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In recent months, India has embarked on a signing spree and operationalized free trade agreements (FTAs) with the UAE and Australia. An FTA with the UK is in advanced stages of negotiation. While these pacts have been advertised as a manna from heaven for India’s beleaguered exporters, a recent report by Global Trade Research Initiative has muddied the waters about their effectiveness in promoting domestic manufacturing and export growth. As India appears keen to embrace FTAs aggressively, an assessment of the role they play and their strategic use holds valuable lessons.

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Empirically, as many researchers have pointed out (‘A Preferential Route: Effectiveness of FTAs in Indian Exports’ by Amit Kapoor and Akshay Bhambri), India’s experience with FTAs to promote exports has been dismal. India’s most significant trade pact, with the Association of Southeast Asian Nations (Asean), signed in 2010, has still not led to the expected export growth to these countries, while imports from them have risen, leading to a widened trade gap.

The experience of other Asian export powerhouses also shows that the role of FTAs has been limited, at best, in their path to export dominance. Japan signed its first FTA only in 2002, and that too with the city state of Singapore, not a major global economy. South Korea too signed its first FTA in 2007 with the US, much after it had asserted itself in global trade with massive export surpluses.

China too enjoys massive export surpluses with the US and EU, despite the fact that it does not have a trade agreement with either. China, however, has been more strategic in employing FTAs. After joining the World Trade Organization, the first bilateral FTA that it signed was with Asean in November 2002 and fully enforced it in 2010. Since then, China’s trade with Asean has grown more than 10 times, with China enjoying a modest trade surplus. Its strategy has been to use FTAs to get tariff-free entry for its manufactured goods to other countries in return for granting its trade partners access to its agricultural, raw material and commodity markets. This ensures that China captures a larger part of the value addition by importing raw materials but exporting finished goods. According to Masahiro Kawai and Ganeshan Wignaraja (‘Asia’s Free Trade Agreements: How is Business Responding’), this is backed by state support and China has the largest proportion of firms getting state help to exploit FTAs among all Asian countries in their sample.

In recent times, the most innovative exploitation of FTAs has been displayed by Vietnam. It joined Asean in 1996 and has since used FTAs to play larger rivals against each other and get access to target markets. Besides participating in FTAs as part of Asean, Vietnam has bilateral trade agreements with the US, Europe, Japan, South Korea and Russia, and is also part of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which includes Australia, Canada, Mexico and potentially the UK in the near future. The shrewdness with which Vietnamese negotiators have structured this ‘noodle bowl’ of FTAs, to borrow a term from Jagdish Bhagwati, has ensured that it is the only country in the world to have FTAs with its principal export markets (US, EU, Japan and Australia) as well as with its principal competitors and suppliers (Asean countries and China).

In a superbly researched paper, Sophie Deprez (‘The Strategic Vision Behind Vietnam’s International Trade Integration’) argues that through a meticulous network of trade agreements, Vietnam seeks to acquire a comparative advantage over its peers. Unlike most exporting countries which have historically relied on a “trade diversion" strategy (i.e., acquiring trade flows through lower labour costs), Vietnam seeks to implement a “trade creation" strategy. A key risk for low-wage countries like Vietnam (and India) is that they become destinations for low value-added products, which are then shipped off to high-skill countries for finishing. Thus, these countries are unable to capture a large chunk of the value addition and get stuck in a middle-income trap.

Vietnam seeks to mitigate this risk through strategic FTAs that allow it to follow a “trade creation" strategy. With FTAs and low/no tariffs both with its peers and main export markets, Vietnam seeks to become a manufacturing destination for exporting companies that set up base in Vietnam and export finished goods to developed markets as well as other Asean countries, thereby allowing it to capture a greater share of the value addition. Vietnam seeks to use its network of FTAs to create more trade flows for itself and position itself at the end of the global production and value chain and not become merely a source of cheap labour for global manufacturers. While Vietnam has a long way to travel before it becomes a global export behemoth, this strategy seems to be paying off handsomely for now.

The lesson for Indian policymakers is that, while individual FTAs have a limited effect on export competitiveness (as in our case), a strategic ‘noodle bowl’ of FTAs could enable a country to create trade flows and climb higher on the value chain. The focus of FTAs should be on creating these network effects, and not on item or country-wise tariffs or a specified comparative advantage.

Diva Jain is a director at Arrjavv and a ‘probabilist’ who writes on behavioural finance and economics. Her Twitter handle is @DivaJain2.

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