For economic growth, Pakistan and India must trade.
[dropcap]T[/dropcap]here continues to be resistance in Pakistan’s policymaking circles and media to awarding India the trading status of “most favored nation.” Relabeling this as “nondiscriminatory market access” by the Nawaz Sharif government is not enough. It is important to show that the concerns are misplaced.
Here’s the context necessary to ensure we don’t miss the forest for the trees: if national living standards are to improve, Pakistan’s economy must grow at 7 percent, or more, per annum for the next four decades. This is required to double gross domestic product every 10 years. To do this, Pakistan needs a growth driver that strengthens traditional economic-growth sources. Regional trade can be such a driver, but the full benefits of this trade will not accrue without Pakistan and India enjoying normal trade relations.
There have been five major growth episodes in the area that today constitutes Pakistan:
In the 1860s, remarkable expansion in canal irrigation extended the range of cropping options for farmers, jump-started economic growth in the Indus Basin market, and increased income and living standards for nearly a hundred years.
The second growth vent is associated with the Korean War, which increased the price of Pakistani jute and cotton. This helped launch highly successful import-substituting industrialization.
In the 1960s, thanks to the focus of Ayub Khan’s government, the agricultural growth rate soared to 10 percent per annum, bringing prosperity to rural areas.
The 1970s and 1980s were characterized by a large outflow of labor, both skilled and unskilled, from Pakistan to the oil-rich Middle East that launched the fourth major growth episode. There was an expansion in the middle class and a consumption-led boom, but also a steady loss of international competitiveness.
For its role in the war on terror, Pakistan was rewarded with concessionary capital by international financial institutions and an expansion of remittances. The result was a five-year run of high growth, but it coincided with rising inflation and energy shortfalls.
Importantly, economic growth of the last six decades created, perhaps for the first time in history, an integrated Indus Basin market for goods, money, and people. Pakistan’s economic managers wisely invested in North-South oriented communications infrastructure—railways, ports, roads, postal system, and telephones—that was key to the development of the Indus Basin market. However, the North-South focus also made Pakistan’s economy lopsided.
Despite sharing borders with three major economies (China, India, even Iran) and being located so close to an important economic bloc (Central Asia), Pakistan’s economic connectivity with an increasingly globalizing world is via only one port city, Karachi. This strategy worked well for 60 years but, given the congestion at Port Qasim Authority and Karachi Port Trust as well as the complex and volatile politics of the city, may have run its course.
[dropcap]H[/dropcap]istorically, the areas that form Pakistan today have carried out economic transactions and forged cultural ties with regions that lie outside its current borders. This has facilitated the mingling of Turkic, Persian and Indian ethnic tribes and has promoted the fusion of languages, cuisine, and religion. Cities such as Lahore, Multan, Peshawar, and those in upper Sindh lay on trade routes connecting lands in the west (Iran, Central Asia, and China) to those in the east (India) and became centers of trade, commerce, culture, and prosperity.
These cultural centers have defined themselves historically as parts of much larger regions that lie outside Pakistan’s borders. This has posed a challenge for Pakistan’s nation-builders. Hemmed in by colonial borders and hopelessly bad relations with India, Pakistani policymakers have attempted to reshape the country’s economic geography. As a departure from historical patterns that emerged over centuries, they created the North-South corridor defined by new borders that facilitated the major growth episodes of the last six decades.
As recently as the 1980s, it did not matter that the old East-West trade routes lay abandoned. China was in a long slumber and was performing far below its potential as an economic giant. In Central Asia, mineral wealth was exploited in the interest of Russia. And India, with its low “Hindu” growth rate, was shackled to a heavy-handed and stifling regulatory framework arising out of Fabian aspirations. All this changed in the last 30 years.
China woke up in the early 1980s and has since become an economic powerhouse with growth rates of 10 percent per annum for over two decades. India followed China a decade later, is now on an impressive growth trajectory of 7 to 8 percent growth per annum, and is seen as an emerging economic power. Across the northwestern border, beyond troubled Afghanistan and our own volatile tribal belt, are the resource-rich Central Asian Republics (Turkmenistan, Uzbekistan, Kazakhstan, Kirgizstan, Tajikistan), keen to exchange their mineral wealth for goods and services that improve living standards. Iran, rich in oil and natural gas, would be free to engage with South Asia once its strategic interests are allied with the welfare of its citizens.
The East-West economic routes (that go beyond trade in goods and include energy flows and movement of workers and investment), and the growth vent associated with them, will not be realized until there is peace in Afghanistan and the tribal belt straddling the Pakistan-Afghanistan border is stabilized. Balochistan would also need to reengage with the federation effectively to allow Gwadar to realize its potential as an integrator of a vast region, stretching into Central Asia and western China, into the global economy. Critically, without normalizing trade with India, the Indus Basin would be a T-junction rather than a crossroads of economic transactions and this would circumscribe welfare gains from regional integration.
[dropcap]I[/dropcap]ndia was Pakistan’s most important trading partner soon after Partition in 1947 and remained so until the early 1950s. The first major disruption to trade happened when India devalued its rupee and Pakistan did not. This increased India’s trade deficit with Pakistan. India put a ban on imports from Pakistan; this led to Pakistani entrepreneurs establishing global trade links. Bilateral trade was suppressed for several decades and then slowly eased up, but was subject to a highly restrictive “positive” list. Bilateral trade increased in the late 1990s with the expansion of the positive list and crossed $1.5 billion in the financial year 2007-2008. Trade was curtailed for two years following the Mumbai attacks, but was back up to the previous peak in FY 2010-2011. A striking feature of bilateral trade is that whereas Pakistan enjoyed a trade surplus in the initial years after Independence, in recent years the trade balance has been in favor of India. With the switch to “negative”-list transactions, bilateral trade is poised to surge to new heights: recent studies show this could be as high as $10 billion.
The impact on Pakistan of trading with India is a much researched topic. There is broad consensus among researchers that consumers will be better off because there will be more goods to choose from and prices will fall. Government, too, will gain because legal cross-border trade will replace smuggling, yielding substantial customs revenues. The impact on manufacturers and farmers would be mixed. The efficient ones will benefit from access to the much larger Indian market, while the inefficient ones will face competition. This would suggest a balanced and nuanced public debate on further liberalization to achieve a World Trade Organization-consistent, Pakistan-India trade regime. The resistance to trade liberalization from a few interest groups who fear a negative impact says little of their ability to face competition.
The naysayers point to India’s pervasive nontariff barriers as the major bottleneck that must be removed before trade is liberalized. The fact is that both Pakistan and India have nontariff barriers that restrict trade over and above the scheduled tariffs. Nontariff barriers in India consist of health standards applied to food imports; complex import licensing and permit schemes; sampling, testing and labeling requirements; quarantine of animals and plants; specification of ports and import agencies; pre-shipment inspections of metal scrap and textiles. India also uses antidumping and countervailing duties. The Overall Trade Restrictiveness Index (OTRI) compiled by the World Bank, based on tariffs and nontariff barriers, takes the high value of 46.7 for India (the highest in Asia) with nontariff barriers accounting for 24.5 percent of the index value (the highest in South Asia).
In contrast, Pakistan relies mainly on tariffs to regulate trade. The OTRI for Pakistan is 22.2 with nontariff barriers accounting for 5.1 percent of the index value. Pakistan’s health-safety legislation is outdated and not enforced; there is little use of antidumping and countervailing measures. However, Pakistan’s large negative list is a substantial nontariff barrier that is India-specific. India, on the other hand, claims its nontariff barriers apply to all and are not geared toward Pakistan. The naysayers respond that given the range of products likely to be traded post-liberalization, Pakistan’s comparative advantage would arise from its location and common tastes and therefore many nontariff barriers are, in fact, Pakistan-specific. Another way to look at it is that Pakistan-India trade liberalization provides an excellent opportunity to dismantle India’s highly distortionary nontariff-barriers regime and Pakistan will forge many international alliances in the process.
Agriculture is another stumbling block. Although WTO-consistent agriculture trade can help in mitigating supply shortages and resulting price hikes, the large input subsidies given by the Indian government to agriculture gives Indian farmers an unfair advantage over their Pakistani counterparts and is therefore a major cause of concern. A comprehensive assessment of the subsidies received by Pakistani and Indian farmers is needed. Large Pakistani farmer associations need to strengthen their capacity to gather evidence on the subsidies enjoyed on either side of the border. This will allow a rational approach to using WTO-sanctioned countervailing measures. Both nontariff barriers and subsidies pose thorny issues that need to be resolved through negotiations as liberalization proceeds. But their resolution as a precondition to liberalization is unrealistic.
Moving from “most favored nation”-based trade to a preferential-trading regime, as the South Asian Free Trade Area envisions, requires a careful assessment of costs and benefits. A preferential-trade regime lowers tariffs (to zero under a free-trade regime) among member countries while maintaining higher WTO-consistent tariffs with the rest of the world. Such preferential-trading arrangements make economic sense when there is a high level of intra-industry trade and investment among trading partners that result in many cross-border transactions with negligible impact on net tariffs. In the absence of such economic linkages, a preferential-trade regime would induce the import of final and intermediary goods from the preferential-trading area that would be uncompetitive under the WTO regime and would, thus, result in harmful trade diversion.
Bilateral trade is also stunted by the current visa regime, limited trade routes, low capacity for transport on overland routes, generally poor trade facilitation on the single land route (Wagah-Attari), and poor banking channels.
WTO-consistent, “most favored nation” trade with India will require Pakistani firms to reorient supply chains to potentially more profitable Indian sources. This necessitates unfettered access to each other’s markets to identify opportunities and strike business deals. Disruptions caused by travel bans and suspension of trade routes would do little to encourage Pakistani firms to develop supply lines with India. The curtailment of economic transactions following the Mumbai attacks was costly and some businesses that were beginning to tap into Indian technical and management expertise were badly burnt.
The potential gains from bilateral trade—in terms of regional economic vibrancy, strengthening of economic growth, creating much-needed productive jobs, and ushering in peace and stability—are virtually limitless. The process of liberalization must not be disrupted for the noneconomic objectives of the grand strategists in Pakistan and India nor stunted by the narrow interests of the protectionist lobbies.
Nabi is country director of the International Growth Center in Pakistan and a visiting professor at the Lahore University of Management Sciences. From our April 5, 2014, issue.