Implications of “South Asia Free Trade Agreement” (Safta) in Economic Development

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Last updated: June 18, 2019

Implications of “South Asia Free Trade Agreement” (SAFTA) in Economic Development 1. Introduction Regional (or Free) Trade Agreements (RTA/FTA) are an attempt to achieve economic gains from the free flow of trade and investment between neighbouring countries. RTAs can lead to increased protection for exporters and reduced protection for importers. Reduced protection can lead to trade creation while enhanced protection increases trade diversion (Grossman and Helpman 1995).Trade diversion can lead to increased transaction costs for countries outside of the RTA, weakening the predictability and transparency of international trade relations and could lead to alterations in global trade due to trade and investment diversions (Hill, 2007).

Over the last decade, the number of such RTAs has been steadily increasing, mainly due to slow progress of multilateral trade negotiations in the Doha round (Crawford and Fiorentino, 2005).SAFTA, formed in 2006, is an extension of SAPTA and SAARC towards free trade, to achieve economic benefits among the countries – Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka. The level of intra-regional trade has been low in this region, and import tariffs have remained high, which does not encourage the success of an FTA (Bandara and Yu, 2003). This reports studies the implications of the SAFTA and its associated nations on global trade, global investment, production efficiency and greater integration of regional economies in the multilateral system. 2.

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Implications on Global tradeResearch on the implications of SAFTA on global trade have been limited, however in general, Crawford and Fiorentino (2005) suggest that trading blocs do not hamper or ‘develop a fortress’ for trade outside the FTA or RTA. Hill (2007) thinks otherwise and cites from the example of EU as a fortress to global trade because the EU has created trade and investment only in certain politically sensitive areas. Thus RTAs cause problems in balanced development of world trade due to trade diversion especially if such preferential agreements do not consider multilateral liberalisation attempts.More specifically, in relation to SAFTA, among other nations, India and Pakistan together account for about 1-2% of global textile trade, which is quite less to be able to seek even joint concession in global markets. However, through increased and progressive bilateral trade, these nations can deal with other blocs more strongly (Jain, 1999). Thus, it is possible that exports to NAFTA and EU may drop and exports to other South Asian countries may increase leading to increased transaction costs for them such as bargaining and lobbying.

Consequently, imports from South Asian countries may also increase. India, which is the most economically developed nation in the SAFTA group, may gain from this scenario (Bandara and Yu, 2003). Jain (1999) argues that this however depends on the trade bloc’s external tariffs; and that the higher such tariffs, the higher the transaction costs will be for outside exporters to trade with SAFTA countries as compared to trading among the members of SAFTA.

At a broad level, Pigato et al (1997) used the global CGE model using the Global Trade Analysis Project (GTAP) to assess the effects of SAPTA on global trade and found that SAPTA will create welfare gains for its member countries. Thus, the outcome of current limited research seems to suggest that the impact of SAFTA on global trade will be marginal with greatest benefit to India, even though it may create some trade diversion effects causing complexities to India’s global trade scenario. 3. Implications on Global investmentIn general, RTAs seem to have a positive impact on global investment particularly in countries with low costs of labour, which can get access to larger and more developed markets in the bloc. For instance in the NAFTA, Mexico’s membership gained it good FDI inflows from US and Canada (Crawford and Fiorentino, 2005). Likewise, non-EU firms have rapidly increased direct investment in the EU after its formation and between 1985 and 1989; approximately 37% of global FDI inflows were directed at the EC (Hill, 2007).

Thus, SAFTA can potentially bring positive FDI inflows to member countries such as Bangladesh, Nepal, and Bhutan etc. if they promise efficient and low-cost labour by proving themselves within the trade bloc first. Jain (1999) agrees that the SAFTA can open a huge market for FDI because most countries have skilled English speaking labour force, abundant raw materials, modern financial systems and a growing middle class. The governments have also shown commitment for trade liberalisation and deregulation making the region attractive for MNCs already.

This is an indication of reduced transaction costs in terms of ownership, localization and internalization, for global investors. SAFTA can thus further improve the position of emerging countries such as India in the global investment marketplace; and also help less developed countries such as Sri Lanka, Pakistan, Bangladesh, Nepal and Bhutan in attracting FDI. 4.

Implications on Production efficiency SAFTA will enable member countries to get production inputs from one another at lower prices. Transportation costs will be low due to geographical proximity and will lead to cost savings. Jain (1999) emphasised that, Pakistan can meet its iron ore needs through imports from India much more economically than buying from faraway places such as Australia, Canada and Brazil. Similarly, India would benefit through procuring scrap iron from Pakistan rather than South Korea.

Not only are the prices lower in the neighbouring country, savings in transportation from the geographic proximity and shorter delivery time would be tremendous”. Jain also speculated the likelihood of increased joint ventures between India and Pakistani firms to gain mutual benefit and make production efficient my complementing resources and reducing transaction costs.Bandara and Yu (2003) however argue that the preferential trade liberalisation in the SAFTA does not benefit smaller countries such as Sri Lanka and Bangladesh, which rather suffer inefficient resource utilisation. Efficiency gains could be better achieved from unilateral trade liberalisation and removal of all tariffs leading to better access to cheaper imported raw materials that can boost production.

The preferential liberalisation has so far not shown any major improvements in production output because the production structures and cultures are relatively similar in member countries thus not gaining uch access to new forms of technology and management skills from each other. However at a macroeconomic level, Jain (1999) argues that productivity will increase given the reduced costs of production and access to raw material, eventually leading to better growth and employment. Also, merchandise trade deficits may be reduced as countries such as India and Pakistan can divert their imports to cheaper bilateral sources in the SAFTA than from the costlier sources from world markets or from other trading blocs. 5. Greater integration of the regional economies into the multilateral systemCrawford and Fiorentino (2005) assert that, in general, RTAs can promote better integration of the economies of participating nations on a wider scale than a country can unilaterally do through the WTO. Issues such as investment, competition, intellectual property rights, labour standards, environment etc. can be better dealt with multilaterally through the use of RTAs. For instance with the SAFTA, member countries can collectively negotiate on these issues and project regional differences and commonalities to the WTO to have better trade policies.

Bandara and Yu (2003) regard NAFTA and EU as the two biggest partners of South Asian countries and that these will gain from the welfare activities brought into place by the SAFTA thus bringing about better integration among the western and eastern trading systems. Albertin (2008), however, believes that regionalism increases transaction costs such as currency changes, search/information costs and bargaining costs, crucially affecting the incentives for multilateralism, causing infeasibility, as policymakers may prefer the RTA to multilateral FTAs.This could pose as a stumbling block on the integration of regional economies into the multilateral system. Hence, the argument remains divided on this issue; however, the outcome seems to depend on policymakers as to how they balance between preferential and multilateral systems. 6. Conclusion Overall, it seems that the SAFTA has neutral implications on global trade, positive implications of global investment, neutral implications on production efficiency and neutral implications on better integration with the multilateral system.It seems that the SAFTA will not be a major turning point for emerging South Asian economies such as India, as Rodriguez-Delgado (2007) points that trade agreements with NAFTA, EU or ASEAN would generate higher trade flows than SAFTA.

However, for smaller countries such as Bhutan and Nepal regional trade is the main channel. A lot of the benefits of the SAFTA also depend on the political disputes such as between India and Pakistan, which have, in the past severely hampered the progress of SAARC and SAPTA (Bandara and Yu, 2003; Jain, 1999).Small countries can lose or gain marginally and big countries such as India are likely to be significant winners, however, these countries should make sure smaller and under-developed countries also gain from the FTA. In essence, SAPTA and SAFTA should help member countries engage in better unilateral liberalisation (Srinivasan, 1998) and keep the momentum of liberalisation going for better economic development of the region.


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