How does trade-creating impact works?

Last updated on March 22nd, 2019 at 09:21 am

You know I am reminded of a line of Groucho Marx. This was a famous person in Hollywood in the early 1930s. He made the statement, which said that I don’t want to belong to a club, which will accept a goon like me.

So, I am thinking about this club, which used to be only six members, then it became 15 and now it is going to be 25. So clearly this is a club which people want to be a member of.

Actually, as you know, the whole point of having a club is that you got to have people outside it. Otherwise, it is no fun because if everybody is going to be a member of the club it doesn’t have importance.

By the way, since I am not handicapped by any diplomatic status please take my comments in the right spirit because I will say a few things, which might be a little provocative to some of the members in the panel. But I just want to share some thoughts and will be happy to interact later on.

I was telling the Ambassador earlier that it is often a matter of confusion especially if you look at it from the Indian perspective. There is a Commission, there is the Union, and there is the Euro Zone and so on.

Often, it is not clear to an average person what are the differences. I am sure that there are very critical differences. But, as I said, this is the reality. It has not happened yet. But it is going to happen very soon that we are going to deal with a big entity with 25 members.

So what is the impact of this and I will try and restrict myself to an Indian perspective because the Ambassador has already given the historical and global perspective. I just want to repeat what he said.

The enlargement leads to something like a 35% increase in area, almost a 20% increase in population or the labor force and however, less than 5% increase in GDP. These are the very rough benchmark I mean Ball Park numbers. This is very important to note because the existing EU members will somewhat labor scarce and capital rich countries.

Typically, I am talking about it from an economist’s perspective. Factors of production are basically labor and capital and they got to be in the right mix. So if you are in a country which is highly labor surplus or has much more labor than capital, you will find the emergence of much more labor-intensive industries such as agriculture or textiles or leather, footwear and so on.

And then if you are in countries, which have a small labor force you will find industries, which are very capital intensive, Iceland is a good example. Iceland is not a member of the EU Trade. They will be knocking on the doors soon.

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So what is happening is that this EU enlargement actually is leading to a much more proportionate increase in the labor force than capital. And I think this is important to note because what will happen is that there is going to be a very good complementarity.

As you know, once you have all these new members in the union whether it is investment laws or employment laws, movement of labor within the community or the European Union will be facilitated. So there is a sense of complementarity there.

Everybody likes to look at it as if in terms of the benefits that these new members will derive. But I think we should not ignore that there are going to be benefits to existing members because of this complementarity in labor and capital. So I just wanted to highlight that.

And apart from that, of course, the Ambassador said that don’t assume that everybody is going to start using Euro. But I think it is more or less a direction, which even the Marks and Spencer of the World have to take.

This is my personal opinion that even if the British have been resisting, trying to use the Euro, I am sure if you go to London today and you go to Marks and Spencer they will be very happy to put prices in Euros and so on.

So de facto we have got Euros spreading all over. So, therefore, I am willing to assume that it is going to happen, maybe not immediately. I would like to again point out that from an Indian perspective, what tends to happen is that when you talk of FDI, when you talk of capital account convertibility, India is still a relatively capital closed country, meaning to take capital in and out of the country is not as smooth, as let us say Thailand.

Although, I must say that there is de facto capital convertibility for corporates, for non-resident Indians, for, of course, non-Indians, foreign citizens and to a very limited extent to Indian citizens. However, it is not as smooth as Thailand.

So what Indian policymakers seem to say when it comes to FDI is that investment inflows are welcome but out-flows we will get twitchy and nervous. It is almost like or even on trade, exports are great but imports, well, we got to think about it.

It is almost like in a classroom, all the mothers, maybe fathers also, want their child to be above average. You can’t have in a classroom all above average students. However, in trade it is possible. Actually, in trade, it is possible to have a win-win interaction between two trading partners.

So here if you look at the impact of EU enlargement from the Indian perspective, I will just talk about exports. What it is going to do to Indian exports? There is a concern that when you have a big trading block it leads to what is called a trade diversion rather than trade creation.

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Meaning that all the trade, which is coming in from this non-EU members currently, which is also competing with Indian exports is going to simply, once it is part of the union because of advantage in terms of tariffs or labor policies and so on, it is going to simply substitute or take away some of the Indian exports.

I think this is a somewhat naïve and maybe somewhat misplaced concern simply because there is also a trade creating impact. So this is the trade diverting impact.

That there is a trade going from India to the current EU, new members join who were also competing for exports but because they are becoming members they are going to divert trade away from India.

But there is also trade-creating impact. How does that work? You got a big market, which uses the same uniform policies, tariffs, in fact as Mr. Caillouet mentioned that generally, the tariffs are going to come lower.

So when you have lower tariffs you are going to stimulate exports. Secondly, I believe invoicing policies will be uniform. Therefore, even though they may not all be Euro invoicing, invoicing is going to be uniform. Customs procedures, he already mentioned, is going to be uniform. So that has what is called a trade-creating impact.

And so what we need to see is whether the trade-creating impact is a dominant or trade-diverting impact is dominant. And I believe that there is potential for trade-creating impact to be more dominant than trade-diverting impact.

All the more so because you see, India’s share in global trade right now has just inched up to 0.8%, not too long ago it used to be 0.5 to 0.6 %. Last year, we have seen the growth of something like 18 to 20%. So 0.8%, the only way to go is up, you can’t go down. So with that, I don’t think that the downside is to be of concern. There are tremendous upsides, so, that is number one.

Trade-creation vs. Trade-diversion.

This single currency impact, I mean, we don’t realize that many people the world over whether you are selling a Toyota in Saudi Arabia or you are selling raisins to Latin America, often the invoicing is in US dollars. This is often because people are not comfortable or sophisticated enough to cross-currency hedging, i.e. you want to hedge against currency fluctuations.

Once you have all these EU enlargements, all these members using the same currency, I am going ahead a little bit by assuming that it is all good with Euro, then you eliminate the need for cross currency hedges, i.e. you need to buy special powered premium or insurance to hedge against.

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So, you are doing this trade but you also will bother about doing currency hedging. If you do an invoice, you book an export order, six months later you find that currency has depreciated unexpectedly and tremendously.

But if you are dealing with a single currency. So that is the benefit to trade. So the elimination of the need to do cross-currency hedging will go and that is a benefit to trade.

The other benefits are procedural benefits. I mentioned is that, as he said, one cannot deny that the practical impediments in customs and clearance and those procedures.

And if you have to deal with 13 different sets or 10 different sets of procedures and officials and policies, that is certainly much worse than having to deal with one uniform procedure which is already existing for the 15 EU members.

So, this cannot be quantified in Dollars or Euros but certainly, there is a tremendous benefit in terms of simplification or unification of procedures.

Just to kind of make my point, I would like to bring to your attention a study done by Exim Bank, I think last year, where they tried to identify what are the hurdles or costs faced by importers and exporters in India. They found that almost 15% of the costs were in terms of what are called transactions cost which relate to paperwork and procedures and customs clearances and so on. And that is big chunk – 15%. So, just apply that at the other end and I am sure it is as high as 15% but it tends to be significant. So that is the third thing about benefits.

So, all said and done, I think, we now have NAFTA, which is North American Free Trade Agreement, which is a big chunk of countries in North America, mostly it is Mexico, Canada, and the USA.

Then you have Marco sore with whom India’s engagement is limited but increasing and you have ASEAN, which is block. So these are all major trading blocks and often people say the trading block is stumbling block or building block for global trade.

Ultimately, of course, we would like to have only one uniform multilateral framework called the WTO. What I feel is that if this EU enlargement, that is the bottom line, is such that it is leading towards aligning themselves with the vision of WTO then I don’t think there is any downside from an Indian perspective.

I mean, because I feel that, what is happening is that there is some concern that the new members who will join the EU are members who are much more vociferous or much more supportive of trade protectionism because they have traditional expertise or comparative advantage in areas, which are of interest to countries like India such as agriculture or some other labor-intensive industries.

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