International trade remains important

Nations with an open and free trade policy will make the most of the recovery in global trade

In the middle of 2022, international trade is being buffeted by a continuing global pandemic, a European war, widespread economic sanctions, battered supply chains and sudden national bans and caps on exports of essential commodities. Perhaps paradoxically, this may be the time to re-emphasise the critical importance of rule-based world trade for sustained global prosperity.

The growth of world trade has been nothing short of phenomenal since the Second World War. The World Trade Organization (WTO) estimates that global goods trade expanded, in volume terms, by about 40 times (4,000 per cent!) between 1950 and 2020 and nearly 300 times in terms of value. Of course, world GDP was also growing fast during this time, perhaps the longest global expansion in recorded history. Nevertheless, World Bank data shows that the share of world trade (including services) in world GDP soared from 24 per cent in 1960 to 57 per cent in 2010, before plateauing thereafter. Indeed, many economists attribute the unprecedented growth in global GDP principally to the sustained surge in world trade. Trade contributed to competitiveness, productivity and technical progress. To be sure, other factors, such as general technological progress, rising national savings and investment, and the spread of good education played important roles too.

A major propellant of this astonishing expansion in world commerce were the eight “Rounds” of multilaterally negotiated tariff liberalisations, under the auspices of the General Agreement on Tariffs and Trade, the precursor to the WTO, between 1947 and 1994. These negotiations were generally driven by industrialised countries, with developing nations being mostly “free riders”. Interestingly, after the formation of WTO, there has not been a single successful Round of multilateral trade liberalisation. The “action” has shifted mostly to a plethora of large and small preferential and free trade agreements (PTAs and FTAs), each with limited member country participation.

This long era of global prosperity, admittedly unequal across nations, occurred despite the prevalence of many local wars (if the death of up to three million Vietnamese in the 10-year Vietnam War, many due to American ordinance, can be described as a local matter). This is just to hint that the current conflict in Ukraine may not be as damaging to global trade and production as many fear. India too benefited as she liberalised her astonishingly complex and restrictive trade regime after 1990 and made the exchange rate market-responsive. India’s trade-to-GDP ratio, which had hovered between a measly 8 and 15 per cent between 1950 and 1990, rose smartly to 27 per cent by 2000 and peaked above 50 per cent in 2011, with the total (goods and services) exports share of GDP touching nearly 25 per cent, helped significantly by the rise in software exports.
 

Illustration: Binay Sinha

Since 2011, India’s trade share in GDP had declined markedly to 39 per cent by 2019, mainly because of the stagnation of her merchandise exports. In dollar value terms, these were only 8 per cent higher by 2018, while those of Bangladesh increased by 61 per cent, Myanmar by 82 per cent, the Philippines by 40 per cent, China by 31 per cent and Vietnam by a whopping 153 per cent (see my “Why Neglect Exports?” in Business Standard, December 12, 2019) Several factors may explain this lacklustre performance. First, by the usual measures (such as the Real Effective Exchange Rate), the rupee’s exchange rate was overvalued for much of this period. Second, as Amita Batra’s recent book, India’s Trade Policy in the 21st Century (Routledge, London, 2022) demonstrates persuasively, India’s failure to participate effectively in the rapid increase in global-value-chain-based trade after 2000, played an important role. Third, the marked rise in India’s tariffs and other protective measures after 2015 also militated against buoyant expansion of the country’s goods exports, both within and outside global value chains(GVCS).

The dynamism of world trade has certainly faltered since 2010, following the global financial crisis and other deglobalising factors such as Brexit, the Trumpian turn towards protectionism in the US, the vicissitudes of the global pandemic and the war in Ukraine and associated economic sanctions. However, it is noteworthy that world trade was fairly resilient during Covid, falling a little in 2020 and then rebounding strongly in 2021. In the medium term, it is quite possible that some of the setbacks of the last decade may lose their bite as time passes. In any case, both trade theory and past experience suggest that for any single nation the best trade policy is to maintain an open and unrestrictive trade policy.

In India too, the pattern has been similar: Substantial declines in both exports and imports in fiscal year 2020-21 followed by rebounds to record highs in 2021-22, partly fuelled by the sustained surge in commodity prices. That surge has strengthened in the first two months of 2022-23, raising the trade deficit to record levels and placing significant pressure on the overall balance of payments.

Looking ahead, the broad priorities for India’s trade policy remain the same as I have outlined in earlier columns:

• Phase out the tariff increases that have occurred since 2017 (some say earlier). As the Russian born, British-American economist, Abba Lerner, stated in his famous “symmetry theorem” of 1936, “a tax on imports amounts to a tax on exports”.

• In dealing with external payments pressures, exchange rate depreciation should be the prime instrument, not tariffs or quota restrictions on imports. One can add, that in dealing with inflation, monetary and fiscal measures are preferable to export bans and duties, which sometimes pave the way to balance of payments problems.

• The government’s recent initiatives to conclude early stages of FTAs with Australia and the UAE are to be warmly welcomed, as are the fresh discussions with other Gulf Cooperation Council nations, Israel, the UK, the European Union (EU) and the new Indo-Pacific Economic Framework. However, to significantly enhance India’s currently low engagement in global and regional value chains, none of these (except perhaps a serious FTA with the EU, which history teaches is highly unlikely to fructify) provides the kind of potential for trade expansion as offered by renewed engagement with the dynamic Regional Comprehensive Economic Partnership (RCEP) in our Asian neighbourhood.

World trade will recover from the manifold challenges of 2022. The question is will India be wise enough to follow the policies necessary to make the most of that recovery?

The writer is Honorary Professor at ICRIER, former Chief Economic Adviser to the Government of India and author of An Economist at Home and Abroad. Views are personal