bringing down tariff levels for member
countries. It made a lot of progress in reducing
Explained: Regional
Trading Agreements
Does a trade agreement between India, Brazil
and South Africa make economic sense? The
three countries are geographically apart, they
are all labour abundant developing countries
without clear gains from trade, and it is not
clear that the agreement will result in trade
creation and an increase in welfare. It may be a
politically useful arrangement, as perhaps most
agreements that are not multilateral are, and
increase the power of these emerging
economies in international forums. Here we
look at the genesis, the history and the
outcomes of trading agreements across the
world.
What are trading agreements?
A trading agreement is an arrangement
between countries to reduce tariff barriers.
Custom duties on imports has been a big
barrier to international trade, reducing trade
and the gains that could be made from trade.
Reducing these leads to an increase in trade
and business.
What are the kinds of trading agreements?
There are multilateral, bilateral and regional
trade agreements. There are customs unions
and free trade areas.
What are GATT and WTO?
The General Agreement on Tariffs and Trade
(GATT), set up after World War II, aimed at
tariffs through various "rounds" of discussions.
Between 1986 and 1994, the "Uruguay round"
negotiated further trade talks and on January 1,
1995, the WTO was created. The goal of the
WTO is to reduce trade barriers among its 149
member countries. It is an example of a
multilateral trade agreement.
What is the fundamental principle of a
multilateral trade agreement like WTO?
The "Most Favoured Nation" (MFN) clause of
the GATT agreement is the fundamental
principle of WTO. It states that all countries
belonging to GATT should be treated equally.
Therefore, if India, a member of WTO reduces
tariffs on goods imported from Singapore, it
should also do so for all other member
countries. This founding principle of
GATT/WTO and is described in Article I of its
preamble.
Do bilateral and regional trading
agreements not violate MFN, the
fundamental principle of WTO?
There are more than 200 regional and bilateral
trading agreements. There are agreements
between countries of Europe, North America,
Asia, Africa and Latin America. There are
bilateral agreements between the US and many
countries such as Chile, South Korea and
Jordan.
Interestingly, the WTO permits such trading
agreements. Article XXIV, which actually
violates Article I on the MFN, says that
regional agreements are permitted as long as
tariffs for those outside the agreement are not
raised as a consequence.
Regional trading agreements(RTA) can be of
broadly two categories: customs unions and
free trade areas. Countries in a customs unions
have a zero tariffs internally and a unified tariff
against the rest of the world. A free trade
area(FTA) is one in which countries maintain
their own tariffs against non-member countries
while having zero tariffs with members of the
FTA. In other words, they do not have a
unified tariff against the rest of the world.
The European Economic Community (EEC) is
an example of a customs union. A good can
enter the EEC in any country and once tariff is
paid at the port of entry, the good is free to
move through the EEC.
Another example of a customs union is
MERCOSUR, formed in 1995, which includes
Argentina, Brazil, Paraguay and Uruguay.
In contrast NAFTA, the North American Free
Trade Area, is a free trade area. It was formed
in 1994. Member countries -- the US, Canada
and Mexico maintain different tariff rates with
the rest of the world. This means that when a
good enters NAFTA through Mexico it pays a
differnt import duty than when it enters
through the US. Only goods which are
produced in North America can move freely in
the free trade area. The others are subjected to
Rules of Origin. A shirt made in India with
labels and buttons stitched on in Mexico does
not pass as a Made in North America shirt and
cannot move freely from Mexico to the US.
This is done to prevent third country exporters
from taking advantage of lower duties in
Mexico to enter the US market.
What have trade agreements meant for
trade and welfare?
While most evidence finds that multilateral
agreements help in increasing trade and
welfare, it is not clear that regional agreements
lead to trade creation, ie. an increase in trade,
rather than trade diversion, i.e an increase in
trade among member countries without an
increase in total trade when the increase comes
at the cost of trade reduction with non-member
countries.
Remember that the purpose of FTAs is to
eliminate tariffs against FTA members, but to
retain them on non-members. Economists have
often criticised FTAs, which may promote
better political ties with neighbours, but are not
based on sound economic principals.
How do FTAs lead to trade diversion, rather
than trade creation?
Under an India South Africa FTA, for
example, instead of importing steel from
Europe, a producer would import it from South
Africa. This does not help the Indian economy.
Morevoer, as long as South Africa does not
satisfy the entire Indian demand for imported
steel, the price of steel in India does not fall.
"Rules of origin" on which FTAs are based
mean that only steel produced in South Africa
can be imported under preferential tariffs -
there will be zero tariff only when there is a
minimum percentage of value added in South
Africa.
PART II: India and Regional trading
agreements
The importance of increasing regional trade
within Asia cannot be emphasised enough. At
a time when regional trading agreements, such
as the EU and NAFTA have led to higher trade
and investment, Asia lags behind. Trade within
Asia is a miniscule proportion of world trade,
even though the Association of South East
Asian Nations (ASEAN) countries(Singapore,
Phillipines, Thailand, Indonesia, Malaysia,
Cambodia, Laos, Vietnam, Myanmar and
Brunei) , along with China, Japan,Korea and
India are among the fastest growing exporters
in the world today. China is expected to enter
into an agreement with the ASEAN countries
to promote trade by cutting tariffs on a large
number of commodities with the region. This
will lead to greater economic integration, in a
region in which members have, until now, seen
themselves largely as competitors, than as
potential partners.
What is the SAFTA?
The South Asia Free Trade Agreement
(SAFTA) is the free trade agreement between
India, Pakistan, Srilanka, Bangladesh, Bhutan
and the Maldives. SAFTA came into being on
1 January 2006 and will be operational
following the ratification of the agreement by
the seven governments. SAFTA requires the
developing countries in South Asia, that is,
India, Pakistan and Sri Lanka, to bring their
duties down to 20 percent in the first phase of
the two year period ending in 2007. In the final
five year phase ending 2012, the 20 percent
duty will be reduced to zero in a series of
annual cuts. The least developing country
group in South Asia consisting of Nepal,
Bhutan, Bangladesh and Maldives, gets an
additional three years to reach zero duty.
What has been India's involvement with
FTAs?
Over the last few years a number of FTAs have
been signed with Asian neighbours like Sri
Lanka and Singapore. Steps are being taken for
the creation of free trading areas within South
Asia and among the members of the ASEAN.
The benefit to India from entering an FTA is
limited when India is dealing with a free-
trading country. Since India is a high tariff
economy, an FTA gives the partner a clear
benefit, but if the partner already has zero or
near zero tariffs, (as is the case with
Singapore) Indian exporters do not stand to
gain much. The FTA does not give Indian
exporters additional market access. While
India has an average custom to total import
ratio of around 20 percent, Singapore is a zero
tariff zone, Srilanka's is much lower at 5
percent and Thailand, with whom the next
FTA is proposed to be signed has custom
collections at 3.8 percent of total imports.
Indian exporters gain little by getting
preferential tariffs in these countries. It is their
exporters who stand to gain. India loses the
custom duties that would have been collected
on their exports.
What are the other implications of Rules of
Origin for India?
There is a big cost in terms of creating a whole
bureaucracy which sits at custom points and
checks whether goods coming from FTA
partners satify "Rules of origin".
Documentation would be provided to them
which would need to show the percentage of
value addition in Thailand for a good being
imported from Thailand. This creates scope for
corruption.
Then why does India try to enter RTAs?
First, there are political gains of belonging to a
group. Second, it is a way to reduce barriers to
trade and reduce custom duties which may not
be as easy to do in a unilateral manner.
Yashwant Sinha, when he was Finance
Minister, had announced that Indian tariffs
would be brought down to ASEAN levels. If
India is part of a deal to cut custom duties, it
becomes easier to do so. While domestic
producers may protest, consumers stand to
gain when duties are cut. In addition, these
agreements can lead to an increase in service
exports an area in which there is slower
progress in multilateral arrangements like
WTO.