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28 QUANTIFICATION OF BENEFITS FROM ECONOMIC COOPERATION IN SOUTH ASIA further estimates the impact of SAFTA on inward FDI into the region. Cost-benefit analysis is undertaken for four transport facilitation projects. RATIONALE FOR SAFTA The costs and benefits of a Free Trade Agreement are strongly premised on whether they are trade creating or trade-diverting. An FTA would be trade-creating if liberalisation by a member country allows it to replace the higher cost domestic supply by a lower cost partner country supply. This creates enhanced efficiency and is therefore beneficial to the member countries of the Agreement. It would be trade-diverting if preferential liberalisation by a member country leads to replacing the lower cost supply from non-partner member countries by higher cost supply from a partner country. In the case of SAFTA both these phenomena would simultaneously take place and whether on balance it is net trade-creating or net trade-diverting would depend on small and large country situations. To determine the real benefits of SAFTA, however there is a need to examine whether proximity and preferential trade is an issue which would change the economic geography and commercial policy of the region. This cannot be easily explained by using standard trade theory even when account is taken of SAFTA imperfections due to limited enforceability. Alternatively, simple models of horizontal multinational enterprise combined with limited enforceability produce a strong inverse relation between physical transportation costs and trade policy cooperation, thereby introducing a preference for regional agreements such as SAFTA (Ludema 1998). The possible role of regionally generated MNC’s makes such agreements viable even if the Preferential Trade Agreement (PTA) generates trade flows which are small. It would be even more useful to extend similar analysis to other models of trade that exhibit strong home market effects. These have produced welfare enhancing effects even though limited. Ludema argues that some progress has been made in extending such analysis to the oligopolistic and monopolistic models of Venables. Theory argues that RTA’s with one high income hub country could lead to convergence to high income level among members in the region (Venables). This could be true for SAFTA with India playing the role of the high income growth pole. Theory also argues that FTA’s will tend to raise trade for countries that are near each other on account of two major reasons: First, because transportation costs would be low and second because economies of scale would accrue easily and multinational production would take place (Ludema 1998). This explains the EU and North Atlantic Free Trade Area (NAFTA) welfare effects but equally applies to Mercosur and ASEAN. For it to apply to the SAFTA region considerable openness in the policy framework will be required particularly with respect to investment. Understanding the geography of trade agreements should include an analysis of transport costs, economies of scale and imperfect competition, all of which would point to increased commercial activity in the SAFTA context. The study estimates the extent of potential trade that exists intra-regionally as well as bilaterally. Further, an estimate is made of increased trade in the region due to removal of factors other than tariffs, e.g. non-tariff barriers. Studies on Mercosur and ASEAN have found that they tend to be net trade creating though the range of trade effects vary from low to high depending on the initial level of liberalisation of the member countries. The more important effects however have been in terms of FDI because FTA’s alter the incentives facing firms for both those located within and outside the FTA direct investment flows are affected. Investments in some cases anticipate the effects on trade. FDI is motivated by foreign investors seeking to exploit input or output markets located in activities where operating of foreign affiliates seem the most efficient strategy. Some other investment project might be undertaken to reap economies of scale or because of increased competition. In fact a study by the World Bank argues that a 10% increase in market size associated with an RTA produces a 5% increase in FDI (World Bank, 2004a). Earlier empirical work on regional integration on FDI have focused primarily on the effects of EU integration which show that EU share of worldwide inward FDI increased from 28 to 33% consequent to the single market programme. FTA might also promote technological spillover among members affecting efficiency of sectors that produce accumable factors such as knowledge creation. This issue needs further examination in the context of SAFTA. On evaluating the diverse implications on FDI of FTA’s, Blomstrom and Koko in the case of Mercosur suggest inclusion of provisions on FDI in RTA’s. Further by providing certainty and credibility on future policies and economic environment there is a possibility of an increase in private domestic investment. Yet another study on the positive welfare effects of FTA’s (Shiff’s and Winters) points to the political dimensions and argues that as a tool of commercial diplomacy FTAs
LITERATURE REVIEW AND RATIONALE FOR SAFTA 29 unambiguously increase welfare by reducing security tensions and conflict. This would appear to apply to the SAFTA case as well. Thus, it is quite clear that to analyse the impact SAFTA would have on the members as well as on the region, it is essential to step beyond the confines of traditional theory. The possibilities of intra-regional trade networks and vertical specialisation need to be taken into account. There also has to be an investigation of the incentives for FDI created by the regional agreement. This study attempts to evaluate SAFTA in this light. The study attempts to estimate the impact on inward FDI into the region due to SAFTA. The quantitative modeling used in this study includes both a CGE modeling and a gravity model. The study also examines the effect of SAFTA on trade in services.
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Page 7: Preface Our consultations with seni
Page 10 and 11: viii CONTENTS 7. Revenue and Welfar
Page 13 and 14: Executive Summary OBJECTIVE This st
Page 15 and 16: EXECUTIVE SUMMARY xiii Table 1 EAMA
Page 17 and 18: EXECUTIVE SUMMARY xv India A full S
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Page 23: Part I BENEFITS FROM TRADE, INVESTM
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Page 46 and 47: 2 Literature Review and Rationale f
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Page 70 and 71: 6 Impact of SAFTA on Member Countri
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Part II BENEFITS FROM DEEPENING INT
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11 Construction and Related Enginee
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12 Tourism and Travel Related Servi
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15 Prospects for the Telecommunicat
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APPENDICES
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Appendix 8 Intra SAARC FDI Collabor
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Appendix 11 Table A11.1 On an Emplo
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Appendix 12 Original Commitments/In
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Appendix 14 Table A14.1 Telecommuni
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Appendix 15 REFERENCE PAPER Scope T
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Bibliography Abelson, P. (1996),
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BIBLIOGRAPHY 241 Cuba (2002), Negot
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BIBLIOGRAPHY 243 (2004), Impacts of
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BIBLIOGRAPHY 245 Silva, Patricia an
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BIBLIOGRAPHY 247 (1998), Tourism Se
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