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Why is India allergic to ambitious free trade agreements?

Source: 
BloombergQuint
Author: 
Raj Bhala
Date: 
Saturday, September 14, 2019

India belongs to the caste of the world’s foremost emerging economies, the BRICS. But, because of its allergy to join any free trade agreement that is ambitious, India is an outcast among the BRICS. This allergy prevents India from achieving what both Prime Minister Narendra Modi and President Donald Trump could rightly call “the deal of the century” – an Indo-American FTA.

‘Ambitious’ means broad and deep. Duty-free, quota-free treatment, immediately upon entry into force, for all merchandise trade, is a hallmark of breadth and depth. So, too, is services trade liberalisation across all modes (cross-border supply, consumption abroad, foreign direct investment, and temporary professional migration), with a minimum of declared non-conforming measures. Likewise, opening government procurement, at central and sub-central levels, with precious exceptions (such as for military purchases), evinces ambition.

To be sure, India is party to FTAs with: 

  • Sri Lanka (signed in 1998)
  • Afghanistan (2003)
  • Thailand (2004)
  • Singapore (2005)
  • Bhutan (2006)
  • Nepal (2009)
  • South Korea (2009)
  • Malaysia (2011)
  • Japan (2011)

It’s in the South Asian Free Trade Agreement (2004) and has a deal with the Association of Southeast Asian Nations Agreement (2010).

Yet, these arrangements incline to commercial insignificance. India is stubborn about ‘duty-free, quota-free, immediately upon entry into force’ (DFQF-EIF) treatment for merchandise, insists on lengthy product exemption lists, and eschews services or government procurement liberalisation.

India excuses its allergy on a deal-by-deal basis. For instance, DFQF-EIF treatment on 100 percent of the product categories listed in the harmonized system of tariff nomenclature with fellow SAFTA parties is not possible, because some of them are unfriendly, while others are too poor and/or in too much chaos. Tariff schedules might be freed gradually, as a confidence-building measure, and as conditions warrant. As for the Regional Comprehensive Economic Partnership that India currently is negotiating with China, India worries this FTA would spell a giant Sino-Indian bilateral trade surplus (in China’s favour), and subject India to endless pressure from China for trade-related concessions.

These excuses are unpersuasive. Six reasons—each of which India can do something about—explain the FTA allergy.

1. India Clings To Multilateralism

Free trade across the 164 members of the World Trade Organization is an economic ‘first-best solution’. But, it’s not in sight. The Doha Round of multilateral trade negotiations died as far back as December 2008 and April 2011, when the last major set of modalities texts were issued – and roundly scorned. These negotiations were buried in by March 2018, when America declared it no longer would participate in the Round.

There is not, and never will be again, any resolute effort to complete the Doha Round.

There will be no broad, deep multilateral texts agreed to based on a single undertaking, whereby all WTO members agree to every provision in every text, and none agrees to any provision until all have agreed to all provisions in an integrated package.

Astute countries traditionally committed to multilateralism, such as Japan, South Korea, and Singapore, reluctantly accepted this reality over a decade ago, and abandoned their nearly exclusive emphasis on multilateral trade negotiations to achieve their trade aims. They shifted to game-changing FTAs, Japan and Singapore with the Trans-Pacific Partnership, and South Korea with a bilateral deal with America. 

Meanwhile, India clung and still clings to the other-worldly dream of a successful Doha Round that would see agriculture market access coupled with subsidy restrictions, non-agricultural and services market access, plus disciplines on trade remedies. In this fantasy, commitments are asymmetric. India gets more than it gives, because its ‘developing country’ status allows it room for protectionism. That’s a nightmare for developed countries, which suspect many WTO members make false claims to that status. In July 2019, America announced it might cease accepting self-declarations of developing country status, and in June had banished India from the Generalized System of Preferences.

Light years from now, there might... might... emerge a plurilateral agreement, encompassing a subset of like-minded WTO members, on a selected topic like electronic commerce, environmental goods, or services. But, India rejects plurilateralism, arguing that as with FTAs, its outcomes are ‘second-best’ and sap the resolve of members to find multilateral outcomes.

India’s own behaviour contradicts its argument: it cannot abjure plurilateral deals while plodding along with ho-hum FTAs. Besides, the less ambitious India’s FTAs, the worse they are as ‘second-best’ deals.

2. India Won’t Cover “Substantially All Trade”

Ironically, India could show fidelity to multilateralism by implementing fully Article XXIV of the General Agreement on Tariffs and Trade. That’s the GATT provision permitting WTO members to forge FTAs or customs unions, subject to two key rules. (The third and fourth rules, ensuring the deal can be implemented in a reasonable period, and giving notice of a new deal to the WTO Secretariat, are not problematic.) The first rule is an FTA or customs union should cover “substantially all trade.” This phrase is vague, i.e., it has no defined meaning. Benchmark possibilities include coverage of 80 percent of all trade among the parties forming an FTA or customs union, and their inclusion of all major sectors.

India’s positive-list default setting in FTA negotiations, whereby it presumes no sector or product grouping will be granted DFQF-EIF treatment unless India affirmatively schedules it for liberalisation, cuts against the “substantially all trade” requirement. Were India ambitious, it would change the setting to a negative list. Unless specifically exempted, every agricultural and manufactured good, services industry, and government procurement market would be presumed open to free trade.

Alas, India’s presumption arises because of political economy: the costs of free trade are visited on discrete, identifiable constituencies, whereas the benefits are spread across diffuse, unconnected groups.

So, Indian producers fearing free trade protest vocally (or, God-forbid, violently) against an Indo-American FTA. They make life hell for average Indian consumers, who could benefit from this FTA through access to a greater range of higher-quality, lower-price products, but who face transaction costs and collective action problems to unite nationwide in counter-protests.

India’s presumption also exists because of its failure to think imaginatively about transition periods.

Not every good, service, or government procurement market needs immediate DQDF treatment. Rather than grant EIF-free trade, India can do what America has done in its FTAs – manage trade through staging categories.

Each category establishes the length of time during which a trade barrier is phased out: EIF is as soon as the FTA takes effect, but any other choice – one to 20 years, for example – is possible. Each staging category also defines whether non-EIF phase-outs are even (e.g., eliminating a 50 percent tariff in 10 years in equal installments of two percentage points),front-end loaded (e.g., cutting 40 of the 50 percentage points in the first five of the 10-year phase-out), or back-end loaded (e.g., cutting 40 of the 50 points in the last five years). American trade negotiators are skilled in these painstakingly technical talks. India needs to enter them with a shortlist of sensitive areas in which it seeks deferred liberalisation via short staging categories.

3. India Might Raise Trade Barriers Against Third Countries 
The second GATT Article XXIV discipline on establishing an FTA or customs union is that it not, on the whole, raise trade barriers against third countries, when compared with the overall average barriers they faced before the deal took effect.

An FTA party should not giveth with one hand to a fellow party, yet taketh away from a non-party, otherwise, the FTA could become a fortress. India has the means to do just that.

India’s Tariff Schedule has plenty of ‘water’ in it (technically called ‘tariff overhang’), which means for many product categories, India’s bound most favoured nation tariff rate is above its actual rate. The gap between India’s simple average final bound and applied MFN rates is 50.8 versus 17.1 percent. GATT Article II mandates that a WTO member not apply a tariff rate above its bound MFN level.

India could take advantage of the gap, boosting those levels against merchandise from non-FTA parties to offset the elimination or reduction of duties for FTA-originating goods.

But for the Article XXIV rule, this flexibility might help encourage India to be ambitious in FTA talks. During the Doha Round, America tried unsuccessfully to persuade India to eliminate the water in its Schedule. Today, the flexibility makes India an attractive FTA partner to America, because an FTA would lock-in (ultimately) zero duties, but raises suspicions among non-FTA parties that it’s an unreliable trading partner.

4. India Underestimates Its Economic Leverage

When, at any time since 1947, have so many American businesses flocked to India imploring it to liberalise its trade regime and consider an FTA? From textiles and apparel manufacturers to high-tech companies, American firms need an exit strategy from China. That’s for good reason: when President Donald Trump entered the Oval Office, the average U.S. tariff on Chinese merchandise was 3.1 percent. By year-end 2019, assuming the Sino-American Trade War still rages and all previously announced tariffs are implemented, that average will rise to 24.3 percent. China’s tit-for-tat retaliation means American exports to China are subject to higher levies.

India is perhaps the first-best alternative country in which to re-orient a supply-chain from China.

Its domestic market exceeds that of Indonesia, Malaysia, Philippines, Thailand, or Vietnam – combined. If an American company decides to Make in India, then it can Sell in India, and across the world, free of trade war worries. Its doing so would mean jobs for Indians. Apple is a case in point. Manufacturing for Apple employs roughly three million workers in China. The Apple Watches and iPhones those workers make can’t sell as competitively in America, with 25-30 percent duties, as they would if they were made in India. Inking an FTA with the U.S. would be a nearly irresistible incentive to pick India over other non-Chinese Asian manufacturing sites.

5. India Underestimates Its Legal Appeal 
As regards attractiveness as a country in which to do business, at or near the top of the list for international traders and investors is rule of law. India fails to appreciate its double legal blessing. First, its legal system is fundamentally western in character. The law of contracts, property, and corporations, plus the structure of the court system and rules of civil procedure and evidence used therein, are not alien to American businesses. Neither Socialist Law nor the Sharī‘a reign in India.

Herein lies the second blessing. For the likes of Apple to invest billions in re-configuring supply chains toward India, certainty and predictability as to legal risk are needed. Legal risk depends on political risk. India is not governed by a Communist Party, nor an absolute monarch. President Xi Jinping or Crown Prince Mohammed Bin Salman have far more power to change, instantly and dramatically, a policy on which traders and investors rely than Prime Minister Modi. Lawyers and the courts, grinding and sometimes corrupt as they are, will stop arbitrary or capricious executive action in India, and those traders and investors will be among the lead plaintiffs.

6. India Underestimates Its National Security Importance 
Ambitious FTAs such as an Indo-American FTA would take India out of its neighbourhood. If the U.S.-China trade war has become a currency war, and further evolves into a Cold War, and if Sino-American naval confrontations across the Nine-Dash Line continue, India’s importance to American national security will increase. No administration in American history has drawn the nexus between trade and national security policy more tightly than that of President Trump. The tighter that nexus, the greater India’s leverage to negotiate a favourable deal.

NAFTA Template? 
“रुकिए (rukiye)! Stop! Too much, too fast, India can’t face all six reasons simultaneously!” 

That statement bespeaks India’s allergy. Fortunately, there’s a cure: the North American Free Trade Agreement.

India could seek a bilateral FTA with America based on the United States – Mexico – Canada Agreement and NAFTA 1.0. Their provisions cover all the reasons, and more, including rules of origin for autos and auto parts and advanced intellectual property protections. Mexico, not a BRICS caste member, ambitiously agreed. Might India?

Faculty name: 
Raj Bhala