Any regional trade agreement needs to recognise the two-way linkages between trade in goods and services.
Currently, trade flows of goods and services coupled with FDI inflows and outflows account for more than half of India’s GDP, even by any conservative estimates. The external sector’s predominance is due to a variety of factors including considerations of comparative and competitive advantages in manufacturing and services; imperatives of foreign capital, technology, skills and managerial expertise, regional value chains, among others.
It is easy to understand that manufacturing as an ‘engine of growth’ contributes to both supply and demand-side growth outcomes through productivity and employment effects via economies of scale. Since manufacturing in one country may not always yield growth outcomes due to size of the market constraints preventing reaping the economies of scale, supply side constraints, regional economic integration across countries through trade and FDI becomes a viable option.
This is because tariff and non-tariff liberalisation vis-à-vis manufactured goods and liberalisation of regulations in services enhance market access in partner countries, relieving the demand side constraints. On the other hand, supply side constraints could be addressed through regional FDI facilitation which may bring not only financial resources but also technology appropriate to regional conditions and managerial and technical skills.
Stretching the analysis further, trade in manufactured goods cannot be stepped up unless institutional mechanisms exist for facilitating concomitant trade in services. For instance, trade in goods is incumbent upon the presence of facilitative services like post-shipment credit, consignment insurance, bank guarantees, shipping services etc, that not only facilitate trade but also contribute to the competitiveness of exports. On the other hand, trade in services in a sector like health is dependent upon trade in goods pertaining to this specific service sector such as medical equipment and medicines that the health service providers are confident of.
Thus, any regional trade agreement needs to recognise the two-way linkages between trade in goods and services. However, in reality, the converse of it could also be observed. Given the increasing trend of disconnect between tangibles and intangibles, for instance in the case of real sector and financial sector, trade in goods and trade in services follow their independent growth paths. In any case, the autonomous flows in both trade in goods and services need to be reckoned with. The added argument stems from the fact that cooperation in upgrading infrastructural services help reducing the transaction costs, making products cheaper in the regional context.
What is more, an FTA in trade in goods may not only spur trade flows, they also can engender cross-country investment flows, the latter takes place to take advantage of tariff concessions under an FTA. India-Sri Lanka FTA is a classic example. It needs to be further acknowledged that the strengthening of trade-investment linkages is thus crucial for achieving higher levels of regional trade and for its developmental impact. Such linkages help improving export supply capabilities in the countries of a regional grouping.
They are also more employment generating with investment made to take advantage of trade liberalisation, regionally. While a Free Trade Agreement (FTA) can spur investment flows in terms of efficiency-seeking regional restructuring, it is the trade-creating joint ventures that ultimately have a decisive impact on regional trade flows. The trade-creating joint ventures are in a position to take advantage of the regional FTA. These have direct implications for the manufacturing sector’s growth dynamism.
In this context, if vertical integration and horizontal specialisation are also focused upon with the help of cross-country investment flows that strengthen trade-investment linkages, the gains in terms of higher trade and investment flows leading to greater employment generation become possible. This may essentially mean distribution of different stages of production in a particular industry regionally in an integrated manner – the vertical integration. Specialisation in the same stage of production with the help of product differentiation across the region, namely, horizontal specialisation.
Considerations as above become important for creating Regional Value Chains (RVCs) in a regional context to achieve the objective of regionally coordinated manufacturing that could serve as the engine of growth with positive implications for employment generation. One of the primary functions of rules of origin is to prevent trade deflection in FTAs when the different modalities of determining the origin of a product aim at a substantial transformation in inputs. However, what remains unappreciated is that these rules of origin and their modalities together facilitate value-addition in the country of manufacturing and play a developmental role through employment generation effects.
This is brought about because value addition in a manufacturing process allows firms to pay wages and salaries to labour, interest to capital, rent to land and profits to entrepreneurs. This means higher the value addition in manufacturing higher would be the potential to employ all factors of production and not just labour. Higher value addition is the avenue to reap higher profits to entrepreneurs. In short, rules of origin under FTAs can play a developmental role by having manufacturing-augmenting and employment generating effects.
In sum, the ‘Make in India’ campaign can become a masterstroke if manufacturing is viewed in an integrated manner along with other sectors and if its external dimensions like the rules of origin under an FTA that emphasise on value-addition are properly understood. These have the potential to make FTAs as instruments to achieve the objectives of ‘Make in India’ and overall developmental objectives through employment-generating effects. However, there is a need to rethink the FTA strategy in the new context of TPP and the assertion that the multilateral process of the Doha Round is abandoned!
(The writer is a Professor, Research and Information System for Developing Countries, New Delhi. Views are personal)