Situating Saarc

  • If Nepal can take advantage of Indian and Chinese markets, there might not be much to gain from Saarc
- RAM C ACHARYA
Situating Saarc

Dec 7, 2014-

The 18th Saarc Summit has ended with 36-point Kathmandu Declaration, which includes almost everything that matters for a nation. To cite a few: forming an economic union, integrating energy markets, ensuring food security, fixing the environment, raising accessibility and quality of education, creating youth employment, and ending the exploitation of women and children. The list continues with provisions to introduce social security for the less fortunate, ensuring the well-being of migrants who go to work in non-member countries, sharing space technology, combating terrorism, providing good governance, and much more.

Among more than 100 regional blocks in the world, Saarc probably is the most ambitious and yet, with the least achievement. As in the past, the Kathmandu Declaration may likely turn into a wishlist. The harsh political realities of the region, the asymmetric size of its member-states, and their geographic locations are built-in constraints limiting Saarc’s potential. Saarc is devoid of synergy—it is not larger than the sum of the bilateral.

However, given the right set of policies, an underperforming Saarc should not inhibit Nepal’s development.

Saarc and the globe

Saarc is tall in population but a dwarf in economic measures. Saarc member-states are home to 24 percent of the world population but generate only 6 percent of global income. In 2013, out of $46 trillion global two-way trade (exports plus imports) of goods and services, this region contributed only $1.25 trillion (three percent). By comparison, China contributed 10 percent and the Association of Southeast Asian Nations (Asean) (with only one-third of Saarc’s population) contributed seven percent. For multinationals, Saarc is not a favourite spot—it occupies only one percent of global foreign direct investment stock whereas China captures four percent and Asean receives seven percent.

With an average per capita income of only $1,400, this is one of the poorest regions in the world. By comparison, the Chinese are five-times and Asean residents three-times richer than Saarc residents. Forty percent of the one billion poorest people in the world live in this region.

The region is mired with anti-business regulations, corruption, and a lack of transparency. But the upside is that India has already moved towards a more business-friendly environment and will likely accelerate under Narendra Modi’s rule. Given India’s large size—contributing 80 percent to the regional income—any policy changes in India can have significant impacts on the region. Saarc members are so asymmetric that the second largest country, Pakistan, contributes only 11 percent to regional income, and the combined income share of other six countries is smaller than that of Pakistan (five percent by Bangladesh, 2.3 percent by Sri Lanka, 0.8 percent from Nepal and Afghanistan each). Bhutan and the Maldives are only eight percent and three percent of Nepal, respectively.

Saarc and its members

Most often, regional blocks like Saarc are formed for economic integration, which entails integration in three markets: product, capital, and technology. Saarc’s report card on integration is dismal; it remains the least integrated regional bloc. Despite its adoption of a preferential trading agreement and subsequently, a free trade area agreement in 2006 for some items with planning to cover all goods by 2016, the product market integration is a farce.

Promises have been limited to rhetoric. There are substantive trade barriers in the form of tariffs, non-tariffs, transportation bottlenecks, red-tape, transit difficulties, absence of land connectivity, complicated visa systems, and so on. As a result, in 2013, only six percent of Saarc trade was intra-regional, compared to 50 percent in Asean. The intra-regional two-way trade of $45 billion was less than half of the Saarc region’s two-way trade with China (at $96 billion) and less than the $80 billion trade with the US.

No doubt, policy-induced obstacles have suppressed the potential of integration. But there are two built-in barriers that impose limit to integration in the region: the asymmetric size and the geographic location of member countries. The combined trade of seven countries is only 20 percent of India’s trade. Even if all seven countries import only from India, they can absorb only one-third of India’s exports. Furthermore, countries prefer to trade with countries that have better technology. Given this, there is no reason for India to put much emphasis on Saarc; it has to look beyond.

The fact that three member states are land-locked and are connected only with one member state puts another dent in regional integration. As inland transport cost is high, these countries prefer to engage with bordering non-member countries than cross member country territory entirely to get to another market.

Saarc and Nepal

Among member countries, Nepal, with less than half of the region’s per capita income, is the worst performer. A well performing Saarc, though highly desirable, will not necessarily drive Nepal’s prosperity. Nepal has not been able to take advantage of its emerging neighbours and will not be able to do so of a more promising Saarc either. The market framework that regional blocs like Saarc develop benefits mainly those economies that are competitive in the production of goods and services. Nepal’s production base has been eroded completely. Generally exports rise with GDP, but Nepal is exceptional. Its real export (inflation adjusted) in 2013 was only 80 percent of that in 2001. Its export revenue of a year can finance imports for only 45 days (for the remaining, they are financed mainly by remittances).

For Nepal to be able to take advantage of foreign markets—whether bilateral, regional, or multilateral—it needs to correct policies that have created anti-trade regimes and hollowed out production. New policies should address the following problems head on: failures of public schools to provide meaningful education; migration of youths to foreign countries; tax preference for non-tradable over tradable; and an over-valued exchange rate. Furthermore, fiscal policies should reverse the long practice of diverting resources from wealth-creating to rent-extracting sectors (such as land, urban homesteads, private education).

These policy changes should be accompanied by a trade policy that is not very different for India and China. Freer trade with India (or with Saarc), with no reciprocal arrangement with China may create a trade diversion. This happens when because of tariff differences among trading partners, a product is imported from a more expensive producer. To illustrate the point, suppose that a product cost Rs 100 in China and Rs 110 in India. If there were equal tariffs say of Rs 20 per unit, Nepalis would import the product from China and pay Rs 120 (Rs 100 to the Chinese producer and 10 to the Nepali treasury) rather than paying Rs 130 from India. Now suppose the tariffs to India (not China) are removed. The product will be imported from India at Rs 110 rather than importing at Rs 120 from China. The Nepali government will lose its tariff revenue of Rs 20 and a more efficient producer (in this case, China) is replaced by less efficient producer (in this case, India) because of discriminatory trade polices (tariffs). Trade diversion is a loss for the country.

Besides, a landlocked country like Nepal, where crossing the immense territory of India and China to export to any other country is almost prohibitive because of transport costs, should maximise its exposition to both neighbouring markets. Furthermore, Nepali companies should be able to learn from both markets. This is particularly important as the Chinese trading sector is more than four-times larger than that of India.

It might be prudent to establish freer (and similar) trading regimes with India and China, irrespective of what happens to Saarc. Given these policy changes, there is not much additional economic gain for Nepal from Saarc above what it can gain by being engaged with India and China in a more purposeful way. Even if Nepal can supply 0.33(one-third of one) percent of Chinaand India’s imports, it will absorbmore than half of Nepal’s GDP.

Acharya is a Canada-based economist who conducts research on economic policies

 

Published: 08-12-2014 09:42

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