Potential of a Free Trade Agreement
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A free trade agreement (FTA) between the United States and India could bring improvements in both trade and welfare in both countries, according to a new article in the Journal of Economic Integration, written by Will Martin of IFPRI and Emiko Fukase of the World Bank. Using the Global Trade Analysis Project (GTAP) model, the paper examines the nature and extent of trade creation and diversion from a potential free trade agreement between the two countries.

 India has undergone significant trade liberalization in recent years and has also seen strong, fast-paced economic growth. Over the period 2000-2011, trade between India and the United States grew rapidly, with US imports from India increasing from USD 13 billion to USD 54 billion and US exports to India increasing from 6 billion to 32 billion. Trade in services and manufactured goods is particularly important in both directions; however, trade in agriculture (including processed agriculture) remains relatively small.

Over time, the United States will likely want to increase its access to India’s growing market, according to the paper. At the same time, other regional agreements could divert trade from India, leading Indian policymakers to seek other avenues of trade. Thus, a free trade agreement between India and the US could be a tempting policy option for both countries in the future.

The potential impacts of a US-India FTA are evaluated using a hypothetical scenario that consists of a 100 percent and a 50 percent Ad Valorem Equivalent (AVE) tariff cut for goods and services, respectively. The results suggest that the overall impacts of an India-US FTA would increase real incomes in both for the US and India; while both countries may see some trade diversion on the import side, they would gain from improved access to each other’s markets on the export side.

A 100 percent AVE tariff cut for goods would increase US exports to India by 63 percent and Indian exports to the US by 15 percent. In terms of agriculture, the expansion of US exports to India would be particularly large at 183.2 percent for agricultural goods and 719 percent for processed agricultural goods. These large increases reflect India’s generally high levels of agricultural tariffs. However, initial protection in the US is relatively low compared to India, meaning that India’s export growth will be smaller given a 100 percent AVE tariff cut for goods. The largest expansion in India’s exports to the US is seen in the textiles and apparel sector (about 85 percent growth); for agriculture, this expansion will only be about 5.3 percent for agricultural goods and 11.6 percent for processed agricultural goods.

A 50 percent AVE tariff cut for services would lead to an overall increase in US exports to India (28 percent) and Indian exports to the US (5 percent). This increase in service exports would cause a slight contraction in the export of goods from the US to India, as resources would be reallocated toward the more profitable services sector. For agriculture, this would mean a decline in exports (-0.2 percent for agricultural goods and -0.6 percent for processed agricultural goods). Increased services exports would not negatively impact India’s agricultural exports to the US, however; for agricultural goods, there would be no change in export levels, while for processed agricultural goods, India’s exports to the US would increase by 0.5 percent. These results for India’s agricultural exports can be explained by the fact that services imported to India could provide important agricultural inputs and could reduce transportation costs. Thus, service imports could help India increase its overall competitiveness in international agricultural trade.

Taking into account both AVE tariff cuts (100 percent for goods and 50 percent for services), the paper finds that exports will grow substantially in both countries. Exports from the US to India will expand by 90 percent, while exports from India to the US will expand by 20 percent. In terms of trade values in 2007 constant prices, the increase in bilateral trade (imports and exports combined) will be as much as USD 29 billion (0.21 percent and 2.4 percent of US and Indian initial GDP, respectively). For agriculture, exports from the US to India will increase by 183 percent for agricultural goods and 714.7 percent for processed agricultural goods; exports from India to the US will also increase, by 5.3 percent for agricultural goods and 12.3 percent for processed agricultural goods.

Reducing tariffs on goods and services, and on both sectors simultaneously, will also bring welfare benefits for both countries. When trade in goods is liberalized (a 100 percent reduction in AVE tariffs), welfare gains will be USD 2.3 billion for the US and 0.2 billion for India. For services liberalization (50 percent reduction in AVE tariffs), the US would see welfare gains of USD 1.4 billion, while India would see a gain of USD 1.2 billion. Combining liberalization in both goods and services would result in a gain of USD 3.7 billion in the US and 1.4 billion in India; these figures represent about 0.03 percent and 0.1 percent of initial GDP in each country, respectively.

The paper also finds that a potential US-India FTA could also have a positive impact on poverty in India through wage increases for unskilled workers. Unskilled labor is abundant in India, and increasing trade in both goods and services would increase the demand for labor-intensive exports. The study’s simulations suggest that real wages for unskilled workers could increase by 0.4 percent as a result of a US-India FTA. The paper does emphasize, however, that trade liberalization can have mixed consequences on poverty in developing countries, and these consequences should be further studied in the context of a potential US-India FTA.

Finally, the paper also looks at how other preferential trade agreements could impact the effects of an FTA between the US and India. For example, if India first signs an FTA with the US and then liberalizes trade with its other trading partners on a Most-Favored Nation (MFN) basis, total Indian imports and exports would expand by 26 and 29 percent, respectively. Growth in the country’s imports would be especially significant in the processed agricultural sector, at 233 percent. Adding a new US-India FTA to other, prior free trade agreements would result in additional welfare benefits for both countries. Combining a US-India FTA with a number of other trade agreements (such as the TPP, US-EU FTA, India-EU FTA, and India-ASEAN FTA) would lead to welfare gains of USD 12.6 billion for the US and 6.2 billion for India, higher than the gains for any one individual agreement.

Overall, the study finds that a free trade agreement between India and the US could be an important step toward more overall liberal trade regimes and provide worthwhile economic benefits to both countries.

Written by:  Sara Gustafson

Photo credit:Flickr, Rajesh_India