In walking away from the Regional Comprehensive Economic Partnership agreement (RCEP) in Bangkok earlier this month, India signalled to the world that it could not compete in a free trade arrangement with the other 15 member countries of RCEP. This has exposed the weak underbelly of the world’s third-largest economy (in terms of purchasing power parity), the fastest-growing major economy, etc.

However, RCEP is a play with many acts, and Bangkok was only the end of act two. There will be other acts to follow. China, the prime mover behind the agreement, has already signalled that India’s concerns would be addressed, as have Australia and other members. Where we go from here remains to be seen. But why did India walk away? Biswajit Dhar (The Hindu, 7 November 2019), Deepak Nayyar (Mint, 8 November 2018) and others have explained why India had little choice but to withdraw at this stage.

First, Indian industry cannot compete with industrial products of most RCEP partners, particularly China, without tariff protection. India’s initial negotiations were for tariff elimination on 80% of imports from the Association of Southeast Asian Nations (Asean) group of countries, and only 42.5% of imports from China, but India was later forced to accept much wider tariff elimination. It was also unable to secure strict rules of origin and other safeguards. So, RCEP, it was feared, would lead to a surge in industrial imports.

Second, low-productivity Indian agriculture—largely based on small and marginal farms—cannot compete with the high-productivity agri-businesses of other countries. But agriculture is the main livelihood for a large share of the Indian workforce. India has thus resisted agricultural liberalization and tariff reductions in all free trade agreements (FTAs). Similarly, India is the world’s largest dairy producer, but is inefficient and its dairy sector needs tariff protection from New Zealand and Australia. All this would have become history by joining RCEP.

A third issue is e-commerce. Conforming to World Trade Organization rules, imports by RCEP countries through e-commerce platforms won’t be subject to any tariffs, implying a much larger opening of domestic markets beyond the tariff cuts. RCEP provisions on cross-border transfer of information and server location would also conflict with the draft national policy on e-commerce and data security. There is a similar conflict in cross-border investment provisions of RCEP and India’s bilateral investment treaties.

For these and other reasons, virtually all stakeholders, including industry, trade unions and farmer organizations, lobbied against joining RCEP. So did all groups across the political spectrum, from the Bharatiya Janata Party and its affiliate Swadeshi Jagran Manch to the Congress party to the Communist Party of India (Marxist). Politically, the Narendra Modi government had little option but to walk away.

Only some of us economists who believe a low-tariff free trade regime can force Indian enterprises to become more competitive have lamented India’s exit. It is seen as part of an ongoing reversal of the liberal trade regime established 25 years ago. Instead of going down, average tariffs in the manufacturing sector have gone up from 11% to around 14% in the last three years and in agriculture, from around 33% to nearly 39%. Quantitative trade restrictions have also come back in various ways. However, it is important to look at the evidence. India’s experience with FTAs has largely been disappointing. While trade has grown, so has India’s trade deficit with most of these countries/groups. It was believed that India had a comparative advantage in services. However, as Amita Batra pointed out (Business Standard, 28 August 2018), India has not gained any more from FTAs in services than in goods. There is little evidence that FTAs have nudged Indian enterprises towards greater competitiveness.

So, where do we go from here? Global value chains (GVCs) have emerged as the dominant channels for international trade, and these GVCs are concentrated within regional FTAs. To grow its exports, India has no choice but to join a regional FTA. In Asia, after Donald Trump walked away from the US-led Trans-Pacific Partnership (TPP), designed to exclude China, the China-led RCEP remains the only game in town. It’s a mega regional FTA, with its members accounting for about 40% of world gross domestic product (in PPP terms), and an even larger share of the world population, and a large share of global trade. All members of the Comprehensive and Progressive Trans-Pacific Partnership—which rose from the ashes of TPP—are also members of RCEP. So, it is still India’s best bet. Whether it can achieve in a few months the better terms it failed to obtain in seven years is doubtful. But India must keep the RCEP option open as long as possible. Meanwhile, India should energetically explore FTAs in places such as Europe, the Americas and Africa.

Membership of FTAs is a necessary but not sufficient condition for rapid export growth. This will require Indian enterprises to strive more energetically for higher productivity. The “miracle economies" of East Asia, Japan, Korea, China, Taiwan, etc., have shown how “hard" states have made this happen through industrial policy. Identify strategic industries important for rapid growth, pick winners in those industries, support them to grow to global scale, and then force them to become competitive or lose state support. There is nothing equitable about this approach, but this is how East Asian countries came to dominate the global economy. Whether India’s “soft" state has the capacity and will to follow this path, or not, will determine whether its economy emerges as a model of successful state-led capitalism or flounders in the morass of crony capitalism.

Sudipto Mundle is a Distinguished Fellow at the National Council of Applied Economic Research

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