View: Why we need not fear bilateral trade deficits when negotiating trade agreements like RCEP

By Arvind Panagariya

Deep down, perhaps the most important factor that concerned Indian negotiators of the Regional Comprehensive Economic Partnership (RCEP) was the threat of competition from China. India has a large existing bilateral trade deficit with China and it was feared that opening to it under RCEP would widen this deficit yet further. A related concern was that an avalanche of new Chinese goods would hit Indian markets, undermining its manufacturing sector and Make in India programme.

Examine first the issue of bilateral trade deficit. Setting politics aside for the moment, as long as a country’s trade in goods and services is balanced in aggregate, economic logic tells us that bilateral deficits and surpluses should not be a matter of concern. There are nearly 200 countries in the world and each of them strives to buy its imports from countries that charge it the lowest prices and sell its exports to countries that offer it the highest prices. It will be a wonder if these myriad transactions result in mutually balanced trade for each pair of countries.

To understand the benign nature of bilateral deficits, consider for a moment how households earn and spend their incomes. I sell (“export”) my services to Columbia University because it pays me the highest salary I can get. I then use that salary to buy (“import”) the goods and services I need from sellers who sell them to me at the lowest prices. In the process, I run a bilateral surplus with Columbia and bilateral deficits with all sellers from whom I buy the goods and services I need. But as long as the dollar value of all my purchases does not exceed my earnings from Columbia, I have no reason to worry. If my total purchases exceed my earnings, I incur debt and if this happens year after year, I have something to worry about, namely, the loss of my creditworthiness.

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The same essential analysis applies to nations. As long as a country holds its overall exports and imports in balance and does not borrow abroad to finance its imports, it has nothing to worry about. If it has to borrow large amounts in relation to its export earnings to finance its imports year after year, it runs the risk of losing its credit in international markets, as we indeed did in 1991.

What about politics of deficits? For example, suppose that India runs a large bilateral trade deficit with China and covers it by running an equivalent trade surplus with the United States. If the US then reacts irrationally to its deficit with India and threatens it with trade barriers, it would seem that India would have to worry about its deficit with China.

But even here, the beauty of economic logic is that as long as India does not resort to borrowing abroad, reduced export revenues from the US will force an equivalent reduction in its total imports, yielding an overall balance. Scarcity of dollars due to reduced export revenues from the US would make them more expensive and lead to a reduction in imports from all sources.

Even the fears that China would flood Indian market with cheap imports are exaggerated. To be sure, cheap imports would come upon opening up since that is the precise point of trade liberalisation. If we do not want cheaper sources of what we need, we may as well prohibit all imports. But we tried that during the heyday of licence-permit raj and the results are there for everyone to see.

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Entry of cheap imports threatens local producers only if the latter remain inefficient and costly. Local producers that respond to competition by adopting new technologies, organising production activity better and cutting costs in other ways survive. Our manufacturing becomes stronger, as it did in the wake of post-1991 reforms.

Moreover, imports cannot expand without the expansion of exports to pay for them. The sad politics of trade, however, is that what is imported is there for all to see. What is exported is invisible to all except exporters themselves and rare trade economists who examine data.

A genuine concern in opening to trade is that it causes dislocation. Firms unable to compete with cheaper imports must find alternative employment. Gradually, expanding export firms absorb these resources, but transition can be painful. This is why trade liberalisation is implemented gradually and in a predictable way, as we did during 1991-2007. Free trade agreements similarly have implementation periods of 15 to 20 years with the bulk of liberalisation back loaded and sensitive sectors excluded altogether.

Our own experience tells us that the gains from trade liberalisation are too large to be foregone on account of transition costs. Free trade agreements have the advantage of announcing the roadmap of liberalisation one to two decades in advance, which gives economic actors ample time to relocate.

Accelerated growth during the past two decades owes much to trade liberalisation. If we are to realise our full potential in the forthcoming decade, further liberalisation either unilaterally or as a part of a set of free trade agreements is a necessity. We must drop our hesitations and act decisively, as we did during 1991-2007.

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(The writer is Professor of Economics at Columbia University)



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