Good neighbours, bad neighbours

Politics seems to be outweighing economics when it comes to decisions on trade. On the one hand, there have been calls in India for an embargo on trade with both Pakistan and China in the wake of political tensions with both countries. At the same time, the Chinese media has been indulging in a fair bit of rabble-rousing over the issue as well, deprecating India’s dependence on Chinese imports and questioning its ability to live without such imports.

Where does India stand vis-à-vis its two neighbours and what should be India’s stance on trade?

Does China have an edge?

On the face of it, China seems to have an edge over India in matters of trade. It is India’s largest import partner, accounting for 16.2 per cent of India’s total imports. It is also the trading partner with which India had the largest trade deficit of $53 billion in 2015-16, compared to trade surpluses with the US and the UK. Moreover, while India’s overall trade deficit has been declining, its trade deficit with China — accounting for about 44 per cent of India’s total trade deficit — has been increasing over the last five years, driven by declining exports and increasing imports.

Contrary to popular opinion, Indian imports from China comprise not only cheap consumer goods but, more importantly, intermediates. India imported chiefly telecom instruments, computer hardware and peripherals, fertilisers, electronic components, project goods, chemicals and drug intermediaries from China in 2015-16. A ban on these imports will affect India’s manufacturing capability, as also prices in our markets, given the lack of cheap import substitutes for these goods.

Currently, all these goods attract a countervailing duty (CVD) and special CVD of 12 and 4 per cent respectively, while some of these goods attract a basic duty of 10 per cent additionally. A ban on these goods will thus not only lead to losses for producers — who use these intermediate goods for further production — and consumers — who will have to pay higher prices for drugs, etc — it will mean a loss of tariff revenues for the Indian government.

There are other effects as well. A rise in the costs of manufacturing the final products using these intermediate inputs would make our exports costlier, thereby reducing our export competitiveness. It may also give rise to blackmarketing and smuggling.

China, in turn, will have to bear the consequences of lower imports from India. China currently has 206 import partners and 209 exporting partners, with more than 8,900 products being traded among these partners. The network effect of trade, as also China’s position in global trade — as almost the epicentre of any shock — implies that what happens in China doesn’t remain in China. The complex cobweb of China’s own trade ties will lead to spillovers (from China to its trade partners), spillins (between trading countries that have China as a key trading partner and impacted by such initial shocks from China), and spillbacks (the reverse shocks on China from its trading partners impacted by initial shocks from China) of any trade disruption.

While India accounts for only 2.55 per cent of Chinese exports, it is one of the top 10 export partners of China. Moreover, India and China share the US as their chief trading partner. India’s size and its openness makes it a prime candidate to transmit any initial trade shocks that it experiences to the rest of the world. According to the IMF’s World Economic Outlook October 2016, India has the potential to amplify initial import shocks by 30 per cent and transmit to the rest of the world, including China. Thus, any bravado on the part of China may be equally misplaced, and unmindful of the harsh realities of an integrated world trading system.

The Pakistan angle

Pakistan accounted for only 0.74 per cent of India’s total exports, and 0.12 per cent of imports in 2015-16. However, these figures mask the large volume of informal trade between the two neighbouring countries.

According to certain studies, the volume of informal trade between these countries is twice that of the formal trade. The chief exports through the informal route include real jewellery (gold, diamond, precious stones), textiles, machinery and machinery parts, electronic appliances, paper, tyres, and so on, while the chief imports include textiles, spices, dry fruits, carpets and cement.

A proper understanding of the benefits of trade and attempts to redirect trade towards formal trade channels will result in a substantial reduction in transaction costs, given the long circuitous routes that such trade takes, chiefly the Delhi-Mumbai-Dubai-Karachi-Lahore route.

Talking about gravity theory

An influential trade theory, the Gravity Model, posits that the value of trade between any two countries, other things being equal, is proportional to the product of the two countries’ GDPs, and diminishes with the distance between the two countries. Thus, the US carries out a lot more trade with Canada — a country roughly the same size as Spain — and Mexico than with the entire EU.

The reason, of course, is that Mexico and Canada are closer to the US, and there are tangible and intangible factors promoting greater trade. It has been estimated that a 1 per cent increase (or decrease) in distance shrinks (or increases) trade by 0.7 to1 per cent. Political factors have, however, impeded India’s trade with its closest neighbours in South Asia, including China and Pakistan. In fact, South Asia ranks almost at the bottom among India’s trading partners by region.

The media in the respective countries need to wake up to the economic reality of trade and the power of trade gravity. While political rapprochment — especially in the wake of continued misdemeanours of the neighbours — may take time, a knee-jerk reaction by way of disrupting trade may exacerbate the respective countries’ problems, as also those of the global economy.

The writer is a professor of economics at the SP Jain Institute of Management and Research, Mumbai. The views are personal.