Potential Benefits from a Deep EU–India Free Trade Agreement

Asia Eur J (2009) 7:43–62 DOI 10.1007/s10308-008-0204-0 O R I G I N A L PA P E R

Potential Benefits from a Deep EU–India Free Trade Agreement Peter Holmes & Anirudh Shingal

Published online: 4 November 2008 # Springer-Verlag 2008

Abstract Both parties to an eventual EU India FTA have agreed that it should not merely address tariff barriers but should also go further into what is known as deep integration, originally developed in the 1990s by R.Z. Lawrence. This relates to the removal of all obstacles to cross border business whether actual trade barriers or domestic regulations. We distinguish deep institutional integration from the deep integration of markets. We ask the question how one may support the other. There are potential market failures that can be addressed by trans-national rules on standards and technical regulations and services, but we conclude that the biggest impact of a deep RTA would be on the domestic economy of India if it provides an opportunity for reform. It should be noted that the paper draws on a study undertaken by the authors for DG Trade, but it represents only the views of the authors.

Introduction The EU’s strategy in free trade agreements (FTAs) places great emphasis on deep integration in the sense that it recognises that shallow integration in the form of the removal of trade barriers such as tariffs and quantitative restrictions (QRs) is inadequate. The term Deep Integration was first coined by Robert Lawrence in 1996. He used it to refer to a process of removing barriers to trade and investment that are behind the border, notably regulatory barriers or even mere differences that make it harder to do business across borders than within jurisdictions. The term deep integration should perhaps be extended so that the policy dimension referred to here can be called Deep Institutional Integration (DII) while simultaneously we should be aware of market processes that are related to this. Deep market Integration (DMI) can be used to refer to market institutions that integrate productive systems. P. Holmes (*) : A. Shingal CARIS (Centre for the Analysis of Regional Integration at Sussex), Department of Economics, University of Sussex, Brighton BN1 9SN, UK e-mail: [email protected] A. Shingal e-mail: [email protected]

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Multinational firms, value chains, corporate networks—are all example of DMI. We might possibly wish further to distinguish the outcome of these processes in terms of trade and investment flows and other possible indicators such as the degree of contestability across borders. We could call this for want of a better term Deep Outcome Integration (DOI). In this paper we examine, (speculate would perhaps be a better word!) what the possible transmission mechanisms are that could justify a deep integration FTA between the EU and India. We do not claim that all of these outcomes will materialise, nor that there will indeed be a successful FTA negotiation. The contribution of the paper can perhaps be read as a negative one: unless DI can be approached in the way we sketch out, a deep FTA cannot happen and a shallow one is unlikely to be very valuable. The UK House of Commons recently noted: It is too early in the negotiations for the Committee to reach a conclusion on the level of India’s preparedness to reach an extensive agreement, which would see liberalisation of the vast majority of trade in goods as well as services, procurement and so on.1 There are several fundamental reasons why we might wish to promote DI rather than merely shallow: 1. When tariffs are low their removal has little effect but if they are high there is a risk of trade diversion, whilst removing regulatory barriers is thought to be generally trade enhancing 2. Where there are despite these qualifications indeed potential positive gains from shallow integration these can only materialise if non-tariff barriers (NTBs) are also removed 3. Experience of the European Internal Market programme and of the recent CEEC accession suggests that the biggest effect of regulatory alignment does not so much lie in the improved market access as in the upgrading of standards (using this term loosely) across the whole domestic economy 4. Evidence also suggests that the productivity enhancing effects of trade occur when fine degrees of specialisation occur, allowing firms to invest in learning by doing in particular product niches or steps in the value chain, and to take part in production systems that facilitate technology transfer Hence if an FTA is to succeed we wish to see the emergence of private and public arrangements that can reduce transactions costs, enhance certainty and predictability of behaviour and create markets that are contestable and free of adverse externalities. The role of an FTA in promoting this deep integration is then to remove unnecessary regulatory obstacles to trade and to creating a facilitating environment in which mutually advantageous private contracts and market-led institutional arrangements can flourish. We have elsewhere (See Gasiorek et al. 2007) tried to schematise the links between trade policy and new types of trade flows, such as the development of “Smithian” specialisation in niche markets and production chains. We see Smithian specialisation as occurring when firms focus on a particular niche product (e.g. screws of a certain gauge) or one step in the chain of tasks going into a final product. 1

Select Committee on Business and Enterprise Fifth Report, April 2008, http://www.publications. parliament.uk/pa/cm200708/cmselect/cmberr/209/20907.htm

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This often involves separating service components from manufacturing. This “unbundling” relies on markets that are credibly open and where quality can be assured without costly post delivery inspection. We see potential market failures that can be addressed as arising out of: & & & & & &

Asymmetric information Learning spill-overs Reputational spill-overs Environmental spill-overs Economies of scale and transactions costs arising from standardisation of conformity assessment etc. Collective action and coordination failures and network externalities

We see a remarkable burgeoning of DMI and DOI in East Asia with only limited DII. Perhaps most remarkable is the intensity of trade links between China and Taiwan in the absence of any official diplomatic links at all or even regular direct flights!2 This leads to the possible conclusion that DII is unnecessary. However we see a historical relationship between DII DMI and DOI.

EU–India FTA A team at Sussex have carried out a study (See Gasiorek et al. 2007) of the potential gains from DI between the EU and India. It is based on the following premises: 1. That for DMI in goods to succeed there must be a base on which to build. We argue below that various forms of intra-industry trade can be seen as creating the basis for profitable DII. Where firms are specialising in niche markets (either horizontally or along a quality axis) the predictability of quality is important. Even a firm selling on price alone will not be able to enter a market if its good falls below a certain standard. Goods whose bad quality can disturb production processes or consumer markets have negative value and cannot be sold at any price. Cheap and cheerful must still be cheerful. Where firms are specialising in outsourced components or services this is vital. We suggest that the growth and level of intra-industry trade is an indicator of DMI and of the scope for DIII. 2. That trade in services is critically dependent on regulatory barriers. Clearly for EU–India this is a major issue for both sides. 3. In services and also in the matter of standards and quality, the biggest benefits are likely to come from the impact of externally driven reforms on the domestic market. Before proceeding we should however be very clear that the domestic impact of deep integration is complex: there will be losers as well as winners. We should distinguish: & & 2

Firms that are currently exporting who will have an improved home business environment Firms able to enter export markets But see Li (2008) for an alternative interpretation of the East Asian story.

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Table 1 Deep integration and routes to gains from trade Traditional trade gains & trade policies Driving forces (economic determinants)

Hecksher–Ohlin comparative advantage: endowments, income, factors’ costs

“Smithian” productivity enhancing gains from trade “Horizontal” IIT

“Vertical” IIT Trade

Productivity gains driven Productivity gains driven by product innovation and by process innovation and specialisation (including thinner division of labour advertisement) (slicing up production chain, e.g. Mexico–US) Type of product Homogeneous (either final Mostly final, differentiated Trade growth is in affected or intermediate) by variety and by quality intermediate goods—may be homogenous/ interchangeable but quality needs monitoring and differentiation along production chain; mostly industrial but not only. Includes more agricultural Services outsourcing niche products. (process of ‘de-commodification’ of commodities) Any firm may be internationally More likely to be Type of firms integrated or integrated; long term involved in subcontracting affiliation or this type of trade subcontracting likely Standards, regulations, Standards mostly Relevant Policy Tariffs QRs etc. Any instruments standards, regulations that conformity assessment Monitoring can be done on Monitoring must be done are purely tariffimport but potentially along the whole prod chain equivalents (especially very costly time consuming controls done at port of import) Reputation, health, learning Lack of quality assurance Market failures/ Any effects, systems, standardisation, externalities general issues of business associated environment with this kind of trade Public policy measures More scope for public Action needed Much scope for intra-firm need to be addressed intervention here to remove resolution and private (especially in case of barriers: coordination; public market failures: e.g. Public vs. policies needed for health issues that Private favourable environment; individual consumers cannot ‘detect’—these interests may require public intervention i.e. driven by public welfare); NB avoid ‘raising rivals’ costs standards ROLE FOR Eliminate border barriers Quality standards ensuring As above all quality and RTAS and equivalent protection of consumer compatibility for and environment processes Traditional Higher profitability from Economies of scale and Gains from trade if RTA niche products plus technology transfer successful learning about value chain + economies of scope

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Table 1 (continued) Traditional trade gains & trade policies Impact of trade expansion on poverty

& & &

“Smithian” productivity enhancing gains from trade “Horizontal” IIT

“Vertical” IIT Trade

Poorest make less tradables Maybe hard for small firms Very poor unlikely to be involved at all, but huge so less able to profit from to meet standards gains if somehow they expansion of formal However there can be sector. But possible positive labour impact if can get into international impact on employment larger can do so value chains. However there can be positive and wages? labour impact (e.g. maquiladoras employment in Mexico)

Consumers who like products made to international (or FTA partner) standards Home firms who cannot meet higher standards and go out of business Consumers who do not want to pay for the international (or FTA partner) standards

An obvious issue arises in the case of pressures to liberalise Indian retailing. It seems likely that opening to foreign competition will increase efficiency, but not only will many small shop keepers suffer, so too will those consumers unable to access new retail outlets so easily3. But with this important caveat in mind we proceed to where this analysis leads us, to the nature of IIT, the standards regime and the role of services. In our study for the European Commission we also looked at barriers to FDI and government procurement. Our conclusions there were broadly similar to those here, that there is appetite for reform that is internally motivated but rationalised by the needs for market access, but there are also major obstacles.

Intra-industry trade As we noted, an important indicator of existing deep integration is the degree to which intra industry trade (IIT) is taking place. Equally, the rate of growth of IIT is an indicator of the potential for further deep integration. IIT may take three forms: first, is the exchange of similar goods (the same trade heading) of broadly similar qualities and prices (Volkswagens for Citroens, for e.g.); second, is the exchange of similar goods of different qualities and prices (Volkswagens for Rolls Royce); and third, is exchange of goods within a trade classification that represents a vertically integrated supply chain (parts for finished or part finished goods). Each of these represents ways in which economic integration can encourage niche specialisation that can generate the productivity gains that represent the main advantages of deep integration. Chauvin and Lemoine (2003) remark that the pattern of Indian trade “suggests a shallow integration in the world economy.” But they note an emerging tendency in which “The technology content of India’s trade is low by international standards, but India has built up strengths in technology niches.” 3

Though with retail outlets mushrooming in every nook and cranny of the country, this may become less of a concern.

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Table 2 Comparative indicators of intra industry trade 1992–2004 Year

HS4 India with World

China with World

Part A Grubel–Lloyd index 1992 0.264 0.353 1996 0.305 0.365 2000 0.355 0.362 2004 0.388 0.369 Part B IIT as share of trade 1992 43% 52% 1996 47% 55% 2000 45% 62% 2004 52% 68% Part C Share of IIT horizontally differentiated 1992 3% 12% 1996 6% 15% 2000 7% 13% 2004 16% 17% Part D Share of IIT vertically differentiated 1992 18% 29% 1996 31% 39% 2000 26% 48% 2004 35% 51%

Brazil with World

0.343 0.345 0.352 0.370

EU with World

USA with World

EU with India

0.529 0.547 0.540 0.534

0.104 0.167 0.197 0.219

0.742 0.779 0.783 0.783

47% 57% 61% 57%

97% 99% 100% 100%

86% 88% 88% 84%

19% 31% 37% 39%

11% 17% 14% 11%

65% 71% 63% 62%

21% 13% 12% 24%

1% 3% 4% 4%

35% 40% 47% 45%

31% 26% 35% 37%

36% 52% 48% 34%

8% 14% 19% 18%

Source: Gasiorek et al. (2007)

Table 2 above sets out some comparative figures on IIT for India since 1992. Part A of the table shows the Grubel–Lloyd index (GLI) for India, Brazil, China, the EU and the USA with the World and for EU–India. The GLI measures the overlap between the industrial structure of imports and exports (here measured at HS4) between any pair of trading partners. The higher the index the greater the intra industry trade overlap with an index of 1 representing total overlap. Part B shows the share of trade (measured as imports+exports) in IIT. Essentially this shows trade in HS 4 Headings where the GLI exceeds 0.15 as a threshold for the existence of IIT in Table 3 Indian cumulative FDI inflows 2003–2006 and GLI India–world 2004

Electrical equipment Transportation industry Fuels Chemicals Food processing industries Drugs and Pharmaceutical Cement gypsum products Metallurgical industries FDI share—GLI correlation Source: Gasiorek et al. (2007)

HS codes

Share of Indian FDI inflows 2003–2006

GLI 2004

85 87–89 27 28–29 16–24 30 25 72–81

27% 14% 5% 7% 3% 7% 6% 5%

0.45 0.45 0.27 0.46 0.32 0.49 0.36 0.32 0.50

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Table 4 Composition of India’s service exports 1997/8, 2006/7 Category (figure in US $ million)

1997–98

2006–07

Growth rate

Travel Transportation Insurance GNIE Communication Construction Financial Software News agency Royalties, copyright & license fees Management Other services Total

2,914 1,836 240 276 171 101 296 1,760 156 21 549 1,109 9,429

9,123 8,050 1,202 250 2,099 332 2,913 31,300 334 97 7,346 745 76,181

213.1% 338.5% 400.8% −9.4% 1127.5% 228.7% 884.1% 1678.4% 114.1% 361.9% 1238.1% −32.8% 707.9%

Percentage shares 31% 19% 3% 3% 2% 1% 3% 19% 2% 0% 6% 12% 100%

12% 11% 2% 0% 3% 0% 4% 41% 0% 0% 10% 1% 84%

Source: Reserve Bank of India Bulletin 2008; own calculations The RBI Bulletin provides a more detailed breakdown of services exports since 2004–05 compared to the preceding period. The table therefore includes only those services categories for which comparable data is available over these two points in time. The percentage shares in 2006/7 therefore do not add up to 100. The categories not included in the table for 2006/7but for which services exports data is available include merchanting, trade-related, operational leasing, legal, accounting and auditing, advertising, R&D, architecture and engineering, agricultural mining, maintenance of offices abroad, environmental, personal, cultural & recreational services and refund and rebates. The two major services categories within these are architecture and engineering and maintenance of offices abroad which accounted for 8 and 3%, respectively, of total services exports in 2006/7

the sector. Parts C and D try to answer the question of how much of the product differentiation is due to the exchange of products of similar qualities (where price would be broadly similar)—horizontal differentiation—and how much would be vertically differentiated IIT where either qualities are very different or international supply chain integration is taking place. Part A makes it clear that India lagged behind China and Brazil in terms of IIT in 1992 but had caught up and indeed may have overtaken both of them by 2004. All three however lag well behind the US and above all the EU. The high level of overlap in the structure of EU imports and exports is one of the defining features of European integration from the first studies of the impact of the formation of the EEC Table 5 India’s RCA index in services vis-a-vis the OECD and India Category

1997

1998

1999

2000

2001

2002

2003

2004

2005

Transport Travel Communication Construction Insurance Financial IT Royalties OBS Personal etc. Govt.

0.9 1.0 1.0 0.3 1.3 0.7 10.0 0.0 0.4 0.0 0.8

0.7 0.7 2.2 0.4 0.9 0.4 9.1 0.0 0.3 0.0 1.3

0.5 0.6 3.3 1.0 0.7 0.4 8.3 0.1 0.3 0.0 1.2

0.6 0.7 3.5 1.7 0.9 0.4 11.7 0.1 0.1 0.0 1.4

0.6 0.6 2.0 0.4 0.8 0.3 11.0 0.0 0.1 0.0 1.1

0.6 0.6 1.8 0.5 0.6 0.5 11.0 0.0 0.2 0.0 0.5

0.6 0.7 1.7 0.9 0.5 0.2 10.0 0.0 0.2 0.0 0.3

0.5 0.6 1.5 0.6 0.7 0.2 8.2 0.0 0.6 0.2 0.3

0.5 0.5 1.3 0.2 0.8 0.3 8.2 0.1 0.7 0.2 0.2

Source: Reserve Bank of India Bulletin 2008, OECD Statistics Online; own calculations

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in the 1960s. This is partly explained by the inclusion of intra EU trade in the statistics where the high degree of integration reduces information costs and generates increased market size and competition with consequent increased demand for differentiated products as well as huge volumes of cross border investment (intraEU FDI accounts for almost half of global FDI). The low level of the EU–India GLI confirms the story of little direct overlap between Indian and EU trade patterns and competitiveness. On one hand this reinforces the inference that tariff cutting in an EU–India FTA could induce trade diversion losses for India given its high tariffs. The low level of the GLI however underlines the potential for increased IIT especially if TBTs and SPS barriers were reduced as part of the FTA. Even if India’s GLI lags the EU and the US, IIT represents more than half of Indian trade in 2004. Part B shows that India is catching up with Brazil but is still a long way behind China. EU–India IIT trade share at 39%, however, is less than India–World (52%) although it has grown much more rapidly since 1992. This suggests once more that EU–India liberalisation could help boost IIT between them and generate productivity gains with the potential to outstrip any shallow integration losses on goods. On the question of horizontal versus vertical integration, it is noticeable that apart from the EU, vertical differentiation (where prices—measured as unit values—are more than 20% different) greatly exceeds horizontal4. This is not surprising in the case of India, China and Brazil since they are likely to export e.g. low quality apparel and import high quality or to be part of globally or regionally integrated supply chains. It is, equally, not surprising that the EU is the exception where horizontal differentiation exceeds vertical, because it represents the most integrated market of national economies at broadly similar level of development in the world where the cross hauling of differentiated but similar goods of equivalent qualities is likely. The share of EU horizontally differentiated IIT has fallen and vertical has risen since 1992 perhaps representing the integration of Central Europe into the EU economy (even ahead of accession) and perhaps some supply chain integration outside Europe. That said, the share of horizontally differentiated trade grew faster than vertical in India between 1992 and 2004 perhaps representing improved quality of Indian goods. EU trade with India is predominantly vertically differentiated and while the share of horizontally differentiated trade has grown faster it is still at a very low level. Once more this suggests that there is potential for preferential liberalisation towards the EU to generate productivity-increasing specialisation particularly on vertically differentiated trade. FDI is another important channel for productivity enhancing deep integration via technology and know-how transfer, quality improvement and specialisation. These are all issues that need to be captured in the GLI. Table 3 above attempts a rough alignment of the sectoral shares of cumulative inflows of FDI into India between 2002/3 and 2005/6 and compares them with HS2 GLI for 2004 (calculated at HS4 level and aggregated). These numbers are positively correlated which suggests that FDI and IIT are connected and that FTA-led trade liberalisation and investment promotion is expected to increase IIT, FDI and productivity. The data we have presented here suggests that deep market integration is beginning between the EU and India and hence the need for institutional facilitation of this. 4

Horizontal plus vertical does not add to 100% because there are trade categories the calculation of unit values is not possible.

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Services Services are the quintessential case where only deep integration can affect trade. Domestic regulation is what is at stake in negotiations The services sector is extremely important for the EU and India from the perspective of a potential FTA. Both the EU and India are predominantly service economies with more than 70% and 50% of the respective GDPs emanating from services. Any agreement between the two that excludes services would ipso facto exclude the most important sectors for both these trading partners. Moreover, there are significant barriers to services trade between the two and substantial coverage of services a la GATS Article V in a potential deep FTA could help deliver improved access to both markets and more rapid liberalization of India’s services than can be accomplished unilaterally. The challenge for the RTA is not only to accelerate liberalization in India’s services sectors (which is continuing, albeit slowly at times and at a varied pace across subsectors), but also to facilitate the implementation of a range of complementary reforms designed to improve the quality of regulation. Recent research has also shown the positive impact of services liberalization on manufacturing productivity in the Czech Republic and India (Arnold et al. 2006, 2007). Thus there are benefits for both the EU and India from preferential services liberalization. Bilateral services exports from the EU to India could increase by 13.9% to 16.5% of the average over 2000–03 if there were some form of a any RTA/ services RTA in place (Shingal, in preparation). A recent CGE study by CEPIICIREM5 simulated two scenarios of 10 and 25% reduction in barriers to services trade between EU–India and found that both trading partners increase their services exports to each other in both scenarios. EU exports to India increase by 5% and 16% in scenarios 1 and 2, respectively (+USD 0.5bn and +USD 1.6bn, resp.) while total Indian exports of services increase by USD 0.6bn following scenario 1 and USD 1.2bn in scenario 2 (+3.3% and +6.5% respectively). The highest export increases are found in Trade and Business services (+201 $ mn and +291 $ mn in scenario 1, +434 and +570 $ mn in scenario 2) but significant increases are also expected in transport, communication, other services, finance and insurance with an increase between 1% and 4% of Indian exports in each of these sectors. The EU has had specific market access/national treatment issues and regulatory impediments with India in the case of satellite services (lack of national treatment), telecom (lack of national treatment and burdensome domestic regulation), private security agencies (limits on FDI), courier (proposed legislation on taxation) and air transport services (tax on business/first class tickets for passengers embarking in India). In addition, import of services in India generally suffers from a range of horizontal barriers such as archaic laws, multiplicity of rules & regulations; inconsistent practices across states and multiplicity of contact points at different levels of bureaucracy; regulatory gaps; public sector bias; and limits on foreign investment and ownership (Gasiorek et al. 2007). Box 1 below provides a list of sector-specific policy barriers in Indian services. The EU would therefore like to focus on these issues in a possible services agreement with India. In terms of specific sector interests, the EU has a key strategic 5

CEPII-CIREM (2007)

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interest in the Indian market in banking, finance and insurance; retail; accountancy; legal; telecom and maritime services. Sectors like IT and telecom are already significantly liberalized in India while others such as construction, health, banking and insurance, education and courier are moderately liberalized. Legal, accountancy, postal and distribution services, on the other hand, are completely closed at present. Important possible objectives in a potential FTA from a European perspective would be to consolidate the extent of market access in Indian in IT and telecom services; to significantly improve market access in moderately liberalized services; and to open up the closed sectors. The important issues for India are market access for Mode 16 and Mode 4 (both contractual service providers and service professionals related to Mode 3) and increasingly Mode 3. The focus sub-sectors include computer and related services, financial services and energy services. In Mode 1, India would be looking at increasing the coverage of sub-sectors to research & development, dental and health related sectors and telephone-based services. In Mode 3, issues for negotiation relate to the need for huge minimum capital requirements imposed by the EU, residency requirements, restrictions on legal entity and the absence of national treatment. In Mode 4, India would like to press for the mutual recognition of qualifications to make effective market access possible. Other issues relate to the avoidance of double taxation on social security benefits of Indian services professionals abroad; visa issues and labour market and economic need tests for Indian services providers abroad; and the fact that domestic regulation is more burdensome than necessary. In addition to specific modal interests, general issues of priority for India are transparency in EU policies and their implementation and the need for harmonization of EU policies across Member States. As an illustration from the financial services sector, banking sector licenses granted by any one EU Member should be acceptable across the EU. From a European perspective, it may be much easier to consolidate market access in India’s liberal sectors and increase access in the moderately liberalized ones. Opening up completely closed sectors would, however, appear to be the most difficult from a negotiating standpoint as far as a potential services agreement between the EU and India is concerned. From India’s perspective, it may be easier to negotiate provisions on Modes 1 and 3 into a possible EU–India FTA on services and also examine regulatory issues vis-a-vis Mode 4. It would, however, be more difficult to negotiate mutual recognition agreements across services between these two trading partners. India, however, would also be looking at the agreement as an opportunity to upgrade domestic reforms and remove other barriers to trade especially in sectors like retail, insurance, legal and accountancy services, where political economy and other reasons stall the domestic reform agenda.

The GATS classifies four “modes” of services delivery (these are the different ways in which services can be traded across borders): Mode One, which is the cross-border supply of services. An illustration of this is business process outsourcing units in India doing online medical transcriptions. Mode Two is consumption of services abroad. E.g. Indian tourists going to the EU. Mode Three is commercial presence, such as Deutsche Bank setting up operations in Mumbai. Finally, Mode Four is the movement of natural persons across borders to deliver services. An illustration of this is Indian nurses joining the NHS in the UK.

6

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Box 1 India’s Autonomous Policy on Services SERVICE Sector

Issues

Accountancy

FDI not allowed; FSP not allowed to undertake statutory audit of companies. Only partnership firms allowed with number of partners limited to 20. No cap on FDI. Foreign architects need to be registered by the Council of Architecture as individuals. Appointment of foreign architects as consultants to Indian architects subject to case-by-case approval by GoI. FDI not allowed. International law firms not allowed presence. Indian advocates cannot enter into profit-sharing arrangements with non-Indian advocates. No cap on FDI. No explicit barriers on commercial presence of foreign firms. Intellectual property laws are not effectively enforced; Tax structure discourages movement along the value chain No cap on FDI. Foreign firms must be incorporated in India

Architecture

Legal

Computer-related or software services Management & consultancy Postal

Courier Telecommunications

Audio-visual services Construction and related engineering

Distribution

Education Environmental Financial services (Insurance) Financial services (Banking)

Health & social services

Tourism Recreational, Cultural & Sporting

Transport

FDI not allowed. Price preferences to state postal operators; No functional demarcation between regulator and service provider; Imprecise definition of USO. No cap on FDI but subject to FIPB approval Fully owned foreign firms allowed in some segments, though voice telephone services continue to have 49% FDI limit. Policy uncertainty on tariff, inter-connect regimes, USOs remain. No cap on FDI in motion picture but FDI not allowed in radio and television services. Up-linking restrictions. No cap on FDI. Price preference to PSUs, as well as a large number of barriers that are external to the sector: land ceiling; unclear land titles; minimum area restrictions; minimum capitalization norm; restriction on repatriation. No cap on non-retail segments and 51% limit on FDI in single brand product retail. Lack of clear responsibilities within the government; Large unorganised sector with low tax compliance; Land market distortions. FDI permitted without cap through the automatic route. FDI permitted without cap through the automatic route. Foreign equity limit of 26% in most segments. Minimum capitalization norms; Funds of policy-holders to be retained within the country; Compulsory exposure to rural and social sectors and backward classes. Private domestic equity limited to 49% and foreign equity limited to 74% with 10% voting rights. FDI and portfolio investment in nationalized banks subject to overall statutory limits of 20%. Mandatory priority sector lending and rural branch requirements for domestic banks. No cap on FDI. Movement of FSP subject to registration by the Medical/ Dental/Nursing Council of India. FSP cannot provide services for profit. Responsibilities divided between the Centre and states; Absence of a standardized accreditation system. No cap on FDI. Land market distortions. FDI is permitted in entertainment services (including theatre, live bands and cultural services), libraries, archives and museums. FDI is restricted to 26% through the Government route in print media. FDI is not allowed in News Agency Services. Lottery, betting and gambling is not allowed. 100% FDI in maritime and road transport but significant restrictions in air and rail transport. Restrictions on inter-state movement of goods; Overlapping responsibilities and coordination issues between government departments (e.g., multi-modal transport).

Source: World Bank (2004); Department of Industrial Policy & Promotion (2006); Gasiorek et al. (2007)

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Standardisation and technical regulation7 The other area of pressing concern and hence an opportunity from the perspective of a possible EU–India agreement is the broad area covered by the term “standards”. This in fact covers: & & & &

Standards as such Regulations which make them mandatory Testing and certification regimes. Accreditation, by which testing and certification labs are approved.

Two basic methods can be used in FTAs to address the barriers created by divergences, harmonisation and mutual recognition. Wholesale adoption by either of these two parties of the other’s regime is of course out of the question. But there are clear avenues for mutual benefit. In terms of market access to each other a key stumbling block is the problem of mutual recognition of each other’s testing and certification measures for products that do meet the other’s standards even where there are differences in domestic regulatory requirements. There are of course in addition a number of products where substantive differences in mandatory standards exist. Our research suggests that for the mutual recognition (MR) issue to be addressed would require major improvements in the way the Indian system works, and that in fact the domestic impact of such changes would be the main positive effects. Discussions on Sanitary and Phyto-Sanitary (SPS) and Technical Barriers to Trade (TBT) issues have been characterised by problems experienced on both sides, rather than merely the traditional issue of developed country norms being perceived as obstacles to developing country exports. The Indian standards regime is characterised by: & & & & & &

Multiplicity of standards, laws and agencies Lack of awareness and a single enquiry point where all the information regarding various standards regime could be available Different regimes for trade and domestic production for domestic market Different problems at different levels e.g. the inability of domestic producers to meet high standards, problems faced by Indian exporters in developed countries etc. Absence of uniform standards on certain products all around the country (due to wide divergences in India’s production structure) An evolving standards (both SPS and TBT) regime—i.e. laws, institutions and measures

The EU and Indian authorities have drawn attention to problems in this area. The perception on the Indian side is that the EU is unjustifiably refusing to accept Indian

7

This section draws very heavily on our input to Gasiorek et al. (2007) and in particular very much incorporates work done by our colleague Ms Sanchita Chatterjee.

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standards while the EU sees Indian standards as non-transparent and inadequately based on science. The diversity of the Indian economy including a large informal sector makes it difficult to have uniform or indeed high national or international standards across all the sectors. Moreover, there are a number of different agencies and ministries in India that are responsible for the standards regime with a number of applicable laws. Unsurprisingly, levels of standards in various sectors in India are at different stages of development and implementation. Standards for few products are relatively developed such as electrical/electronic goods and medical devices, while India does not have any standard for toys (well developed in Japan for example). Standards for drugs are not well developed in India either. It is reported that the Central Drugs Standard Control Organisation of India does not have the capability to certify on standards equivalent to the US Food and Drug Authority (FDA). In electrical appliance and package drinking water, Indian standards are largely similar to international standards. Standards for medical laboratories (labs) are also well developed. There are a few ISO 15189 medical labs. On food CODEX and WHO standards are relatively easier for India to meet. For some products Bureau of Indian Standards (BIS) certification is mandatory. However some major products still do not have well developed standards. Unlike many other countries there is no mandatory certification on monitors, computer peripherals etc in India. Newer standards are also being developed. For example, in June 2006 the BIS came out with specific international safety standards for information security management systems (ISMS) for the IT industry. These standards are identical to the standards issued by the International Standardisation Organisation (ISO) and International Electrotechnical Commission (IEC)8.

8

www.tribuneindia.com/2006/20060605/biz.htm—54k

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Box 2 Important Ministries and Laws on Standards and Quality in India Ministries

A few laws governing standards

Ministry of Agriculture: Various departments

Agricultural Produce (Grading and Marking) Act, 1937 (AGMARK) Insecticides Act 1968 Milk and Milk Product Control Order (MMPO) 1992 Meat Food Product Order 1973 Plant Quarantine (Regulation of Import into India) Order, 2003. Livestock Importation Act Prevention of Food Adulteration Act 1954

Directorate General of Health Services, Ministry of Health and Family Welfare Ministry of Food Processing Industries Department of Commerce, Ministry of Commerce Ministry of Consumer Affairs, Food and Public Distribution

Central Pollution Control Board, Ministry of Environment & Forests Bureau of Energy Efficiency Ministry of Power Chief Controller of Explosives, Department of Industrial Policy & Promotion, Ministry of Commerce Directorate General of Mines Safety, Ministry of Labour & Employment Department of Road Transport and Highways, Ministry of Shipping, Road Transport and Highways

Fruits & Vegetable Products (Control) Order—FPO 1955 Food Safety and Standards Act, 2006 Export (Quality Control & Inspections) Act 1963 Standards of Weights & Measures Act, 1976 Bureau of Indian Standards (BIS) Act 1986 Essential Commodities Act, 1955. Various orders passed under the Essential Commodities Act Water (Prevention and Control of Pollution) Act, 1974 Air (Prevention and Control of Pollution) Act, 1981 Environmental (Protection) Act, 1986 Energy Conservation Act 2001 Indian Explosives Act, 1884 Petroleum Act, 1934 Inflammable Substances Act, 1952 Mines Act 1952 Motor Vehicles Act 1988

Source: Websites of Various Ministries of the Government of India, Gasiorek et al. (2007)

There have been criticisms of the manner in which India has used standards measures. It has been alleged that the India government has been using standards as non-tariff barriers. For example, it has been alleged that after the abolition of quantitative restrictions on imports in 2001 to fulfil its WTO obligations, India imposed quality and testing requirements for some imported products9. The Indian government has also been criticised for using standards measures to keep out exports from other developing countries10, despite little systematic evidence of India using standards measures to keep out exports. However it is a fact that India’s free trade agreements usually do not deal with standards issues. The issues between the EU and India—both from the EU and Indian sides—have been discussed in various fora. In July 2006 the issues were discussed in an EU– 9

The Hindu Business Line, 3 April

10

Debroy (2005)

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India SPS/TBT working group meeting in Delhi. In the meeting, the EU and India discussed their relevant legislative and regulations setting processes and sought responses from the other side on the specific problems described above. However, there was not much discussion on the way forward or possible clauses on SPS and TBT in the context of a free trade agreement. India has drawn attention to problems it faces with the EU’s Waste Electrical and Electronic Equipment (WEEE) and Energy Using Products (EUPs) directives and the Regulation on Registration, Evaluation and Authorisation of Chemicals (REACH). However no FTA is going to help here. Nor with problems identified on labelling requirements for Listing of Foodstuff Ingredients and alleged cases of SPS barriers on India’s exports reported for: marine products, mango pulp; egg powder, mushrooms and wooden handicrafts. It is difficult for India to impose high national or international standards across all the sectors in the domestic economy because many Indian producers would not be able to meet these. This, combined with the fact that India is a signatory to the WTO SPS and TBT agreements, implies that India cannot apply higher standards to imports than that for domestic production (violation of the National Treatment principle). India’s standards regime is still evolving but there is growing awareness among Indian consumers about the need to have health and safety measures, and companies about meeting standards to access export markets. Though the BIS has come a long way, its functioning still needs to be improved by bringing more transparency in the formulation of standards, improve its testing and certification procedures, and engage in greater information dissemination, training and capacity building activities. In India–Singapore Comprehensive Economic Cooperation Agreement (CECA) Mutual Recognition Agreements (MRAs) on conformity and standards were signed for four products: food, drugs, telecom and electric goods. It also contains a section on technical training. India has MRAs with five other countries. Mutual recognition of conformity assessment between the EU and India in certain identified sectors could potentially help to lessen some of the barriers and will be beneficial to both the economies. There may be various ways to conformity assessment. Firstly, the EC could assess existing labs, certification and inspection bodies in India. Reportedly such a process has already been initiated by the EC. Secondly, there could be accreditation of relevant bodies—a more cost effective procedure. India is slowly learning and accepting the system of accreditation. Accreditation is not so well established in the food sector which is governed by Codex standards but much more accepted in the engineering and other non-food sectors, in which ISO standards are accepted and have elaborate standards for conformity assessment 11. The signing of an FTA could be a way to increase mutual comprehension. Even though India is hesitant on technical assistance, training and capacity building to officers from various standards bodies may be useful in bringing India’s standards regime in line with international best practices.

11

ISO 17020 for inspection bodies, ISO 17025 for labs and ISO Guide 65 for product certification

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India’s services growth story India is now a services economy! The services sector in India has been witness to rapid growth, especially since the 1990s, which has now led to India becoming an “outlier” in terms of its services sector performance in the years since the turn of this century. Services now contribute more than half of the country’s GDP, which is higher than the share for countries at a comparable level of per capita income as India. Amongst the top 20 services exporters in 2003, India had the fastest growth of services exports over 1994–2003 and services trade now accounts for a quarter of the country’s total trade. The sector’s importance as an employer has also been growing over time—the share of services in total employment has risen from 20% in 1995 to 32% in 2003. Looking at a more disaggregated breakdown of the services growth story, we can see that the increase in Indian services has been led by hotels and restaurants, real estate and business services, and communication—all of which have grown at more than 15% over the last decade. Other than storage services, all other services subsectors have registered double-digit growth rates. These growth rates can be compared with the much lower rate of growth in Agriculture (thus reflected in the sector’s declining share in GDP), and a growth rate over the period for industry of just over 11%. Looking at services trade more closely, India experienced the fastest growth of services exports over the period 1993–2003, with this growth exceeding 17% per annum. This placed India amongst the top 15 services exporters in 2003 (see charts below). This growth rate for services exports is more than two-and-a-half times greater than the growth of EU services exports over the same time period, and is significantly higher than that of the Quad (US, EU, Canada and Japan), China and all major South East Asian economies. The picture is not very different for services imports with the exception that China exhibited the fastest growth rate of services imports amongst the top 15 services exporters in 2003, with India in second place. Again, over the last decade, India’s services imports have gown almost twice as fast as those of the EU and faster than those of the Quad and all major South East Asian economies (Gasiorek et al. 2007; Figs. 1, 2, 3). Considering next the composition of India’s services exports, we find them to have changed dramatically over the last decade, both in terms of value (a massive increase of 708% from USD 9.4 to USD 76.2 bn) and structure (see Table 4 above). The most significant change in export structure has occurred in the share of software services—up from 19% in 1997/8 to 41% in 2006/7. Travel and other services have witnessed the other major changes, wherein shares have come down from 30 and 12% in 1997/8 to 12 and 1%, respectively, in 2006/712. On the whole, five sub-sectors comprise the majority of services exports in India—software, travel, transportation, management and architecture and engineering. These made up more than 75% of all services exports in 1997/8, going up to 92% in 2006/7. In terms of 12

A major reason for the big change in the contribution of other services exports to the total is their coverage—with a more detailed breakdown available since 2004–05, this category largely comprises unclassified services, while in the preceding period they also included advertising, rentals, office maintenance, prizes, exhibitions and the like.

Fig. 1 The growth of services exports has exceeded the growth of services value added which in turn has been more than the growth of GDP. Source: Gasiorek et al. (2007)

Current USD (indexed at 1990=100)

Potential benefits from a deep EU–India free trade agreement

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Stellar growth of services exports

600 500 400 300 200 100 1990

1992

GDP

1994

1996

Services VA

1998

Goods exports

2000

2002

Service exports

growth rates, software, management and communication services have grown more than ten times during this period. While the above analysis gives us an idea of the importance of the services sector for India, a more interesting exercise for the purpose of this paper is to find out how globally competitive the two economies are in the export of these various services.

Fig. 2 Sectoral growth rates, average annual (%). Source: Gasiorek et al (2007)

Sectoral growth rate, average anuual (India, 1995/6-2004/5) Agriculture Storage

7.1% 8.7%

Banking & insurance

10. 7%

Industry

11. 1%

Trade

13. 2%

Public admin & defence

13. 3%

Transport

14. 6%

Social & personal

14. 6%

Construction

14. 6%

Communication

15. 2%

Real estate & business svs Hotels & restaurants

17. 5% 18. 7%

Source: Gasiorek et. al (2007)

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India's services exports have grown the fastest over the last decade amongst the top 15 services exporters in 2003 India

17.1%

China Russian Federation Hong Kong Turkey Korea Canada

India has the second fastest growth of services imports over the last decade amongst the top 15 services importers in 2003

14.4% 10.2% 9.1% 8.6% 7.3% 7.2%

EU

6.7%

Australia

6.1%

China

13.1%

India

12.3%

USA

8.6%

Mexico

8.4%

Korea

8.4%

Singapore

8.3%

Russian Federation

8.2%

Canada

6.6%

EU

6.3%

Switzerland

6.0%

Australia

5.9%

Japan

5.9%

Switzerland

5.7%

Thailand

5.3%

USA

5.7%

Malaysia

5.5%

Hong Kong 4.0%

Singapore 5.0%

Malaysia 3.6%

Thailand 4.0%

Japan 2.0%

Source: Gasiorek et. al (2007) Fig. 3 Average annual growth rates of services exports and imports over 1993–2003 for the top 15 services exporters and importers in 2003

To do this, we calculate indices of Revealed Comparative Advantage13 (RCA) for various services sub-sectors. Given that disaggregated data for services is available only for a few categories at the global level, we calculate the RCA with respect to the total for the OECD countries and India14 over the last decade (see Table 5 above). Our results indicate that, as expected, India has a massive comparative advantage in the export of IT services as well as a significant one in exporting communication services, the latter primarily comprising telecoms exports. Both these sub-sectors are largely driven by private enterprise and in that the market structure is quite competitive. They are also both amongst the most-liberalized sectors in the Indian economy in terms of market access to foreign investment. The interesting difference however emanates from the extent of state intervention, government policy and regulation in these services. Indian IT is said to have flourished primarily on account of the sector being “forgotten” by Indian policy makers and continues to operate without a regulator even now. On the contrary, India has always had a National Telecom Policy especially in the aftermath of the New Industrial Policy, 1992 and 13

The RCA index for a given sector is calculated by taking the share of a particular sector’s exports in that country’s total exports of goods and services, and dividing this by the ratio of global exports in this sector to the total global exports of goods and services. An RCA index with value greater than unity indicates a comparative advantage in the sector, while a value less than unity indicates a comparative disadvantage.

14

In any case, OECD services exports made up 75% of global services exports in the last decade.

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this also sector has an independent regulator in the form of the Telecom Regulatory Authority of India (TRAI).

Conclusions We cannot claim in this essay to have demonstrated that a deep FTA between India and the EU would necessarily bring very large benefits. We have however shown that India is increasingly revealing a comparative advantage in areas of trade that have a potential to be affected by deep integration, IIT flows and services. And we suggest that in an increasingly sophisticated economy an upgrading of the standards infrastructure would benefit the domestic economy, but the challenge as we have seen is to avoid imposing excessively burdensome standards on those parts of the economy that cannot yet cope with them and where this no market justification. If we had space and time we would have added the case of investment in non-service activities. Here again our study found that multiple bureaucratic barriers hinder both foreign and domestic investors. Similarly, in the area of public procurement, nontransparency and burdensome bidding procedures, lack of national treatment and the absence of a formal bid challenge procedure are the main issues that confront potential foreign bidders of government contracts. We would conclude on the note that if deep integration succeeds, its effects are more like to be “erga omnes” i.e. benefiting everyone than pure tariff cuts. If licensing procedures are simplified this affects all parties, EU firms, Indian firms and third country firms (whose EU subsidiaries also benefit automatically). Even though India has lowered its rates autonomously in recent years, there are still legitimate doubts about the trade diversion effects of discriminatory tariff cuts by a country with high tariffs, these risks are much less for deep integration. Acknowledgements This paper draws heavily on “A Qualitative analysis of a potential Free Trade Agreement between the European Union and India” by Michael Gasiorek, Peter Holmes, Sherman Robinson, Jim Rollo, Anirudh Shingal and CUTS International. It includes material based on the research by Ms Sanchita Chatterjee.

References Arnold, Jens Matthias, Beata Javorcik and Aaditya Mattoo (2006) ‘The productivity effects of services liberalization: Evidence from the Czech Republic,’ World Bank Policy Research Working Paper 4109 Arnold, Jens Matthias, Beata Javorcik, Molly Lipscomb and Aaditya Mattoo (2007) ‘Services Reform and Manufacturing Performance: Evidence from India,’ World Bank, mimeo CEPII-CIREM (2007) ‘Economic impact of a potential FTA between the European Union and India,’ Framework Contract No TRADE/05/H3/01/1c, Commission of the European Union—DirectorateGeneral for Trade Chauvin, Sophie and Françoise Lemoine “India in the world economy: Traditional Specialisations and Technology Niches” CEPII Working paper No 2003–09 Debroy, Bibek (2005) ‘The SPS and TBT agreements- implications for Indian policy’. Indian Council for Research on International on Economic Relations (ICRIER Working Paper 163, June 2005 Department of Industrial Policy & Promotion (2006) ‘Foreign Direct Investment Policy,’ Ministry of Commerce and Industry, Government of India

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Gasiorek M et al (2007) ‘A qualitative analysis of a potential free trade agreement between the European Union and India’ http://trade.ec.europa.eu/doclib/docs/2007/june/tradoc_135112.pdf Li, X (2008) ‘Regional Trading Agreements in East Asia: Effect on Vertical- Specialisation-Based Trade’, this volume. doi:10.1007/s10308-008-0215-x Shingal, Anirudh “Three Essays on Trade in Services: Exploring tradability, regional trade and government procurement,” University of Sussex DPhil Dissertation, in preparation World Bank (2004) ‘Sustaining India’s Services Revolution: Access to Foreign Markets, Domestic Reform and International Negotiations’