Monday, December 12, 2005

Free trade: What can India learn from Hong Kong

WTO ministerial meeting was being held in Hong Kong, this month, and as in the past, this time too, anti-trade and anti-globlisation groups were protesting outside on the streets. In this article, "What can India learn from Hong Kong", published in the Far Eastern Economic Review, in December 2005, I look at the experience of Hong Kong, a city that has thrived on an unilateral free trade policy, and was not even negotiating at WTO!

There is more than a little irony that the World Trade Organization ministerial is being held in Hong Kong this month. Hong Kong is the epitome of the success of unilateral free trade policies: A few pieces of rock, devoid of any natural resources, the territory today ranks among the most prosperous places on earth. Hong Kong’s success is rooted in the institutions of rule of law and economic freedom. The territory did not negotiate any free trade deal. It just declared it unilaterally, and the rest is history. Yet the contrast between the success of Hong Kong’s unilateral free trade policy and the current deadlock in wto negotiations could not be more glaring.

The WTO’s troubles started at its birth 10 years ago. The hazards of multilateral trade negotiations were exposed quite early on the streets of Seattle in 1999. The next ministerial in Doha, Qatar, which came soon after the 9/11 tragedy, launched a new round of negotiations—but this small success was short-lived. Long before they landed in Hong Kong, the multilateral negotiators have been trying to navigate the turbulent sea of different issues and interest groups since negotiations collapsed in Cancun, Mexico in 2003.

Freedom to trade is a cornerstone of human civilization. It gave rise to cities which provided a platform to engage in trade. It created an opportunity to specialize and improve productivity, and exchange the surplus of one’s produce with others in the marketplace. Two lessons follow from this very brief summary. Free trade is undertaken voluntarily, and consequently it is a win-win situation for both parties engaged in the exchange. If the deal was not mutually beneficial, trade would take place. Secondly, it is people who engage in trade—not countries.

The fatal flaw of multilateral trade negotiations lies in the fact that since national delegates are engaged in the negotiations, they increasingly fall under the sway of vested interests who seek to use the trade talks to protect their own privileges, or at the very least to delay the process of trade liberalization. The multilateral approach to trade replaces the natural win-win situation of voluntary trade between private parties with the flawed assumption that trade is a “zero-sum” game.

National negotiators use this as a cover, finding justifications to protect apparent “national interests.” In reality, they aim to protect vested commercial interests, be they farmers or manufacturers, from competition. Inevitably, the result is deadlock as presently witnessed at the WTO. To a large or even greater extent, the same tendency applies to bilateral and regional trade negotiations.

Thus, the location of Hong Kong as the venue for the present WTO ministerial meeting is more than mere coincidence. By all accounts, the trade negotiators are unlikely to achieve any substantive breakthroughs apart from renewing their commitment to continue the negotiations.
But should the wto fail in Hong Kong, this could only help to bring focus back to the benefits of real free trade. The trade negotiators, policy makers and the international media now have a unique opportunity to learn from the unilateral free trade policies of Hong Kong, and experience the rich dividends such a policy has yielded.

Two economies that starkly demonstrate the effect of unilateral trade policy are India and Hong Kong. Half a century ago, these two poor countries in Asia decided to travel two distinct economic paths.

India, a nascent democracy, decided to shape its destiny by isolating itself from the international economy, adopting the philosophy of “self-sufficiency.” It sought to build its future by harnessing its own domestic resources and promoting infant domestic industries. The international community looked favorably upon this new experiment with democratic socialism in India, and provided assistance to help the country on its way. India’s fiscal and regulatory policies aimed to make international trade irrelevant. Sky-high tariffs were backed by nightmarish procedures, and the public sector was commanded to scale the economic heights. When combined with
India’s historical tendency toward food shortages and famine in the first half of the
20th century, these restrictions paralyzed India’s economy and perpetuated poverty.

By the mid-1970s, agriculture (which was predominantly in private hands) was helped by the hybrid seeds of the first green revolution technology. This moved India away from being a “basket case” to being a “bread basket.” But otherwise, India’s huge endowment of natural resources could hardly be harnessed efficiently in this system. Even the country’s democratic foundations were shaken by the emergency rule in 1975-77. Through sporadic attempts at reforms in the 1980s, the economy fell to the depths of despair in 1991, with an unprecedented foreign-exchange crisis. The crisis triggered the economic reforms of the 1990s, which have succeeded in reigniting the belief that India could soon be an economic power on the world stage.

During the period that India unilaterally shut itself out of the world, Hong Kong unilaterally adopted free trade policies and maintained the institutions of economic freedom. It did this partly out of necessity. At the same time, it carved out a special economic niche for itself, taking advantage of its precarious geographical proximity to China, which had adopted closed-door socialist economic policies in the aftermath of the communist revolution. Chinese entrepreneurs went into overdrive, seizing every opportunity that China and the region provided. The British government in the territory had a policy of benign neglect—keeping economic interventions to a minimum, while maintaining the critical institutions like the rule of law. Yet this was hardly a conscious decision of the colonial masters, since the United Kingdom itself did not adopt the same approach.

Though Hong Kong comprised a few fishing villages and was devoid of any natural resource base, its unilateral approach to trade combined with its protection of market institutions enabled the country’s economy to flexibly grow and adapt to global change. Consequently, while the Indian economy stagnated, Hong Kong economy skyrocketed. In fact, India’s share in global trade declined continuously between the 1960s and the 1980s. Despite its much smaller size, Hong Kong’s international trade (including re-exports) remained at a much higher level. Since its economic reforms in 1991, India’s economic growth rate has increased as compared to that of the 1970s and 1980s. But even after the reforms since 1991, India’s average tariffs remain relatively high—in the range of 25% to 35%—while Hong Kong’s are still zero. While Hong Kong consistently remained in the top position in terms of overall economic freedom consistently over the years, India’s freedom has improved only marginally by some measures. Despite appreciable improvement over the last decade, the level of economic freedom in India is much lower than in Hong Kong.

So here we have two countries that followed two very different policies, quite unilaterally, and achieved two opposite outcomes. The numbers say it all: The per capita income of Hong Kong is $27,179 using purchasing power parity, and India’s is a meager $2,892. Two global indices—The
Heritage Foundation’s Index of Economic Freedom and the World Bank’s Doing Business 2005—indicate that the divergent outcomes in Hong Kong and India are not mere coincidences. These indices show that restrictive and bureaucratic economic policies contribute to delays and bottlenecks which adversely affect the performance of businesses of all sizes. The contrast is equally glaring in the two countries’ trade regimes. While Hong Kong averages close to the rich countries in all categories, India takes almost three times as long to complete import and export procedures.

As for international trade, India’s problems stem not from too much trade in goods and services, but too little. In 2002, India’s total exports and imports stood at $87.7 billion and $74 billion respectively, in 1995 dollars. For tiny Hong Kong, the corresponding export and import figures were $321 billion and $301 billion respectively. Clearly the problem of any poor country is not that it trades too much, or is flooded by foreign imports, but that it trades too little. Even in relative terms, India’s share of world trade has fallen to 0.8% today from 1.5% in 1950. This brings us to the current Doha Round of WTO negotiations, due to end by 2006, where agriculture has become the major sticking point. The agitation of so-called “development” organizations around the touchy issue of agricultural subsidies has led many to argue that if the rich world does not reduce or eliminate its agriculture subsidies, then the poor countries should not open their markets to produce from the rich countries. But this argument misunderstands the fundamental purpose of trade, and demonstrates ignorance about the progression of economies.

After relying on a policy of economic self-sufficiency for decades, India had very little economic diversification. This explains why today, India’s agricultural sector produces approximately one-quarter of India’s gdp—and 70% of India’s population is involved in farming. The majority of India’s farmers are poor smallholders who have extremely low productivity, which relates to a variety of government-imposed barriers inside India: taxes between states, which leads to corruption and bribery among low-level bureaucrats; extremely poor infrastructure; and a range of price regulations that do not allow prices to reflect the true supply and demand situation.

Smallholder farmers are the victim of these policies—since they cannot attain a better price for their produce, they cannot afford technologies to improve productivity, or find alternative nonfarm economic opportunities. It is precisely these people—at least 600 million Indians—who would benefit most from unilateral trade liberalization. Why? Because they are farmers out of need: They grow food or primary goods because they have no other choice. For the poor, it does
not matter where the food comes from, if it is accessible at a lower price. From this perspective, cheap and subsidized food from the rich countries would only help stimulate economic growth and improve welfare in poor countries. First, it would induce reforms in the agricultural sector
in poor countries, making it much more competitive. Agriculture will not remain a liability, but become a source of economic strength. Secondly, low-cost imports will only facilitate the transition of poor countries from being dependent on agriculture and natural resources to being more diversified.

Thirdly, this transition from agriculture to manufacturing and to services will actually enable today’s poor countries to graduate out of poverty. Finally, it would serve to harness human potential and unleash human creativity and entrepreneurship, which would spread prosperity
around the world.

Effectively, India adopted this more liberal approach in the trade in services, a sector which has experienced rapid growth since the early 1990s and in the post-WTO period. India’s relative success in information technology-related services is a reflection of the benefits of unilateral economic and trade reforms. Factors such as India’s telecom liberalization acted as a massive
boost for the growth of information-technology services. In sharp contrast to it hardware, and the manufacturing sector in general, which were hobbled by government regulations, India’s it services faced few policy-induced obstacles. Indeed, the outside world now sees India’s trade in services as evidence that the country is escaping the “Hindu rate of growth” that characterized India’s economy for the past few decades. Rather than being ambivalent towards opening other service sectors like banking and insurance, India would do well to unilaterally open all the service sectors.

Again, Hong Kong is an almost perfect example of unilateral free-trade policies cutting across all sectors of the economy. This is why Hong Kong seamlessly managed the transition from being a low-end manufacturing and trading port in the 1960s to being a high-end economy dominated by the service sector. The success of unilateral free-trade policies will also make irrelevant another thorny issue at the wto, that of “special and differential treatment” for countries which are at different levels of economic development.

With unilateralism, entrepreneurs in every country would have the freedom and ability to discover their competitive advantages and to specialize. Otherwise, “special and differential treatment” will, in fact, impose “special and differential punishment” on ordinary consumers. This large group is unrepresented in these international jamborees, but suffers the most from a lack of choice and competition.

India is no stranger to unilateral reforms—the economic situation in 1991 was so dire that only a unilateral approach would suffice. India undertook a whole range of domestic economic reforms unilaterally, reducing tariffs and delicensing large sections of the economy. Today, a unilateral approach to trade would propel India towards becoming a modern, diversified economy. The country would be better able to acquire inputs and capital for all kinds of economic activity, to better utilize its natural and human resources.

Competitive market processes would drive up the value of people’s labor, and would diminish the number of people (mostly farmers) who still live an impoverished existence. Given India’s enormous potential, it is now time for it and other poor countries to take a leaf out of Hong Kong’s unilateral approach to free trade. It would benefit India in the short and long term, by harnessing the great entrepreneurial spirit, vigor and optimism that is now driving India forward.