Hyundai Motors’ reported decision to move production of one of its hatchback cars from India to Turkey is a small example of a bigger truth: preferential trade deals such as free trade agreements (FTAs) divert rather than create trade. They are inefficient substitutes for the real thing: A multilateral free trade system where imports from all countries are treated at par.
Illustration: Jayachandran / Mint
The Business Standard quoted Hyundai India’s managing director H.S. Lheem saying that the auto maker plans to shift production to Turkey because India does not have an FTA with Europe. In effect, production will be moving from a low-cost to a high-cost country only because of discriminatory tariffs rather than production efficiency. Global welfare will be reduced.
This is a lesson that economists have never tired of repeating. But it is worth mentioning once again in these columns because trade ministers and officials from around the world are meeting in New Delhi this week to figure out ways to revive the Doha Round of global trade negotiations. But even as the multilateral talks have sputtered to a halt, country after country has gone ahead and signed FTAs. India closed two such deals recently, with the Association of Southeast Asian Nations and South Korea.
Such FTAs are preferable to autarky and high tariff walls, but are suboptimal in terms of global growth and welfare.
Economist Jagdish Bhagwati has savaged the proliferation of FTAs in recent times, using a wonderful metaphor to describe them. Bhagwati says preferential trade pacts are like a bowl of spaghetti, a tangled and slippery mess that distort incentives and punish the efficient. They repeat a thousand times what Hyundai Motors plans to do: encourage decisions that are second best.
That is why so much hope rides on the revival of the Doha trade talks. The previous round imploded in July 2008, because of US stubbornness and Indian grandstanding. Much has changed since then. Global trade has plummeted because of the economic crisis. The US has a new president who is a less ardent free trader than his predecessor and one who has been distracted by his domestic problems. India, too, went through an election and has more or less the same government, though new commerce minister Anand Sharma is likely to be less inflexible than Kamal Nath, his predecessor.
The world needs a new multilateral trade deal.
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