The Indian Economy Blog

September 17, 2006

Multilateralism and Free Trade Zones

Filed under: Business — Edward @ 12:58 pm

Discussions on the Doha round rumble on, and on. There is no immediate and obvious end in sight. In the vacuum that this creates a number of ‘alternative’ solutions have been finding their way onto the table. Last week Manmohan Singh and Thabo Mbeki met in Brasilia with Brazilian President Lula da Silva to review strategy on one of these fronts. The week before British Conservative leader (and possible future UK Prime Minister) David Cameron visited India and advanced his own idea, an EU/India free trade agreement.

And yesterday the Financial Times revealed that the German leader Angela Merkel was considering a plan for a free-trade zone between Europe and the US.

A senior aide to Angela Merkel said the chancellor was “interested” in promoting the idea as long as such a zone did not create “a fortress” but rather “a tool” to encourage free trade globally, “which she is persuaded is a condition of Germany’s future prosperity”.”

Maybe it is just a coincidence that news of Ms Merkel’s proposal comes hot on the heals of the decision by the US, Canada and the European Union to complain to the World Trade Organisation about China’s tariffs on car parts, but there can be no doubt that China’s move up the value chain will lead to more tension than was produced by – say – the mass exportation of textile products. Additionally, the longer that China is in the export business the better the quality of the product that will be leaving that country.

More than likely none of these proposals will get very far (which is not to say that the demands for more protectionism may not increase). South Africa is faced with very grave and serious problems in the wake of the AIDS epidemic, and though there is no doubt that Brazil is doing a lot better than some are trying to suggest, there is not an evident synnergy between the India and the Brazilian economies. Both, to one degree or another, need China and both need a free flow of goods and services with the G7 economies.

Angela Merkel’s interest in full and complete access to the US economy is evident (Germany runs a trade surplus, internal demand is consistently ‘deficient’ due to the age structure of its more elderly population, and German companies are very competitive in export markets), but it is not so clear that other EU partners will take the same view. Italy and Spain, for example, run deficits, and their export industries are nothing like as competitive. It is also far from clear that such a proposal would meet with universal approval in France. Vis-a-vis the US, which is, of course, already running a significant deficit, increased competition from German companies inside the US may not prove popular either.

As for Cameron, and his proposal (which I incidentally would support), my guess is that this would only serve to reveal, just one more time, how much out of step the UK is with the rest of the European Union. It is, of course, a beautiful dream.

Back in the world of reality, what it really needed is more focus all round, and some real progress on Doha, although this, it seems, is going to be very difficult with the reality which lies behind all these new-found Growth Pandas and Growth Elephants becoming more evident by the day.

(Postscript: it may be worth mentioning, since it may not be obvious to everyone at first sight, but very few – if any – of the car components which are the subject of the current WTO complaint will be entering China having been manufactured in the  US or Germany. Very few of the components which currently go into German cars are in fact manufactured in Germany (they have all been outsourced to the new Estern EU members) and I guess in the case of the US they come from Mexico or elsewhere. Obviously the Indian components industry may well be involved in this chain at some level, anyone have any info?).

10 Comments »

  1. Sorry to nit-pick, but the EU-India FTA has already been proposed by the joint EU-India working group on trade. Work has begun on designing the framework. Though David Cameron has supported it, it can hardly be called his own idea.

    http://trade-info.cec.eu.int/doclib/docs/2006/april/tradoc_128460.pdf

    Comment by shankar — September 18, 2006 @ 2:44 pm

  2. One of the interesting things for me to watch has been how the stance of trade negotiators has changed since Doha was launched. Initially, there seemed to be some hope that the involved policymakers viewed trade as inherently good for both parties: the exporting nation benefits by having added production, and the importer gains by having lower prices. To be perfectly clear, importing does impose other costs on the economy — as you have to retrain the effected parts of the workforce and find them prodcutive employment somewhere else (ideally, further up on the value chain, but this obviously does not always happen). However, in my view, even taking that into account, the net benefit that accrues to the importing nation is larger than what the exporters get. My reasoning is simply that the benefits of added production and the costs associated with retraining and moving jobs are localized (ie. effects a small portion of the population) whereas the benefits from lower prices can be enjoyed by everyone. Furthermore, there is also the indirect benefit of competition, and the added productivity this creates.

    Over time, the talks have devolved into mercantilist haggling – with countries “measuring success in terms of export market access, while ‘paying’ as little as possible in terms of import concessions” (Grant Aldonas, ‘Why trade negotiators need some driving lessons’, FT May 4, 2006). This fundamental change in the way our policymakers view trade has led to the predictable impasse at Doha. Allow me to put forth two reasons that brought us here:

    (1) The old problem of ‘concentrated costs, diffuse benefits’: In a democracy, the voices that will be heard in a particular debate (in this case trade) are obviously the ones which are most-effected by a particular piece of legislation (in this, say the domestic farmers at risk of displacement by an FTA). Since the costs of the legislation are concentrated in this small group, but the benefits spread over an entire population, the small group will obviously lobby a lot harder against the legislation, than all of us will lobby for it.

    (2) Changing relationship between capital and labor and increasing income inequality: (this point could take up an entire paper) I think part of the protectionist response has been because, as the bargaining power of labor has been reduced in the marketplace, it has naturally vented itself in politics. As the recent Gordon-DewBecker paper pointed out, the benefits of productivity growth over the past few years have accrued disproportionately to the highest wage earners and asset-owners. In this sort of environment, I am not surprised that the power of vested interests has increased so much in politics. I would not be surprised if this gets worse still.

    While this comment diverges a bit from the content of the post, my point is simply that I don’t think that those who benefit the most from increasing trade and globalization are doing enough to safeguard the process. In order to effectively do this, we need to reassess our international institutions and we need to take credible steps to mitigate the ‘costs’ mentioned above.

    Comment by Nandan Desai — September 18, 2006 @ 8:27 pm

  3. Spurred by concern about China’s growing economic might, Germany is considering a plan for a free-trade zone between Europe and the US.

    A senior aide to Angela Merkel said the chancellor was “interested” in promoting the idea as long as such a zone did not create “a fortress” but rather “a tool” to encourage free trade globally, “which she is persuaded is a condition of Germany’s future prosperity”.

    (The US, Canada and the European Union) complained to the World Trade Organisation about China’s tariffs on car parts, raising the prospect of Beijing facing its first WTO dispute. The three said they had lost patience with Beijing’s refusal to open the $19bn (€15bn, £10bn) a year market.

    News that the free trade zone, last pursued by Sir Leon Brittan, when European trade commissioner in 1998, is being debated in the German chancellery testifies to the rapprochement between Washington and Berlin since Ms Merkel’s election last November.

    This convergence of views was underlined this week when Wen Jiabao, Chinese premier, was politely chided by Ms Merkel for China’s poor human rights record and recent restrictions on foreign news agencies, during an official visit to Berlin.

    As German perceptions of China have grown more American, Washington’s approach has also shifted. Speaking before his first trip to Beijing, Hank Paulson, US Treasury secretary, this week outlined a more balanced policy mixing traditional US criticism with praise for China’s reforms.

    Ms Merkel’s aide said it was “far too early” to tell whether the project of a transatlantic free-trade zone would be part of Germany’s priorities when it assumes the six-month presidency of the European Union and chairs the G8 group of leading industrial nations from January.

    “The west needs to pull together,” Gabor Steingart said yesterday. His book, World-War for Prosperity, a warning about the dangers of globalisation published this week, is credited with influencing the debate in the German chancellery. “What Nato did for the west under the cold war, Tafta [Trans-atlantic free-trade area] can do in the current battle.”

    Comment by Trader 4 Life — September 18, 2006 @ 9:37 pm

  4. Shankar

    “Though David Cameron has supported it, it can hardly be called his own idea.”

    OK, point taken. The interesting thing, unfortunately, seems to be that he is the only EU leader (and he isn’t really even a ‘leader’, or not yet at any rate) who is even warming to the idea.

    Nandan

    “One of the interesting things for me to watch has been how the stance of trade negotiators has changed since Doha was launched.”

    Yes, I think this is the point. At the start it was the leaders of the developed economies who were trying to persuade those in developing economies of the need for globalisation, now this situation has changed somewhat. Apart from, possibly, Blair,there doesn’t seem to be a major leader in the developed world who wants to risk being seen pushing it, and Blair, of course, is about to go. Meantime many in the developing economies now see the importance of globalisation.

    Otoh, behind the public reticence there is also realism.

    “However, in my view, even taking that into account, the net benefit that accrues to the importing nation is larger than what the exporters get.”

    Not sure about this, I think it very much depends what is being imported. IT services are a lot more problematic than T-shirts. In straightforward econoomic terms I think it also depends whether there are non-linear, increasing returns effects which mean the thing isn’t a simple division of labour issue.

    “My reasoning is simply that the benefits of added production and the costs associated with retraining and moving jobs are localized (ie. effects a small portion of the population) whereas the benefits from lower prices can be enjoyed by everyone.”

    Brad Setser had an interesting take on this one recently:

    http://www.rgemonitor.com/blog/setser/144955

    (Altogether off topic, but while Brad is an excellent economist, this emphasis on capital loses which might be borne by the Chinese central bank if the US dollar falls – but, of course, at least in the short term they have a built-in interest in ensuring it doesn’t fall too much relative to the yuan – leaves me saying, ‘huh’. I mean even if they do take a substantial capital loss while one billion Chinese get developed, this would seem to me to be cheap at half the price).

    “In a democracy, the voices that will be heard in a particular debate (in this case trade) are obviously the ones which are most-effected by a particular piece of legislation”

    Yes, this is the point. But don’t mistake the noise of politics for the pragmatism of the decision making process. I would say at the level of interconnection already established globalisation is fairly secure, increasing the reach of trade agreements is another thing. It may come, but there is no guarantee. (The EU and Turkey is a good example here. I would be most surprised if Turkey doesn’t become an EU member in the end, even though many politicians are currently publicly taking an anti-Turkey stance. The cost of saying no is just too high. Ditto globalisation).

    “Changing relationship between capital and labor and increasing income inequality”

    Yes, well this would be the skill-bias argument. Those without marketable skills are much more exposed to global labour price levels (whether or not this comes in terms of inward migratory flows). This is why the skill composition of the trade flow is not irrelevant, since this would spread what Stephen Roach calls the ‘labour arbitrage’ effect ever higher up the social ladder. It is noticeable that even inside the EU itself it is the services directive that has met with the most resistance.

    Of course, if prices were actually falling as a reflection of this arbitrage process then things would be more politically palatable, but then we don’t have a free market in agriculture, commodity and energy costs are rising, and the cheap finance globalisation has produced has had the frustrating consequence of actually making housing more expensive.

    “In order to effectively do this, we need to reassess our international institutions and we need to take credible steps to mitigate the ‘costs’ mentioned above.”

    Well, yes, but this may be easier said than done. To be continued.

    Comment by Edward — September 19, 2006 @ 2:01 am

  5. From the way Mr. Nath behaved during the Doha round and from the way India is dealing with ASEAN during FTA negotiation, FTAs are effectively dead under this governments – for at least three more years. Supreme Sonia opposes them and Commies oppose them. Negotiations will continue but I doubt any major agreements (nothing beyound the non-consequential Brazil or South Africa agreements) will be signed until there is new government in Delhi.

    I also doubt US and EU will be signing any FTA with any third country, especially India. It took US all presidential political capital to pull of an FTA with tiny Ecuador. With Democrates in Congress – forget any FTAs anytime soon.

    Comment by Chandra — September 19, 2006 @ 4:35 am

  6. With regards the auto and auto component exports from India, a few observations

    a) The small car/ compact cars are being exported by Hyundai, Ford, Suzuki/ Maruti from India in a material way (almost 20% of the production is for international markets). Nissan and Suzuki have proposed a joint effort to make the small/ compact car for exports (about 250,000 units per year level) with an investment of USD 2 bn in their chairmans visit to india last fortnight. The thinking is more and more that India will be become a hub of small-car export/ design and obviously a big consumer as well

    b) The Tata’s have come closing to announcing the launch dates of their Rs 1 lakh/ car . Maruti came out with a statement yesterday saying that they would reduce the M800 price by INR 60,000, so that it would be about Rs 1.5lacs or so, and thus meet the competition. The Maruti CEO, said at even the revised pricing level they would be profitable due to the 92%+ indigenisation level of the components. Or the availability of a new car at sub USD 2500/- levels is not far off, even with Indian tax-structures at Indian street-pricing levels. Given the relative success of Tata;s in their previous models – Indica, this time around the global majors are also taking this development seriously, as this is being done at capital spends of USD 300 mn or so which is far below the USD 1 bn level which is needed for a global major to launch a new platform

    c) There are many auto-component manufacturers who are suppliers to the global majors. The level of auto-ancillary exports is about USD 2 bn level, which is relatively small, but it is fast growing. There are many Demings award winners (the highest quality levels – Sundaram Fastners, TVS Lucas…), Bharat Forge ( Top3 castings manufacturer with operations in India/ Europe/ China), MICO – part of the Bosch group, which has increased its operations to close to USD 1 bn level in India, of which 30%+ is exports. Or there are a variety of players – domestic, technology oriented, global, auto-majors who are all in the auto-ancillary export space. This is attractive to India as its strength is in combination of design/ short-runs/ engineering category (vs China) rather than volumes/ infrastructure/ capital sections of the auto/ components space. Chennai – Pune – Gurgaon is the cluster around which many of these units have come-up and this cluster development is further reinforcing the developments in this sector

    d) India has signed a FTA with Thailand, which has also a base in auto business in 2003 or 2004. Toyota/ Honda are using this route to increase their auto-capabilities (designs/ auto ancillary suppliers) for the Indian markets. However no other auto-major has used this route. Reasons – dont know

    Comment by envenkat — September 19, 2006 @ 12:19 pm

  7. Envenkat,

    “With regards the auto and auto component exports from India, a few observations”

    Thanks a lot for this.

    Chandra:

    “Negotiations will continue but I doubt any major agreements (nothing beyound the non-consequential Brazil or South Africa agreements) will be signed until there is new government in Delhi.”

    I fear you may be right.

    Nandan:

    “This fundamental change in the way our policymakers view trade has led to the predictable impasse at Doha.”

    Yes, and now Rodrigo Rato is starting to worry:

    Global economic growth is at risk of peaking because of high oil prices and rising protectionist sentiment, warned Rodrigo de Rato, the International Monetary Fund’s managing director, on Tuesday.

    “The global growth cycle may be close to its peak,” Mr de Rato said in his opening statement at the joint IMF and World Bank plenary session in Singapore.

    “The best hope for continued high growth lies in further increases to international trade. If this does not happen, the outlook is less encouraging.”

    Comment by Edward — September 19, 2006 @ 3:09 pm

  8. Edward,

    I suppose I am more of a skeptic than you about the security of already-established globalization. Yes, in some ways, you are right. The advent of telecom technologies and the web cannot be undone (though it can be temporarily subverted as China has shown), and the human linkages between people from different countries cannot be taken away.

    Nevertheless, I tend to agree more with the historian Niall Ferguson who argues that increasing global interconnectedness always breeds a nationalistic response. The context he uses is the international linkages that emerged during various empires, and then most recently prior to the outbreak of WWI when the world was basking in the glow of the industrial revolution. Except for the last example, all the previous bouts of globalization were centrally directed by a hegemon so let’s ignore those since they are not valid comparisons. The period before WWI though certainly is – although it was led by the US and UK, it was not entirely planned and directed by them. Moreover, it was driven by the diffusion of technology accross national borders, much like today.

    The purpose of the comparison is just to say that I still think that it could all fall apart – and certain events over the past 5 years have given me reason to believe that it very well might. The fact is that globalization can empower anyone who wants to exploit it — even those that are hell bent on taking the ‘system’ down (the guys who attacked my city on 9/11/01 come to mind). Nuclear proliferation, which is more of a concern now than during the cold war (when there were far more warheads), would obviously accelerate this process because the nation attacked would realize (correctly) that the potential costs of globalization outweigh its potential benefits.

    I am rather convinced that the path that world leaders are taking towards more economic globalization without the necessary safeguards and appropriate mechanisms is fundamentally unsustainable – and either there have to be major changes or something will give. I don’t think it’s prudent to underestimate the forces that are opposed to globalization and the potential impact they could have if they succeed.

    Comment by Nandan Desai — September 19, 2006 @ 8:57 pm

  9. Nandan,

    “I suppose I am more of a skeptic than you about the security of already-established globalization.”

    Fair enough, no harm in that.

    “Nevertheless, I tend to agree more with the historian Niall Ferguson who argues that increasing global interconnectedness always breeds a nationalistic response.”

    This has now become a sort of orthodoxy, and I’m not sure I agree with it. But before going further let me say that I do think Ferguson’s historical perspective is interesting, including the comparison he often makes between Britain vis-a-vis the US after WWI, and the US vis-a-vis China and India today.

    I posted on this back in 2003:

    http://bonoboathome.blogspot.com/2003/04/to-debtor-spoils-of-war.html

    Basically this also fits in with what I am saying above about US indebtedness and China. Basically those who lend money in sufficient quantities simply cannot afford to let their clients go to the dogs. This was a point Keynes used to make. And it does fit in with the issue of just how far the ‘new protectionism’ can go.

    But lets step back and look at all this more theoretically (which is normally my preferred posture).

    I doubt (despite Nietzsche and Poincarré) that there is some ‘iron law of history’ just out there waiting to repeat itself.

    We could also look at globalisation as a process of joining up the dots in global economic activity, a process which has now been going on for hundreds if not thousands of years. I think we are both agreed that technological change is a key driver here. Back in the 19th century, if my economic history memory serves me aright, key transatlantic factors were the invention of the refrigerated container ship and the telegraph. Today we can see there are other forces at work, especially in the integration of capital markets, which, in the context of globalised deregulation (and following the big bang of the 1980s) should not be taken lightly. What people can and can’t do is very much conditioned by this background.

    Now, in one sense we can see globalisation as a historic series of ‘waves’ (rather like the tide coming in), waves which rise and recede, but seem to reach on each new occasion ever higher levels.

    On the cultural level don’t ignore the way in which inter-connection, homogenisation of tastes and consumption patterns, multicultural tendencies (take ‘world music’, and culinary habits as just a couple of examples) are changing peoples very sense of ‘national’ and ‘ethnic’ identity. This is an ongoing process, so appeals to ‘national traditions’ and ‘national champions’ now don’t quite mean what they meant even as recently as 20 years ago.

    Now, on the more theoretical level, I would say that work in network theory is very important here. A few years ago Duncan Watts and Steve Strogatz published what was in fact an epochal paper in Nature: Collective dynamics of ‘small-world’ networks, Nature (393), 4 June 1998.

    Here’s a thread with some of the stuff which followed:

    http://citeseer.ist.psu.edu/context/46576/0

    Now cutting a long story very short, S&W were playing around with graph theory and networks, and what they found was that simply by adding random links the average path length (ie the shortest way from A to B anywhere in the system) reduced substantially, and in a non linear fashion as you added nodes.

    They also found that the emergent nets which were created exhibited another interesting property, that the ‘nodes’ where not all identical, but that the degree of ‘inteconnectedness’ followed a power law distribution pattern. Another physicist – Barabasi – then took up their finding and applied it to look at the internet, and found a similar picture. Now one of the things I would add is that we could very easily take the sort of graphs Barabasi has generated (he has also applied this to the protein map dervied from the human genome and found a similar structure) and treat them as a very useful *proxy* for the global economy.

    One of the other characteristics of the structures they identified is that the networks were highly *robust* to the disappearance of certain nodes, but that there were some nodes – called giant nodes – which if they were switched off rapidly caused the whole structure to collapse.

    Now what is the relevance of all this to globalisation?

    Well in the first place, if some people (not giant nodes) choose to back away the system will continue without them, but they will move backwards (Jarred Diamond has looked at this in the context of Tasmania some hundreds of years ago, but we could think Cuba today. Not an appetising prospect).

    OTOH if a giant node like the US were to start to pull out this could lead to very serious consequences, and I think the people responsible for policy making are very well aware of this.

    This is why I think that the pace of expansion of global trade agreements will slow, but that we will see very little in the way of moving backwards.

    Also an informal argument from game theory might help here: who will be the first to cry ‘chicken’ and pull back? The dynamics of doing this are not at all evident. To stop globalisation you seem to need an agreement between all the major players as a preliminary precondition, or if you don’t have this one party will simply try to ‘leap frog’ at the expense of the others. If the US started to turn its back on global supply chains, while maintaining trade links with Germany (the subject of this post), then Germany could try to leverage an advantage by outsourcing, invoicing in Germany and then selling cheap products to the US. Basically this is the process which has been operating in reverse, since it has been US outsourcing which has driven German and French companies onto the globalisation path.

    So really what I’m saying is what we have is ‘like it or lump it’, there doesn’t seem to be any easy way of turning back.

    Comment by Edward — September 20, 2006 @ 1:52 pm

  10. I like the analogy!

    This debate will continue in many other contexts–I’m sure–so, for now, I’m going to get back to doing my work while streaming the GA session webcast.

    Slightly off-topic, but as I listened to the various world leaders speaking yesterday, I was struck by two things:
    1. Political myopia: an insistence over arguing about the things which shaped yesterday’s world and an unwillingness to argue about the things which will shape tomorrow’s world
    2. How the a–holes (pardon my French) always define the terms of the global debate, and the visionaries get marginalized. Even though they should be taking this unique opportunity to figure out how to manage a globalization process that is getting messy, they’re captivated by the Bush’s, Ahmedinejad’s, and Chavez’s and their ideological quibbles (although, even I was mildly amused when Chavez kept referring to GWB as “the devil”)

    I’m not trying to make a point here – just venting.

    Comment by Nandan Desai — September 20, 2006 @ 10:56 pm

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