Mega External Preferential Trade Agreements and Their Impacts on Indian Economy

Date01 February 2016
Published date01 February 2016
Subject MatterArticles
Mega External Preferential
Trade Agreements and
Their Impacts on Indian
A. Ganesh-Kumar1
Tirtha Chatterjee1
This study examines the impacts on India of three mega external preferential
trading agreements (PTAs) from which the country is excluded using the Global
Trade Analysis Project (GTAP) model combined with POVCAL poverty analy-
sis tool. The simulation results show that each of these PTAs cause consid-
erable trade diversion. However, the impacts on India’s trade flows, domestic
output, returns to factors, aggregate welfare, inequality and poverty levels are
rather small. In contrast, multilateral trade liberalization has significantly large
and favourable impacts on all these variables. In particular, welfare improves by
1.7 per cent of GDP, inequality falls by over half percentage point and poverty
head count lowers by 12.3 per cent over base levels under a multilateral free
trade scenario. These results suggest that the country should continue with its
efforts for achieving a multilateral trade agreement. At the same time, the coun-
try should hedge against the possibility that a global trade agreement does not
materialize. One way to protect the country’s interest is to aggressively pursue
preferential trading arrangements in parallel with key members of these three
mega PTAs. This is likely to ensure that the country does not lose market
share due to preference erosion.
JEL: D58, F13, I31, O24
Trade policy, preferential trade agreements, poverty, computable general
Foreign Trade Review
51(1) 46–80
©2016 Indian Institute of
Foreign Trade
SAGE Publications
DOI: 10.1177/0015732515616545
Corresponding author:
A. Ganesh-Kumar, Professor, Indira Gandhi Institute of Development Research (IGIDR), Gen. A. K.
Vaidya Marg, Goregaon (E), Mumbai 400065, India.
1 Indira Gandhi Institute of Development Research (IGIDR), Goregaon (E), Mumbai, India.
Ganesh-Kumar and Chatterjee 47
Globally, the last two decades have seen an exponential rise in the number of
preferential trading agreements (PTAs) and regional trade agreements (RTAs)
between countries, from around 70 in 1990 to nearly 400 in 2013. Several reasons
have been attributed for this sharp rise in the PTAs. These include: (a) the slow-
paced progress in the Doha Round of multilateral trade negotiations that began in
November 2001, (b) the desire for deepening market access and widening trade
rules relating to issues such as trade standards, labour standards, property rights,
investments, services and so on beyond the provisions of the multilateral trade
regime under the World Trade Organization (WTO) and (c) the relative ease of
negotiations amongst a smaller group of countries.
India too has been engaged in pursuing PTAs/RTAs with its South Asian neigh-
bours, the Southeast Asian countries that form the Association of Southeast Asian
Nations (ASEAN) group, with the European Union (EU) and so on. The country is
already a partner in 19 PTAs/RTAs currently and is engaged in 19 other trade nego-
tiations (Ministry of Commerce & Industry, 2014). In general, the scope of the
PTAs involving India has been narrow, and the country has not displayed adequate
vigour, nimbleness and speed in pursuing PTAs involving major trading nations.
Thus, for instance, India does not find place in some of the major PTA initia-
tives currently under negotiations, even though they may have significant impacts
on the country. Three such external mega PTAs that are currently under negotia-
tion in which India does not find a place are the Trans-Pacific Partnership agree-
ment (TPP), the Trans-Atlantic Trade and Investment Partnership agreement
(TTIP) and the EU–ASEAN free trade agreement.
What are the likely impacts of India’s exclusion from these mega PTAs that
are currently under negotiation? This study attempts to address this question using
the GTAP model, a global computable general equilibrium (CGE) model com -
bined with POVCAL poverty analysis tool developed at the World Bank.
Theoretical literature on PTAs/RTAs has focused mainly on two questions,
namely, their impacts on: (a) member countries and (b) the world trading system
as a whole. The general conclusion is that the impacts depend upon whether the
specific PTA/RTA is ‘net trade-creating’ in which case it is a ‘building block’ or
‘net trade-diverting’ that makes it a ‘stumbling block’ for multilateral trade liber-
alization (Bhagwati & Panagariya, 1996; Panagariya, 1998; Robinson &
Thierfelder, 1999). An excluded country could face adverse impacts if its exports
to a particular member country in a PTA get displaced by exports from other
members of the PTA because of the preferences that PTA members enjoy. A simi-
lar outcome on the excluded country’s exports can arise due to preference erosion
when its preferential trade partner becomes member of another PTA. Whether this
happens or not ‘is essentially an empirical issue that must be settled by analysis of
data’ (Lewis, Robinson, & Theirfelder, 2001).
Empirical assessments of PTAs on an excluded country have typically focused
on diversion of its exports. A sharp reduction in exports would affect the total
demand faced by domestic producers, and this in turn could affect sectoral and
aggregate output, income, consumption and ultimately household welfare.
Besides, significant loss in export revenue can have serious repercussions on the
48 Foreign Trade Review 51(1)
balance of payments with attendant consequences for the exchange rate and over-
all macroeconomic balance.
PTAs can also affect the imports of a non-member country when members of
a PTA reduce their exports to the excluded country if they do not find it as profit-
able as exporting to other PTA members. If for some commodities the excluded
country is dependent on imports from PTA members, then the only way it can
import sufficient quantities to meet its requirements is by paying a higher import
price. The rise in import price can cause the domestic price of such commodities
to rise sharply, which in turn would have adverse impacts on welfare.
To assess these overall trade effects of a PTA on non-member countries, the
analytical framework should encompass both exports and imports. It should cap-
ture the welfare impacts on households taking into account the linkages between
trade flows, domestic production, household income and consumption, and the
macroeconomic impacts that changes in trade flows can bring about via their
impacts on the balance of payments. An analytical framework that is naturally
suited for studying these impacts in a consistent manner is the CGE model.
The GTAP model (Hertel, 1996) is a global CGE model that is particularly
suited for studying the impacts of PTAs on an excluded country since it covers all
the economies of the world, and endogenizes the trade flows amongst them in a
theoretically consistent manner. As is the case with all CGE models, the GTAP
model captures the linkages between domestic production, trade flows, income
generation and distribution, and consumption and savings decisions of all agents
in the economy, and endogenously solves for the market clearing prices. This
study makes use of the GTAP model to study the impacts of the three mega
PTAs currently under negotiation on India. In particular, the impacts on sectoral
trade flows, outputs, prices, macroeconomic aggregates and aggregate welfare are
examined using the GTAP model.
While the GTAP is capable of assessing the aggregate welfare impacts on all
countries due to changes in trade (or any other) policy in any part of the world, the
model is not directly amenable for analyzing the impacts on income distribution
and poverty. Hence, the outcomes of the GTAP model are carried into the
POVCAL poverty analysis tool developed at the World Bank to assess the pov-
erty impacts on India due to the mega PTAs.
The rest of the article is organized as follows. The next section briefly describes
the GTAP model and describes in detail the simulations that have been carried out
here. Further, it also briefly describes the POVCAL tool and the procedure adopted
in this study to use this tool along with the GTAP model to assess the distribu-
tional impacts. The third section reports the simulation results, while the last sec-
tion provides some concluding remarks.
Analytical Framework and Experiment Design
The GTAP Model
The GTAP model is a comparative-static multi-region multi-sector CGE model
that has been used by several researchers around the world for assessing various

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