Revisiting international trade's role in domestic development

Unlocking trade-enabled economic development alongside tenets of development including gender equity, income inequality, infrastructure, and other SDGs is very much possible

Against a backdrop of rising trade protectionism, increasing bilateral trade agreements, and a growing body of evidence supporting trade’s positive influence on economic development and job creation, India has an opportunity to revisit international trade policy consistent with its own domestic development agenda. Specifically, revisiting policy with the potential to address the modern economic, social, and environmental dimensions of sustainable development. In this article, we explore why trade and economic development—especially poverty alleviation—has had mixed results, why we believe integrated trade and domestic policies could address some of the issues, and four tensions we must address to develop a more progressive and inclusive trade policy specific to India.

Importantly, this re-exploration addresses a 50-year-old convention and bias against international trade for developing countries for two reasons. First, that it prevents the poor from benefiting from trade with countries with higher productivity—a bias rooted in the idea that developing countries’ exportation of primary products would largely exploit natural resources and limit higher-value job creation, given those economies were valued primarily for low-cost labour and mineral resources. That, despite near-term gains from exports, in the long-run, such transnational trade benefits developed economies at the cost of developing ones. Second, the idea that imposing high import tariffs benefit developing countries through important substitution, inducing domestic production and higher-value job creation. This led to a belief that international trade worked well for already well-endowed developed countries but exacerbated domestic inequality for developing countries by displacing domestic economic activity. This view on trade protectionism is dated. Unable to reflect the empirically positive experiences of other Asian and Latin American countries, India’s own enhanced capacity, and an opportunity for India to participate in global value chains (GVCs) in an increasingly polarized geopolitical context (e.g. iPhones made in India). 

Several Asian economies followed an export-led trade development path in the 1970’s, including Taiwan, Korea, and Singapore. At this time, China remained focused on domestic capacity and India followed an import-substitution strategy. Recently, beyond China, we have seen the export-led rise of Bangladesh, Vietnam, and Malaysia over the past two decades. While these economies focused initially on competing in areas where low-wage and natural resources provided an advantage, they all migrated over time to higher-skill and higher-paying products and jobs. This boosted jobs and wages among lower-income segments of the workforce, leading to greater economic growth. Unlike 50 years ago, however, the ill-effects of industrialization including air pollution, afforestation, water contamination, indigenous population dislocations, and degrading labour rights, are critical inputs to consider for any development path discussion today. 

Since 1978, China followed a concurrent privatisation and trade liberalization program, opening state dominated industries to non-state entrepreneurs. Domestic policies focused on labour deepening, price reforms in agriculture, labour reallocation from agriculture to non-state industries with higher per-capita productivity, capital deepening and development of the coastal regions and SEZs with tax incentives to attract foreign investors. More recently, as US tariff barriers and Chinese labour costs rose, China opened its domestic financial markets in a bid to shift its proposition to foreign companies from efficiency-seeking to market-seeking FDI. Having built a strong position as the preferred destination for global manufacturers, it is now opening its financial markets. 

Recently, there have been compelling correlations published on the confluence of integrated trade policy with economic growth, job creation, and inequality reduction. We also believe much of these economic and social objectives can be achieved while keeping sustainability commitments on track. 

Why past results have been mixed. We certainly have examples of successful export-led industries in a few industries in India: generic pharmaceuticals, chemicals, and IT Services among them. Yet, many of our past efforts have fallen short in seizing opportunities enabled by trade, domestic industrial policy, and labour policy. Natural opportunities in job-rich areas such as textiles, auto components, and agriculture remain partly unrealized. There are structural issues that a revised trade policy can address. 

First, in India’s current trade context, and as past lessons from Latin America demonstrate acutely, high economic growth rates do not protect us from balance of payments pressures and do not deliver adequately sufficient employment gains. Also, GDP growth rates that don’t benefit from trade often requires funding growth through borrowings instead of growth through earnings. Even as India remains a favoured destination for FDI, a disproportionate amount goes into the services sector, not into manufacturing. To put this into perspective, average FDI from FY15-FY21 into manufacturing was $8.6B compared to $25B into services. Under this model, higher-paying white-collar jobs will continue to outgrow blue-collar jobs which are necessary to address increasing inequality among semi-skilled workers. This will need to change if India wants to achieve its goal of becoming a $5T economy and reduce poverty at the same time. 

Second, the positive impact of trade liberalization on GDP growth is understood, but its impact on income distribution and therefore poverty is not well understood, as seen for example in an IMF study by Dr. Topalova. With large vulnerable populations, where income inequality is already pronounced, the idea that increases in growth could exacerbate inequality, comes at significant social and political costs. However, this research focusing on within-country variations, instead of cross-country comparisons (which suffer myriad comparison issues), may be more relevant to India’s context. This study demonstrates that geographical and inter-sectoral labour mobility, and industry concentration are critical factors that explain the relative progress, or its lack, in poverty alleviation for rural Indian districts in particular. In a regression framework, Topalova establishes how district poverty and inequality are related to district-specific trade policy shocks. Further, they demonstrates that major tariff adjustments made in the past were uncorrelated to the industry’s perceived productivity potential. 

Finally, in many developing economies, the benefits of tariff and trade protected industries flowed mostly to a politically connected elite, exacerbating domestic inequality. Acknowledging that policies have not adequately accounted for market mechanisms and institutions that work for the poor. As Abhijit Banerjee and Esther Duflo explain, policy makers have a natural bias towards seeking big change for big results despite an increasing body of evidence that suggests a series of small adaptations and shifts drives bottom-of-the-pyramid impact and its rewards. This is a bias that exists on all sides of the political spectrum. In Poor Economics, they describe a quest for ‘big interventions that reallocate or invest large sums to remake the poor all at once’ and achieve progress through ideas that scale-up rapidly, without an adequate understanding of how the poor make decisions about important factors like mobility and investment. 

Revisiting trade policy will require us to openly address some natural tensions and trade-offs, have greater confidence in our competitiveness, and embrace the current geo-political context. We believe there are at least four tensions we must resolve in order to explore more open trade policies:

Tension 1: That trade-enabled economic development does not trickle-down to the poor, leading to increased economic and social inequality. The primary question here is whether trade policy and domestic poverty reduction methods can go hand-in-hand. We believe they can. 

Tension 2: Acknowledging a coherent solution requires Trade policy and industrial policy to go hand-in-hand. This requires harmonizing tariff liberalization, investment liberalization and trade facilitation implementation, even as these are often influenced by competing priorities. The primary goal here is to develop an integrated framework that gets all three right in the context of specific opportunities and trading partners. While independently these levers have been shown to have a positive impact, an integrated liberalization approach magnifies both economic development and reductions in inequality. 

Tension 3: Participation in global value chains (GVCs) and free trade agreements (FTAs) with important trading partners presents a significant opportunity, while balancing geo-political considerations. India can present a more confident face and drive the narrative as a more mature economy by securing a larger share of GVCs before demanding local value addition. The primary question here is one of preparedness and timeliness, and whether long-pending domestic economic reforms can be accelerated by trade, and not a bottleneck to participate in GVCs and well-crafted FTAs. Can reforms and trade be mutually symbiotic and reinforcing? 

Tension 4: That multilateral trading policies and systems may be inadequate for the new normal in trade relations where free trade agreements (FTAs) are gaining rapid acceptance, and speed matters. Further, finalizing these FTAs in a timely manner with countries where we share a complimentary trade relationship requires speed and adopting a proactive instead of passive or defensive stance. 

In conclusion, the evidence required to build confidence in economically and socially progressive trade—one that enhances India’s share of global and regional trade with an integrated and more liberal trade policy for India—should be an urgent priority. Unlocking trade-enabled economic development alongside tenets of development including such as gender equity, income inequality, education, infrastructure, and other SDGs is not only possible, but with the right frameworks in place, within reach. 

Nirvaan Pandit is a Research Intern, Infisum Modelling Pvt Ltd, India

Dr. Badri Narayanan Gopalakrishnan, Former Head, Trade and Commerce, NITI Aayog.