Monday, 3 October 2016

Integrating with the global economy

In World Economy News 03/10/2016

Brexit, the appeal of Donald Trump, and the rise of nationalist anti-immigration parties in Europe, all reflect an angry anti-globalization mood in industrialized countries. What does this imply for India? Singapore’s deputy prime minister, Tharman Shanmugaratnam, in the first Niti Aayog lecture addressing cabinet ministers and senior officials, offered an answer. He said no country has been able to achieve rapid growth without integrating with the global economy and India should integrate more fully than we have. He recognized that our size, diversity and democratic polity imposed special constraints, and we had done well given these constraints. But we cannot expect to achieve 8-10% growth if we continue with business as usual. Putting it colourfully, he said we cannot just go on scoring singles—we have to start hitting fours and sixes.
To integrate with the global economy, we need to increase our competitiveness. This calls for some bold reforms to improve the quality of infrastructure and logistics, greater ease of doing business (covering government/business interface in the Centre and states), a financial system that serves small- and medium-sized firms, skill development, labour market flexibility, etc. It also calls for new initiatives in our external engagements, some of which are discussed below.
Reducing import duties
Import duties were reduced very substantially after 1991, but they need to be reduced further. In 1997-98, then finance minister P. Chidambaram had set the target that import duty rates should be reduced to Asean (Association of South-East Asian Nations) levels by 2000. Sixteen years after that target date, our import duties remain significantly above the Asean level.
Now that we have signed a free-trade agreement with Asean, retaining higher duties than those in Asean will raise our domestic cost structure, making it difficult to compete with the low duty imports that will be allowed from Asean. It will also reduce the competitiveness of our exports to those markets. We should move to lower most non-agricultural duties to reach an average of around 5% in two years. This will also help tackle the problem of duty inversion, which has been a source of much complaint. Those who worry about an adverse effect on the economy, should recall that duties were reduced much more sharply after 1991, with considerable benefit.
Duty reduction may be resisted because of revenue loss. However, contemporary best practice holds that import duties should not be viewed as a revenue source. Whatever indirect tax revenue we need should come from the non-distortionary GST (goods and services tax), which is now clearly on the horizon.
Trade negotiations
We also need to rethink our approach to trade negotiations. We have traditionally preferred trade negotiations within the multilateral World Trade Organization (WTO) framework, viewing regional trade agreements as distortionary. We were also committed to the Doha Round as a “single undertaking”. These perfectly reasonable positions have become unsustainable after the Doha Round was effectively abandoned in Nairobi in 2015.
One reason for the abandonment of Doha is that industrialized countries, seeing the changes in the structure of world trade with the growing importance of global value chains, lost interest in obtaining tariff reductions and became much more interested in “deeper integration” of behind the border standards on issues such as labour, environment, protection of intellectual property, competition policy, etc. This could not be pursued within the tariff-based negotiations in the WTO, so they shifted their focus on pursuing “mega regional agreements” such as the Trans-Pacific Partnership (TPP) involving the US, Japan, Korea and some developing countries, and the Transatlantic Trade and Investment Partnership (TTIP) involving the US and the European Union (EU). These mega regionals were negotiated among a small group of industrialized countries, and it was expected that they would then be opened to other countries to join if they were willing to accept the terms of the agreement. An unstated purpose of the exclusionary approach was to keep China out of the initial negotiations and offer entry only after the terms were set.
The TTIP has run into roadblocks and no early resolution is expected given the anti-globalization mood in Europe. The TPP has been signed, but not yet ratified by the US, and opinions vary on whether it will be ratified soon. However, we should note that China is widely reported as preparing itself internally to meet the TPP standards, so that it keeps open the option of joining if it wishes. If China does join the TPP, it will be a very powerful trade block, and staying out of it will put us at a severe disadvantage.
Dani Rodrik of US’ Harvard University has argued that uniform standards across countries at very different levels of development is not necessarily a welfare improving step. This may be technically correct, but against this we have to keep in mind that if the major trading nations do harmonize standards at higher levels, countries which apply common standards internally will find it much easier to integrate into global value chains which drive exports. Perhaps we should also, like China, start preparing ourselves internally.
More immediate decisions are needed in the context of our stalled negotiations with the EU and the ongoing process in the Regional Comprehensive Economic Partnership (RCEP). A successful outcome would send a very strong signal of India’s willingness to engage with the global community. In the case of RCEP, it is also a geopolitical signal of our willingness to walk the talk on “Act East”. Trade negotiations are complex exercises in which no country gets everything it wants. There are inevitable compromises at the last stage, when our negotiators may have to concede on some points, in order to gain on others. It is important to prepare public opinion not to regard every concession as a failure.
Business has a big role to play in building support for trade agreements. Unfortunately, Indian business has been more concerned with ensuring that protection to domestic producers is not diluted and less with getting access to export markets. This must change. We cannot simultaneously aim at rapid growth and also believe that we cannot face foreign competition. If there are internal constraints that make us uncompetitive, we should work to overcome them while welcoming global integration.
There are some plurilateral negotiations being pursued by the industrialized countries within the WTO, e.g. trade facilitation, zero tariff on environmental goods, information technology agreement (ITA) II, government procurement. These are stand-alone agreements delinked from the Doha Round as a “single undertaking”. We have recently signed up on trade facilitation, but have been unwilling to join the other negotiations, possibly because we regarded them as distractions from the Doha Round as a single undertaking. Now that the Doha Round is dead, we need to take a considered view on whether we should join. Here again we should not assume that we cannot increase our competitiveness.
The Trade in Services Agreement (Tisa) is a plurilateral agreement outside WTO being negotiated by the US, EU and several countries, including some developing countries. We have a comparative advantage in high-end services, but we are not part of Tisa. When Doha was still alive, it was possible to believe that a multilateral agreement on services would be negotiated in that forum. Since that is no longer possible, we need to address the question of whether we should be part of Tisa. One of our problems in services is that we have been fixated on Mode 4, which involves movement of persons. This is in our interest, but as long as unemployment remains high in industrialized countries, it is unlikely that we will get any comfort in this area. We should, therefore, be realistic in our expectations.
Other issues
Two other elements of policy which have an impact on our external engagement are taxation and investor protection. The fact that multinational corporations (MNCs) operate across the world in different parts of the value chain gives them the opportunity to shift profits to lower tax destinations. The incentive is particularly high in India because corporate tax rates are much higher than in other countries. We should align our corporate tax rates with those of other countries. MNCs will still be tempted to shift profits to tax havens which have exceptionally low tax rates ,and the Organisation for Economic Co-operation and Development is working on ways to counter such base erosion and profit shifting. We should support this effort and act in accordance with internationally agreed best practice. But we should not go beyond the international consensus.
Investor protection through bilateral investment treaties is another critical dimension of engagement. We do not have a treaty with the US and have recently started negotiation. The US is seeking to introduce many new features, including on intellectual property rights, which could pose problems. We too have modified our earlier template by excluding international arbitration until investors have exhausted the remedies offered by the domestic judicial process. This may have been reasonable if our domestic process was speedy, but it is not. The negotiations with the US will give a good idea of whether there is common ground. If we come to an agreed position vis-à-vis the US, we can reasonably push it with other countries. However, we should avoid any unilateral abrogation of existing treaties.
To summarize, it is to our advantage to deepen engagement with the global economy and we must do what is necessary, domestically and externally, to facilitate the process. The suggestions above provide a core set of initiatives in external economic policy. Perhaps the government should set up a high-level committee, including representatives of business, trade economists, and legal experts in trade and investor protection, to make specific recommendations for action.

Source: Livemint