Why India needs to defend free trade
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Earlier this month in Japan, Prime Minister Narendra Modi said his government seeks to pursue economic policies that will make India “the most open economy in the world”. His statement was lost amid the domestic din following his controversial decision to pull high-value banknotes out of circulation.
Chinese President Xi Jinping made a similar point on the sidelines of a conference in Peru. He pledged to further open up the Chinese economy so that the benefits of economic integration were shared more widely. These parallel statements by the leaders of the two largest emerging economies come at a time when protectionist sentiment is gradually casting a long shadow in the developed world, especially after the election of Donald Trump as the next US president. Global trade by value has also been shrinking.
The backlash against globalization in several rich countries is because a growing numbers of voters there believe that free trade has harmed them, as jobs have moved to Asia. A robust debate is still under way among economists whether technology has been a bigger reason why median incomes have stagnated in these countries, but the dominant narrative blames free trade.
The situation in India and China is quite different. Millions have been pulled out of poverty because of the opportunities offered by globalization. Economist Branko Milanović has provided one of the most evocative visuals of what he has described as the greatest reshuffle in global incomes in the past three centuries. His elephant diagram shows that the two groups that have seen the most rapid rise in incomes in the two decades after 1988 are the few in the top income percentile (the global elite) and the hundreds of millions around the median income (mainly people from India and China).
This fact partly explains why leaders such as Modi and Xi are committing themselves to open economies even while Western countries that originally pushed for globalization are getting attracted to protectionism. Their middle class has been one of the undisputed beneficiaries of globalization, and hence has a strong interest in more economic integration with the rest of the world.
But what precisely does being the most open economy in the world entail? Modi did not provide any details. Trade policy has definitely become less restrictive since the advent of economic reforms: import tariffs that were once among the highest in the world have come down dramatically. The goal set by the initial reformers that average tariff levels should come down to East Asian levels has been met. There is no doubt that the old protectionist walls have been dismantled.
The trade-policy reforms over the past 25 years have also resulted in better trade outcomes. The trade/gross domestic product ratio has doubled. India, however, can never reach the levels of openness of a country such as Singapore because of its size. Smaller countries tend to have a higher trade ratio because their domestic markets aren’t big enough.
The record is less encouraging when it comes to trade in services, despite the success of the software services industry. Trade in services usually increases in tandem with prosperity, so India still has some distance to go. The other two indicators of openness are restrictions on foreign direct investment (FDI) and capital account controls. India has far fewer FDI restrictions, though some sectoral caps persist, but the experience of China shows that there is an umbilical link between higher FDI and more international trade.
India has also brought down most of its barriers to capital inflows, though there are still controls. The standard measure for capital account openness—the Chinn-Ito index—shows that India has far more controls on capital flows compared to its peers. The traditional view within the economic policy establishment has been that capital-account convertibility should be a gradual process, and deeply dependent on durable macroeconomic stability as well as a strong banking system. The Modi government has as yet shown no sign that it has broken with this convention.
India is definitely a far more open economy than it was before the economic reforms of 1991. Millions of Indians have benefitted from its integration with the global economy, though that has increased the income gap between those who could take advantage of globalization and those who could not. India and China should be important voices in the protection of the liberal international order—both through a more active role in global institutions and through domestic reform that advances the cause of global economic integration.
Should India and China stand up for globalization when its advocates are dwindling across the developed world? Tell us at firstname.lastname@example.org