By Dhruva Jaishankar
This article was originally published by Observer Research Foundation on December 4, 2020.
In the past few weeks, there has been another round of critical commentary about India’s supposed reversion to economic autarky. Although the backdrop has been the Indian government’s unveiling of its Atmanirbhar Bharat (“self-reliant India”) campaign, the immediate catalyst was India’s decision last year to withdraw from the Regional Comprehensive Economic Partnership (RCEP). RCEP, which was signed last month, is intended to further lower barriers to trade between the ten members of the Association of Southeast Asian Nations (ASEAN), China, Japan, South Korea, Australia, and New Zealand. India already has preferential trade agreements with ASEAN, Japan, and South Korea, meaning that the most significant consequences of its inclusion would have been to its trade with China, Australia, and New Zealand.
India had three specific objections to RCEP, as negotiations progressed. The most important was that the threshold for rules of origin – the criteria for determining the source of products – was very low. As a consequence, while India might have inserted specific clauses pertaining to trade with a particular country, these could have been easily circumvented. The second issue for India was inadequate safeguards against import surges, effectively limiting its ability to prevent dumping. The third objection concerned ratchet obligations, which would have ensured that certain privileges extended to third parties would apply to RCEP members. In sum, the final terms on offer in RCEP would have locked India into a high level of trade dependence on China, a country with which it already had a massive trade deficit, not to mention political differences, most notably on the disputed boundary.
India’s Trade Dilemma
Does India’s withdrawal from RCEP mean that its commitment to free trade is dead? The realities of trade between countries are, to put it simply, based on two basic principles. One is that free trade is a net benefit. Improved market access and less trade friction benefits businesses and reduces costs for consumers. This is the basis of trade liberalization theory which has underpinned globalization since the end of the Cold War. The second reality – and one often side-stepped by proponents – is comparative advantage. The fact is that not all parties benefit equally from free trade. Those countries that are richly endowed with natural resources, such as oil exporters, will obviously garner a disproportionate advantage. Other major beneficiaries will be those countries that serve as trading hubs: Singapore, Djibouti, Hong Kong, and Luxembourg trade more than three times their GDPs; the Netherlands, Bahrain, and the UAE over 150%. Finally, there are others that have built up their own export advantages over years, such as Vietnam, South Korea, and – most notably – China. In many cases (although not all), such advantages have not been accrued through laissez-faire economic principles, but by jealously guarding markets, offering attractive terms for investors, providing generous subsidies, and emerging as factories catering to the rest of the world: in other words, smart industrial policy. While free trade benefits everyone equally in a level playing field, the fact is that the playing field is never truly level. Talk to trade negotiators from any country, and they will describe day-to-day negotiations in terms normally reserved for blood sport.
Keeping these two realities in mind, India’s leverage in trade negotiations is restricted to only a few areas. One is access to its large market, which has become more highly sought after as global trade volumes have plateaued after 2008. A second area concerns perhaps the one thing India has in plentiful supply: people. But the international movement of people is much more politically contested than the flow of goods or capital. Countries such as Singapore that readily dismiss Indian democratic considerations when it comes to farmers and shopkeepers are quick to justify their own immigration restrictions on political grounds. Third, there are a few areas where India is required to meet global consensus, such as environmental standards. At times, India has held global consensus hostage (as on trade facilitation) when it felt its own concerns (as on food security) were not being sufficiently addressed. Finally, there remain a few critical areas where India is internationally competitive and integrated into global supply chains, and where it would genuinely benefit at the current juncture from global market access. These sectors include information and communication technology services, generic pharmaceutical production, automotive parts, gems and jewelry, and refined petroleum products. But such sectors are still few and far between.
With these basic realities in mind, India’s recent trade negotiation efforts have focused on reviving trade relations with complementary economies, rather than potential competitors. Indian negotiators did manage to work out a ‘phase one’ agreement in principle with the United States under Donald Trump’s presidency. But the addition of more onerous demands by the U.S. Trade Representative made that agreement unviable, and it may now be some months before an incoming Biden Administration can turn its attention to that issue. A second line of effort extended to the European Union. But after India-EU trade talks stalled in 2013, Brussels decided to lower the priority it accorded to India and conclude other outstanding negotiations (as with Mexico and Japan) first. A third, and new initiative, might extend to a post-Brexit United Kingdom. But ultimately only the successful conclusion of one or more of these negotiations would send a positive signal about India’s strategic commercial intentions.
Open On Goods, Closed On Services
Trade deals are, of course, not the same as trade and India’s trade with China, the United States, Europe, and the Gulf has been climbing even in the absence of trade agreements. In fact, when it comes to India’s relative openness, the record is much more mixed than both critics and proponents sometimes imagine. Many may forget that India was a founding member of the General Agreement on Tariffs and Trade (GATT), the precursor to the World Trade Organization. Since liberalizing in the early 1990s, its exposure to international trade has grown considerably. India’s international trade accounted for 40% of India’s GDP in 2019. This is higher than Japan (37%), Bangladesh (37%), China (36%), Brazil (29%), and the United States (26%). It has the third largest current account deficit of any country, after only the United States and United Kingdom. Highly visible consumer sectors are dominated by foreign manufacturers. Japanese companies accounted for over 55% of the Indian passenger vehicle market in 2018 and Chinese mobile handset manufacturers dominate almost two-thirds of the Indian market. (Korean companies are no slouches either, accounting for about 18% of passenger vehicle sales and 24% of mobile handsets in India).
Along some measures of openness, India rates among the most open major economies in the developing world. India’s import coverage ratio of non-automatic licensing (2.77%) is by far the lowest of the large developing economies, and on par with France or Germany. Barring South Africa, India rates as the easiest developing economy in which to start a foreign business according to the World Bank, and fares better on this score than South Korea and France. According to OECD assessments, India’s FDI restrictions are on the higher side (0.21) but far less than China’s (0.33) and comparable to Canada’s (0.17). In the decade following the global financial crisis, India imposed fewer new FDI restrictions than either Australia or Indonesia.
The picture is certainly less flattering when considering certain other aspects of trade liberalization. India’s average applied tariffs under Most Favoured Nation status is high at 13.4%, yet still less than South Korea’s 13.8%. (South Korea has off-set this by successfully negotiating a large number of trade agreements.) What might be surprising to many observers is India is perhaps most restrictive when it comes to services trade, an area of apparent Indian advantage. According to both the OECD and World Bank, India has the highest services sector restrictions among the G20 economies for which recent data is available. Considering India’s constraints in such sectors as higher education and legal practices – rather than in business processing or R&D – this becomes more readily apparent.
Future Choices
At present, the recent steps that have been taken by India to restrict its economy in certain areas are driven by two different forces. One is certainly the spirit of autarkic nationalism. In this view, shared widely by ideologues on the left and right, some small business owners, and political leaders, India should never have opened up in the first place. Foreign trade is bad, and India should revert to self-sufficiency through import substitution and other restrictive measures. But the second motivating factor is more specific, related to concerns – shared with many other countries – about India’s overdependence on China. For the time being, these two worldviews are in alignment. The recent steps India has taken – raising certain tariffs, more targeted investment screening, stepping back from trade negotiations, scrutinizing public procurement, and banning certain technology companies – have been welcomed both by free trade and China-sceptics.
But in the longer-term there are questions as to which sentiment will win out. This is also readily apparent in the different interpretations of Atmanirbhar Bharat. While political leaders from the prime minister down have stressed that self-reliance is meant to ensure resilience and not a closed economy, not all regulators or implementers of policy have necessarily interpreted it that way. Foreign investors have been receiving mixed signals, which will complicate Indian efforts at economic revival after the COVID-19 pandemic. The reality, however, is that India has little choice but to remain globally-connected, even if selectively so. Not only is its economy more trade dependent than is often appreciated, but for the foreseeable future it will be reliant on energy imports, technological tie-ups, and international education and research opportunities.
This survey of India’s trade realities should lend itself to a few clear conclusions. The first is for India not to be swayed by others’ narratives when it comes to the benefits of free trade, but remain focused on leveraging its comparative advantages. The facts do not support the popular notion of India as a particularly closed economy, certainly when it comes to non-agricultural goods trade, although the liberalization of its services sector is arguably overdue. The second is that for India, smart industrial policy is the way forward in a post-pandemic global economy. Whether Atmanirbhar Bharat and its associated policies produce the necessary results is still an open question. But if India is to be better positioned to compete in an open global economy, it will have to industrialize. Third, while India’s recent restrictive trade measures have been motivated by both genuine trade-scepticism and China-scepticism, India will have little choice but to remain globally integrated in many areas, even if on selective terms. Approaching trade in terms of national competition is necessary in a competitive international environment. But India should not lose sight of the fact that international trade – if truly free and fair – will ultimately be to its benefit.
Dhruva Jaishankar is Executive Director, Observer Research Foundation America.