The Pulse

India Needs a More Integrated Economy to Fully Benefit From Big Trade Deals

Policy measures like the GST will help India adapt to the external integration provisions of the TPP and RCEP.

India Needs a More Integrated Economy to Fully Benefit From Big Trade Deals
Credit: Alexander Mazurkevich via

External integration in the Asian region is entering a new phase with negotiations for the Trans Pacific Partnership (TPP), the Regional Comprehensive Economic Partnership (RCEP), and other bilateral agreements. The consensus holds that the benefits of integration are significant, with income gains that override trade diversion and other costs. Indeed, these regional agreements could generate domino effects for wider regional and global trade initiatives to revive growth.

How best can India be a partner to these efforts and sustain its growth leadership in an inclusive way? The costs of exclusion from the growing integration are significant, especially now that traditional economic growth engines have shifted from agriculture to manufacturing and services.

India has made it clear it intends to be part of the process. But external integration has domestic policy implications that need to be managed well and quickly implemented to allow India to reap its benefits.

What are these implications and how can they be managed? The most important is the need to make India a more integrated domestic economy, so that it can attract, and absorb sustainably, the foreign investment generally associated with increased external integration. This will help raise productivity and build more inclusive growth.

Conflicting evidence shows that India has tight and highly heterogeneous product, tax, and labor markets and regulations across its states. The persisting cross-state differences have resulted in varying degrees of competition in the domestic economy, affecting productivity, investment, competition, and employment. These regulations impede the flow of goods, increase costs, and affect the business environment. They also reduce the efficiency of the labor market—that is markedly inconsistent with India’s demographic advantage.

Recent evidence confirms their effects on states:

  • There is a negative correlation between competition in product markets, and foreign direct investment and total factor productivity across the states.
  • Ditto for the high degree of labor market regulation and heterogeneity across states.
  • Various cross-state tax barriers impede the flow of goods and increase costs unpredictably. This raises the barriers to entrepreneurship, and is correlated to the existence of informal labor markets and persistent low formal sector employment.

In this context, the Goods and Services Tax (GST), in particular, has been much in the public debate. On the positive side, successive governments have tried to reduce cross-state tax barriers, knowing that rationalizing state and central taxes into a harmonized GST will be the key to a more unified domestic market. A study done by the National Council of Applied Economic Research  in 2014 estimated that the growth effect of a well-designed GST could be in the range of 0.9 percent to 1.7 percent.

The case for GST becomes more pressing if India is to be a full partner of ongoing external integration.

But where does external integration stand today? There hasn’t been a major multilateral trade agreement for almost two decades, but regional and bilateral trade agreements have fostered in this period. Such trade integration has been very much the focus for the 21 APEC members, and the ASEAN community. China’s much vaunted supply chain effect in East Asia followed dramatically its WTO membership in December 2001, and escalated the global effects of East Asia’s manufacturing competitiveness.

External integration is now moving closer to new standards that many call the 21stcentury template, of which the envisaged Trans Pacific Partnership (TPP) is at the vanguard. It potentially comprises the U.S. and 11 other countries in the Americas and Asia Pacific, including Japan. It seeks to extend existing trade pacts by liberalizing relatively protected sectors such as agriculture, pharmaceuticals, investment, and services, and opening rules on competition, intellectual property, labor, internet access, environment protection, and marine activity and conservation.

The TPP was expected to have been negotiated by now, opening the room for U.S. Congressional approval well before the 2016 elections in that country. Toward this, President Barack Obama has acquired from Congress “fast track authority,” which means that the Congress can only accept or reject the negotiated deal, not amend its parts. But it is not there yet.

Why is it potentially so important?

  • First, its 12 members represent 40 percent of global GDP and about a quarter of global exports.
  • Second, it could open up leading sectors in both emerging and advanced countries—such as service, investment, and technology.
  • Third, for emerging markets, it will expand market access for their manufacturing industries, and help build their financial integration.
  • Fourth, Japan’s potential entry could be historically important—opening up its domestic investment, insurance, services, and farm trade for access by TPP members.

India and China are not in the TPP negotiating process, but they are in the negotiations for the RCEP. The RCEP is a complementary focus on integration among the 16 Asia Pacific countries, which have a higher share of global exports (than the TPP) and account for close to 30 percent of world GDP.

What is the difference between the TPP and RCEP? Both cover extensive areas of activity. Beyond that:

  • The RCEP seeks to integrate consistently existing free trade agreements between ASEAN and its individual partners, while keeping special preferences and exemptions for lower income countries.
  • The TPP is more ambitious in trying to develop new 21st century rules for trade and investment for advanced and emerging market countries.
  • The TPP rules envisage much greater transparency and discipline on government interventions in the market and on intellectual property rights.
  • It remains to be seen how the TPP will take into account and accommodate the circumstances of its diverse members.

The TPP and RCEP are not the only rising planks of regional integration. Bilateral trade agreements are also being extended in the Asia Pacific. Among them, Korea is following some of the TPP aims in its free trade agreements with the U.S. and the European Union, and is working on expanded agreements with China and Japan. As for the TPP, Korea, Indonesia, Thailand, and Philippines are already considering their future membership—thereby potentially creating a TPP of 16 countries.

In this context, the costs of non-participation—and exclusion—are potentially significant from both sides. China is mulling over the costs of its non-participation in the TPP. But it is also clear that the TPP loses by not having China—the world’s biggest manufacturer—as a member.

In conclusion, ongoing external integration has become an important driver to create a more unified domestic market. There is now greater urgency for India to reduce the various cross-state differences, better integrate the domestic economy, attract FDI from external integration more uniformly and sustainably, and build employment and growth more evenly across the states. A better integrated domestic economy will also help multiply the benefits from India’s growing physical and social infrastructure.