Report

26 QUANTIFICATION OF BENEFITS FROM ECONOMIC COOPERATION IN SOUTH ASIA
Baysan and Panagriya (2006) examine the economic
case for SAFTA. They study SAFTA in the light of
the preferential trading arrangements in the region,
particularly ISFTA, in order to draw lessons. Subsequently
they examine the qualitative and quantitative
arguments to assess the feasibility of SAFTA. The results
are mostly pessimistic. The following qualitative
arguments fail to provide a strong case in favour of
SAFTA. Firstly, the economies are relatively small as
compared to the rest of the world both in terms of GDP
and trade flows. The economic size of the region
remains small: less than one-twentieth of the world in
terms of GDP. If we exclude India, this figure drops to
0.4%. Consequently, the probability that the most
efficient suppliers of the member countries are within
the region is slim. Hence an FTA is likely to be largely
trade diverting.
Secondly, the level of protection amongst SAARC
countries is very high with the exception of Sri Lanka.
If a country participating in a regional arrangement
were not open they are likely to suffer from welfare
losses due to trade diversion. The third reason which
makes the economic case for SAFTA weak is political
economy of selection of the excluded sectors and rules
of origin (ROO) issue. This leads to inefficient selection
as domestic lobbies make sure that the sectors that do
not withstand competition are excluded from tariff
preferences and lobbies go along free trade in sectors
in which they are competitive. A similar pattern is
observed in case of ROO. A common argument advanced
in favour of SAFTA is that there is substantial informal
trade between countries. There are three arguments
relating to this issue. First, if the real costs associated
with informal trade are higher, benefits of such cost
saving need to be weighed against cost of trade diversion.
Second, an FTA might make formal trade even
more expensive than informal trade by adding to the
costs of complying with the ROO. Third, all the
informal trade between India and Pakistan may not be
due to restrictions that preclude trade at the MFN terms
and a part of it may try to evade even the MFN tariff.
Apart from the theoretical arguments, quantitative
studies that have estimated the impact of SAFTA have
used mainly three types of models, that are either gravity
models; or general equilibrium models; or partial
equilibrium models. The studies employing gravity
models predict that the impact of a South Asian FTA
will be small for India and much larger on the smaller
countries. Second, amongst studies using CGE models
to SAFTA, there are two important studies, Pigato et
al. (1997) and Shakur and Rae (2005). Pigato et al.
find that the unilateral trade liberalisation yields larger
gains than SAFTA. Shakur and Rae find that SAFTA
leads to a 0.21% gain in real income in India, 0.03%
gain for Srilanka and a loss of 0.10% for Bangladesh.
The largest gain of 0.21% is too low and the authors
conclude that the South Asian countries will gain much
more from unilateral/multilateral liberalisation.
The third types of studies have employed partial
equilibrium models. Govindan (1994) concludes that
liberalisation would yield welfare gains through
increased trade within the region. Derosa and Govindan
(1996) further demonstrate that the gains are much
larger when liberalisation is on a non-discriminatory
basis. Given, the pessimistic economic assessment the
study indicates that the move toward SAFTA gained
momentum due to political reasons such as with the
entire world moving ahead with more and more PTAs,
there is an element of following a trend around the
world. Also, SAFTA is seen as a vehicle for promoting
political ties between India and Pakistan. The case of
India and Pakistan is often compared to France and
Germany but the differences in the two situations raise
serious doubts about the validity of the argument.
On the whole, it can be said that the pessimism
with respect to gains from SAFTA arises mainly because
of lack of economic conditions for success of RTA,
which are trade complementarities and differences in
competitiveness of the countries. Empirical literature
suggests that the existence of complementarities is
needed to enhance the probability of a regional trade
arrangement to be net trade-creating, rather than net
trade-diverting. The statistical measures such as the
complementarity index argue that the higher the
observed values of the index between partners, the more
likely is it that a proposed regional trade agreement
will succeed (Michaely 1996). Indices of trade complementarity
developed by Drysdale (1969) have been used
by Kemal et al. (2000) to estimate the complementarity
indices for all five leading South Asian countries using
time series trade data. It was found that there is a lack
of strong trade complementarity in the bilateral trade
structures of South Asia. Lack of trade complementarities
raises the questions on the future prospects of SAFTA.
To identify different countries’ competitiveness
among different commodity groups, the export revealed
comparative advantage (XRCA) indices have been
estimated by some studies at the three-digit level
(Samaratunga 1999 and Kemal et al. 2000), which
show that the comparative advantage countries in South
Asia have an almost identical pattern of comparative
advantage in a relatively narrow band of commodities.