Leave Pakistan’s MFN status intact
In the midst of rising tensions in the wake of the Uri attack, some in India are calling for the withdrawal by India of the most favoured nation (MFN) trade status for Pakistan.
As international trade economists, we find the current state of the discourse disappointing. Let us recall that the World Trade Organization (WTO) is built upon the General Agreement on Tariffs and Trade (Gatt), negotiated in 1947, just as undivided British India was preparing for partition. Gatt’s articles of agreement were signed by all its founding members—including India and Pakistan—in October 1947, and ratified the following year by both countries.
In signing Gatt, nations agreed to abide by its cornerstone principle—non-discrimination in trade relations, whereby an importing country may not discriminate against imports based on their country of origin. Confusingly, this principle of non-discrimination, articulated in Article I, is referred to by Gatt as “General MFN Treatment”, with the legal text requiring that any “favour” in trade granted to another member country shall be immediately and unconditionally granted to all other member countries.
The terminology is confusing: MFN does not imply favouritism, but actually rules it out. More importantly, it rules out discrimination in trade against any member country.
There is another twist. Anticipating that some member countries may, in the future, wish to pursue comprehensive economic integration with other members, Gatt also permitted departures from the principle of non-discrimination, through its Article XXIV, which allowed for the formation of preferential trade areas (such as the European Union, which was eventually formed).
In the same spirit, and acknowledging that India and Pakistan had historically been an integrated economic unit, Article XXIV, Paragraph 11, allowed an exception from its non-discrimination rules as follows: “Taking into account the exceptional circumstances arising out of the establishment of India and Pakistan as independent States and recognizing the fact that they have long constituted an economic unit, the contracting parties agree that the provisions of this Agreement shall not prevent the two countries from entering into special arrangements with respect to the trade between them, pending the establishment of their mutual trade relations on a definitive basis.” In short, Gatt provided an exception to its rules in order to enable India and Pakistan to enjoy a closer bilateral trade relationship than they would be required to extend to other Gatt nations.
Thus began trade between India and Pakistan under Gatt. Trade relations remained vibrant for an extended period after Partition. As noted by former Pakistan commerce secretary Zafar Mahmood, in 1948-49, India accounted for around 56% of Pakistan’s total exports and 32% of its total imports. Indeed, despite the hostilities of 1948, India remained Pakistan’s largest trading partner until 1955-56.
The trade relationship took a nosedive with the 1965 and 1971 wars, and only resumed, on a limited scale, after the Simla Agreement was signed in 1972.
Importantly, trade between the countries then took place on the basis of “positive lists” (only goods specifically on the list could be traded)—rendering this illegal under Gatt MFN rules and also in violation of the Article XXIV, Clause 11 exception, which had permitted more (not less) liberal trade than the two countries had with other Gatt nations. In 1996, with the formation of the WTO (which subsumed Gatt), India granted Pakistan MFN status, but Pakistan, despite some tentative steps in the direction of normalization, is yet to reciprocate.
Given this state of play, what should India do?
In our judgement, it would be the wrong decision for India to revoke Pakistan’s MFN status.
First, there is simple economic logic. Free trade remains the best policy even if your trading partner wishes to be more closed. As economist Joan Robinson is supposed to have said, if your trading partner dumps rocks into their harbour to block entering cargo, you do not make yourself better off by dumping rocks in your own harbour.
Second, trade with Pakistan accounts for less than 1% of India’s total trade, and the figures for Pakistan are not very much higher. Thus, even strategically, trade policy with respect to Pakistan today can neither be offered as a carrot nor wielded as a stick. Nor does it amount to much for India.
Third, offering MFN status to a trading partner is an obligation, not a choice, for WTO members. The fact that Pakistan is not living up to its WTO obligations is not a good reason for India not to do so. Indeed, India would be perfectly within its rights to raise Pakistan’s non-compliance at the WTO.
Finally, we might place some modest hope in the classical concept that free trade fosters not just prosperity but also peace and friendship, in the “doux commerce” thesis of economist Albert Hirschman: the idea that commerce “sweetens” human behaviour.
India can legitimately claim the moral high ground in fulfilling our WTO obligations while Pakistan does not. Revoking Pakistan’s MFN status would shred this advantage. It may offer revanchist satisfactions, but it would not reflect mature statesmanship.
Vivek Dehejia and Pravin Krishna are, respectively, a Mint columnist and a professor of economics at Johns Hopkins University, US.
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