“India’s Trade
Policy Choices: Managing Diverse Challenges”
Citation: Polaski,
S., A. Ganesh-Kumar, S. McDonald, M. Panda and S. Robinson. 2008. India’s Trade Policy Choices: Managing
Diverse Challenges. Carnegie Endowment for International
Peace, Washington D.C.
Executive
Summary:
India is a country of contrasts, marrying huge potential
with profound and chronic challenges. Its recent high economic growth rates
have improved the prospects that the world’s second most populous country will
be able to raise incomes broadly for its 1.1 billion people and contribute to
global economic stability and growth. And yet India remains the largest
reservoir of poverty in the world, with 300 million poor people, according to
the national poverty line, and more than 800 million people surviving on less
than $2 per day, an international measure of poverty. Almost two-thirds of
Indians still live in rural areas and well over half of the population works in
the agricultural sector, where growth has stagnated at less than 3 percent for
the last decade. By contrast, India’s world renowned high-technology service
sector has grown strongly in recent years but still employs less than 1 percent
of the workforce.
Trade Policy Challenges
As India engages more deeply with the global economy,
its policy makers face the challenge of devising trade policies that take into
account the stunning diversity of its economy and people. While taking
advantage of opportunities offered by increased economic integration, they must
manage the challenges that a more open economy will pose for the majority of
Indian workers and farmers. The country’s current commitments on trade policy
through institutions such as the World Trade Organization (WTO) are modest and
leave broad policy discretion over tariffs and other trade measures in the
hands of national policy makers. As India pursues a new multilateral trade
agreement and numerous bilateral and regional trade pacts, it is moving into
uncharted territory, where the decisions it makes will constrain its existing
policy space and have a significant impact on the evolution of its economy.
This study seeks to contribute to the knowledge base upon which the Indian
government and public and the country’s international trading partners can
evaluate the difficult policy choices the country faces in the realm of trade.
The study uses a global trade model and a national model of the Indian economy
to explore the effects of a range of possible trade choices on the economy, its
sectors, its workforce, and its households. The study simulates potential
outcomes of the Doha Round at the WTO and several possible bilateral free trade
agreements (FTAs), including a trade deal with the
European Union (EU) that is currently under negotiation and possible trade
pacts with the United States and China. It also considers other potential
effects of closer integration with the global economy by simulating changes in
the global prices for rice and wheat, the two most important food grains in
India. World agricultural price changes would affect India differently if it
binds its tariffs at lower levels.
The Main Results of the Study
Of the potential trade pacts simulated in the study, a
multilateral agreement at the WTO has a much larger impact on the Indian
economy than bilateral trade agreements with the EU, the United States, or
China. Overall, India’s real income would increase by about six times as much
under a Doha agreement compared with the gain from the most beneficial
bilateral agreement. Still, the gain would amount to only about $1.2 billion,
or one-quarter of one percent of the current economy. Exports would increase by
about 4 percent, while imports would grow by about 3 percent. Domestic
production would increase by about $4.5 billion, or one-half of one percent. A
Doha agreement along the lines of the study’s simulation would be positive, albeit
quite modest, for India.
The simulations of changes in the world prices of rice
and wheat show potentially significant effects on the country if it binds its
agricultural tariffs at levels that would prevent it from offsetting global
price shocks. For example, a 50 percent decrease in the world price of rice
could have a negative impact on India’s real income as large as the positive
impact of the entire Doha agreement as simulated in the study. Even a 25
percent decrease in the price of rice has negative effects on all major
components of the Indian economy, including private consumption, investment,
exports, and imports. Seventy-eight percent of households would experience real
income losses from such a price change, and the distributional impact would be
regressive, with the poorest households losing the most. These results suggest
that the Indian government’s concern over the potential negative effects of a
Doha agreement on poverty and rural development is well founded and that it has
been correct to seek provisions such as a “special product” designation for
agricultural products that are important to livelihoods and a “special
safeguard mechanism” to allow it to shield domestic producers from sharp
negative price shocks to key commodities
The simulation of a free trade agreement with India’s
largest trading partner, the European Union, shows that Indian exports would
increase by about 5.5 percent and its imports by 3.4 percent, more than under a
Doha agreement. However the overall impact on India would be slightly negative,
with overall real income and private household consumption showing small
declines. An India-U.S. free trade agreement has smaller effects on India than
an agreement with the EU, which is not surprising given that the existing trade
relationship is smaller. Exports and imports increase by roughly one-third as
much as under a pact with Europe. The overall impact on the economy is slightly
positive, while households lose slightly.
An India-China FTA, which is the subject of a feasibility
study by the two governments, would produce even smaller gains for the Indian
economy than would an agreement with the United States, along with smaller
losses for households. Exports and imports would each increase, but by smaller
amounts than under the other bilateral agreements.
Creating employment is an important goal of the Indian
government, both to absorb unemployed workers, currently estimated at about
40.4 million, and also to generate opportunities for the large numbers of
underemployed workers in rural areas and the estimated 7 to 8.5 million annual
new entrants into the labor force. All the trade pacts simulated in this study
would induce small increases in demand for unskilled labor, with a Doha
agreement increasing demand by 0.9 percent (about 4 million jobs based on
current employment levels). An India-EU FTA would increase demand by 0.5
percent (about 2.3 million jobs), an India-U.S. FTA by 0.3 percent (1.4 million
jobs), and an India-China FTA by 0.2 percent (900,000 jobs). Although these
additional positions would be welcome, they represent a very modest
contribution to India’s employment needs. Clearly, employment creation will
depend much more on Indian domestic demand than on export-led growth for the
foreseeable future.
The results of the study indicate that continued trade
liberalization, particularly at the multilateral level, can contribute to
India’s growth and development. However it must be recognized that the
potential gains are modest and the risks are not insignificant. Balancing the
defensive interests of India’s poor households with the quest for improved
efficiency and market opportunities will require careful trade negotiations and
appropriate complementary measures.