By Arvind Panagariya
Asia has suffered over the last decade from the proliferation of regional trade agreements elsewhere. The time is now ripe for an India-China free trade area – a vital step for any viable Asian trade bloc
India-China trade is among the fastest growing bilateral trade relationships in the world. According to Indian Commerce Ministry data, India’s exports to China rose from a paltry $18 million in 1990–91 to approximately $4.6 billion in 2004–05. India’s imports from China expanded with equal speed, from $35 million to $6.7 billion over the same period. China is now the largest source of India’s imports and the second largest destination of its exports.
This phenomenal expansion of bilateral trade, which has accompanied a rapid growth in incomes in the two giant economies and is expected to continue, invites the obvious question: is the time now ripe for the formation of an India-China Free Trade Area?
Discriminatory trade blocs are generally flawed, since they fragment the world trading system and lead to inefficient allocation of resources. But given the current state of play in the FTA game, a case for India-China FTA can indeed be made on strategic grounds. During the last decade, with the creation of the North American Free Trade Area (Nafta), several expansions of the EU and a host of smaller FTAs in Latin America, Asia has suffered from the diversion of trade of these regions away from it. One response to this diversion is for Asia to move towards a bloc of its own. Such a bloc may give Asia the necessary leverage to pry open Nafta and EU blocs to outsiders.
If one accepts this argument, an India-China FTA is probably the best starting point for such an Asian bloc. For example, as an alternative, even if India and China both make good on their respective framework agreements with the members of the Association of South-east Asian Nations (Asean) to forge FTAs with them, an effective Asian bloc will not form without these two countries signing an FTA agreement with each other. On the other hand, if India and China signed an agreement, chances are much higher that the remaining countries in Asia will rush to sign agreements with them.
Presently, Asean is driving the integration process in Asia, but with the emergence of India and China as major economic powerhouses and the relative stagnation faced by the most populous Asean country, Indonesia, its ability to serve as the engine of Asian integration has substantially diminished.
An India-China FTA also has the advantage that it would help promote an alternative FTA template that focuses on trade integration rather than non-trade subjects, including labour standards, intellectual property rights and even restrictions on the use of capital controls. These subjects are integral parts of the US FTA template that the US may eventually want to turn into the WTO template. An Asian bloc that relies on a “trade only” template will be an effective instrument for countering the US template in the future WTO negotiations.
Internally, India can surely benefit from cooperation with China in shaping its labour-intensive industry. In particular, direct competition with China may help push some of the key reforms necessary to stimulate the expansion of the labour-intensive industry. With wages in China now rising, the time is ideal for India to move decisively into such labour-intensive sectors as apparel, footwear and toys. Likewise, China could gain from increased interaction with India in the information technology sector.
While the case for the India-China FTA is compelling, a note of caution is in order as well. Given the high level of protection in India, there remains the possibility of what economists call trade diversion: with tariff-free access to the protected Indian market, China may displace the more efficient outside suppliers of the imports. India can minimize the potential damage from this diversion by continuing to lower its outside tariffs as it has been doing during the last fifteen years.
Arvind Panagariya is Jagdish Bhagwati professor of Indian political economy at Columbia University