ECONOMIC INTEGRATION AND TRADE PROTECTION: POLICY ISSUES FOR SOUTH ASIAN COUNTRIES

Transcription

1 ECONOMIC INTEGRATION AND TRADE PROTECTION: POLICY ISSUES FOR SOUTH ASIAN COUNTRIES MAUSUMI KAR This article shows that economic integration acts as a viable instrument of protection for individual countries, when benefits of discriminatory protectionist policies like the multifiber arrangement are withdrawn. Using United Nations Conference on Trade and Development statistics for and applying an extended version of the augmented gravity model, we show that the formation of a trade bloc like the South Asian Free Trade Area unambiguously promotes member countries exports of textile and clothing at both intra-bloc and extra-bloc levels. The expansion of south-south trade is facilitated by the growing intraregional trade in intermediate goods. The creation of a regional value chain can shield the smaller countries in the context of enhanced global competition. (JEL F14, F15, F13) I. INTRODUCTION Countries in South Asia stand out as an exception in a world where regional trade agreements are increasingly cornering and consolidating resources and markets. The emergence of the concept of the regional trading bloc has traversed a long way after Jacob Viner popularized the original idea in the 1950s. Since then, a large number of economic cooperation, free trade zones, currency unions, and so forth have been formed, and epitomized by the formation of the European Union (EU). The growing number of various other arrangements that exist in the Middle East, within the countries of sub- Saharan Africa, in the Asia-Pacific region, between countries of South America, and so forth has already created a stable variant of the multilateral trade regime, where blocs instead of individual countries negotiate the conditions of international trade. However, despite a multitude of attempts, the level of implementation of a defined structure across the South Asian countries has been both slow and incomplete The author likes to acknowledge and thank the Session Chair and the participants at the WEAI International Conference at Singapore for their valuable suggestions and comments. The author is also indebted to Professor Saibal Kar for his insightful comments and cooperation. Kar: Associate Professor and Head, Department of Economics, Women s Christian College, Kolkata , India. Phone , Fax , mausumi2606@yahoo.co.in Contemporary Economic Policy (ISSN ) Vol. 36, No. 1, January 2018, Online Early publication June 16, with the feeble initiatives of SAPTA (South Asian Preferential Trading Arrangement) and ABBREVIATIONS ATC: Agreement on Textiles and Clothing BIMSTEC: Bay of Bengal Initiative for Multi-Sectoral Economic Cooperation CECA: Comprehensive Economic Cooperation Agreement CEPA: Comprehensive Economic Partnership Agreement EU: European Union FISME: Federation of Indian Micro and Small & Medium Enterprises FTA: Free Trade Agreement GATT: General Agreement on Tariffs and Trade GDP: Gross Domestic Product MFA: Multifiber Arrangement MFN: Most Favored Nation OECD: Organisation for Economic Cooperation and Development ROC TF: Regional Organizations Cooperation Mechanism for Trade Facilitation RTA: Regional Trading Arrangement SAARC: South Asian Association for Regional Cooperation SAFTA: South Asian Free Trade Area SAPTA: South Asian Preferential Trading Arrangement SITC: Standard International Trade Classification TFIs: Trade Facilitation Indicators TLP: Tariff Liberalization Program UNCTAD: United Nations Conference on Trade and Development WTO: World Trade Organization doi: /coep Western Economic Association International

2 168 CONTEMPORARY ECONOMIC POLICY BIMSTEC (Bay of Bengal Initiative for Multi- Sectoral Economic Cooperation) 1 and more recently by the formation of SAFTA (South Asian Free Trade Area). SAFTA was envisaged primarily as the first step toward the transition to a free trade area leading subsequently toward a Customs Union, Common Market, and Economic Union. Indeed, individual countries belonging to any such group get the benefits of trade creation within the bloc as well as import protection from other countries effective through group-based trade negotiations. It should be interesting to study and explore if benefits from membership of a bloc outweigh the losses due to recent withdrawal of other country-specific protection previously available, such as the abolition of the well-known multifiber arrangement (MFA) which allowed protected export market to small developing countries, such as Sri Lanka and Bangladesh, belonging to this region. It leaves us with an ample time period to estimate if the withdrawal and the simultaneous free-trade association formed by countries like India have outweighed each other in terms of the net benefits from parallel trade policies. Our study takes a closer look at the existing dynamics of cross-border trade in South Asia, exploring the potential for such trade through the lens of one key sector in which nearly all countries in the region have strong comparative advantage vis-à-vis other parts of the globe, namely, textiles and clothing (henceforth T&C). Despite the global competitiveness of this sector as enjoyed and influenced by most of the South Asian Association for Regional Cooperation (SAARC) members, there was very little regional interlinkage within South Asia s T&C industry. Currently, less than 4% of SAARC s global T&C exports are traded within the region. Thus a significant, but so far unrealized, potential exists to strengthen intraregional linkages within South Asia s T&C sector and make it a powerful global hub of production and exports in this sector. This project has the noble potential to investigate the importance of such intraregional trade in the context of complete elimination of the bilateral MFA 2 quota system in 2005, 1. Here, we must mention that SAARC is the regional intergovernmental organization and geopolitical union in South Asia that promotes the development of regional cultural integration and for that reason we have not mentioned SAARC as an attempt for economic integration. 2. MFA was a bilaterally determined quota system that was introduced to protect the interests of the T&C manufacturers of the developed (North) countries primarily, having which used to monitor the international trade in T&C since 1974, and its integration within the General Agreement on Tariffs and Trade (GATT) framework through the Agreement on Textiles and Clothing (ATC). As it has been shown in earlier studies that existence of MFA quotas actually gave protection to the smaller and lessdeveloped countries in South-East Asia (see Kar 2012; Kar and Kar 2011), only the bigger textile giants such as India and China are expected to and eventually found to have been reaping the benefits from the withdrawal of this system. Now, we try to explore, with the help of an augmented version of the gravity model, whether the formation of regional trading arrangements (RTAs) like SAFTA serves to promote the magnitude of trade or not and if so, then whether the intra-bloc trade 3 is substantially accelerated vis-à-vis the effect of extra-bloc trade creation. The remainder of the article is as follows: Section II, comprising of two parts, portrays the background that motivates us doing this piece of work. The first part of Section II briefly narrates the specifications relating SAFTA, while the second part sums up the important findings obtained from and the methodologies used by some earlier relevant studies. The analytical framework including the theoretical formulation of the gravity model and its associated empirical exercise of multivariate regression using panel data is presented in Section III. Then Section IV presents and analyzes the estimation results. Some interesting relevant issues are demonstrated in Section V to substantiate the main premise of the article implicating the radical changes in the emergence of the new regional order. Finally Section VI discusses the results and concludes. II. PERSPECTIVES A striking feature that characterized Indian exports until the last century was India s absence from any prominent preferential trading bloc or RTA. India had previously signed several comparative disadvantage in this sector vis-à-vis the developing (South) countries mainly on account of low-wage costs. It was not supported by GATT and thus was finally replaced by ATC in 2005 after phased elimination that ensured MFN status to each exporting country of T&C like other commodities. 3. Available evidence suggests that intraregional trade in T&C was never prominent for South-East Asian countries as compared to North-South trade. Hence, any improvement in intraregional trade in T&C after the formation of SAFTA may be treated as trade diversion (as formally conceptualized by Viner 1950).

3 KAR: ECONOMIC INTEGRATION AND SOUTH ASIA 169 bilateral trading agreements with the East Asian countries including Comprehensive Economic Cooperation Agreement (CECA) with Singapore in 2005 and a Free Trade Agreement (FTA) with Thailand in 2003, Comprehensive Economic Partnership Agreement (CEPA) with South Korea in 2009, and CECA with Malaysia in Recently, however, an India-ASEAN FTA was signed in Bangkok on August 13, 2009 and it came into effect from January 1, Paradoxically, these agreements are not so significant for India s attempts at expanding the T&C exports to such destinations, because all the above-mentioned partner countries are competitors for India with regard to T&C trade worldwide (Kar 2015). Nevertheless, it is of note that India is the largest economy in the South Asian region accounting for more than 80% of South Asia s gross domestic product (GDP). More than 90% of the regional trade of Bangladesh, Nepal, and Sri Lanka as well as a major part of their global trade are with India. Trade amongst the remaining South Asian countries is much smaller than India s trade with any of its South Asian partners. Owing to its central geographical location in the region, India is also at the helm of all regional trade facilitation and transit issues. The pace and direction of economic integration in South Asia, therefore, is largely a function of India s relations with other economies of the region. In recent years, India has taken several measures, both bilaterally and under the ambit of SAFTA, to facilitate trade in the region. A. Formation of SAFTA In 2006, India, along with Bangladesh, Bhutan, Maldives, Nepal, Pakistan, and Sri Lanka, signed the SAFTA under the aegis of the SAARC (Afghanistan was included as a member in 2007). The main element of the agreement was a reduction in tariffs by all members under a tariff liberalization program (TLP), except on items that are included in the members sensitive lists. Members also agreed to the elimination of para-tariffs and nontariff barriers and the adoption of trade-facilitation measures to remove barriers to cross-border movement of goods. The SAFTA came into force on January 1, 2006 and is operational following the ratification of the agreement by the seven governments The Agreement on SAPTA was signed on April 11, 1993 and entered into force on December 7, 1995, with It was expected that the SAFTA, when fully implemented, would provide the member countries improved market access in this region and help to enhance their exports (i.e., almost tarifffree imports are projected to be possible by the year 2016). This seems to have been achieved very recently. The dynamic gains could even be higher than the static gains due to the possible expansion in the scale of operation via access to the markets of the relatively larger member countries. This article examines the implications of SAFTA for the South Asian countries in the context of multilateral trade liberalization. The analysis also projects for the future organizational structure of the T&C sector in this region where a regional value chain may develop among these countries and the sector becomes locally integrated. B. Review of Earlier Findings The gravity model has been widely used in international economics since the 1960s as Tinbergen (1962) and Pöyhönen (1963) provided initial specifications and estimates of the determinants of trade flows while Aitken (1973) applied it to RTAs. Inspired by the above studies and theoretically supported by Linnemann (1966), Bergstrand (1985, 1989), and Deardorff (1998) and lately, by Anderson and Van Wincoop (2003), gravity modeling has evolved into a popularly entitled empirical instrument for the analysis of international trade flows. Again, Limão and Venables (2001) investigated the extent of dependence of trade volume the desire of the member states of SAARC (India, Pakistan, Nepal, Sri Lanka, Bangladesh, Bhutan, and the Maldives) to promote and sustain mutual trade and economic cooperation within the SAARC region through the exchange of concessions. The SAFTA is an agreement (of the nature of preferential trading arrangements) reached on January 6, 2004 at the 12th SAARC summit in Islamabad, Pakistan. It created a free trade area of 1.6 billion people in Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka (as of 2011, the combined population is 1.8 billion people). The seven countries (except Afghanistan) signed a framework agreement on SAFTA to reduce customs duties of all traded goods to zero by the year SAFTA requires the developing countries in South Asia (India, Pakistan, and Sri Lanka) to bring their duties down to 20% in the first phase of the 2-year period ending in In the final 5-year phase ending 2012, the 20% duty is expected to be reduced to zero in a series of annual cuts. The least-developed nations in South Asia (Nepal, Bhutan, Bangladesh, Afghanistan, and Maldives) have an additional 3 years to reduce tariffs to zero. India and Pakistan ratified the treaty in 2009, whereas Afghanistan as the eighth member state of the SAARC ratified the SAFTA protocol on May 4, 2011.

4 170 CONTEMPORARY ECONOMIC POLICY on geography and transport of the median coastal economy for the sub-saharan African trade using three different datasets, confirming the importance of infrastructure in explaining the relatively low levels of African trade. Taneja, Prakash, and Kalita (2013) rightly identify that transaction costs of trading across borders continue to be high due to poor infrastructure, lack of automation, and archaic transport protocols. In the context of assessing the impact of regional economic integration on participating countries trade patterns, Ekanayake, Mukherjee, and Veeramacheneni (2010) offer some interesting observations on Asian trade and integration arrangements employing an augmented gravity model that signifies the importance of language and culture as determinants of trade resistance. Furthermore, Yang and Martinez-Zarzoso (2014) use a theoretically justified gravity model of trade, establish trade creation above tradediversion effects, and generally examine the impact of the ASEAN-China Free Trade Agreement on exports. The study of Martinez-Zarzoso and Nowak-Lehmann (2003) also demands attention as they try to assess the MERCOSUR-EU trade and integration-induced trade potential for MERCOSUR. The basic gravity model was extended with the inclusion of a single regional dummy to capture the effect of the FTA on intraregional trade; another set of dummies was included in later works to capture the FTA s trade-diversion effects on nonmembers and found insignificant for both nonmember countries (Soloaga and Winters 2001) and members as well (Krueger 2001). The survey suggests that relatively fewer studies have been conducted on South Asian intraregional and global trade. It was only after the envisioning of the economic cooperation under the SAARC regime that scholars started to pay attention to the region. Tewari (2008) explores the emerging possibilities of deepening intraregional trade and investment in South Asia by focusing on the T&C industry as the lens for examining these prospects. Furthermore, Rahman, Shadat, and Das (2006) applied an augmented gravity model to SAPTA and nine additional regional trading blocs to find significant intraregional trade creation in SAPTA. It nevertheless warned that net export diversion would also take place as the larger economies of the region India, Pakistan, and Bangladesh would gain from SAPTA but the others might be adversely affected. Some authors like Srinivasan (1994) and Srinivasan and Canonero (1995), however, expressed less optimism about the potential of economic integration in South Asia. A more recent study by Rodríguez-Delgado (2007) used a modified gravity equation to examine the effects of SAFTA s trade liberalization program. It argued that SAFTA would have only limited effects on regional trade flows, arising basically from increasing exports from India, and imports from Bangladesh and Nepal. According to an Organisation for Economic Cooperation and Development (OECD) study (OECD/WTO 2015), South Asian countries face the lowest costs among the developing regions that surely contribute to their impressive value chain integration. Although much of this might be due to nonpolicy-related factors, such as economies of scale in shipping (Haddad 2007), it also reflects the importance of investment in the region in physical infrastructure. India s and Pakistan s performance stands, comparatively, closer to China, but the other South Asian countries are among the lowest performers in Asia, with landlocked Afghanistan, Bangladesh, and Nepal scoring particularly low (OECD/WTO 2015). In this backdrop, our study will try to demonstrate that the formation of RTA like SAFTA has actually enhanced border trade (especially intra-saarc trade) by significant improvement of trade facilitation indicators (TFIs) in the last couple of years 5 and more importantly the concerned countries are increasingly involved in vertical linkages. Earlier, Hummels, Ishii, and Yi (2001) identify and document a deeper dimension to international integration involving the interconnection of production processes in a vertical trading chain that stretches across many countries. Also, Sanyal and Jones (1982) make the important point that all goods trade can be thought of as intermediate goods trade, because marketing and distribution services are added to the final goods before they are sold. However, to the best of our knowledge, no previous study has yet allowed for a methodological approach that addresses directly the determinants of integration-induced dynamics in trade relations with both fellow member and third countries. None of them projects the phenomenon of economic integration as an alternative safeguard 5. Details about the ongoing work of the SAARC Group on Customs Cooperation in the harmonization of customs documentation and procedures by member states and the interoperability of systems being followed by customs administrations and the preparation of simplified customs declaration forms for trade in goods in the SAARC region are available from ROC TF (2014).

5 KAR: ECONOMIC INTEGRATION AND SOUTH ASIA 171 measure for the weaker nations in the context of global trade reform especially when a particular discriminatory nontariff policy is withdrawn worldwide. This article aims to fill this gap in the gravity literature. III. EMPIRICAL MODEL AND DATA We use an extended version of the augmented gravity model as an analytical tool for measuring the impact of the formation of SAFTA on the SAARC countries and its closest neighbor China. The reason behind incorporating China, along with the SAARC countries is to capture the effect of the formation of SAFTA on the largest competitor of the SAARC countries in South Asia (moreover, China-safeguard policies regarding its T&C exports, introduced by the western countries since 2005, after China s World Trade Organization [WTO] accession in 2001, make this country inexorable for our study). Above all, it is mentioned earlier (see Kar 2012) that the phasing out of the bilateral MFA quota regime and its consequent replacement by ATC have shown dissimilar impacts on different countries in South-East Asia. Hence, a study of this kind excluding China may lose its significance. However, we have not considered the small dependent economies of SAARC such as Nepal, Bhutan, Maldives, and Afghanistan in our study because of their insignificant contribution in the total trade of this region. Accordingly, for this study, we have taken the following five textile exporting countries, namely India, Bangladesh, Pakistan, Sri Lanka, and China. As importers, we consider the four SAFTA countries (as we want to observe their intra-bloc trade) along with the traditional major importers of T&C in the world market such as the United States (USA), EU countries (presently, 28 in number), United Arab Emirates (UAE), and Japan besides China. Our study is expected to help us to oversee and compare the effects of new regional order amidst withdrawal of protection and to project for the future organizational structure of this sector in this region. A. Analytical Structure and Empirical Specification In a generalized gravity model, trade between country i (considered as exporter) and country j (considered as importer) is positively related to the size of the economies and negatively related to the distance, a proxy for transportation costs, between them. In addition a number of bilateral factors that foster or impede trade are usually included as explanatory variables. Hence, adding the time dimension, the basic gravity structure can be specified as: (1) X ijt =αy β1 it Yβ2 jt Popβ3 it Popβ4 jt Distβ5 ij Fϕk kijt μ ijt where X ijt is trade flows or exports from country i to country j in year t. Y it and Y jt are GDPs for countries i and j in year t, where Pop it and Pop jt denote the respective populations. Dist ij denotes geographical distance between the two countries, which is often measured using great circle calculations. Finally F k denotes other bilateral factors such as FTAs, prevalence of nontariff barrier like MFA, and so forth. This generalized version of gravity model has been applied by a large number of empirical studies (viz. Baier and Bergstrand 2007; Yang and Martinez-Zarzoso 2014, etc.). One of the key issues there is to analyze the specific effects of trade policies by introducing dummy variables, namely FTA ijt, to indicate the existence of a regional trade agreement between countries i and j. In our model, the impacts of the formation of SAFTA can be engulfed by following the Vinerian specification of integration effects with an extension of three different sets of FTA dummy variables representing trade creation and diversion effects in terms of export and import, as proposed by Carrère (2006), Martínez-Zarzoso, Nowak-Lehmann, and Horsewood (2009), and so forth. In order to overcome the problem of country-specific heterogeneity (which is ignored by treating all the countries in a certain FTA as a homogenous group), we apply the panel data fixed effects regression model to control for all the time-invariant factors that vary bilaterally. Our objective is to obtain unbiased estimates for the SAFTA dummy variables, namely trade-creation effects within the tradebloc (SAFTA1 ijt ; i.e., when i & j both are the members of SAFTA), trade-creation/diversion effects in terms of enhanced/reduced volume of exports from intra-bloc countries to extra-bloc countries (SAFTA2 ijt ; when i is a member but j is a nonmember) and the possibility of a reverse trade-creation/diversion effect in terms of imports (SAFTA3 ijt ; when i is not a member but j is a member of the bloc), using a panel data approach that controls for all country-and-time and time-invariant country-pair unobserved heterogeneity.

6 172 CONTEMPORARY ECONOMIC POLICY In addition to taking into account the effects of the formation of SAFTA, we also want to investigate the effects of the associated tariff rates on these countries trade as liberalization of MFA quota does not reduce the tariffs imposed by importers (mainly the North) on the exporters of T&C products (primarily the South). As per the FTA norm, we are assuming that the SAARC countries do not impose any tariff on each other after the formation of SAFTA that is, after Besides, we also wish to signify the outcome of the global trade policy of withdrawal of MFA quota on T& C trade for these strategic countries and this intention requires us to incorporate the MFA variable in our theoretical formulation also. Considering all these, the baseline augmented gravity model for our empirical exercise is given by (2) X ijt =α 0 +β 1 Y it +β 2 Y jt +β 3 Pop it +β 4 Pop jt +β 5 Dist ij +β 6 MFA ijt +β 7 TARjt +ϕ 1 SAFTA1 ijt +ϕ 2 SAFTA2 ijt +ϕ 3 SAFTA3 ijt +υ ijt. Taking log on both sides, 7 we get (3) ln X ijt =α 0 +β 1 ln Y it +β 2 ln Y jt +β 3 ln Pop it +β 4 ln Pop jt +β 5 ln Dist ij +β 6 MFA ijt +β 7 ln TAR jt +ϕ 1 SAFTA1 ijt +ϕ 2 SAFTA2 ijt +ϕ 3 SAFTA3 ijt +υ ijt where ln denotes variables in natural logs. B. Variables The dependent variable, X ijt indicates bilateral exports from ith country (exporter) to jth country (importer) in period t (in thousand $US) while Y it and Y jt are the levels of nominal GDP in countries i and j in period t, measured in million $US at constant prices (2005) and constant exchange rates (2005). Pop it and Pop jt are the populations of the ith country and the jth country, respectively in period t, measured by absolute value in thousands (de facto population of the country as of July 1 of the respective year). Dist ij measures 6. We have argued earlier that for some product categories, at least, the import duties have become zero across members of the SAFTA. 7. Exceptions are the binary variables such as MFA, SAFTA1, SAFTA2, SAFTA3, and so forth. the great-circle distance between the capital cities (or economic centers) 8 of countries i and j, measured in kilometers. The geographical distance is used as proxy for transportation and communication costs as well. TAR jt represents the value of Most Favored Nation (MFN) tariff rate imposed by jth importing country (simple average of simple averages) on its imports. It is used as a regressor in our exercise as we have also taken into account the extra-safta importers such as the USA, UAE, EU countries, China, and Japan who are expected to impose MFN tariff rate on their imports from any of the exporting countries irrespective of being a member or a nonmember of SAFTA. MFA ijt is a binary variable used as a dummy to indicate T&C trade between two countries in the presence or absence of MFA. So its value is 1 so long as trade had taken place under its surveillance, that is, until 2005 and zero otherwise, that is, from 2006 onwards. SAFTA1 ijt,safta2 ijt, and SAFTA3 ijt are binary variables that measure the specific trade effects in the SAFTA. SAFTA1 ijt takes a value of 1 after 2006 if both countries i and j in year t belong to the SAFTA and zero otherwise. A positive and statistically significant coefficient of SAFTA1 ijt represents trade-creation effects and indicates that intraregional trade has been promoted more by the FTA. Similarly, SAFTA2 ijt takes a value of 1 if exporter i belongs to the SAFTA in year t and country j does not and zero otherwise. A positive and statistically significant coefficient of SAFTA2 ijt is indicative of a trade-creation effect outside the bloc and signifies that regional integration leads to a change in the direction of exports from SAFTA member countries to nonmember countries, and conversely a negative change in the volume of exports is indicated by a significant negative coefficient of SAFTA2 ijt. Contrarily, SAFTA3 ijt takes a value of 1 if exporter i is not a member of SAFTA in year t but the destination country j belongs to SAFTA and zero otherwise. A positive and statistically significant coefficient of SAFTA3 ijt is similarly indicative of a trade-creation effect in terms of imports and shows expanded imports from nonmember countries to member countries. The converse is true for a trade-diversion effect as well. Finally, υ ijt is the error term assumed to be distributed log normally. We select a fixed effect 8. For example, Brussels, the headquarters of the EU, is used as the economic center for 28 member countries of the EU bloc and the distance of its exporter s capital is measured from Brussels for EU s imports.

7 KAR: ECONOMIC INTEGRATION AND SOUTH ASIA 173 S A F T A 1 φ 1 > 0 φ 1 < 0 TABLE 1 The Possible Outcome of Trade Effects SAFTA2 SAFTA3 φ 2 > 0 φ 2 < 0 φ 3 > 0 φ 3 < 0 Pure trade (export) creation Net trade creation (through expansion of extra-bloc exports) (if φ 2 > φ 1 ) Net trade diversification (through contraction of intra-bloc exports) (if φ 2 < φ 1 ) Net trade creation (through expansion of intra-bloc exports) (if φ 1 > φ 2 ) Net export diversification (through contraction of extra-bloc exports) (if φ 1 < φ 2 ) Net export diversification (through contraction of both extra-bloc and intra-bloc exports) Pure trade (import) creation Net trade creation (through expansion of extra-bloc imports) (if φ 3 > φ 1 ) Net trade diversification (through contraction of intra-bloc imports) (if φ 3 < φ 1 ) Net trade creation (through expansion of intra-bloc imports) (if φ 1 > φ 3 ) Net import diversification (through contraction of extra-bloc imports) (if φ 1 < φ 3 ) Net import diversification (through contraction of both extra-bloc and intra-bloc imports) model as the Hausman test rejects the possibility of random effect specification for such models. It would be unfair not to provide any additional explanation of Trade-Creation Effect and Trade- Diversification Effect here as the terms export diversification effects (first described by Endoh 1999) and import diversification effects (first defined by (Balassa 1967) are different from the definitions proposed by Viner (1950). One observation of intra-bloc trade alone is not sufficient to confirm whether or not there is net trade creation in a FTA. For example, an increase in intrabloc exports may be associated with a reduction in exports to extra-bloc countries and then there will be net trade creation if and only if the first effect outweighs the later and vice versa. Similarly an increase in export to extra-bloc countries may be accompanied by a reduction in imports from extra-bloc countries and a dominant import diversification effect indicates a welfare loss for the member country. Thus, we need to examine the magnitude and direction of the coefficients of all the SAFTA variables. The possible outcomes of trade effects are presented in Table 1. C. Data We have considered a 19-year period starting from 1995 (the beginning year of the withdrawal of MFA) to 2013 (the date of availability of latest data). A panel dataset of five exporting countries and nine importing countries/regions has been used for this analytical exercise. Again, MFN tariff rates that are effectively applied on the manufactured goods by the countries of origin are taken as the relevant data for different importers. We have extracted the export, import, and all other data (except distance) from the bilateral trade database of the United Nations Conference on Trade and Development (UNCTAD) on the basis of the Standard International Trade Classification (SITC) under Revision 3. The data has been collected for two-digit code numbers 26, 65, and 84 indicating categories of textile fibers, textile fabrics and yarns, and clothing, respectively, and expressed in nominal values. The data for distance is obtained from the World Bank database. Since we are predominantly interested about the broad direction and flow of trade for the T&C industries across the trading bloc after the complete withdrawal of MFA, further desegregation of the textile data should be unwieldy for the purpose. IV. ESTIMATION RESULTS AND ANALYSIS This section presents the main results of our empirical exercise. The descriptive statistics and the correlation matrix of the variables dealt with are presented in Tables A1 and A2, Appendix S1, Supporting Information, while the regression results are offered in Table 2 below. A number of interesting observations evolve out of the regression results presented in Table 2. The results show that the value of export from any source to any destination depends quite significantly on a number of variables, like GDP of both

8 174 CONTEMPORARY ECONOMIC POLICY TABLE 2 Regression Results of the Gravity Equation Dependent Variable: ln X ijt Variables lny it 1.672*** (.133) 1.627*** (.134) 1.729*** (.136) 1.729*** (.152) lny jt 1.020*** (.129) 1.007*** (.129).788*** (.146).793*** (.148) lnpop it.816*** (.197).780*** (.198).917*** (.202).921*** (.215) lnpop jt.240* (.145).253* (.145).112 (.152).112 (.154) lndist ij.595 (.367).490 (.372).205 (.387).216 (.392) MFA ijt.173*** (.035).161*** (.035).289*** (.052).289*** (.054) lntar jt.358*** (.129).315** (.130).306** (.128).304** (.128) SAFTA1 ijt.097** (.044).116*** (.044).115*** (.044) SAFTA2 ijt.150*** (.045).149*** (.045) SAFTA3 ijt.001 (.078) Constant (1.537) (1.549) (1.569) (1.592) No. of obs Chi-square Source: UNCTAD and World Bank Database. *Significant at 10%; **significant at 5%; ***significant at 1%. the exporter and importer (reflecting their sizes) and the existence of MFA in a direct way. This reveals that along with the size of the exporting and importing countries economies, the MFA has also promoted these countries exports in a significant manner, irrespective of their association with any RTA. It is important to note that the emergence of SAFTA has no conflict with the prevalence of MFA as we have already mentioned that SAFTA came into existence in 2006 when MFA had already been fully abolished. The results show that the populations of both the exporter and the importer have negative impacts on the value of exportable by any country although it is not significant for the importing country. The significance of the negative regression coefficient of population of the exporting country (logpop it ) can be explained from the demand side, where the native market size may be rather influential in dictating the outcome. Quite contrary to most of the earlier studies, the present set of results show that distance has no significant impact on a country s export, although the sign is expectedly negative for an exporting country showing the role of transport cost on exports. 9 The value of tariff has the usual negative impact on exports and this effect is immensely 9. There may be various reasons for this. One reason may be the fact that when the partner s GDP is large, then distance is not a significant impediment to trade (see Marimoutou, Peguin, and Peguin-Feissolle 2010). Besides, when other policy variables like MFA and other trade facilitating indicators like removal of tariffs, etc. becomes significant, distance may lose its importance (see Bleaney and Neaves 2011; Brun et al. 2005). significant, particularly in the absence of economic integration. However, before we discuss the implications of being part of a trading bloc, let us explain the role of MFA until For the left-truncated data including all the MFA years, the impact on exports is rather strong for all specifications. The introduction of three SAFTA variables (SAFTA1 ijt, SAFTA2 ijt, and SAFTA3 ijt ) has made the results sufficiently robust. The significant values of the regression coefficients of SAFTA1 across all specifications (columns 2 4) imply that exports grow at a staggering level (as shown by the coefficient of significance at 1% level in columns 3 and 4) when both the exporter and the importer are members of SAFTA. This result unambiguously confirms our anticipation of the trade-creation effect of SAFTA. In conducting the regression exercise, we have introduced the variables of SAFTA one by one and observed the level of significance of the coefficients in order to gauge the effects of the changing status of the trading partners, when within or outside the SAFTA block. Quite interestingly, with the inclusion of SAFTA1 dummy alone (i.e., when both are member countries of SAFTA and other two arrangements are ignored), the exports grow by almost 10% and are statistically significant at 5%. However, when we include SAFTA2 (i.e., the exporter belongs to the block while the importer does not) along with SAFTA1, both variables become significant at the 1% level and the coefficients get larger, meaning exports grow by 11% and 15% owing to SAFTA1 and SAFTA2, respectively. Subsequently, inclusion

9 KAR: ECONOMIC INTEGRATION AND SOUTH ASIA 175 of SAFTA3 retains the above results, although it is not significant by itself. These results are very important for our study in the sense that trade-creation effect takes place irrespective of any conditional arrangement. This is equivalent to saying that formation of trade bloc necessarily encourages member countries exports both intra-bloc and extra-bloc. The insignificant negative value of the coefficient of SAFTA3 depicts that if a member country imports from a nonmember country, then, the export of the nonmember country has little or no impact. This suggests that formation of the RTA does not necessarily discourage imports from the countries outside the trading bloc. Overall, the above results clearly suggest that as far as the trade in T&C is concerned, the formation and accession of countries into the trading bloc is unambiguously beneficial for the promotion of exports and trade creation, generally. Moreover, in terms of the trade effect matrix showing different possible outcomes of integration, we can definitely say that our results show that formation of SAFTA indicates pure trade creation on one hand (as both φ 1 & φ 2 > 0) and net trade creation (through expansion of intra-bloc imports) on the other hand (as φ 3 < 0butφ 1 > φ 3 ). V. OTHER RELEVANT ISSUES This section directly connects to the results of the empirical exercise presented in the previous section by specifically mentioning the changes that have been observed in different facets of the emergence of a new regional order. As we are talking about the economic integration among South Asian countries in making SAFTA, we must take care of the trade-facilitating measures in order to identify the factors of impediment to this integration procedure. Additionally this exercise firmly signifies that the destination of exports of these SAFTA countries are actually changing, inclining more toward themselves, and thereby promoting South South Trade as against North South Trade which is a very important trend. Most importantly, the growing share of intra-safta intermediate goods trade is also another significant matter of concern for establishing the regional value chain. A. Reorganization of Export Destinations of Different Countries The formation of SAFTA creates a very interesting state of affairs of change in the shares of TABLE 3 Shares of Exports of Textile Items to Major Destinations from India Year China UAE USA SAARC EU Source: Ministry of Textile, Govt. of India (ON 512, 314, and 186). different destinations of India s and other smaller countries export baskets in the last couple of years. Table 3 demonstrates this change for India, whereas Tables A3 E3 in Appendix S1 describe those for other smaller nations of this region. The share of the USA s import in India s total export has subsided from about 35% in to nearly 26% in The prominent decline started from 2006 to 2007, the year of effective implementation of SAFTA, when the shares of SAARC countries are just showing the opposite trend owing to their reduction in duties for intraregional trade. Such statistical information provides enough food for thought for the potential researchers about the significance of regional integration on the T&C trade of this region. A similar trend to that of the USA is shown by the EU countries although their decline is not so prominent. Nonetheless, the share of UAE remained more or less same. Similar trends of reshuffling of destination markets have been observed for Pakistan (see Table A3, Appendix S1), Nepal (see Table B3, Appendix S1), Bhutan (see Table C3, Appendix S1), Maldives (see Table D3, Appendix S1), and Sri Lanka (see Table E3, Appendix S1) all of which depict a substantial increase in the market share of SAARC countries together at the cost of decline in that of at least one prominent destination such as EU and/or USA. This development is an important one indicating an inclination toward South South trade and enhancing intrabloc exports. In order to analyze the causes of such export market diversion, we should not forget the significance of transport cost, included in the cost functions of the firms selling in different markets at the same time. The large multimarket firms can only survive in the face of severe international

10 176 CONTEMPORARY ECONOMIC POLICY competition owing to their economies of scale and scope. There is ample evidence to indicate that transport costs for both domestic and international trade are quite significant. 10 It has been estimated that, for intercontinental trade, transport costs (averaged about 16% of the value of the good shipped) play a central role in allocating bilateral trade and that they are comparable in magnitude to tariff rates. Besides, it has also been asserted by some earlier studies 11 that as trade liberalization reduces or removes artificial barriers to trade, transport costs have a substantial impact on trade flows, with a doubling of transport costs from their median value reducing trade volumes by 45%. The transitional phase of regional integration of the SAARC countries through the formation of SAFTA encourages the exporting firms to reroute their products, away from the conventional western countries (lying in the other hemisphere of the globe) toward the closest neighboring countries for which the transportation cost is lowest. B. TFIs of the Concerned Countries A most recent finding of the OECD indicators for assessing the impact of specific trade-facilitation measures on developing countries trade seems particularly decisive for this part of our analysis. Sixteen TFIs have been constructed, corresponding to the main policy areas under negotiation at the WTO, with the aim to estimate the impact of addressing specific hurdles in the trade and border procedures of a given country. The econometric analysis 12 reveals that enhancing trade facilitation has a positive impact on trade flows and the most significant trade-facilitation measures (i.e., those that have the highest impact on trade volumes) are information availability, harmonization and simplification of documents, automated processes and risk management, streamlining of border procedures, and good governance and impartiality. Moreover, the combined effect of improvements in these areas is greater than the simple sum of the impact of individual measures varying for varied income level countries. We here try to exhibit the values of different indicators for individual SAFTA countries for 2012 and and make an attempt to assess 10. See Frankel, Stein, and Wei (1996), Hummels (1998). 11. See Limão and Venables (2001), Krugman (1991), and Dalal and Katz (2003). 12. See Moïsé and Sorescu (2013). 13. As data available from OECD s TFI database. FIGURE 1 TFIs for Bangladesh the reduction in cross-border trade costs for them that will also be an important component of integration in addition to tariff reduction. Furthermore, we compare the TFI contour for each of these countries to reflect their relative position. It is worth mentioning here, that the value of TFI indicators ranges between 0 and 2, that is, TFI of value 2 corresponds to the best performance that can be achieved in that particular area of trade facilitation. The use of individual TFIs enables the countries to better assess which trade-facilitation dimensions deserve priority. A list of 11 available indicators on the basis of which contours (Figures 1 7) have been drawn is shown below 14 : 1. Information availability: (A) 2. Involvement of trade community: (B) 3. Advance rulings: (C) 4. Appeal procedures: (D) 5. Fees and charges: (E) 6. Formalities documents: (F) 7. Formalities automation: (G) 8. Formalities procedures: (H) 9. Border agency cooperation internal: (J) 10. Border agency cooperation external: (K) 11. Governance and impartiality: (L) The above contours show that in the areas of information availability (A) and involvement of trade community (B), the four prominent SAFTA countries are doing very well. India 14. Data for these indicators are obtained from OECD s TFI database.

11 KAR: ECONOMIC INTEGRATION AND SOUTH ASIA 177 FIGURE 2 TFIs for India FIGURE 4 TFIs for Sri Lanka FIGURE 3 TFIs for Pakistan FIGURE 5 TFIs for Nepal has also performed particularly well in advance rulings (C), governance and impartiality (L), formalities and appeal-related procedures (D&H), and automation(g). The most significant improvement is observed for fees and charges (E) over the last couple of years that corroborates the projection of reduction of tariff and other trading charges at the verge of completion of integration process and if the country can unshackle its border agency cooperation (both internal and external, i.e., J & K ) along with easing of documentation formalities (F), then trade costs can be substantially abridged. Bangladesh exhibits almost the same kind of feat except for items C, D, and H. Bangladesh has also demonstrated a similar kind of development in fees and charges thereby indicating diminution of duties and taxes in recent years. Pakistan and Sri Lanka have also shown signs of improvement in all the areas of action in 2015 except for external border agency cooperation (K). Sri Lanka should also pay heed to items like D and L in order to ensure trade facilitation. Although Nepal and Bhutan have a long way to go in order to achieve optimum values for TFIs, yet in the area of internal border agency cooperation both of them have touched the peak. Bhutan also performs well in involving their trading community with the actual trading process. Similar data for Afghanistan are not available in

12 178 CONTEMPORARY ECONOMIC POLICY FIGURE 6 TFIs for Bhutan FIGURE 7 TFIs for All Countries: 2015 Source: OECD Database, Trade-Facilitation Index. the database and data for only 2015 are obtained for Maldives. C. Emergence of Regional Value Chain: Growth in Intra-SAARC Intermediate Goods Trade The process of economic integration in South Asia may have certain other implications too. It may be possible in future that textile industry would be vertically integrated within this region with different countries producing different levels of products according to their respective comparative advantages and assembled/ reunited together for final export. We can show evidences of growing intraregional trade in intermediate goods among the SAARC countries and thereby indicate the possibility of creation of a regional value chain amongst them. For this, we have considered shares of intra-saarc trade of different varieties of T&C items (SITC-3-digit levels) in the total world trade of these items and presented them in Appendix S1 as Table A3 (for textile fibers and wastes, i.e., course materials), Table A4 (for textile yarns and fabrics, i.e., intermediate products), and Table A5 (for clothing and apparels, i.e., finished goods). We have demonstrated the percentage shares of intra-saarc trade of different items (with SITC codes in parenthesis) in total world trade over the stipulated years in the following figures (line-diagrams) namely Figure 8, Figure 9, and Figure 10, using the data in Tables A3, A4, and A5 of Appendix S1, respectively, and observed almost a similar trend for the same groups of items. As observed from the above figures, the share of intra-saarc trade in total trade of all kinds of textile fibers (raw and coarse material used for manufacturing other items) remains more or less similar over the years (Figure 8), whereas the share of trade among the SAARC countries in total trade of most kinds of textile yarns and fabrics, that are used as intermediate inputs, increases substantially after 2006 (Figure 9). Among all varieties, knitted fabrics (SITC Code 655) shows maximum increase where special fabrics (SITC Code 657) shows almost no change in SAARC s share. As compared to these intermediate goods trade, the trade of final goods, clothing, and apparel, among the SAARC countries has not grown significantly with respect to the total trade of clothing and apparel from the SAARC countries to the rest of the world (Figure 10). Very insignificant improvement of the share of intra-saarc trade in final goods is indicative of a very important phenomenon, that SAARC countries do not export much of the final clothing and apparel items to themselves. In contrast, they export an enlarged amount of intermediate goods to each other to retain the comparative advantage of these region vis-à-vis North countries in textile and apparel trade. This observation is actually substantiated by executing similar exercises for two most prominent countries of SAFTA, namely India and Bangladesh, by finding out their performances in intra-saarc trade, whether exhibiting a similar trend of growth of intermediate goods or not. Surprisingly, our investigation yields the same trend for these two. The tables (Tables A6 and A7, Appendix S1) clearly demonstrate the fact, that owing to credit and other capacity