The "Forgotten" Economics in the SAFTA Debate -- by: Athar Osama

With the recently concluded meeting of the SAARC Leaders in Dhaka, the debate on the South Asian Free Trade Agreement (SAFTA) has once again come into the forefront of the foreign policy discussion in the region. Many Pakistani newspapers have carried news items and editorials on the subject. On November 11, 2005, for example, this newspaper carried a news clipping that suggested that the Foreign Ministers of the the seven South Asian countries were meeting to "push a free trade agreement". If this were to come true, the resultant South Asian Free Trading Area (SAFTA) would create the world's biggest free trade area comprising 1.4 billion people, including 60 per cent of the world's poor. The news item, however, did not stop here and went further to quote an "anonymous" source in the Foreign Ministry as stating that the council of Foreign Ministers of SAARC states would aim to push regional integration forward to include "trade in services, enhanced investment and harmonizing of customs union and, beyond that, a South Asian Economic Union." (SAEU)

While much of this, one would assume, is likely to be merely hype and symbolics, the discussion and its portrayal in the media, however, is striking in its lack of participation of the trade experts and theorists of the region. Like war, politics and economics too are too important to be left to politicians alone. It is not only the right of the people--the citizens of all seven of the South Asian countries--to know the various arguments in support for or against the establishment of SAFTA and SAEU but also to be fully engaged in the decision, if and when such a decision is required of them. It is not merely an act of coincidence that European Union, over the last decade or so, has seen several referendums to judge the opinion of the respective people of its member countries on whether and how to proceed forward with greater integration. Free trading areas, and especially economic unions, whenever they come about, require tremendous commitment and impose disproportionate costs on various segments of the populations of the countries involved, that must be taken into account and catered for before moving forward, or at the very least, must be made known to those who are most likely to bear these.

Yet, in their enthusiasm to become a part of a free trading zone or an economic union and not be left out in this new found euphoria, politicians and even trade experts, in the recent years, have talked rather casually about these very serious instruments of economic and trade policy. The political and economic costs of miscalculation or misadventure are substantial, not only in terms of the opportunity cost but also the distress and dislocation of affected segments of the population. This article is an attempt to critically evaluate the possible effects of SAFTA in the light of the economic theory and practice of trading blocks. In a future article, I would address the broader issues and challenges in putting together an economic union of SAARC countries. For paucity of space and time, this would clearly not be a conclusive discussion on the subject. What it attempts to do, however, is to highlight certain elements of our collective knowledge and experience that is clearly missing from the ongoing debate leading to these momentous events and decisions in our history. It is important that we ponder over these issues, debate their value, and exercise adequate judgment and caution moving ahead with these irreversible, and potentially costly, changes.

The trend towards greater regionalization in the international trade has been continuously evolving alongside more one of greater globalization. These developments are partly motivated by the realization, on the part of the western nations, of the political difficulties of trying to 'pull everybody together on the high-road to prosperity through trade liberalization' and partly due to the mere negotiating burden of establishing a worldwide free-trading regime as has been experienced during the Uruguay and Doha Rounds of trade talks. The approach of pursuing concurrent regionalization and globalization of trade, therefore, allows their proponents to materialize whatever gains from increased trade that they can without having to wait for the entire world to come on board. While this trend towards regionalization of trade has certainly helped in pushing the agenda of the multi-lateral trade talks, the benefits of these regional arrangements have been more suspect.

Before we attempt to theorize the potential benefits of SAFTA by looking at the benefits realized from other similar arrangements, like EFTA, ASEAN, MERCUSOR, GCC, and NAFTA etc., it is important to revisit some lessons from the trade theory. The theory of international trade has come a long way from its simplistic view of Ricardian comparative advantage that advocated the welfare enhancing effects of free trade "no matter what". Paul Krugman, an influential MIT economist, having pioneered the field of strategic trade theory, acknowledges the inevitable ground reality "that everybody could gain, however, doesn't mean that every actually does".

Several trade economists have highlighted the conditionalities that must precede the realization of substantial benefits from various kinds of free trading and economic integration agreements. Maskell, Lipsey, and Viner talk about these in the context of a customs union, for example. According to them, some of the economic characteristics of countries that are ideal to create welfare-enhancing customs unions (and by that extension trading blocks and economic unions) are: complementary yet competitive economic and industrial structures; greater proportion of trade among members relative to total trade; closely coordinated exchange rates; larger economic area; less complementarity vis-à-vis protected industries; greater differences in cost structures of production of similar products among members; and greater range of products etc.

In fact Mikesell, while specifically looking at the prospects of trading arrangements between developing countries, stresses that many of the characteristics of the developing countries contemplating such arrangements, namely, intra-regional trade comprising mostly commodities (either due to complementary natural endowments or agricultural escape clauses), non-existence of trade in manufactures or industrial goods, generally import substitution orientation, disparate levels of development, and lack of proper redistribution policies make them unfavorable candidates for such arrangements, especially if undertaken amongst themselves.

The prescription from this analysis being that developing countries with similar economic and social structures stand a much lesser chance of benefiting from free trading agreements and economic integration arrangements, and therefore, must be very cautious before attempting to implement these. Maskell, however, allows for the possibility that while, for developing countries, the opportunities of static ( i.e. one time) welfare-enhancing benefits from such arrangements are small, there might be some dynamic benefits to be gained over the longer run. These include possibilities of greater specialization by altering the consumption and investment patterns, increased competition within industries, and major re-organization of domestic markets.

The overwhelming evidence from three free trading arrangements between similar sets of developing countries, namely, Mercusor, GCC, and ASEAN, however, tells a different story. Mercusor ( i.e. Mercado Cummun del Sur or Common Market of the South) is an economic arrangement of Latin American countries with Brazil and Argentina being the leading players in the arrangement that includes smaller countries such as Peru, Uruguay, and Paraguay etc. Started with much fanfare in 1991, Mercusor has little to show in progress against its very ambitious goals and has almost gone into an oblivion.

GCC ( Gulf Cooperation Council) is another arrangement between relatively similar developing (or semi-developed) countries in the Arab world that comprises 6 nations of the Persian Gulf, namely, Bahrain , Qatar, UAE, Saudi Arabia and Oman. With an initial deadline to establish a Common Market well past its year 2000 mark, it too has little to show in terms of accomplishments. The intra-GCC trade remains below 10% of the member countries' total trade of around $100 billion a year. The intra-Arab investment that it was supposed to generate shows and even more abysmal picture. Arab countries, on average, invest 1 dollar in other Arab countries for every 8 dollars that they invest outside the Arab world.

Similarly, while ASEAN seems to have made some headway in its political and social goals of achieving regional stability in South East Asia, its economic record is patchy. The main thrust of the ASEAN's economic arrangement was on joint venture investment cooperation between members which, some believed, would help create something along the lines of Europe's 'national champion' industries that would be able to exploit ASEAN-wide markets through effective monopolies and become competitive in the rest of the world. Three notable programs, namely, ASEAN Industrial Investment Projects (AIP), ASEAN Industrial Complementation (AIC), and ASEAN Industrial Joint Venture Program (AJV) were launched to undertake such projects. From its inception in 1967 until 1987, 30 AIC projects proposals had been considered but only 2 had been approved, both in the automotive industry. No AJV projects were implemented in the first six years of that program. The generally accepted verdict on these ASEAN schemes for coordinating investment projects and increasing complimentarity of the economic structures of the member countries is that they have failed because of the "effective opposition of national interests concerned for the profitability of their local investments".

The relatively thin record of achievements of the three economic integration arrangements most relevant to our experience calls into question the economic logic behind SAFTA itself. Clearly, the lessons learnt from several of the arrangements cited above or even SAARC's prior record on promoting intra-regional trade have not made it into the deliberations that have led to policy-making and target setting on SAFTA. The inherent logic behind the proposed, very ambitious, deepening of economic integration in South Asia seems to be that since the lesser ambitious schemes of regional integration ( e.g. SAARC itself) don't seem to have resulted in increase in trade between these countries, forging ahead with more ambitious ventures (such as SAFTA, SAEU etc.) might actually push things beyond a point of no-return and literally force these countries to enhance trade with each other.

This logic clearly does not internalize the idea that despite the ambitious designs of SAFTA proponents, the reality of the quite similar and even competing economic structures of these seven South Asian countries remains the same, and is not likely to change in the near future and/or without considerable expense and suffering for selected segments of population in these societies. Yet, none of these countries seem to have either a plan in place ( e.g. a social safety net for those who will lose jobs by hundreds and thousands) or even the will to share the disproportionate burden of costs that would have to be incurred if SAFTA is to ever be successful in doing what it plans to do. What these countries' leaders seem to be forgetting is that soon after the initial hoopla around creating such an arrangement would be over, it would be everyone left to fend for oneself in a rapidly changing and very turbulent economic landscape and, given the track record of governments in these countries, much of the brunt would be born by the poor and displaced workers themselves.

What good then is SAFTA for? Clearly, the short-term effects of putting SAFTA into place are likely to be turbulent and costly for certain segments of the member countries' populations. These, in the absence of corrective and compensatory mechanisms, are likely to lead to considerable displacement and misery to the workers. If the SAARC member countries are to justify the immediate benefits that accrue to some sectors at the expense of others, it is logical that they also devise adequate mechanisms to share the costs and alleviate the suffering of those who are on the wrong side of the trade equation. Mechanisms to do this have been in place in the European Union where the more fortunate members transfer a part of their benefits to the less fortunate ones and in NAFTA where the US government has a plan to compensate and retrain displaced workers to take up other jobs. The best SAARC countries have been able to do to plan for that transition so far is to come up with long "negative lists" of items that cannot be freely traded within the proposed SAFTA which, if one thinks about it, actually kills their entire purpose anyway. At the very least, we require setting up of a revolving fund to share the cost of this transition. This fund must be funded by member country contributions in proportion to the benefits they would derive from SAFTA and would disburse these funds to countries in proportion with largest economic dislocations.

It is also important, for realizing the potential long-term dynamic benefits of SAFTA, that proper consensus building must happen before the SAARC countries embark on this venture. Without the right consensus--among people but also among various governments and populations--this could potentially be a tremendous waste of energy and effort. What is the point of merely going through the motions if the countries are ultimately going to drag their feet on true trade liberalization, as they seem to have already started to do? What benefit--and to whom--would such a superficial effort likely to bring? Unless the true costs and benefits of SAFTA are analyzed and presented, in a transparent and convincing manner, to the people of the SAARC countries, appropriate institutional and organizational arrangements are put in place to deal with short-term costs and realize the promised long-term benefits of the proposed arrangement, the expectations of various state and non-state actors are managed appropriately, and steps are taken to address the sensitivities of various countries and minimize political resistance to the plan, SAFTA would remain an unrealized dream, at best, and a costly blunder, at worst. There is a lot that we can learn from the experiences of other such arrangements as we embark upon this venture of our own.

The author (Athar.Osama@gmail.com ) is a public policy analyst and a Doctoral Fellow at Frederick S. Pardee RAND Graduate School for Public Policy, Santa Monica, CA.