own terms.
  • Merely making it easy for MNCs and large companies to invest will not increase the growth of the economy.
• Third-Find ways to speed up the process of learning.
  • Policymakers must learn how to speed up the process of learning within informal enterprises by developing their ‘soft’ skills.
  • Large schemes to provide enterprises with hard resources such as money and buildings, which the government finds easier to organise, are necessary but inadequate for the growth of small enterprises.
• Fourth-Networks and clusters of small enterprises must be strengthened.
  • They improve the efficiency of small firms by enabling sharing of resources.
  • More clout to negotiate: They give them more clout to improve the terms of trade in their favour within supply chains.
  • Reduced last-mile cost: They reduce the ‘last mile costs’ for agencies and providers of finance and other inputs to reach scattered and tiny enterprises.
• Fifth-The drumbeat for labour reforms must be changed.
  • The laws should be simplified, and their administration improved. And, their thrust should be to improve the conditions of workers.
• Finally- The social security framework for all citizens must be strengthened.
  • Health insurance and the availability of health services must be improved.
  • And disability benefits and old-age pensions must be enhanced.
  • The purpose of ‘labour reforms’ must be changed to provide safety nets, rather than make the workers’ lives even more precarious with misdirected attempts to increase flexibility.