This is a very simplistic understanding of a complex decision that was made with a pragmatic mindset taking into consideration multiple factors. It is important to discuss some of these key factors in order to fully appreciate the wisdom of India’s position, taken in 2019, to sit out of the RCEP.
Basic premise of gains from RCEP was flawed
India already has several functional free trade agreements (FTAs) — around 13 pacts and a 14th one under consideration with New Zealand. As far as trade in goods are concerned, India was able to be more strategic in each of these individual agreements to ensure that its key concerns take into account its own manufacturing sector’s growth priorities.
Such bilateral negotiations allowed India to better leverage the attractiveness of its large market in return for greater flexibility in goods, and a much better deal in services. Such greater flexibility was crucial in helping keep out sensitive sectors, or sectors where India wants to attract investment and has launched its own industrial promotion policies (such as PLI). Therefore, negotiating strategically with greater flexibility with individual partners worked better for India than pursuing a mega-regional deal like RCEP.
This flexibility is now proving to be essential to India’s economic security, competitiveness and job creation that address the needs of its demographics, which gives the country the world’s single largest youth cohort in recorded history.
RCEP is a shallow agreement when it comes to services and non-tariff measures
Incremental gains from RCEP would have been even more limited given that India’s comparative advantage lies in its services sector, which accounts for a significant portion of its GDP and exports. RCEP negotiations were primarily focused on trade in goods, with limited provisions for services liberalisation. This imbalance would put India at a disadvantage since its export strength in IT, software and professional services wouldn’t gain much from RCEP. India’s request for more liberal market access for its professionals and skilled workers in RCEP countries wasn’t adequately addressed, further diminishing the potential benefits of joining.It needs to be noted that India has been able to negotiate far more ambitious commitments in its bilateral agreements with major RCEP member states (Malaysia, Singapore, Korea, Japan and Australia), and there is always the prospect of deepening the India-ASEAN Agreement in Services that will cover Indonesia, Thailand, the Philippines and Vietnam.The same holds true for RCEP disciplines to address non-tariff measures. India has been able to negotiate similar or better terms in individual agreements with RCEP member states. RCEP does not have a chapter on digital trade, an area of enormous importance to managing digital delivery of services and integration of digital features embedded in goods (think of smartphones, IoT enabled industrial equipment or future industrial concepts like remote manufacturing or 3D printing).
India’s new FTAs include disciplines on digital trade, but India has the flexibility to pursue this with partners it can trust and where it sees a value for such disciplines.
RCEP supporters are looking at the past: A changed world after the global financial crisis
As even the most fervent supporters of RCEP are forced to acknowledge that the agreement lacks ambition in all areas except tariff liberalisation for goods, the basic premise of those who argue that India should have joined the RCEP, therefore, is linked to the issue of across-the-board tariff liberalisation which its proponents argue would help India integrated into global and regional value chains.
This premise is linked to the so-called Washington Consensus that argues that export-oriented industrialisation and minimum government intervention in terms of industrial policies and tariffs would allow market forces to push counties to their most optimal and efficient outcomes, leading to improved competitiveness and economic opportunities.
It is important to remind readers that the orthodoxy of this Washington Consensus is of relatively recent vintage. It emerged under a certain unique constellation of circumstances around the 1970s before crashing into the boulders of the 2008-09 global financial crisis and the parallel meteoric rise of China.
Container revolution reduced shipping costs by a whopping 1/35th of what they were (from about $6 per ton to $0.20 per ton). The current cost of freight is between 5% and 8% of goods traded. Without the container revolution, it would have been several times higher. Thus, it is easy to see that the impact of the container revolution has been a much more significant factor in the growth of global trade than any reduction in tariffs. While containers were developed in the 1950s, its impact on global trade really started to be felt from the 1970s due to wide adoption and development of global container shipping networks.
The container revolution was complemented by three further developments in the 1990s — the Uruguay round negotiations leading to the formation of the WTO in 1995; the maturing of the information technology (IT) revolution, including the internet-based applications, and widespread adoption of such IT tools globally; and China’s accession to the WTO in 2000.
Just like the container revolution helped address the cost of geographical distance that impeded globalisation, the IT revolution addressed the challenge of coordination, management and operating costs across distances. Even smaller firms were now able to coordinate and run operations globally using enterprise-based IT solutions.
The Uruguay Round tariff commitments rationalised and reduced tariffs and, more importantly, brought in an element of certainty to trade policy. Governments were made accountable to a rules-based trading system that reduced the risk of sudden changes in trade policy and introduction of trade barriers.
China’s economic reforms started in the late 1970s and its primary focus was to grow manufacturing and create jobs. The Communist Party had realised that its survival and legitimacy depended on its ability to deliver economic opportunities and better living standards to the Chinese people. To that end, China opened up to FDI and started investing heavily in development of export-led manufacturing, especially in the special economic zones in its southern coastal regions.
China was free to adopt whatever means necessary to achieve these objectives in the 1980s and 1990s. The Chinese state had full control on all factors of production, including labour. China’s famous Hukow system of internal migration permits allowed it complete control on the movement of workers, and it used this leverage to keep wages under control and manage the labour force. This was industrial policy on steroids executed by a non-market authoritarian system; replicating this anywhere outside China has been impossible.
The results showed. China went from having a 3.7% share in global manufacturing output to close to 6.4% in 2000. WTO membership in 2000 allowed China to claim the privileges of a rules-based global trading system. But the obligations were only on paper, without the country actually becoming accountable. Between 2000 and 2010, China’s share of global manufacturing output increased from 6.4% to a whopping 18.2%, almost trebling in just a decade.
The period between 1970s and 2010 was thus the golden period of offshoring of manufacturing based on product cycle and wage cost arbitrage. Falling trade costs due to the container revolution allowed the most labour-intensive parts of the production process to be offshored to countries with lower wages.
The success of these models, especially in smaller Asian and Latin American economies, helped cement an ideological orthodoxy that export-oriented industrialisation was the way to go. This completely ignored the fact that larger economies require the development of complex industrial systems in order to sustain growth and continue to create jobs and economic opportunities, and most large economies — including Germany, the US and Japan — have historically not adopted pure export-oriented strategies for their industrial development and growth. China’s success was falsely attributed to such export-orientation, and this is now being challenged and questioned by the very same institutions and academic establishments that led the chorus earlier.
After the 2010s, automation, robotics and the rise of technologies like 3D printing have changed the economic fundamentals that shaped global trade in the 40 years between 1970 and 2010. The circumstances that allowed the rise of Japan, followed by Taiwan, Korea (the SE Asian tigers) and China do not exist today.
As these technological changes intensify, it will further increase the terms of trade in favour of technology intensive goods that define the industries of the future (products related to green energy transition, electronics and engineering). It would also reduce the cost advantage of lower wages, given the much easier substitution between labour and capital equipment due to the rise of low-cost automation equipment and the ease of their adoption (think robots and 3D printing).
The fundamental assumption that massive and comprehensive dose of tariff liberalisation and market forces will allow countries to integrate into the global economy, move up the value-chain and create gainful employment for a majority of its citizens has lost all its legitimacy. Industrial policy is back with a vengeance, and most aggressively in those countries that were its biggest opponents and supporters of the Washington Consensus.
Rise of the industrial policy
The current phase of industrial policy revival is also characteristically different from earlier phases: previously industrial policies were aggressively adopted by late industrialisers as a means of catching-up with industrial leaders. Germany and France in the mid-1800s, US in the later 1800s, Japan in the early 1900s, followed by Russia, China and India are some examples of this.
The current phase, on the other hand, is characterised by aggressive industrial policy actions by countries that are industrial leaders, such as China, the US and the EU. The advanced industrial economies and China account for close to 90% of industrial policy interventions, with the rest of the world, including India, accounting for just about 10%. The overall budget outlay of different industrial policy initiatives by the US government is close to $1 trillion just at the Federal level. Conservative estimates of Chinese state support to industries stands at $270 billion, and this is a conservative estimate for reasons we discuss later in this article. Germany has committed close to $64 billion in industrial policy support for green technologies and semi-conductors. In comparison, India’s PLI scheme’s outlay is a relatively modest $26 billion.
The case of China is especially interesting. China uniquely dominates global market share in exports across a wide range of sectors that includes both capital- and labour-intensive sectors, and relatively low technology as well as high-technology sectors. This has never been historically true of any country in the post-industrial revolution world.
Such mega industrial policy initiatives are hugely trade distortive. To argue that “business-as-usual” solutions of trade liberalisation, as is envisaged in RCEP, that assumes free and fair competition based on market principles obviously do not apply to this situation.
A late industrialiser with a relatively modest budget, like India, therefore, needs far more policy space in order to have any chance at competing with dominant industrial economies who have unleashed such mega industrial policy programmes. Policy tools will have to include providing some targeted tariff protection to segments of industries so that the newer industries have time to scale up without having to compete with imports that have more likely been the beneficiary of trade distorting support provided by a major industrial power. Such protection cannot be in perpetuity, but tying one’s hands through binding commitments on tariff elimination in mega-regional agreements will take away whatever flexibility is required to respond to this very changed dynamic in the global economy.
The China factor
The rise of China, as if on steroids, was made possible because a large non-market economy was allowed to free-ride on a rules-based global trading architecture. The rules tied every other large economy’s hand and subjected them to disciplines and accountability that did not effectively extend to China. I use the word effectively because the older generation of economic technocrats in WTO and other Bretton Woods’ institutions who allowed this to happen and were asleep at the wheel are particularly sensitive to criticism. They argue that China took on very significant obligations in order to qualify for WTO membership. This is an asinine response showing complete ignorance of how the Chinese system works.
China’s use of unfair subsidies is not through officially declared policies at the central or even state levels, but through case-by-case individual factory or unit-level support that come from multiple agencies and several state-owned enterprises. It is near impossible to monitor, track and enforce accountability with credible evidence such as a disaggregated, micro-level policy of industrial support, especially in the WTO system where the burden of proof required is significant. It also needs to be noted that such micro-level application of industrial policy but under overall macro-level coordination is not possible in democratic systems that require greater accountability from governments at all levels and allows much lesser discretion.
This fundamental difference between a non-market China and other large economies is compounded by the ability of the Chinese state to influence enterprise-level decisions in both its public and private sector. Indeed, the Chinese state has significant ability to even influence subsidiaries of foreign firms using their leverage of access to China’s large market. The denial of market does not need to be through the typical instruments recognised by WTO rules, but through more subtle levers of permits, access, regulations and micro-level operational aspects that has nothing to do with tariffs or restrictions on market access or FDI. Once again, such subtle coercion would never be exercised as policy, but on a case-by-case basis at the firm level. The use of such instruments in a market-oriented and transparent rules-based economy is impossible as all economic actors will use multiple channels to push back against such efforts — including media, open lobbying using interest group associations, and legal remedies using independent judiciaries.
Entering into a trade agreement that includes China will expose any country to this massive risk of having to compete with an economic ecosystem that is prone to using trade-distorting state support and the ability to control factors of production and even individual firm behaviour. India rightly decided to not subject itself to such a risk, especially at a time when the global economy was undergoing transformative change in terms of technology and demographic shifts.
Supply-chain vulnerability: Post-pandemic vindication
India’s non-participation in RCEP proved insightful when the Covid-19 pandemic exposed the vulnerabilities of overreliance on China-centric supply chains. The global shift toward “China Plus One” strategies highlights the risk of depending heavily on a single country for critical supply chains. By staying out of RCEP, India positioned itself to diversify its trade partners and reduce the risk of overdependence on China.
It needs to be noted that the US and the EU have the policy space to pursue the China Plus One strategy given that they do not have an FTA with binding tariff concessions with China. India’s engagement in the supply-chain pillar of the Indo-Pacific Framework for Prosperity (IPEF), along with key trading partners, prioritises the need to address such supply-chain vulnerabilities due over-dependence.
Recent developments and the vindication of the Indian position
All these factors clearly underline why not joining the RCEP has protected India from unfair competition while preserving policy-space for it to react to a fast-changing world.
The orthodoxy that tariff liberalisation is always the optimal policy under all circumstances is now being seriously questioned under the changed circumstances in the global economy. It is also clear that the only incremental element of the RCEP would have been providing market access to Chinese imports through tariff reduction as RCEP had low-levels of ambition in other areas of trade policy; and India already has agreements (or is negotiating) with all the other RCEP member states.
Recent protectionist measures against Chinese imports by both the US and the EU clearly indicate the perils of advocating free trade with a non-market economy, which can hardly be expected to be fair and based on transparent market-based principles. The post-pandemic consensus for a China Plus One strategy in all major economies is the final vindication of India’s sagacity.
Pritam Banerjee is Head of Centre for WTO Studies (CWS), Indian Institute of Foreign. View expressed in this article are personal and does not represent that of CWS.
Read More: It is now becoming clearer why India’s decision to stay out of RCEP was correct