Economic integration woes of South Asia
Economic and trade outcomes have remained persistently stunted because of the hostile political relationship between India and Pakistan
Arecent World Bank Report — A Glass Half Full (2018) — says intra-regional trade in South Asia, lowest among all regions in the world, has the potential to increase three times its present levels, and trade between India and Pakistan has the potential to increase from its current insignificant $2 billion to $37 billion. The report thus reiterates a well-known fact that trade in South Asia is far below its potential. Among the many earlier studies on the subject is one by the author (“India’s Global Trade Potential: The Gravity Model Approach”, Global Economic Review, 2006; ICRIER
Working Paper 151, 2004) that predicted, at almost 27, the ratio of potential to actual trade between India and Pakistan to be the highest among South Asian nations. The estimates were undertaken using an augmented gravity model that predicts potential trade based on economic size and physical proximity of the trading pair of countries, along with other explanatory variables such as population, historical and linguistic proximity of the trading pair of countries and their participation in regional or bilateral free trade agreements (FTAs).
The World Bank study, using a similar methodology, also highlights the fact that the gap between actual and potential trade for South Asia has been widening since 2001. This has occurred in a region that has one of the most dynamic economies of the world, with the Indian economy averaging growth of over 7 per cent over the past 15 years. The South Asian region was among the first to recover from the global financial crisis with a growth rate of 8 per cent in 2009. However, in an apparent contradiction, trade within the region has hovered around 5 per cent of the region’s total trade. Unsurprisingly, the gap between actual and potential intra-regional trade has been rising since 2001.
The large potential notwithstanding, South Asia remains a unique exception to the “natural trading partner hypothesis” mainly because of the persistent conflict between its two major economies: India and Pakistan. As a result, South Asia has been unable to translate its inherent advantages of geographical, historical, cultural and linguistic proximity to achieving economic integration in the region.
The conflict between India and Pakistan has persisted for seven decades despite a long history of confidence building measures (CBMs) between the two countries, ranging from no war pacts, agreements for noninterference in bilateral affairs, regular communication through establishment of military and heads of state hotlines, and economic CBMs such as Pakistan’s promise of granting most favoured nation (MFN) status to India on two occasions without actual fruition in policy. In fact, often, a CBM announcement is accompanied by, or followed soon after, by some conflict escalation. Most recently, the newly elected Pakistan prime minister’s expressed intention to take forward the bilateral relationship to a “talk and trade” mode was soon followed by the killing of Indian security personnel at the border. The talks were called off even before they started. The CBMs, military or economic, have therefore not altered the fundamental nature of the India-Pakistan bilateral relationship that is beset with hostility and conflict. Since these are two largest economies of the region, the conflict-ridden relationship dominates the South Asian landscape. The conflict variable thus needs to be factored into any serious analysis and explanation of intra-regional trade in South Asia.
In my book, Regional Economic Integration in South Asia: Trapped in Conflict? (Routledge, 2013), I had extended the augmented gravity model by including conflict in its multiple dimension — bilateral, with third country (as with Afghanistan), spillover effects of civil conflicts and, more importantly, “anticipated conflict”. While actual conflict endangers trade transactions, expectation of conflict further raises risks of trading within the conflictprone region and therefore the trade/ transaction costs through increased possibilities of currency instability, breach of contract, low institutional credibility and increased government restrictions through increased tariff, para tariff and non-tariff barriers, thus greatly reducing the scope for profitable trade. My analysis showed that conflict, actual and anticipated, reduces trade by over 65 per cent in general and by 75 per cent in South Asia. Conflict costs impinge on common borders negating the positive impact of geographical contiguity and the cost is higher if the trading pair is also in strategic rivalry as are India and Pakistan. Furthermore, where countries make an attempt to establish trading arrangements in a context of unresolved and enduring conflict, the outcome of these is close to null.
Both SAPTA, the SAARC Preferential Trading Arrangement, and SAFTA, the South Asian Free Trade Area Agreement, were rendered ineffective on account of the persistent conflict between India and Pakistan. In case of SAPTA, the intensification of the bilateral tensions and the war in Kargil led to the suspension of the fourth round of negotiations in 1999 and for SAFTA, Pakistan’s stance of a short positive list of tradable commodities for Indo-Pak trade violated the spirit of the agreement and prevented its effective implementation. Although a change in stance was promised in 2012, only a partial fulfilment has occurred so far. Pakistan has specified a negative list for trading with India under SAFTA, but neither the granting of the MFN status to India nor a more politically acceptable non-discriminatory market access (NDMA) for India happened.
The case of South Asian economic integration, therefore, is sui generis wherein the economic and trade outcomes have remained persistently stunted by the hostile political relationship between the two large regional economies. It remains a challenge that may not be easy to overcome in the short or medium term. In that context, it may be wiser to focus on alternative formulations, whether subregional such as the BBIN (Bangladesh, Bhutan, India, Nepal) or inter sub-regional initiatives such as the BIMSTEC (Bay of Bengal Initiative for MultiSectoral Technical and Economic Cooperation). With India in the lead, these arrangements can take forward the interested partners from South Asia on a more feasible and profitable path of economic integration and trade enhancement.