T C A Srinivasa-Raghavan: Regionalism: The way to go

LINE & LENGTH

The Comprehensive Economic Cooperation Agreement signed with Singapore earlier this week will be notable for many things. But the one thing that catches immediate attention is the muted response of the multilateral fundamentalists.

Until even a year ago, they would have worked themselves into a rare state. Their response after the free trade agreement with Thailand in 2003 was loud and persistent.

But not this time. It is almost as if they have thrown in the towel and resigned themselves to the inevitable. The reason is that RTAs have become the norm. Only the fundamentalists were holding out in the trenches.

The growth of regionalism has in fact been one of the major international developments after the Second World War. The term is a euphemism invented by America to describe a situation where groups of other countries have kept it out of their markets (and more recently, it has kept them out of its own markets).

The truth is that regionalism has always had two dimensions. The first is the political part, of maintaining order in the international system. The second is the encouraging of economic cooperation within that region. Which comes first is anyone's guess.

But one thing is clear: Countries seem to feel less threatened by regionalism than by globalisation. The proliferation of regional arrangements attests to their popularity, maybe for this reason.

Economists, however, as is their wont, have been arguing against regionalism in favour of multilateral trading arrangements. But as usual they are about 20 years behind the times. Even the US, the once high priest of multilateralism, moved away from it in 1984, when it first started putting together Nafta.

In economics literature, in spite of the evidence substantiating the usefulness of regional trading arrangements, the glass has always been half empty or half full, depending on the perspective. This is not surprising. It is genuinely difficult to determine whether such arrangements are good things or bad.

Most trade economists are agreed that they are bad. Most commercial interests think they are good or at least better than multilateral arrangements because they limit competition and provide preferential treatment. And most governments tend to follow the interests of the latter, especially when collateral political interests can always be tagged on to the group.

Perhaps the only issue to be determined is if, in the medium term, such an arrangement allows member countries to restructure themselves to a level of efficiency that is a few notches higher. In that sense, it is not unlike the different leagues in sports when teams move from lower leagues to the higher ones as their skills improve.

That said the case for regional trading arrangements cannot be pushed beyond a point because, first, they are inherently temporary in nature because their benefits to the more light-footed countries begin to diminish with time. These then want to move up the ladder.

Second, purely from an incentives point of view, in the long run such arrangements can create more problems than they solve because they create the wrong sets of incentives, especially in the complex rules of origin game.

The other question is, albeit a theoretical one really, is whether RTAs can coexist with multilateral arrangements. In practice they can if only because given a particular technology, distance and transport, costs create optimal trading areas. Outside of these it makes no real sense to trade except for grossly undervalued currencies, such as that of China now and Japan in the 1970s and 1980s.

But is regionalism always successful? Politicians seem to think so but that is because they fail to distinguish between the necessary and sufficient conditions for regional cooperation and/or integration to succeed.

Necessary conditions are those without which the desired outcome will not be achieved, no matter what else happens. Political will is an example of this, as is the existence of a regional trading agreement.

Sufficient conditions are those conditions alone that ensure the outcome by being present. But these are very rare because the requirements are stronger in order for a condition to be sufficient.

It is rare, or well-nigh impossible, to find a condition that is both necessary and sufficient. However, external threats combined with open economies have almost always led to regional agreements.

Then there is distance""or more accurately, the absence of distance. Not to put too fine a point on it, trade over shorter distances has, is, and will always be, preferred to trade over longer distances.

The idea that trade and investment are distance-neutral is simply not true, except in the case of disembodied services that can be delivered via satellite. For every other form of trade, distance is important. The proportion of trade over shorter distances increases over time in relation to trade over longer distances. The point is too obvious to be laboured.

It is no surprise therefore that China has replaced the US as Japan's largest trading partner. Likewise, India's trade with China has grown more than it has with Japan. The reason is that, all other things remaining the same, the cost of transport per unit of trade makes a difference to the profit per unit sold.

Incidentally, of the many features that distinguish the twentieth century, the decline in transportation costs has received very little attention. This decline has resulted in monumental changes in patterns of trade and investment.

Attention has been focused on how far away places have begun to trade with each other. But what is less focused upon is that this process has resulted in regional integration on a scale hitherto unimagined.

The most striking example of this, of course, is Europe. But the same thing has been happening elsewhere also, less speedily perhaps but quite as surely. East Asia is a case in point and it is beginning to look as if South Asia too will follow suit in due course.

Until that happens, India seems to have decided, not without reason, that it may as well get into arrangements with countries outside Saarc. The Thailand deal was the first. The one with Singapore is the second. More will probably follow, including perhaps one with China.

The short point is that the centre of economic gravity in the world is gradually shifting towards Asia. The West can either be part of the solution, in which case it can join us.

Or it can be a part of the problem creating obstacles""and be left behind.

Grateful thanks to the Asian Institute of Transport Development and UNESCAP for allowing me to excerpt heavily from a paper presented at the Second UNESCAP-AITD ANTLER Conference, New Delhi, April 14-16, 2005