The Political-Economy of the South Asian Economic Union -- By: Athar Osama

In a preceding article on the subject, I analyzed the merits and demerits of South Asian Free Trade Agreement (SAFTA) from an economics standpoint. I concluded that if economic theory and the experience of existing trading arrangements was any sign of things to come, SAFTA does not seem to make much economic sense, at least not in the short run, and without adequate the necessary safeguards and sharing or transfer of costs and benefits among participant countries--mechanisms that they have, thus far, largely hesitated to put in place or have ignored outright. The political-economic ambitions of the region's politicians, however, do not stop here. The 2002 Katmandu Declaration on Economic Integration, in addition to calling for creation of a South Asian Free Trading Area by 2006, calls for the creation of a South Asian Customs Union (SACU) by 2015, and a South Asian Economic Union (SAEU) by 2020.

In this article, I would go beyond the case for SAFTA and examine whether, in the longer-run, a South Asian Economic Union along the lines of European Union, for example, makes any more or less sense than the former. In doing so, I would look at the issue from two lenses. Firstly, what additional effort and political-economic capital would the SAARC countries have to spend to realize a full-blown economic union, under what circumstances does that make sense, and what bottlenecks might be expected along the way. Secondly, and more importantly, whether or not a political rationale for moving forward with an economic union change our decision calculus, and if so, what are the implications of that for how the countries must approach the current (and on-going) efforts to bring about SAFTA in the lead on to an SAEU.

To answer the first question, it is important to first understand what various types of trading and economic integration arrangements mean and what are their inter-relationships with each other. These agreements can be broadly characterized under two classes, namely, free trading arrangements-blocks and economic integration schemes. The former-type deal strictly with ever deepening level of trade cooperation between participant countries while the latter-type includes other aspects of national policy, in addition to the trade, as well.

The various classes of trading arrangements start from a natural trading block that is an informal and naturally occurring ( i.e. not achieved through conscious policy choice) arrangement between countries which trade disproportionately with each other; to a preferential trading agreement in which two countries choose to apply lower tariffs to each others' products than to the same goods coming from other countries; to a free trade area that comprises an association of trading nations whose members agree to remove all tariffs and non-tariff barriers among themselves; and finally the customs union that is an agreement between two or more political jurisdictions to abolish customs duties and other trade restrictions among themselves and to adopt a common policy regarding trade with political jurisdictions outside the union.

Among the second class of these arrangements, namely, the economic integration schemes, are the common market that requires, besides the establishment of a customs union, the free movement of all factors of production, namely, goods, capital and labor and a gradual coordination of economic policies to sustain the arrangement; the monetary union that requires national governments to give up two key instruments of economic policy, namely, exchange rates and monetary policy, followed by establishing of common foreign reserves and a common stand on international monetary negotiations ; and finally, the economic union that goes beyond the monetary union and requires harmonization of social, taxation and fiscal policies by a supranational governing institution through a partial or complete transfer of national sovereignty.

What is interesting about this taxonomy is the pre-requisites and conditionalities as well as the relationships between the various kinds of arrangements. Establishing a customs union, for example, requires a lot of give-and-take on the part of the participants as they have to come up with a mutually agreeable and uniform external tariff structure that all members could live in. While a free trade area, on the other hand, allows some degree of relaxation as members
can have their own external tariffs for non-members countries that allows them, to an extent, to protect their import competing sectors. In Paul Krugman's words, therefore, "the latter [free trade area] is politically straight forward but an administrative headache, while the former [customs union] is just the opposite". Setting up each successive layer of integration also requires expending increasing levels of additional economic and political capital on the initiative. While the conditions for free trade areas and customs unions are relatively technical, setting up a common market requires considerably more commitment through factor mobility that might in turn require certain social commonalities like language, ethnicity, race and non-discrimination in certain elements of public policy. Going a step further, for example, in setting up an economic union calls for an even greater commitment and coordination between its members as it requires, in its strictest form, the alignment of monetary, fiscal and even social policy – all of which are generally considered as sovereign rights of a nation state.

C. Westerate, in a 1948 paper titled "The Economic and Political Implications of a Customs Union", talks at length about how the establishment of a Customs Union requires not only the absence (between the union countries) of import duties, quotas and exchange controls, but also of other protective measures, such as export subsidies and preferential rates etc. In a very simple yet convincing way, Westrate goes on to elucidate how an Economic Union between countries is bound to imply that the countries must have identical policies on a whole range of economic and social issues such as price policy, internal monetary policy, credit policy, wages policy, labor legislation, taxation policy, international trade policy, employment policy, external monetary policy, trust and cartel policy, and policy vis-à-vis nationalization of industries etc.

Westerate's analysis highlights how imbalances between these policies of member countries would lead to capital and labor flight towards the country of favorable policy position and thus undermine the political feasibility of such a union. Simply speaking, if SAARC countries are to form a South Asian Economic Union one day, they must be prepared to relinquish sovereignty over a whole list of policy areas not only within the trade sphere but also within the broader socio-economic sphere as well. Under this scenario of open and free movement of goods, capital, and labor, therefore, if any one of the SAARC countries (lets say India or Pakistan) want to encourage a certain industry by providing some protection or subsidies to it, this action is likely to create imbalances in that country in the favor of that particular industry which would mean that that industry in other countries would begin to migrate to this favorable country. This is going to mean a loss of revenues for the country where the industry is migrating from and hence attract retaliatory treatment of some sor thus jeopradizing the political feasibility of the economic uniont. The same dynamic plays out in all of the above mentioned policy areas.

This, Westerate argues, means a loss of policy sovereignty for all of the member countries involved, irrespective of whether they like it or not. Failing to do would mean that either the economic union would collapse under political pressures or the full benefits of an economic union would not be realized by the participating countries. Westerate's analysis, taken on its face value, has considerable logic behind it. It also imposes a very strict set of conditions on any such proposed venture. Setting up a customs union, a common market, or an economic union is certainly no child's play. It is very serious business that raises a whole Pandora's Box of interesting issues and challenges for the participating countries. Are the countries involved committed enough to the idea of an economic union that they would make the hefty economic, social, and political sacrifices needed to realize such an arrangement? Are the imperatives of setting up an economic union strong enough that the participants are willing to give up their sovereignty of economic and social policy? Are the countries involved willing to share--through mechanisms of fiscal transfers--the burdens that might, time and again, accrue to them due to the loss of autonomous policy-making ability?

Until these and other tough questions are adequate addressed by the politicians and people of the respective countries, the claims of setting up common markets and economic unions are just that--merely claims. Since the political requirements of undertaking an economic union are much more difficult and stringent than a common market or a free trading area, there is sometimes a likelihood that the strictest of all the conditions could eventually end up driving the results of even the preliminary stages of integration. This has particularly been the case with SAFTA and its precursor SAPTA (South Asian Preferntial Trading Area) whereby political considerations and rivalries have often hampered the realization of welfare benefits from the relatively harmless free trading arrangement.

What is, then, the future of the South Asian Economic Union? The answer to that question comes from the political rather than economic realm. As alluded to in a recent article by Dr. Shahid Javed Burki, a ex-WB economist and longtime proponent of SAFTA, the overriding motivation for forcing these seven South Asian countries and their 1.4 billion people towards greater integration are clearly political. After the end of the second world war, for example, it was inconceivable that Germany and France would ever enter into an economic arrangement--much less a union--of the kind that they find themselves in today. Some have argued that the biggest benefit of the EFTA and EU is that it has diminished the prospect of another war between these traditional European rivals to a virtual impossibility. Similar factors were at play when ASEAN was founded in the 1960s as the smaller countries in South East Asia region vowed to cooperate amongst each other to guard against possible invasion by larger players in the region ( e.g. China, Korea, and Japan). That seemed to have worked thus far as well.

The proponents of SAEU--whether they belong to the SAARC region itself our outside of it--are clearly looking at the larger political gains that are to be achieved from this scheme. Whether SAFTA and SAEU would be able to tie these seven South Asian countries, often at odds with each other, in bonds of friendship and tolerance is an open question. If anything, the past record of SAARC seems to suggest the opposite. Through its history, SAARC has been seriously hampered by the regional rivalries of these countries, especially that of its two largest players, India and Pakistan. Would forging ahead with SAFTA/SAEU change the foreign policy dynamic between these two very important members of the group or would it become another classic case of throwing good money after bad?

If the past and current behavior is a credible sign of things to come, the chances of realizing its political objectives of the SAFTA/SAEU are somewhat questionable. This is primarily because of the demonstrated lack of magnanimity among its larger members, most notably India, towards the smaller ones. While Indians may have lesser to gain economically from such an arrangement, they certainly have much more to gain politically if SAFTA or SAEU is to become a success, for it would not only cement India's tricky relationship with its neighbors but would also give it the largest share of representation in the unified voice of a (sub-)continent. Besides, as has been the case with EU and NAFTA, successful and sustainable economic integration arrangements require a large country to act as an anchor for the arrangement. The question is: Can Indians make the kind of sacrifices (made by larger EU members e.g. Germany and France) needed to make this arrangement a reality? Can India really prove themselves worthy of leading a group of skeptical countries without actually making them feel that they are being led? Can India show the kind of magnanimity fitting of an emerging super-power that has no insecurities about its new-found status--and hence no need to assert it--that would be required of an anchor country to make SAFTA/SAEU a success? This is the same role, played by Germany and France for the EU and the United States for NAFTA, that have helped keep these arrangements on track.

If the unsuccessful SAARC is to transition into a successful SAFTA (and more), the countries of this region would have to have a clean break from the past and build a different kind of relationship in the future. The onus for doing so clearly lies with India. Without that, SAFTA is likely to be still-born or, at the very least, lead to suboptimal results. The other countries of the SAARC region are justified in looking towards India's current actions, policies, and postures for signs of things to come. If, for legitimate or not-so-legitimate reasons, such degree of commitment is not to be expected of the SAARC countries, especially India and Pakistan, going forward with SAFTA, SACU, and SAEU is going to be a costly experiment whose failure can be easily foretold.


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