Author : Nilanjan Ghosh

Expert Speak Raisina Debates
Published on Nov 06, 2019
RCEP without India

Source Image: Getty Images/Lakshmiprasad S

Finally, a decisive turn to RCEP negotiations comes with India staying away from the mega-trade deal. PM Modi categorically stated in his speech on November 4, 2019, at the RCEP summit in Bangkok, “…The present form of the RCEP Agreement does not fully reflect the basic spirit and the agreed guiding principles of RCEP. It also does not address satisfactorily India's outstanding issues and concerns. In such a situation, it is not possible for India to join RCEP Agreement”. This is a rational move as far as India is concerned! it would not have been wise joining the RCEP given the present state of affairs. That does not mean that India should altogether give up on RCEP, but should think of joining the mega-trade bloc at an appropriate time.

India has already signed a host of free trade agreements (FTAs) and comprehensive economic cooperation agreements (CECAs) which also include investment agreements. Many of these have been with the South-east Asian nations, with whom India’s trade deficit only increased after the agreements came to effect. Even with other RCEP nations with whom India does not have trade agreements, namely, Australia, New Zealand, and China, India faces a massive and growing trade deficit. Of course, the biggest concern in the bloc is still with China with whom the Indian bilateral trade deficits lurk around USD 55-60 billion, and with long-standing strained geo-political relations despite the recent Modi-Xi meet in Tamil Nadu. Therefore, signing a multilateral RTA where China is a member has both economic and political implications! India’s participation in RCEP therefore boils down to the question of whether India and China can have a mutually beneficial relationship through international trade and investment.

On the other hand, cheap imports with widened choices of cheaper products have increased the demand for imported commodities within the Indian economy.  This has negatively affected domestic industry, as seen in the sectors of the edible oil processing, automobiles, electronics, telecom and white goods. Axiomatically speaking, if free trade really leads to cheaper imports of intermediary goods or services, they help in making domestic industry more competitive, and reduce the prices of final goods in export markets. From that perspective, regional economic integration can help barrier-free access of the cheaper exports to the external markets and would have been conducive for “Make-in-India”. However, this might not be the case with RCEP, as there are many other concerns that remain, especially on market access with services.

From a macroeconomic perspective, policymakers involved in Regional Trade Agreements (RTAs) must take cognizance of the potential trade-offs between the key stakeholders of the economy, including consumer benefits and producer surplus or domestic industries. This apparently refutes the existing thinking of pro-RTA groups who propagate the view that “trade is good; more is better”. The Report of the High Level Advisory Group (HLAG) chaired by Surjit S. Bhalla recently placed in public domain has almost taken this position, while being positive about India’s participation in RCEP. Such ultra-trade position is based on the fundamental assumption of “non-satiation” of utility function, as it exists in neoclassical microeconomic theory. This renders inherent reductionism to public policy economics, and definitely does not augur well for international trade in the case of a developing economy like India. Whether it is this report or many others, there is an indelible tendency of trade economists to justify free trade through its positive  impacts on economic growth by adopting Computable General Equilibrium (CGE) or its variant Global Trade Analysis Project (GTAP) models. That is how HLAG and many others have justified India’s participation in RCEP. Their assumed “omnipotence” in CGE and GTAP models is definitely not in sync with the ways things should have been looked at. The impracticality of such models can be deciphered from the “away from reality” assumptions like  (a) technique of representative agents— all households, firms, agriculture, sectors, etc steamrolled into an optimising firm; (b) their behavioural assumption as always optimising, whether it is utility or social surplus, and which, time and again, has been falsified; (c) the “well-behaved” nature of production and utility functions , i.e., satisfying the convexity properties, despite the widespread acknowledgement of non-convexities (that yield multiple equilibria); (d) the rigidity in the frameworks, and (e) assumption of existence of complete knowledge, which is impractical! Further, growth enhancement is not everything! The models fail to provide estimates on the impacts of trade on the product value chain. So far, there has not been a single analysis that provides precise estimates on the impacts on value-chain if India signs RCEP.

On the other hand, there are reasons to believe that regional trade agreements like the RCEP need not always be beneficial from the “Make in India” perspective. While “Make in India” is the flagship project to attract foreign investment, this was never conceived of at the cost of domestic industry. Even after more than quarter of a century of economic reforms, Indian manufacturing are yet to mature to be competitive enough to face the vagaries of competition brought about by international trade. This situation prevails also because of a host of unimplemented reforms in the product and the factor of markets. While the introduction of GST was thought of to be a major step in this regard by rationalising supply-chains, and removing the fragmented nature of the markets, multiple rates of GST often cause problems of compliance across the value-chain of a commodity. On the input side, critical reforms need to take place in the labour market. Despite low relative labour cost, labour productivity in India in manufacturing is still one of the lowest in the world, and spatially fragmented labour laws escalate costs of transaction, though some late attempts have been made in the Union Budget proposals announced on July 5, 2019 to rationalise them. Under such circumstances, the Indian industry is hardly in a position to compete in a level playing ground in a free-trade region. “Make in India” is meant to create enabling conditions for both domestic and foreign businesses to thrive. If domestic industry has to thrive, it needs protection as also the enabling conditions created by factor and product market reforms.

Further even, for India to really gain from investments from these nations, the enabling business conditions proposed through these reforms would be of utmost need. Building business competitiveness and bringing policy reforms can mitigate large parts of the challenges brought about by RCEP, and convert them to opportunities. It needs to be kept in mind that in terms of ease-of-doing-business index, with the exception of Cambodia, Laos, and Philippines, all other nations rank higher than India, and hence can boast of better business conditions for attracting investments.

At the same time, it was being continuously argued that the RCEP would facilitate India’s Micro, Small and Medium Enterprises (MSMEs) to effectively integrate into the regional value and supply chains. While the opportunity indeed exists, so are the threats! It is important that complementarities in trade be looked at while getting into any form of FTA. Whether this complementarity really exists is a working hypothesis without any solid empirical analysis or evidence. Rather, things may simply work the other way round. On the other hand, inefficiencies in the labour markets, low productivity, inefficient production process, high transaction costs created by fragmented markets do not allow Indian products to be competitive enough in the final goods and inputs markets. India’s MSME sector may find a larger market, but given its inherent inefficiencies it is highly unlikely to compete with the ASEAN.

Trade liberalisation of the RCEP partners with respect to services had been a thorny issue from the Indian perspective. In the cases of FTAs with East and Southeast Asian economies, beginning with Singapore in 2005 to the last one signed with South Korea in 2011, India has been insisting on capitalising on its pool of 'skilled' labour force to gain from improved access to employment opportunities in these economies. This has been expected to come about by increasing the ease of movement of professionals through the liberalisation of what is called Mode 4 in services trade. To this end, India has been willing to trade up its remaining tariff policy manoeuvrability in the manufacturing industry (and even in the agricultural sector). In the context of the RCEP, this again raises a matter of concern. Whether promoting services at the cost of manufacturing in the trade pact acts as a boon or a lost opportunity needs a more deliberate cost-benefit analysis.

The literature on international trade claims that for “small” economies (ones that do not influence the prices of goods and services traded in the global economy) “preferential trade agreements” (PTA) are not really the best moves for such nations. India, despite its huge population and increasing income leveles, is a price-taker, rather than “price-maker” in the global trade. When a country preferentially reduces trade barriers with its partners in a PTA, it is raising the relative trade barrier against countries that are not members of the agreement.

On the other hand, the RCEP, in its attempt to harmonise foreign investment rules, intellectual property rights (IPR) laws and several other laws and standards beyond what has been agreed by developing countries at the WTO, it takes away an economy’s ability to customise trade policies according to the needs of specific time periods. This would be another long-term cost that the Indian economy has to bear.

RCEP without India

Those, supportive of the RCEP, hold the view that India should enter the agreement, considering the diminishing importance of TPP after the US’ exit. The RCEP will pave the way for a new world trade order and have implications on geopolitical concerns. Many contend that China’s BRI is all about strategic influence via its vast network of roads, railways and ports. India’s exit came at the time when China allegedly was pushing for closing the deal during the RCEP summit. This definitely has a broader strategic connotation for China from both economic and geo-political fronts: a> the inking of the deal may have been perceived by China as an attempt to neutralize the negative impacts of the ongoing China-US trade war that has resulted in a substantial decline in its exports; b> it would also send signals to the occident about the economic strength of the Asia-Pacific that would have immense implications for broader strategic geopolitical dynamics in the Indo-Pacific (especially in the context of the Quad that has Australia, India, New Zealand, and US, as members, but with three of them negotiating in the RCEP). At the same time, Japan, Singapore and ASEAN reckon that a new world economic order may indeed be created.

With India moving out, RCEP as a trade deal loses a large part of its sheen. A large part of attraction with RCEP was with invading the most potent market of this part of the world, India! To the outside world, India presents a market of 1.4 billion population whose incomes are increasing at 6-8% over the last few years. It provides a demographic dividend from the perspective of the presenting a huge youth consumer base, who are getting richer. Further, it has a weak domestic industry which can hardly cater to the needs of the diversified needs of the population who are getting wealthier. The existing industrial productivity is low, and inefficient production processes and supply chains are not conducive enough to withstand the foreign competition. The economy aspires to be a 5-trillion-dollar one, organically driven by consumption demand, as has happened so far. What more does an external player need? Such a large fertile market with low domestic competition is hardly present in any of the other RCEP economies. Hence, with Indian exit, there is no doubt that quite a bit of shine in the trade deal is gone for the time being. However, India definitely needs to think of its domestic economy first, and has acted with the right caution that it should have! Till India properly comprehends the potential benefits, costs, and the associated threats including the geostrategic concerns, India should refrain from signing the RCEP.

The views expressed above belong to the author(s). ORF research and analyses now available on Telegram! Click here to access our curated content — blogs, longforms and interviews.


Nilanjan Ghosh

Nilanjan Ghosh

Dr Nilanjan Ghosh is a Director at the Observer Research Foundation (ORF) in India, where he leads the Centre for New Economic Diplomacy (CNED) and ...

Read More +