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26 QUANTIFICATION OF BENEFITS FROM ECONOMIC COOPERATION IN SOUTH ASIA Baysan and Panagriya (2006) examine the economic case for SAFTA. They study SAFTA in the light of the preferential trading arrangements in the region, particularly ISFTA, in order to draw lessons. Subsequently they examine the qualitative and quantitative arguments to assess the feasibility of SAFTA. The results are mostly pessimistic. The following qualitative arguments fail to provide a strong case in favour of SAFTA. Firstly, the economies are relatively small as compared to the rest of the world both in terms of GDP and trade flows. The economic size of the region remains small: less than one-twentieth of the world in terms of GDP. If we exclude India, this figure drops to 0.4%. Consequently, the probability that the most efficient suppliers of the member countries are within the region is slim. Hence an FTA is likely to be largely trade diverting. Secondly, the level of protection amongst SAARC countries is very high with the exception of Sri Lanka. If a country participating in a regional arrangement were not open they are likely to suffer from welfare losses due to trade diversion. The third reason which makes the economic case for SAFTA weak is political economy of selection of the excluded sectors and rules of origin (ROO) issue. This leads to inefficient selection as domestic lobbies make sure that the sectors that do not withstand competition are excluded from tariff preferences and lobbies go along free trade in sectors in which they are competitive. A similar pattern is observed in case of ROO. A common argument advanced in favour of SAFTA is that there is substantial informal trade between countries. There are three arguments relating to this issue. First, if the real costs associated with informal trade are higher, benefits of such cost saving need to be weighed against cost of trade diversion. Second, an FTA might make formal trade even more expensive than informal trade by adding to the costs of complying with the ROO. Third, all the informal trade between India and Pakistan may not be due to restrictions that preclude trade at the MFN terms and a part of it may try to evade even the MFN tariff. Apart from the theoretical arguments, quantitative studies that have estimated the impact of SAFTA have used mainly three types of models, that are either gravity models; or general equilibrium models; or partial equilibrium models. The studies employing gravity models predict that the impact of a South Asian FTA will be small for India and much larger on the smaller countries. Second, amongst studies using CGE models to SAFTA, there are two important studies, Pigato et al. (1997) and Shakur and Rae (2005). Pigato et al. find that the unilateral trade liberalisation yields larger gains than SAFTA. Shakur and Rae find that SAFTA leads to a 0.21% gain in real income in India, 0.03% gain for Srilanka and a loss of 0.10% for Bangladesh. The largest gain of 0.21% is too low and the authors conclude that the South Asian countries will gain much more from unilateral/multilateral liberalisation. The third types of studies have employed partial equilibrium models. Govindan (1994) concludes that liberalisation would yield welfare gains through increased trade within the region. Derosa and Govindan (1996) further demonstrate that the gains are much larger when liberalisation is on a non-discriminatory basis. Given, the pessimistic economic assessment the study indicates that the move toward SAFTA gained momentum due to political reasons such as with the entire world moving ahead with more and more PTAs, there is an element of following a trend around the world. Also, SAFTA is seen as a vehicle for promoting political ties between India and Pakistan. The case of India and Pakistan is often compared to France and Germany but the differences in the two situations raise serious doubts about the validity of the argument. On the whole, it can be said that the pessimism with respect to gains from SAFTA arises mainly because of lack of economic conditions for success of RTA, which are trade complementarities and differences in competitiveness of the countries. Empirical literature suggests that the existence of complementarities is needed to enhance the probability of a regional trade arrangement to be net trade-creating, rather than net trade-diverting. The statistical measures such as the complementarity index argue that the higher the observed values of the index between partners, the more likely is it that a proposed regional trade agreement will succeed (Michaely 1996). Indices of trade complementarity developed by Drysdale (1969) have been used by Kemal et al. (2000) to estimate the complementarity indices for all five leading South Asian countries using time series trade data. It was found that there is a lack of strong trade complementarity in the bilateral trade structures of South Asia. Lack of trade complementarities raises the questions on the future prospects of SAFTA. To identify different countries’ competitiveness among different commodity groups, the export revealed comparative advantage (XRCA) indices have been estimated by some studies at the three-digit level (Samaratunga 1999 and Kemal et al. 2000), which show that the comparative advantage countries in South Asia have an almost identical pattern of comparative advantage in a relatively narrow band of commodities.
LITERATURE REVIEW AND RATIONALE FOR SAFTA 27 The lack of trade complementarity in bilateral trade flow and the similarity of the pattern of comparative advantage in the region have been identified as some of the main constraints for the growth of intra-regional trade (Kemal et al. 2000). Daniel (2007) evaluates the SAFTA within the global structure of overlapping RTAs using modified gravity equation. First, it examines the effects of the Trade Liberalisation Program (TLP) which started in 2006. SAFTA would have a minor effect on regional trade flows and the impact on custom duties would be a manageable fiscal shock for most members. However, there exist studies that argue in favour of SAFTA. Raihan and Razzaque (2007) using CGE modeling estimate the trade creation and trade diversion effects of SAFTA. They show that a full implementation of SAFTA will lead to welfare gains for India, Sri Lanka and rest of South Asian countries, though Bangladesh suffers from welfare loss. Bangladesh’s welfare loss is mainly driven by the negative trade diversion effect. Simulation results also suggest that the negative trade diversion effect can be undermined by some associated unilateral trade liberalisation measure. It is also important to note that trade diversion for Bangladesh and possibly for other LDCs under SAFTA is inevitable. Bangladesh and other LDCs in South Asia will have to raise their export share into the Indian market substantially in order to increase welfare through positive terms of trade effect. Export diversification in this regard is very important. World Bank Study (1997) analyses the static welfare consequences of preferential liberalisation. Using an integrated general equilibrium model of the world economy (Global Trade Analysis Project, GTAP) it shows that regional trade liberalisation would increase the welfare between 0.5% of GDP for India and one percent for the rest of South Asia. The welfare gains from regional liberalisation are the sum of trade creation effects (increased trade between countries in the region) from lower barriers minus trade diversion losses caused by replacing non-South Asian imports with now preferred South Asian goods plus the terms of trade gains associated with increased access to each other’s still protected markets. The benefits to the rest of South Asia are larger than to India because the former gains free access to many highly protected markets of latter which results in a significant improvement in terms of trade. The study does not, however, estimates individual country impacts except for India RIS (2004) reports the result of studies conducted in the framework of gravity model. It suggests that complete elimination of tariffs under SAFTA may increase the intra-regional trade 1.6 times. It further suggests that in the dynamic framework the gains from liberalisation are at least 25% higher than the static gains. Kumar and Saini (2007) estimate different scenarios for SAFTA and its implications welfare on each country. They find that a South Asian Free Trade Area, as envisaged under the SAFTA scenario, does not result in welfare gains for all the member countries. SAFTA results in small welfare gains for all the South Asian countries except Bangladesh. Rest of South Asia (RSA) gains most by about half a billion dollars, while India gains by about US $204 millions and Sri Lanka by just US$89 millions only. Bangladesh on the other hand suffers welfare loss of about US$225 millions. The gains in welfare for RSA, India and Sri Lanka are basically due to gains in terms of trade, and to a lesser extent from improvements in allocative efficiency in the case of RSA and Sri Lanka. Bangladesh loses out both in terms of allocation efficiency and terms of trade by US$104 and US$106 millions, respectively. In sum, there exists a debate in the literature on the possible gains of SAFTA. Studies using different methodologies arrive at different results. Most of the studies have examined the impact of lowering tariffs to zero under SAFTA though few studies have also examined the impacts under alternative scenarios. The main objective of this study is to give a holistic picture of the effects of SAFTA on trade, inward investments and welfare aspects. More importantly, the study has focused on the potential of trade in services in the region and explored the ways of harmonising the regulations existing in different modes of trade in the identified services sectors. Possibilities of arriving at MRAs in different services sectors are delved on. In arriving at the conclusions on impacts of SAFTA, the study adds to the existing literature in three important ways. First, it estimates the change in the extent of complementarity and competitiveness at SITC five-digit level of the South Asian region for the years 1991 and 2004 to assess the change in the composition of competitiveness basket as well as their complementarities. The change in the complementarity and competitive baskets overtime to a large extent is able to resolve the differences arrived at by the studies estimating the impact of SAFTA using pre and post 2000 trade data. The impact on each country’s trade and welfare is analysed using CGE modeling which is followed by the estimates of trade creation and trade diversion following SAFTA using the gravity model. The study
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Page 7: Preface Our consultations with seni
Page 10 and 11: viii CONTENTS 7. Revenue and Welfar
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Page 23: Part I BENEFITS FROM TRADE, INVESTM
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Part II BENEFITS FROM DEEPENING INT
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11 Construction and Related Enginee
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12 Tourism and Travel Related Servi
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15 Prospects for the Telecommunicat
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APPENDICES
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Appendix 8 Intra SAARC FDI Collabor
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Appendix 11 Table A11.1 On an Emplo
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Appendix 12 Original Commitments/In
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Appendix 14 Table A14.1 Telecommuni
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Appendix 15 REFERENCE PAPER Scope T
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Bibliography Abelson, P. (1996),
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BIBLIOGRAPHY 241 Cuba (2002), Negot
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BIBLIOGRAPHY 243 (2004), Impacts of
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BIBLIOGRAPHY 245 Silva, Patricia an
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BIBLIOGRAPHY 247 (1998), Tourism Se
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