Dec 21, 2015

What WTO can learn from COP

Negotiation technique matters especially when consensus is the key. COP came up with a solid document at the end of recently completed summit at Paris. WTO came up with a limp document at the recently concluded Nairobi meet.
Both summits mandated consensus approach. WTO ministers at Nairobi quibbled over things, the country reps met in suspicious groupings, and tried to outsmart each other.  On the other hand, COP summit had groups engaging in fruitful discussions and finally came up with decently good promises from each participating members. COP might have fallen short in the eyes of some climate pundits, but it was satisfactory to all the participants. WTO outcome was one more inconclusive document, reiterating nonsense, and was yet not satisfactory to many, including India, for various reasons. 
COP used negotiation method of 'Indaba' used by native African tribes like Zulu and Xhosa. More about how this method apparently helped here
WTO is fast moving towards irrelevance. Time to think of better negotiation techniques? 

Oct 24, 2015

Global Value Chains and India: Policy perspectives and challenges

(This post originally appeared in the World Trade Centre Bangalore newsletter)

The engraving on the back of my phone reads: 'Designed in California; Assembled in China'. It skips the in betweens, as to where the components and sub-assemblies came from. If they indeed decide to do the full list, it might fill the entire back case. On an iPhone, which is designed by Apple in California, the component sourcing will take us through ASEAN, Japan and many other countries. Some of the software and technology that goes into it might again come from US, Germany and other countries. Though the iPhone is finally assembled in China, the value addition by Chinese is less than 10% for each phone shipped out of that country. The value addition is different for other brands of smartphones, depending on sourcing patterns. This is an example of Global Value Chain (GVC) at work, smartphone GVC in this case. GVCs have changed the way one thinks about international trade and related policy making. 

Industrial clusters plugs into GVCs. China has shown in last three decades that clustering of similar industries lead to synergies resulting in faster development of the entire sector. The resulting whole is bigger than the sum of its parts. China has spent considerable efforts in developing such clusters by way of SEZs and otherwise. Apart from conscious sectoral push by the Governments, clustering also results when a big firm decides to pitch base at one place, bringing all its suppliers and vendors along to tent nearby. Imagine a Toyota coming into the outskirts of Bangalore and getting most of its primary vendors into Bangalore and nearby areas. Or in coming future, one might imagine a Foxconn trying to set up manufacturing base in India, bringing along its main suppliers. Clustering might also happen spontaneously, like in Silicon Valley, where precipitating conditions required for such development exist. Industrial clustering as a policy tool needs careful thinking again. Our SEZ policy shows how this shouldn’t be done. 

Containerisation and globalisation has hastened the process of evolution of GVCs in the last two decades. GVCs have contributed significantly to the development of ASEAN region and China. Countries that integrate themselves to the GVCs get upgraded in terms of technology, as they have to comply with the best international practices in production and quality maintenance. When GVCs encompass industrial clusters, which usually happens for products in late growth and mature stages of product lifecycle, it leads to economies of scale which cannot be easily replicated. The mass manufactured electronic components coming out of such arrangements get sold at price points that wipes out competition relying on alternative strategies. The clustering also leads to faster adoption of process innovations and best practices as the human resource, which is mobile between clustered firms, acts as idea pollinator. 

In short, there is no disputing the importance of GVCs and industrial clusters specialising in  sectors of manufacturing in the globalised economy. An unplugged country stands to lose heavily and risks being left behind. There are hardly any products, except commodities and low value added agriculture products, that are not produced in value chains spread across countries. From aeroplanes and mobiles to the clothes and shoes we wear and the pills we pop, almost everything comes out of such value chains. 

An analysis of India’s Foreign Value Added share in Gross exports over years shows that India is being drawn, willy-nilly, into integrating into the these value chains. This development was also acknowledged in the latest Economic Survey. 

A sectoral analysis of trade in intermediates show that the GVC integration spreads across sectors, except agriculture, mining and metals, where the trade in intermediates is not as significant as in some other sectors. Services integration, appears low at present based on this approach of data collection, is going to grow with time as better policy arrangements are put in place internationally through region trade agreements and multilateral arrangements. The trend in services integration is positive for India. 

The data points that we are ‘almost’ there when it comes to integrating with the GVCs of the world. However, it also reveals the challenges. Most of our achievements came during easy times, before 2009, and the progress thereafter has been lacklustre. 

Today, we are in a tricky situation. For the past few decades, upto the financial crisis, international trade grew at a rate of around 7% a year, which was almost double the rate of growth of world GDP. Post financial crisis, the trade growth has remained sluggish, and for the last couple of years it has grown at around 3 percent, lesser than the pace of world GDP growth. In terms of trade to GDP share too, the world trade rose from around 40% of world GDP in the early 90s to peak at around 61% in 2011. It has now fallen to around 60%. A rise in 1 percent in global income would have lead to around 2.2 percent of increase in world trade in the 90s, but it lead to a growth of just 1.3 percent in the 2000s. This has fallen further after the financial crisis. This had lead to the theory that the world trade has ‘peaked’.

While economists like Paul Krugman deny the peaking theory, there is a significant risk arising out of slowing trade. One of the theories advanced by IMF ( regarding underlying causes for the above pertain to saturation of Global Value Chains. There is good evidence that the phenomenon of fragmentation of manufacturing process that enabled development of GVCs has matured during early 2000s. Further discretisation of manufacturing stages might not happen at the earlier pace. 

This would mean that we might be entering a stage where we will have countries trying to capture more share of different GVCs, across sectors, at the cost of others. Also, countries would try to move up the value chain by trying to capture more stages to themselves. To cite an example, Chinese imports of intermediates has fallen from 60% to 35% in last 15 years. The commensurate increase seen in domestic value added percentage in China’s exports vindicates the theory. We also see indigenous Chinese smartphone manufacturers such as Xiaomi sprouting up who operate at the top of the pecking order in the value chain. 

This development puts industries involved in GVCs from India in a peculiar position. Given the fact that the exports from India has stayed stagnant for last few years, the issue is serious not only for the industry or firms, but also for the economy. The solution lies in some innovative and radical departure from earlier way of thinking for both industries and policymakers. 

Industries participating in GVCs face challenges that are different from purely domestic firms that cater to local market. A tariff wall that helps a purely domestic firm from competition abroad, might act as a barrier for a firm trying to participate in GVC. Also, a small duty at the border might amplify adversely if the good shuttles multiple times at different stages of production. Therefore, the line of thinking that we need to protect our industries by erecting tariff barriers is dangerous for sectors in which there is potential to participate in GVCs. While I don’t suggest that  we jump to near zero tariffs from tomorrow, a careful cost-benefit analysis is needed and undue fears of killing domestic industries need to assessed realistically. The negative approach taken by India at the recently concluded ITA-II agreement at WTO, where we declined to agree for tariff reductions in electronic hardware items, needs a serious rethink.

At the second stage, India needs to engage in developing cohesive regulatory regime, with uniform technical and quality standards built into its regional trade agreements. We should focus on developing and engaging in regional value chains that complement GVCs. While a lot of discussion happens on tariff lines and relative comparative advantages, the points on not so easily quantifiable non-tariff barriers get a short change. A poorly drafted quality standard, which acts as a technical barrier and adds to the costs at the border, might throw a domestic firm out of the GVC. A poor IP law would keep high technology products away from the country for the fear of getting copied.

Thirdly, any initiative that eases transaction time and cost at the border, and within, would provide significant advantage. The firms in the GVCs need to maintain just-in-time delivery schedules and border harassment, whether by customs or myriad inspection and licensing agencies, is suicidal. While infrastructure improvements such as power, roads and ports is a medium to long term issue, one can start focusing on cutting down on documentation and trade facilitation at the border as an immediate measure. India’s stand to go ahead with Trade Facilitation Agreement at WTO is significant if implement in true spirit. 

The recent initiative of make-in-India, when dovetailed with National Investment and Manufacturing Zones, can lead to significant clustering effect. This needs good investment climate to succeed, and the Govt. appears to be making serious efforts in this regard.
Similarly, Skill India might play an important role too. The trained human resource is a pre-requisite for moving up the value chains or to capture more parts of it. Demographic dividend and the energy of young population of India needs to be harvested through such measures. Availability of trained human resource is a factor that cannot be easily replicated or transferred across borders.

Finally, any amount of unilateral policy efforts by the Government would not suffice if industry plays sleeping partner. Being the primary stakeholders in a punishing market economy, industries need to work with the Government, by providing timely inputs regarding developments in the sector and by covering emerging issues. While the policy might act with a lag, or the policymakers might be oblivious to the latest, the industry cannot afford to nap on developments.

To sum up, while it might be a fact that GVCs have matured and trade might have peaked or saddling, there still is ample scope for moving up the product value chains and to capture more bits of it by careful strategising. A significant country like India, apart from depending on domestic consumption demand, should also focus on this aspect. While it might not be an export led growth story all over again, it might be a case study on value chain domination through better policymaking. A side effect would of course be better export performance. 

Oct 10, 2015

How TPP affects India's exports - or doesn't

Trans-Pacific Partnership (TPP) was finalised recently between the 12 pacific rim countries. 

Donald Trump hates it and calls the deal terrible. Paul Krugman doesn't like it very much and calls himself a 'lukewarm opponent' of the deal. These two exist at either ends on the scale of knowledge of international economics. And both oppose the deal. Hillary Clinton falls somewhere in between, she opposes too. Everyone, except Obama and the trade ministers who agreed for the deal seem to be opposing. Even the so called industrial lobbies, pharma, tobacco and such, who hoped to get a secret sweet deal for themselves, are opposing. I am yet to see a trade-deal that was opposed by so many and is still going ahead. Funnily enough, I see that some in India are rueing that they are left out. Probably that explains as to why Indian trade minister insists that "we are not left out". One wonders how. 

TPP is not another ordinary deal. It tries to push the envelop on regulatory coherence, pushes boundaries of intellectual property regime and secretly aims to hand over the monopoly to industrial giants in fields such as pharma, tobacco, auto and other sectors. While couched in regular terms of economic development, free trade and such, it is a strong push by industrial lobbies to get their way in a globalised world. The lobbies have the heaviest footprint on the deal, probably stronger than any individual country, including US. US Congress had reservations about the secrecy surrounding negotiations and the clauses that made the deal to be kept secret even after ratification for few years. 

Prima-facie, despite all misgivings, I feel the recently concluded deal is not as monstrous as some make it out to be. The details are yet to be revealed fully, but the draconian IP and regulatory requirements do not seem to be as bad as one earlier thought. Probably that explains why industries are protesting. 

For a country like India, we are not yet at the level to engage into agreements like TPP. Our bureaucrats are at the infancy of understanding of complex trade deals in economic terms. We are still a tariff heavy developing nation. Our institutions on IP and regulatory matters are still developing. Our red tape beats any non-tariff barrier one might imagine. And our farmers, though supported, are not subsidised to the level of US or some European countries. Our Pharma sector is doing well, and we have our own way of working on Pharma IP requirements; which by the way, has helped many LDCs. At this stage, for India to even consider joining a deal like TPP is not wise. 

In coming days, the deal needs to be ratified in country after country, and as the details spill out, it might hold lessons for many of us who are observing from the side. Till then, it would be meaningless to predict whether TPP affects India's exports or not

Sep 4, 2015

The case for a weaker rupee

I believe there is a good case for a weaker Rupee. It is not about just following the fashion. China has devalued its currency recently, and before that Japan had done so, and there were doubts that Euro's quantitive easing was a proxy for weakening Euro. The method adopted to devalue the currencies might be different; direct intervention, bond buying or quantitive easing, but the end effect is a weak currency. India needs to evaluate the options now. 

India's merchandise trade deficit has hovered constant around 180 billion dollars for around four years now. The gap is filled partly by earnings from services sector and partly through the foreign inflows. A bare reading of only current account deficit indicates that we have room for a devalued currency. If we are targeting to have better export performance, we need to go with a weaker Rupee. There might be a lag, but it should work, given international experience.

Krugman has written an article in NYT here. He talks about what can be learnt from Dollars of different nations. When talking about currency depreciation, he has this to offer:

...we learn that what right-wingers call currency “debasement” — a decline in a currency’s value in terms of other currencies — can be a very good thing. Canada was able to combine spending cuts with strong growth in the 1990s because exports were raised by the depreciation of the loonie. Australia rode through the Asian financial crisis of 1997-98 with little damage thanks largely to a falling Aussie...

That should give us a strong cue to consider Rupee depreciation. And as Krugman rightly mentions, the right-wingers somehow attach their ego to the currency value. When Rupee depreciates, there are howls of protest. There is nothing sacrosanct about the value of the currency. If Rupee is 70 or 75 to a  dollar, it's just a number that we need to get used to. The effect of the value is something that we need to focus upon. And given that international experience has traditionally proven that a weaker currency is good for exports, that should seal the case. 

The issue regarding competitive devaluation, that is, what if everyone around does so, given that the entire world is not pegged to any standard value (say Gold), is moot. Such competitive behaviour might doom the entire world. However, that doesn't justify not moving first. 

Aug 1, 2015

ITA-II agreement at WTO and India: Some points

The Information Technology Agreement - II (ITA-II) is now tentatively finalised at WTO. India has decided to stay away, blaming the earlier version ITA-I for the sorry state of IT related hardware manufacturing in India today, and believing that India needs to retain duties on IT products in order to bring the Indian IT manufacturing industry to speed. This agreement is mainly a tariff reduction agreement that would bring the import duties on agreed products to zero thus (probably) helping trade. 

ITA-I was finalised in 1997, around 18 years ago and included products that are no longer in practical existence, and excluded products that have since been invented. Also, due to faster product life cycles of IT hardware the rate of obsolescence is high. A revision was necessary to that extent. 

There were differences over items in the list, as expected, and the negotiators were able to navigate around to reach consensus among interested parties. 51 countries that agreed to go ahead with ITA-II cover more than 90% of the total IT products manufactured and traded. The countries in the list, especially China, Japan, South Korea and Taiwan strived hard to protect some products they believed their domestic industry needed tariff support. The recent bilateral agreement between China and US on IT products helped in hastening ITA-II. 

There were some news items in the inside pages about this deal in India. There was no notable debate on the subject here. One reason might be that the impact of this deal appears limited to one sector, and that too not a particularly sensitive sector like agriculture. However, as India is looking to become a manufacturing hub, this sector cannot be ignored. Also, given that electronic hardware imports will surpass oil imports in coming decade, this sector will gain importance. The stand that ITA-I has harmed our IT manufacturing sector was accepted as wisdom, without anyone substantiating as to how exactly ITA-I damaged our industry.  That premise, or wisdom, needs to be questioned. 

Let me take a simple case. Suppose a high tariff on Cisco IP-phones, which the IT services sector uses commonly in voice conferencing, is essential to protect our infant domestic industry that makes digital phones. How do you justify the cost and does it really help to place such products behind tariff walls? 
Logically, the benefit of high import duties on Cisco phones should go to domestic equipment manufacturers, local firms that make similar equipment. There are currently very few suppliers of such phones in the world who can compete with Cisco. The technology might be easy for a local firm to duplicate, but the economies of scale (the product is mainly manufactured in China), the proprietary communication protocol it uses, and the established network support of Cisco will keep it ahead. In short, the entry barrier is steep. So a domestic firm replacing Cisco is ruled out in near term.  Therefore, a tariff barrier in India would directly add to the cost of IT services knowing that the demand for Cisco IP phones is almost inelastic.
That leaves us with the other possibility. Cisco might consider manufacturing in India to avoid high import duties and make the product cheap for Indian customers. This possibility arises if India becomes a significant market, that provides manufacturing cost advantage, and Cisco senses that it would lose out on another competitor who produces locally. Otherwise, given current monopolistic domination of IP phones by Cisco, it is difficult to imagine Cisco moving into India from China. China currently provides other advantages in terms of good infrastructure including better connectivity. 
Also, there is a significant effect of global value chains on IT hardware manufacturing. I have blogged about this in detail earlier.
Given the above, the cost of imposing import duties on Cisco phones would directly pass on as additional cost on IT/ITES sector. Of course, Govt. would be slightly richer by way of import duty collections. 

Most of the products on the ITA-II list are similar. They are used by IT software sector (LCD screens, processors, printer ink etc), or by IT hardware manufacturers (NC machine tools etc). Of course, there are nonsense consumer items which can be considered simple white goods and not IT hardware. Products such as smart refrigerators, smart air conditioners, LCD televisions are unacceptable in the list. Some were opposed and struck down, such as LCD television, but some still exist. India should have probably bargained to remove such white goods, while not totally walking away.

I mostly agree with India's stand of walking away. This has given India the flexibility to take a call on each product independently. If India wishes, she may impose or reduce duties on items of interest. However, knowing that we have product lines with inverted duty structures, items where raw material duties are higher than on finished products, the ability of commerce/finance ministries to strategise on such details is moot.
Also, the fact that there was no brouhaha over India not getting into the deal points in the direction that we do not matter at world stage in this area, indicating that probably this is not the right time for India to get into ITA-II. We would be in bad bargaining position.
Nevertheless, we need to work on IT hardware manufacturing, given that we would be moving into increasingly digital age where even the governance would need huge IT hardware. There are some good (M-SIPS) and some half hearted initiatives (DGFT) related to this by various ministries. It's time an umbrella strategy is made and implemented to avoid getting caught in a situation where we continue hiding behind tariff walls, to protect the ever infant industry, and opposing ITA-III, IV or whatever number the world agrees on.

Jun 24, 2015

Export Import Bank debate in the US

Ex-Im Bank of the USA is a federal government backed institution which specialises in trade finance. It is similar in functions to India's Exim bank except that Indian Exim bank doesn't get into trade insurance, which is handled by another body called Export Credit Guarantee corporation of India. In fact, India's Exim bank copies most of the functions of US Ex-Im bank given that US institution predates Indian one by more than five decades. 

US Ex-Im bank is under threat of being de-authorized, unless the US congress re-authorizes it shortly. 

The bank's critics, mainly the republicans, bank on the argument that such subsidising banks lead to market distortion and help private sector players, and therefore, they are a form of corporate welfare scheme. They choose the winners in the private sector by choosing whom to help by providing easy access to credit for international trade. It is nothing but crony capitalism in another form, subsidising the rich. 
The bank's supporters argue that closing down Ex-Im bank would put American manufacturers at a disadvantage in the global market as there are competing banks being run by other countries, notably China, which support the domestic manufacturers to capture global market. This would lead to job losses, and loss of access to global market. 

Most of Indian Exim bank's trade finance is directed in such a way that the buyer in the global market uses it to procure Indian goods. Such finance is directed through lines of credit mechanism, project finance, long term overseas investment finance etc. The Exim banks across the world usually step in to fill a void that is not filled by the conventional banking and regular trade finance. And most of the Exim banks are sponsored by the governments. China is currently the biggest user of Exim bank mechanism for international trade finance.  

It is interesting to note that the US is even debating on the existence of such an important institution. Such important institutions should not be given expiring charter, like what the US has done. It should be enacted by an act of parliament, like what India has done. Exam banks do not just give packing credit or trade insurance, they are the source of stability for long term international trade finance, and are extension of trade and commercial diplomacy. Losing Ex-Im bank for the US might have long term implications which might not be easily quantifiable today in terms of loss of jobs or dollars earned. 

Jun 21, 2015

The frigidity of Indian Exports

The trade figures for May 2015 are here. The trade decreased, both in terms of exports and imports.   Exports were down by around 20% this month over last year, and imports were down by around 16%.  We exported around 22 Billion USD of merchandise in May and imported around 32 Billion USD worth of goods. At this rate, we would be lucky to touch the figure of USD 300 Billion of exports by the end of year.  On services front, the net services earning stood at around 5.6 Billion USD. A new foreign trade policy was released last month, with a stated aim of doubling the exports in next five years.

The last sentence of the above paragraph is in contrast to all other sentences. Therein lies the problem in making policies that target the outcomes that rely on multiple underlying factors. We can't just double exports without addressing the fundamentals that lead to better export performance. 

Now, there are reasons as to why the figures are not encouraging. Oil prices are low. This leads to lower numbers on both imports (crude) and exports (refined petroleum products) as oil is currently the single largest contributor to merchandise trade. Global demand continues to be low, which is another major factor, dragging down the demand for all products in general. Merchandise trade growth as we know it, has peaked, about which I have elaborated in another post here, and that leaves very little elbow for India's trade to wedge in. India continues to suffer from whatever disadvantages it suffered in the area of international trade for long time and not much has really changed on the ground. 

Apart from better global growth and thus better demand, which itself is a distant possibility, there is hardly much that can be done in the short term. A devalued rupee in itself doesn't assure better exports, and even if it helps, it has its own lag effect. 

All is not that bad if we look at our general economy. Though the trade figures are low, our current account deficit, as a percentage of GDP, is under control. Rupee is not volatile. Inflation is subdued, helped by low oil prices. Government expenditure is not worrisome. Monetary sector looks fine, if we overlook the bad debts of banks. What's not so good is the real sector, from which we can derive the exports. Though the Index of Industrial Production data is showing the so called green shoots of growth recently, it is still far from satisfactory. Overall, the macroeconomy is stable, but weak. 

Given the above, if one wants to increase exports, there has to be some kind of built in incentive. The best incentive is the price difference based on market economy, and that is a function of global demand, which is not stirring.

Govt of India has tried various export promotion measures, about which I will elaborate in some other post, but most of them have failed to stir exports. What one must now realise is this. Do whatever, the export performance in the end is a strong function of global demand. Policymakers must realise that there are two, and only two areas where they can intervene to improve exports. 

a) By providing better infrastructure. Infrastructure includes not just roads, ports, and physical infrastructure but also effective regulatory regime, policy stability, governance,  ease of doing business and all other aspects that good governance can provide. 
b) By imparting training and awareness, including support, about international trade. 

The first one, better infrastructure, is a time taking affair. And there is hardly much that can be done in an isolated way. It is a systemic issue and can be tackled only by the whole-of-government approach. 
The second one can be ramped up faster. The various export promotion councils, there were 38 of them last time I counted, have morphed into glamorised beggars, and should be ideally put to task for the second point. Apart from one or two councils, they have hardly proved themselves useful. The DGFT, which makes foreign trade policy, should be a lean organisation and the field offices of DGFT should be the nodes that liaison with state governments and various agencies towards export promotion activities. Unfortunately, DGFT field offices have reduced to implementer of various tax nullification schemes, which can ideally be done by customs. 

Lastly, one must realise that there is nothing called increasing exports by taking measures. An increasing exports is a result of robust manufacturing and services sector that is producing more than the country can consume, and is able to produce goods and services that the world demands. If our exports are frigid, there is a good reason somewhere above. 

Jun 6, 2015

The ITA II at WTO and India's stand

Way back in 2012, I had written about how India is wrong in opposing ITA 2 agreement at WTO blindly. You can find it here.

ITA 2 is the Information Technology agreement - Version 2, that is currently being negotiated at WTO. The agreement is solely a tariff cutting mechanism in the trade of IT hardware products. India was a signatory to the first version, and rightly or wrongly blames it for the poor state of electronic hardware manufacturing industry in India today. India has strongly opposed any expansion of product coverage under the deal. You may read the news reports here and here. The premise is, if we cut the import duties on electronic goods, our domestic electronic manufacturing would suffer as it would then be easier to import than to produce locally.

In the light of time that has elapsed since the last post,  I thought I should revisit the issue.

Meanwhile, Krugman has opposed USA's trade deals, the transpacific and transatlantic deals that are under discussion. He says that these deals appear more to be oriented towards big pharma and Hollywood's needs, in terms of IPR strengthening, than anything arising through the deal in terms of Ricardian gains arising out of increase in trade volume due to respective comparative advantages in different products by decreasing tariff barriers. Because the tariffs are already at the floor and there is hardly much that remains in  terms of tariff negotiations among these nations. 

The views of our policymakers, in terms of opposing the ITA2 deal at WTO, matches Krugman's latest view of cautious opposition about regional agreements. However, the similarities stop at that. Our opposition stems from the insecurity arising out of lack of knowledge about what would happen if we agree on tariff reductions, and a blind belief that we need to oppose in order to gain an upper hand at negotiations. While one may understand that lack of knowledge may lead to taking wrong positions, one fails to appreciate opposing the deal for the sake of opposing. It is naive to support tariff barriers in IT hardware sector for two reasons.

One, the current IT hardware products are manufactured in value chains spread across nations. An iPhone might have its R&D centre at California, but it is manufactured across multiple east asian countries including China. The parts shuttle across boundaries, without hitting tariff walls, until the iPhone is finally assembled at China and is shipped out. Any country that places an additional cost in terms of tariff walls on the free movement of parts risks being excluded from the chain. If India chooses to keep the barriers, it chooses to continue in the silo that it has built for itself. There is hardly any mentionable IT hardware manufacturing in India today. We blame it on ITA1, whereas the truth lies elsewhere.

Two, we have IT software and services sector, that is doing well, and which has a complementarity  with cheap availability of IT hardware. A reduction in import cost of IT hardware directly adds to the bottomline of this sector.

One must also add that the infant industry argument, when it comes to IT hardware manufacturing sector, doesn't hold good. In this sector, an isolated infant industry, protected by tariff walls, cannot survive in this century. One might suggest a myopic approach of using special economic zones to achieve global integration, but if a policy sounds so good for a zone, it cannot be so wrong for a nation. The right way to go about it is to give right incentives to invest in IT hardware manufacturing in India. The recent efforts by the IT ministry is laudable in the regard. We need to integrate with the global value chains if we are to build economies of scale.

Finally, our officials must acknowledge that the era of tariffs is passe. Countries using such regressive  measures face serious threat of being left out from all regional groupings. If one wants to erect walls, it has to be regulatory in nature, through intelligent non tariff barriers such as quality and technical requirements, IP laws and so on. The game has changed.

Lest I be misunderstood as an 'yay-free-trade' champion, I must put the disclaimer that I am talking specifically about IT hardware manufacturing sector here, with regard to ITA2 agreement at WTO. There are areas such as agriculture, where we still need some direct tariff barriers and such general 'yay-free-trade' approach might not be right.

Mar 20, 2015

RCEP and India - Are we missing something?

Regional Comprehensive Economic Partnership (RCEP) is a Free Trade Agreement between ASEAN countries plus three (China, Japan, South Korea) and three more (India, Australia, New Zealand). The contours of this FTA is under discussion and negotiations are on. More at wikilink

India is already into trade agreements with most of the participating countries in RCEP. The traditional discourse in the media focuses on how our 'Look East Policy' needs this FTA. Also, RCEP is supposed to work as a common framework which will remove some of the confusion that arises out of multiple FTAs in this region with India, each having its own scope, its own rules of origins and such. In addition, we are not part of the other two big trade negotiations, viz., the trans-atlantic and trans-pacific agreements, currently underway. 

There are some points that I thought the greater debate in Indian media (if ever there was one on such topics) is missing, and which can be discussed in a post like this. 

China, the biggest partner at RCEP, is a country where the wages have shot up. The wages have risen by around 12% per annum since 2001. This has created challenges in sustaining low cost manufacturing model of China. Of course, Chinese productivity too has soared in tandem, but that's no solace to industries that are labor intensive, such as garments, shoes, assembly lines of electronic goods and so on; basically those functions that cannot be easily automated. Some firms have moved interiors, away from coast, in search of lower wages and some have fanned out, into ASEAN. The so called 'Factory Asia' concept, that encompasses complex web of FTAs between China, Japan and ASEAN and covers major portion of world value chain, is deepening. The wage differential is significant between countries like Vietnam, Indonesia, Philippines and China. For example, the wages in Vietnam is around one fourth of that in China. Naturally, labour intensive Chinese firms are relocating to these countries. India is not a beneficiary. We are not yet locked into the production value chains to the extent that we should have been. We need to understand the reasons for this. 

Factory Asia concept succeeded because these countries have low tariff duties between themselves, thanks to the multiple FTAs between them. Also, these countries are geographically closer, and use proximate and efficient ports such as Hong Kong, Singapore, Busan, Shanghai etc. In addition, the management can easily move across locations due to geographical proximity, leading to closer control and higher confidence about the quality. Another factor that is strengthening Factory Asia is the increase in purchasing power of China, and a conscious move towards consumption led growth model in China, which has gathered pace. The production of goods closer home cuts down the transportation cost and time. In short, a low tariff barrier (through SEZs and FTAs), combined with proximity and efficient infrastructure has done the trick. With the fall in transportation costs due to containerization, the geographical proximity is the one that matters least.

India, unfortunately is geographically away from this hub (relatively speaking) and suffers from inefficient port infrastructure, adding to time delays, thus further alienating us away from Factory Asia. Of course, the sectors in which we still manage to thrive, such as Garments and Leather, Gem and Jewellery, etc, are the ones in which transportation costs are low and not much discretization is needed in terms of stages of manufacturing. Contrast this with electronic gadgets where such discretization is prevalent, and India vanishes off the map. 

Now coming to our approach towards FTAs, we have seen that India tries to ensure that our domestics are protected behind tariff walls, while we try to penetrate others' market. That approach, alas, has flopped. Most of the FTAs India has signed show abysmally low usage and effect. There has hardly been any impact of these FTAs on India's trade growth. We might as well write them off as useless. At least, if the FTAs had integrated us to the value chains it would have yet made some sense, but even on that count positive data is elusive.

Now, coming to RCEP, we are again looking at the same approach (from what I could make out from the discussions around, correct me if I am wrong). We would go with our conservative positive list, try to ensure we concede minimum, while maximizing our gains at RCEP. Frankly, this is the exact approach that would kill RCEP.

The actual trade in the successful Factory Asia model happens between duty free zones; components shuttle from one SEZ to another in China and neighbors till the final product is made and shipped. Anything hidden behind tariff wall is simply a no-no into the production chain, as it would add to costs and time delays in clearances and documentation. It is indeed sad that Indian policymakers are thinking in terms of tariff lines and protectionist measures. We have nothing to show that this approach works. We are not part of major value chains, nor are we growing significantly in terms of world share in goods production. Our approach in the WTO last year, where we blocked the trade facilitation agreement, reeked of this conservative mentality. We are yet again following the same approach, at the behest of some vested interests who want the tariff walls to remain forever They might be vociferous, but they have dim understanding of policy-making and economics. Such elements are best ignored as long as they don't come up with hard data to support their stand.

In addition, one has to understand that the world has moved beyond the stage of cheap wage model. The Chinafication is complete and has stabilized around the south China seas. If we indeed want to be a part of the goods producers network, like our slogan make-in-India declares, we need to start seriously looking at ways to integrate ourselves into the production chains. We are located where we are and can't change that. If major shipping lines do not pass through our ports, it has more to do with our bad port infrastructure than our location. It is sad that Colombo is preferred transshipment destination over Chennai due to congestion issues. A high tariff barrier, and time consuming documentation only adds to the woes. We can sit here with cheap and low productive labour forever and wait for Chinese wages to go up, or look at what has gone wrong in our model and reboot it. To start, let us acknowledge that we need RCEP more than RCEP needs us.

PS: I have ignored the services sector in this post, to be covered separately in another post.