Illustration: Jayachandran/Mint
Illustration: Jayachandran/Mint

What India must do to be a free trade champion

It has spoken up in favour of a liberal trade regime, but its exports sector needs a structural transformation to take advantage of one

The tariffs and counter-tariffs levied by the US and its allies and rivals alike are mounting. Global trade growth surged last year and continues to do so. From a post-crisis average of 3%, it hit 4.7% last year and is expected to achieve 4.4% in 2019. But that, the World Trade Organization has warned, is contingent on escalating trade tensions not acting as a spoiler. New Delhi is ostensibly playing on the side of the angels. It has spoken repeatedly about the benefits of a liberal trade regime at international forums in the recent past. But as its Regional Comprehensive Economic Partnership (RCEP) dilemma shows, rhetoric and reality don’t always match up. The question is: Is India positioned well enough to benefit from lowered trade barriers and tariffs?

As of 2016-17, India’s share of world merchandise exports stood at 1.65% while its share of world service exports was twice that at 3.35%. But the political sensitivity of the factors affecting services trade—cross-border movement of professionals and the behind-the-border nature of regulation among them—makes it difficult to make headway. This has been the case at the RCEP where India’s efforts to fold services trade liberalization into the pact have come a cropper. Goods trade, on the other hand, is an area of relative consensus. However, recent warnings from several quarters about the possible negative consequences for India of the RCEP—and in some instances, bilateral free trade agreements (FTAs)—are not without merit.

Indian goods exports are currently dominated by petroleum products, chemical products, textiles and garments, and engineering goods. This is a problem. In a seminal 2007 paper (What You Export Matters, Journal Of Economic Growth) Ricardo Hausmann, Jason Hwang and Dani Rodrik argued that quality matters more than quantity. Exports with higher productivity and sophistication will contribute more to economic growth. This connects with another phenomenon. As countries change and diversify their export baskets, they naturally tend to go in for goods that are relatively closely related to goods they are already producing. But all such goods clusters are not equal. Countries that focus on denser clusters have an easier time developing a comparative advantage in those products when it comes to international trade. Unsurprisingly, denser clusters occur more frequently around more sophisticated goods.

In the nearly three decades since liberalization, India’s goods exports have moved up the value chain. That said, the basket continues to be dominated by goods of relatively low sophistication. In a 2015 International Monetary Fund working paper (Make In India: Which Exports Can Drive The Next Wave Of Growth?), Rahul Anand, Kalpana Kochhar and Saurabh Mishra have calculated that India’s goods export basket skews substantially more towards low-tech manufacturing than the median of peer emerging economies. This hamstrings India on two fronts. It limits the domestic productivity and income-boosting effects of exports and it makes it harder for India to gain the comparative advantage needed to take full advantage of bilateral and regional free trade pacts.

Little wonder India’s trade deficit with the Association of Southeast Asian Nations, Japan and Korea—it signed FTAs with them in 2010 and 2011—grew from $15 billion in FY11 to $24 billion in FY17. The current poor performance of Indian exports undoubtedly has something to do with the demonetization shock, the goods and services tax (GST) snafu when it comes to refund payments for exporters and the twin balance sheet problem. But the long-run problems go deeper. A depreciating rupee may help to an extent, but it is no panacea. Indian exports are more sensitive to demand than price. That leaves the third factor that drives India’s exports—domestic supply-side constraints.

These are not new. The Economic Survey 2017-18 had pointed out that “Improved logistics have huge implications on increasing exports, as a 10% decrease in indirect logistics cost can contribute to around 5-8% of extra exports." India has logistics costs around double of those in developed economies. Power shortages and poor reliability also affect export growth significantly. India’s continuing discom woes—not to mention the need for a workable long-term balance between renewable energy and thermal power—are crucial here. Then there are the multiple factors, ranging from onerous labour laws to regulatory costs, that keep companies small. Such companies have neither the capital and scale to move to more sophisticated goods, nor the worker skills to be part of such value chains. Poor innovation capital—there is a buffet of reasons, from the lack of quality higher education to low public and private expenditure on research and development and a lacking legislative framework—doesn’t help.

Free trade, for all the distributional issues that have rightly come into sharp focus over the past few years, is a net good. New Delhi is right to champion it. But its RCEP dilemma shows the gap between theory and practice. That gap won’t be bridged without a structural transformation in Indian exports.

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