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Free Trade Agreement with China is Ill-timed

Free Trade Agreement with China is Ill-timed
Highlights

Indonesia, Thailand, Singapore, Malaysia, Philippines, Vietnam, Myanmar, Brunei, Cambodia and Laos have a Free Trade Agreement (FTA) known as ASEAN.

Indonesia, Thailand, Singapore, Malaysia, Philippines, Vietnam, Myanmar, Brunei, Cambodia and Laos have a Free Trade Agreement (FTA) known as ASEAN.

Trade between these countries is virtually "free," that is, nil or nominal import duties are imposed on movement of goods between these countries.

These countries made an FTA with China in 2010. As a result, goods from China could also enter these countries with payment of nominal import duties. Subsequently, their goods trade with China went from a surplus of USD 53 billion per year in 2010 to a deficit of USD 54 billion in 2016.

This means that the ASEAN countries have gained less access to the markets of China and China has gained more access to the markets of ASEAN from the FTA. Now China is spearheading the move to form the Regional Comprehensive Economic Partnership (RCEP) which will expand the ASEAN + China FTA to include Australia, India, Japan, New Zealand and Korea.

The RCEP provides that 92 percent of India's goods would become tariff-free over the next 15 years. We are already reeling under the influx of imports from China.

This will become much worse. The march will begin immediately and conclude in 15 years. Most countries wanted India to slash existing tariffs up to 90 percent and make them zero in 15 years. The reduction of tariffs would allow Chinese goods to enter with greater force and Indian industries will be hit badly.

India is already running a trade deficit of USD 50 billion per year with China. The RCEP will lead to an increase in the same. We may also have a surge in imports from New Zealand in dairy products; and coffee, spices and garments from Vietnam.

A meeting is scheduled on Monday to sign the RCEP. Prime Minister Modi is expected to attend the same. India has expressed some reservations on specific issues; but fundamentally thinking in the government is that we must join the RCEP. The differences are about some specific issues.

Therefore, it is not clear whether India will sign the RCEP on during the scheduled meeting on Monday at the time of writing this article.

The basic issue is whether free trade is good for us. Economic theory says that free trade is good for all countries. Every country will export goods that it can produce cheap and import goods that other countries can produce cheap.

Thus, India may export pharmaceuticals to China and import electric lights from China. People of China will get cheap pharmaceuticals produced in India and people of India will get cheap light produced in China.

The standard of living of the people of both the countries will improve. However, this beneficial result of free trade is not seen in our direct experience. We have seen that ASEAN-China FTA has led to the worsening of the deficit of the ASEAN and India vis-à-vis China.

The free trade espoused by the World Trade Organisation has led to the worsening of our trade deficit with China. In other words, free trade has given an edge to China against other countries.

The main reason for this is that there are few labour laws in China. Workers can be hired and fired at will. China also reportedly allows industries to pollute the environment.

An Indian manufacturer may have to install pollution control equipment leading to higher cost. The Chinese industry can pollute and reduce its cost of production. Thirdly, reports indicate that Chinese bureaucracy and politicians make corruption in promoting industries.

The officials and politicians take bribes to give away government land; to provide subsidies from the local government; or to exempt from licensing restrictions. This corruption leads to lower cost of production.

Indian bureaucracy and politicians, on the other hand, take bribes to put obstructions in registration of land purchased from the market; to raise petty objections or simply delay the grant of permissions. India's cost of manufacturing is high because of these reasons.

An FTA with China under RCEP will put us at a disadvantage.

Yet our government is inclined to promote free trade and join the RCEP. The reason is that free trade is especially beneficial for Multi-national Corporations (MNCs).

They can produce lights in China and export to India; and produce pharmaceuticals in India and export to China. They would have to produce lights in India and pharmaceuticals in China in absence of free trade.

Adoption of free trade with China under the RCEP will, therefore, provide competitive advantage to the Chinese industries. Indian industries already reeling under Chinese imports will be further hit. Perhaps, for this reason, Chinese President visited Mahabalipuram to soften up our stance.

The theory of free trade says that every country will export those goods that it can produce cheapest. India's strength is in services — software, music, translation, medical transcription, big data analysis.

Thus, for free trade to be beneficial for us, we must push for free trade in services. The RCEP countries are not willing to move ahead in this.

Therefore, RCEP will be a loss proposition for us. We will face increased imports of manufactured goods but not be able to make increase exports of services. For this reason, India should not sign the RCEP.

It is clear that RCEP will have a deep impact on the Indian economy, perhaps deeper than the impact of the WTO. The Vajpayee government had constituted a Commission to Review the Working of the Constitution.

The Commission had noted that "neither the Parliament nor the people of the country were taken into confidence before signing (the WTO) agreements." Ideally, the government should call for a referendum on RCEP and seek instruction from "We the People…" before moving ahead with the RCEP just as the British government had called a referendum on the Brexit.

The stance of the Commerce Ministry is that we must not be left out of the global economy. That is indeed true. But shall we embrace the global economy in a lop-sided FTA limited to manufactured goods—where we do not have a comparative advantage.

In conclusion, RCEP is good but only after we have (1) pushed China to implement labour laws and environmental safeguards; (2) reform our bureaucracy and make it pro-business; and (3) we have persuaded the RCEP members to sign an FTA on services.

The writer is formerly Professor of Economics at IIM Bengaluru

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