Opinion: India's New Trade Motto Is About Expanding Its Comfort Zone(s)

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The concept of a paradigm shift, originally expounded by Thomas Kuhn, is centred around the profound transformation in foundational assumptions within prevailing theories. Its applicability extends far beyond the realms of science to areas like policymaking. This theory posits that significant progress often occurs not through gradual improvement but through revolutionary changes that redefine fundamental understandings. In the domain of policymaking, this manifests as a departure from established norms and practices in response to accumulating anomalies or inefficiencies that the current paradigm cannot satisfactorily address. This paves the way for innovative frameworks that better tackle contemporary challenges.

Embracing The Developed World

Drawing a parallel to Kuhn's theory, India's evolving stance on trade policy and Regional Trade Agreements (RTAs) exemplifies a strategic paradigm shift within its economic policy framework. Historically, our RTAs were not with our major trading partners. Moving away from its traditional focus on just South-South cooperation, India has progressively embraced RTAs with the developed world. This pivot reflects a recognition of the mutual benefits that can be derived from enhanced market access for Indian goods and services in these economies, signalling a significant re-evaluation of India's trade strategies in favour of fostering economic growth and development through more integrated global trade relations.

Latest in this series of RTAs is the Trade and Economic Participation Agreement (TEPA) with the European Free Trade Association (EFTA)signed by India on March 10. Through TEPA, India aims to enhance its trade and economic ties, thereby stimulating growth, employment, and technological advancements within its own economy. Such agreements underscore the importance of RTAs in bridging the economic divide between developing and developed nations, ultimately contributing to global economic prosperity.

Why TEPA Is Significant

TEPA is characterised as a modern and ambitious pact, underpinned by unprecedented commitments, including a binding investment of $100 billion and the creation of 1 million direct jobs in India over the next 15 years. The agreement, spanning 14 comprehensive chapters, focuses on enhancing market access, trade facilitation, investment promotion, and more. It ultimately aims to significantly boost the “Make in India” initiative and provide ample opportunities for India's skilled workforce. EFTA's commitment to opening up 92.2% of its tariff lines, which encapsulates 99.6% of India's exports, alongside India's offer of 82.7% of its tariff lines covering 95.3% of EFTA's exports, underscores the depth of this economic collaboration. TEPA not only promises to strengthen India's export sectors, such as IT services and pharmaceuticals, but also paves the way for greater integration into European markets, particularly through Switzerland's significant trade connections with the EU.

As mentioned earlier, this is part of India's larger strategy to forge trade relationships with countries that have an appetite for Indian manufactured goods. India's strategic pivot toward RTAs marks a notable shift in its economic engagements, with implications for its aspirations of becoming a manufacturing alternative to China. A 2020 analysis by the Economic Advisory Council to the Prime Minister (EAC-PM) of the 'China+1' manufacturing strategy revealed a striking trend: industries that were diversifying away from China showed a pronounced preference for Vietnam. A critical factor behind this preference is Vietnam's extensive network of RTAs with developed economies, granting it preferential market access that companies find highly advantageous. This network of agreements positions Vietnam as a more competitive destination for firms looking to capitalise on these established trade links, which ultimately makes the country an attractive node in the global supply chain.

India And Vietnam: Two Different Outlooks

The strategic trade alliances of India and Vietnam in 2020 showcase a tale of two contrasting approaches to economic partnerships. Vietnam's trade agreements are predominantly with nations that have advanced economies, reflecting its successful engagement with markets that have the potential to offer significant economic benefits and growth opportunities. This includes access to larger consumer bases and high-tech resources, positioning Vietnam favourably in the international trade arena.

India's trade agreements, conversely, seem to be focused on forging stronger connections with other emerging economies. This preference may stem from various factors, including geopolitical strategy, the nature of India's exports, and the regulatory landscapes of potential developed-economy partners. While such alliances with developing nations can bolster regional solidarity and collective growth, they may also reflect the challenges India faces in penetrating the more established markets, which are often guarded by complex trade barriers and competition.

In 2020, India's web of RTAs largely included the developing world, fostering closer economic ties with countries across Africa, South America, and Asia. The data indicate that many of these RTAs were established between 2007 and 2011, a period corresponding with the United Progressive Alliance (UPA) government in India. During this era, the RTAs appear to have resulted in a trade balance skewed in favour of India's partners. These countries managed to export more to India, benefiting from access to its vast market, while India's exports to them did not keep pace. The trade dynamics could be reflective of the terms negotiated within these RTAs, which may have been more favourable to the partner countries, or indicative of the competitive challenges Indian industries face in diversifying their export baskets or meeting the demand specifics of these markets.

The Post-2020 Shift

The government, however, has taken cognisance of it and has brought a paradigm shift in its trade agreements. Post-2020, India has actively engaged in signing RTAs and Free Trade Agreements (FTAs) with developed countries and is currently in negotiations with others. A notable agreement is the India-Australia Economic Cooperation and Trade Agreement (ECTA) signed in April 2022, which marked the first trade agreement with a developed country after more than a decade. The pact aims to enhance cooperation across a wide range of economic and commercial relations between the two nations, covering sectors like Trade in Goods, Trade in Services, Technical Barriers to Trade (TBT), and more.

In addition to Australia, India has also revitalised its trade relations with the UAE through the Comprehensive Economic Partnership Agreement (CEPA), which was resumed in February 2022. The agreement aims to increase goods trade to $100 billion within the next five years, with a potential to touch $250 billion by 2030. It is also expected to generate significant employment opportunities across various sectors.

India is also in the process of negotiating RTAs with the European Union and the UK as well as exploring Free Trade Agreements with Israel and the Gulf Cooperation Council (GCC) countries. These negotiations and agreements are part of a broader strategy to engage more closely with both developed and developing economies across the globe.

How Developing Nations Benefit From Partnerships

The idea that between developed and developing nations, RTAs are more advantageous for the latter is an intriguing concept in international economics, supported by substantial empirical evidence. The benefits for developing countries often manifest through increased Foreign Direct Investment (FDI), economic growth, and reduced inequality.

Drawing parallels from the well-established concepts of "trade creation" and "trade diversion" in international trade theory, RTAs can similarly influence investment patterns. "Investment creation" refers to the phenomenon where new investment flows are generated due to the enhanced attractiveness of a market as part of a trade agreement. This could be due to reduced barriers, better market access, or a more stable and predictable investment environment.

The Investment Boon

On the other hand, "investment diversion" occurs when investment is rerouted from more efficient non-member countries to less efficient member countries within an RTA, solely due to the preferential treatment afforded by the agreement. While investment diversion might seem detrimental at a global efficiency level, for developing countries within an RTA, this can still represent a significant boon as it brings in capital, technology, and expertise that might not have been accessible otherwise.

Several studies have provided empirical backing for these concepts. For instance, the research by Yeyati and colleagues demonstrates that FTAs between a home country and a host country are positively correlated with increased bilateral outward FDI. This suggests that when countries enter into trade agreements, businesses within these countries are more likely to invest in each other, driven by the benefits of the FTA.

Büthe and Milner's analysis further corroborates the positive impact of trade agreements on FDI inflows, specifically highlighting that developing countries that are part of numerous trade agreements tend to receive more FDI. This influx of investment is crucial for developing countries as it can lead to job creation, technology transfer, and infrastructure development, thereby fuelling economic growth and development.

Quality Of FTAs

Moreover, it's not just the existence of RTAs that matters, but also their quality. Agreements that include comprehensive liberal investment rules and equitable dispute settlement mechanisms are particularly effective in attracting FDI. These features reduce the risks and uncertainties associated with investing in foreign markets, making developing countries more attractive destinations for foreign investors.

Thus, these agreements and ongoing negotiations signify a shift in India's trade policy towards more strategic and beneficial trade partnerships, focusing on reducing trade deficits and enhancing economic cooperation. The impact of these agreements could be multifaceted, potentially leading to increased trade flows, enhanced foreign investment, job creation, and a stronger position for India in the global trade network.

(Bibek Debroy is Chairman & Aditya Sinha is OSD, Research at the Economic Advisory Council to the Prime Minister)

Disclaimer: These are the personal opinions of the author.