Simple economics: India would've incurred a huge cost by joining RCEP

Now, RCEP will incur the costs of losing the Indian market which was the only worthwhile market

India’s decision not to join RCEP has pleased some people and annoyed others. None of these people, however, are using basic economics as a reason for their reaction. 

There is a very simple condition laid down in economics. It’s called the Heckscher-Ohlin Theorem. It says that trade between countries depends on what David Ricardo, a very influential English economist in the 19th century, had called competitive advantage.  

He meant that countries export products that use their “abundant and cheap factors of production, and import products that use the countries' scarce factors.” 

In India, the abundant factors are labour and land. But neither is cheap. In fact both are very costly compared to the costs in most other countries. And capital being scarce is of course costly.

Simultaneously, the legal and regulatory arrangements which govern India’s markets for land and labour make it impossible for Indian manufacturing to scale up. And without scale, India can’t complete with China. That’s all there is to it. 

As it is, manufacturing contributes only around 15 percent to GDP. It used to be nearly 25 percent 25 years ago. 

If India joins RCEP, the share of manufacturing will fall even further. You can bet on that, because ever since India started entering into free trade agreements, the share of manufacturing has been falling. 

It has been argued that being part of RCEP will force major economic reforms in India. But that is an assumption. Recent history shows there is no relationship between reforms and opening up to greater international trade. 

It must also be kept in mind that China isn’t a trading country. It’s a selling country. It prefers to sell rather than buy. This is reflected in its trade account. It runs a trade surplus with every country that took part in the RCEP negotiations.

India told China, please buy more from us. China said no. It says no to everyone. That’s because of its political imperative to keep employment high. Otherwise it could face Hong Kong type problems. 

The second reason is the difference in attitude and appreciation. China, as a matter of policy, is focused on selling and not trading. India, as a matter of attitude and structure, is focused on trading, and not selling. 

This approach, along with the structural hurdles which the government has erected, has converted Indian manufacturers into traders. Even table fans are now imported from Thailand or China. Even the labels of Indian companies are not made here. 

Finally, everyone also forgets that RCEP was China’s defensive position after the 2008 crash. It feared protectionism in the US — quite rightly as it turned out — and decided to create its own economic free trade zone.

Those familiar with East Asian history will recall that Japan had sought to do precisely this. The difference is that it tried to do this by going to war first. China is building the zone peacefully but will go to war to defend it, which was the western imperial approach. 

  

So has India done the right thing in staying out of RCEP? I definitely think so.

Within RCEP, India would have incurred a huge cost. Without it, it’s RCEP that will incur the costs — of losing the Indian market which was the only worthwhile market.

Twitter: @tca_tca