Effects of Free Trade Agreements on Trade Activities of Signatory Countries

Abstract

The study analyses the effects of free trade agreements (FTAs) signed by India on the changes in the trade volumes of member states. The article analyses the benefits of the economic integration of export earnings to meet the import demands. It is found that FTAs improve economic activities among the signing countries. This article highlights the role of FTAs in the economic activities of countries signing the trade agreement. Post FTAs, the compound annual growth rate (CAGR) of exports increased and imports reduced. This research will help researchers identify the areas and countries where FTAs are desirable and help improve economic activities.

JEL Codes: F15

Keywords

Development economics free trade agreement India preferential trade agreement WTO economic policy policy analysis

I. Introduction and History of Free Trade Agreements

The European Commission defines free trade agreements (FTAs) as agreements that eliminate or cut customs duties, remove quotas and reduce the trade restrictions for commerce in goods and services between two or more participating countries (European Commission, 2019). An FTA’s primary goal is to strengthen the domestic economy and create employment between the participating countries. FTA increases the volume of trade in goods and services, increasing countries’ trade revenue. FTAs have many formats, such as regional trade agreements (RTAs), customs unions (CUs), economic integration agreements (EIAs), and preferential trade agreements (PTAs) (Jung, 2012).

The idea of Free Trade has existed for a long time. The spice trade from the East to Europe existed long before industrialisation (Gurtu et al., 2017) and is the oldest example of free trade. The first modern trade agreement was signed between Britain and France on 23 January 1860. The Cobden–Chevalier Treaty promised that France would eliminate all the import prohibitions on British manufactured goods while capping most duties (Grossman, 2016). The Classical Economists (such as Adam Smith, David Ricardo and Thomas Robert Malthus) and Neoclassical Economists (such as Alfred Marshall, John Bates Clark and John Hicks) formalised the concept of free trade. Their schools of thought dominate free-market economies (Clark, 1908; Giddings, 2016; Hicks, 1946; Malthus, 1798).

A proponent of free trade, Adam Smith (1723–1790), anticipated the ‘invisible hand’ to guide the operation and efficiency of free trade, that is, it will be driven by the dynamism of market supply and demand forces (Smith, 1976). Smith’s (1976) central idea is that free trade enables countries to specialise in products that can be offered at a lower cost domestically. Moreover, David Ricardo (1772–1823) further contributed to the idea of free trade development. Modern free trade versions have a plethora of neoclassical strategies and regulations to optimise the welfare outcomes most suitable to each contracting party. Nearly a century before Smith, Sir Dudley North (1641–1691), extended the first appeal in favor of free trade (North, 1907). North concluded that industry and freedom bring wealth (Gerken, 1999).

FTAs between countries do not suggest an immediate elimination of import tariffs. However, import tariffs reduce over time (Bond & Park, 2002), resulting in increased trade. While the debate about the monetary benefits of free trade continues, the additional trade gains compensate for revenue losses due to lower tariffs (Jung, 2012). However, Hamanaka (2012) and Kalirajan and Paudel (2015) suggest that countires sign trade agreements where they face a high level of trade interdependence. Bhagwati (1993) frowned upon multilateral free trade. The author adds that the only feasible way to continue reducing trade barriers is to go down the PTAs route, hoping to obtain worldwide free trade.

The differences in PTAs are widespread and give the feeling of a ‘spaghetti bowl’ (Bhagwati, 1993). Nonetheless, all forms of trade relaxations, for example, unilateralism, bilateralism, regionalism, and multilateralism, are good for economies and societies. These relaxations move societies in the direction of free trade (Summers, 1991). The viable way to reduce trade barriers is to adopt the preferential free trade areas in light of the assumption that this path will procure worldwide free trade (Bhagwati, 1995). Member countries of an RTA reciprocally remove trade barriers while maintaining such barriers for non-member countries. The number of FTAs (within and outside the region) and their stages for the Asian Development Bank (ADB) are given in Appendix A.

India signed 43 RTAs with the various countries from 1976. These trade agreements signed by India are classified into various blocks like PTAs, Comprehensive Economic Partnership for East ASIA, Comprehensive Economic Cooperation Agreement (CECA), Comprehensive Economic Partnership Agreement (CEPA), FTA, Regional Trading Agreement (RTA), Regional Comprehensive Economic Partnership (RCEP), Free Trade Area, Customs Union Preferential Trade Agreement (CUPTA), Economic Partnership Agreement (EPA), Treaty of Trade and lastly Trade agreement.

Thirteen RTAs are in effect, sixteen are under negotiations, thirteen agreements are under various stages of consultation and study, and the remaining one RTA, between India and Gulf Cooperation Countries, has been signed but not in effect (Figure 1). It has yet to be notified to WTO (Asia Regional Integration Center, 2019). However, only one agreement was signed in 1976. The rest of the agreements were signed post-1991 when the economy opened for trade liberalisation. Therefore, the agreement signed in 1976 has not been considered for further analysis and is not included in Figure 1. The article will focus on the trade trajectory of only eleven RTAs, which are in effect.

Figure 1.

Source: Asia Regional Integration Centre (2019).

The remainder of the article is organised as follows: Section II presents a literature review and explains trade creation (TC) and trade diversion (TD). Free trade is a conventionally justified debate that global commerce increases the welfare gains of all countries involved. Section III provides research methodology and analyses based on the data of merchandise and trade figures after entering a free trade pact, followed by Section IV concludes the discussion on the benefits of economic integration.

II. Literature Review

The literature review covers TC and diversion, followed by types of trade blocs. The section covers FTAs and RTAs signed by India after 1991 because the trade liberalisation process started in 1991 in India. Further, it covers FTAs signed by India between 2001 and 2018 in greater detail.

Trade Creation and Trade Diversion

TC refers to an increase in imports from a competent supplier of goods, and a TD refers to a rise in imports from a less competent supplier of goods (Viner, 1950). Viner (1950) developed the theoretical concepts of TC and TD, and was the first to analyse the global politics of trade agreements. The Customs Union Issue provided a framework in 1950 for the contemporary orientation over the benefits or possible negative impacts of preferential trading agreements (Viner, 1950). This framework sets the tone for contemporary free trade formations like the European Union, NAFTA, APEC, Association of South East Nations (ASEAN), and trade liberalisation. The idea was further supplemented and refined by Meade (1956) and Lipsey (1957). TC can occur when introducing an RTA allows supply from a more efficient producer of the product. In contrast, TD means that an RTA diverts trade away from a more efficient supplier outside the RTA towards a less efficient supplier within the RTA. Therefore, economic parity and matching efficiency are beneficial in RTAs for TC to occur. Indiscriminate RTAs could tend to the case of TD.

Types of Trade Blocs

All trade agreements are not the same in their influence on economic activities. The variety of trade agreements in the order of increasing areas of influence is shown in Figure 2. PTA and Economic Union are on the opposite ends of the spectrum. PTA is the simplest form of a trade agreement, but it does not eliminate trade barriers among its members. The next is FTA, which eliminates internal barriers but maintains independent external barriers. Customs Union eliminates internal barriers and agrees on common external barriers. Common Markets further eliminate internal barriers, adopt common external barriers, and allow free movement of resources. Finally, an Economic Union eliminates internal barriers, adopts common external barriers, allows free movement of resources, and agrees on a uniform set of economic policies.

Figure 2.

Source: WTO–Regional Trade Agreements 2019.

Free Trade Agreements

RTAs talk of liberal and free trade among member countries. ‘Nations and the political elites or parties who govern them have other aims besides satisfying the wishes of commercial interests... that these arrangements often constituted no more than preferential trading areas and that they were a possible threat to multilateral trade cooperation’ (Brown, 2003). Such instruments pursue a case of protectionist trade (Brown & Ainley, 2005). The proposition that protection can be beneficial when an industry generates external economies is part of the conventional trade policy (Rodriguez, 1975).

FTAs are levelers at one stage and protectionists at another stage (Bhagwati, 1995). Further, the author mentioned FTAs as ‘Orwellian Newspeak’ in a discussion paper titled ‘American FTAs Infatuation’. It is essential to understand the difference between FTA and Free Trade. FTAs liberalise trade on a discriminatory basis, whereas free trade is a barrier-free regime in favor of all (Panagariya, 1996). The ‘Rules of Origin’ clause of most FTAs raises a fundamental question—Do goods have a nationality (Bhagwati, 1995)? The answer to this question is a philosophical nightmare. The ‘Spaghetti Bowl Syndrome represents the current operations practices’, and ASEAN free trade practices have been mentioned as the ‘noodle bowl’ (Bhagwati, 1995). In the postwar context, John Manard Keynes referred to this as a policy bias, discriminatory, and bilateral barter (Bhagwati, 1992).

India’s Trade Agreements

Import Substitution and Industrialisation (ISI) model dominated in India until 1991. India opened to world economic liberalisation and joined the global free trade movement in 1991. India was one of the 23 founding Contracting Parties to the General Agreement on Tariffs and Trade (GATT) that was concluded in October 1947 and a member since 8 July 1948. India’s participation in international economic negotiations illustrates its ambivalence toward the importance of trade and the world trading system in accelerating development (Srinivasan, 1998). Although India participated constructively in the negotiations after liberalisation in 1991, the focus was limited to trade in goods (Sharma & Bhogal, 2017). Trade liberalisation has been pursued as a critical strategy for fast-tracking growth. India needed a change in its policy outlook and worked actively in the quest for preferential trade relations.

The export-import policy of 1992–1997 was a significant landmark in India’s economic history. It made a conscious effort to dismantle various protectionist and regulatory policies (Ministry of Commerce & Industry, 2019). The foreign policy of 2004–2009 made provisions for the smooth operation of imports. Moreover, the new foreign trade policy 2015–2020 came into effect on 1 April 2015, designed to phase out incentives and export subsidies. This was supported by other authors a long time ago (Brander & Spencer, 1985; Spencer & Brander, 1983). The authors showed that government policies such as export subsidies and import restrictions, under the right circumstances, deter foreign firms from competing for lucrative markets, whereas many authors believe that a country is likely to reduce its external tariff when it enters FTAs (Bagwell & Staiger, 1997; Bohara et al., 2004; Bond et al., 2004; Trefler, 1993).

The literature review discusses the emergence of countries for their economic benefits as markets became attractive after removing trade barriers. The role of FTAs is growing enormously in various formats, but it is still not clear how these FTAs are promoting the economic growth of partner countries. India needed to import things as economically as possible in the trade liberalisation process, that is, without massive tariffs to make export attractive.

III. Research Methodology, Analysis and Discussion

From a methodological perspective, literature reviews could be content analyses, where quantitative and qualitative aspects are assessed structurally (Brewerton & Millward, 2001). The methodology used in this research is related to that of Rostow (1959), which was first published in 1960, carrying the sub-title ‘A Non-communist Manifesto’. This was based on five factors (a) the traditional society; (b) the pre-conditions for take-off; (c) the take-off; (d) the drive to maturity; and (e) the age of high mass consumption. The author argued that the economies of all countries could be placed within one of the five different stages of economic growth (Figure 3).

Figure 3.

Source: Rostow (1959).

According to Rostow (1959), the traditional society is less developed in terms of science and technology, and attitudes towards the physical world. Structured within limited production functions, it fails to reach even a modest level of output. The second stage is the transition stage, enabling societies to build up conditions for take-off for economic growth. The third stage is the Take off stage, where the country has been liberal towards foreign investment, trade, and other allied activities. The drive to maturity stage is the period when a society has effectively applied the range of modern technology to the bulk of its resources. The last stage is the age of mass consumption, where society’s attention shifts from production problems to problems of consumption and welfare in the broadest sense.

This paper applies the Rostow model to analyse India’s FTAs. The model is based on capitalist control and integration into the global economy with unfavorable trade models and a lack of control over its resources. The model has some limitations as no growth is automatic until internal and external variables of social, political, and climatic factors influence the business environment’s need to push. India’s productive efficiency and competitiveness lag that of China due to economies of scale. India is far behind China in terms of total productivity and output. The Indian industrial productivity needs TD and an efficient business climate to become a dominant player in the global value chain. Although India has been liberal towards FDI and trade agreements, it needs to take advantage of the pool of resources, revisit all the trade agreements for better export earnings and analyse whether the country benefitted from trade agreements with the developed and developing economies. India’s trade deficit before and after FTA regimes continues to be a concern.

The article compared the growth rates of India’s imports and exports with those of the countries on the agreements before and after FTA. Countries without FTAs are considered a control group. Ten trading partner countries without a trade agreement have been used as the control group. The growth rates of this control group have been compared with FTA countries. The major benefit of FTAs is growth in the trade between the signing countries besides several social and political benefits. Compound annual growth rate (CAGR) has been used to measure growth instead of a simple average growth rate. CAGR stabilises the trend as it smoothens the seasonal or cyclical variations in exports and imports.

The FTA signed by India and Afghanistan in 2003, known as the PTA, is discussed here. India and Afghanistan have had a strong partnership for centuries. India played a significant role in the reconstruction and rehabilitation of Afghanistan. The trade between India and Afghanistan has increased at an annual rate of 17.4%, from US$19.4 Mn in 1995 to US$782 Mn in 2018 (Figure 4). Similarly, India’s imports have increased by an annual rate of 19.1% from US$8.07 Mn in 1995 to US$446 Mn in 2018 (OEC, 2018). However, the trade in goods and services has not increased due to political turmoil and unstable situation in the region. The trade agreement could not pick up the momentum expected from the pact. The geopolitical circle makes India’s trade agreement more lucrative as it bridges the gap to access markets in eastern Asia and the Middle East.

Figure 4.

Source: OEC (2018).

The next PTA was signed with Chile in 2007. The agreement was finalised after several rounds of negotiations with talks held in New Delhi in November 2005. India’s exports to Chile have increased at an annual rate of 13.7%, from US$51.5 Mn in 1995 to US$994 Mn in 2018 (Figure 5). Similarly, India’s imports increased from US$93.5 Mn in 1995 to US$1.34 Bn in 2018 (OEC, 2018). Has India benefited from this trade agreement? The trade agreement needs to be reviewed and analysed to identify if India benefited from its export earnings to buy imports.

Figure 5.

Source: OEC (2018).

The third PTA agreement that India has with Mercosur countries came into effect in 2009. Mercosur is a trading bloc with four founding members: Brazil, Argentina, Paraguay, and Uruguay (Figure 6). India’s Exports to Argentina have increased at an annual rate of 11.4%, from US$68.2 Mn in 1995 to US$818 Mn in 2018. On the other hand, there has been a significant increase in India’s imports from Argentina from US$177 Mn in 1995 to US$1.62 Bn in 2018 (OEC, 2018). The main product imported to India was Soybean oil.

Figure 6.

Source: OEC (2018).

India and Brazil share a very close and healthy bilateral relationship. The relations are based on a shared global vision, shared economic values, and a commitment to foster economic growth with social inclusion for the welfare of the people of both the countries. India’s exports to Brazil have increased at an annual rate from US$148 Mn in 1995 to US$3.62 Bn in 2018. Further, India’s imports from Brazil have increased at an annual rate of 11%, from US$367 Mn in 1995 to US$4.02 Bn in 2018 (OEC, 2018). India and Brazil have benefitted from these PTAs compared to other Mercosur countries.

India’s exports to Paraguay have increased from US$11.8 Mn in 1995 to US$202 Mn in 2018 (OEC, 2018). At the same time, India’s imports from Paraguay have increased from US$475,000 in 1995 to US$247 Mn in 2018. India mainly imported Soybean Oil from Paraguay. India and Uruguay have maintained cordial relations and have supported each other on major international issues. India’s exports to Uruguay have increased from US$18.5 Mn in 1995 to US$209 Mn in 2018. Similarly, India’s imports increased from US$6.76 Mn in 1995 to US$36 Mn in 2018 (OEC, 2018).

Another RTA of India was with Singapore, knows as the CECA. This was a strategic relationship agreement to increase trade, investments and economic cooperation, and expanded bilateral cooperation on maritime security, training forces, joint naval exercises, developing military technology, and fighting terrorism. The agreement came into effect in 2005. India’s exports rose from US$980 Mn in 1995 to US$9.1 Bn in 2018 (Figure 7). On the other hand, India’s imports from Singapore have risen from US$1.06 Bn in 1995 to US$13.4 Bn in 2018 (OEC, 2018). India’s main imports from Singapore include electronic goods, non-electrical machinery, transport equipment. India has benefitted from this trade agreement with Singapore. There are many reasons, including social, political, and business environment, that make Singapore the best economic partner for trade. The trade forecast trajectory shows an increasing path of trade between the countries in years to come.

Figure 7.

Source: OEC (2018).

The next CECA was initiated in 2005 with Malaysia. The negotiations were launched in 2008, and the trade agreement came into effect in 2011. India’s exports to Malaysia have increased from US$539 Mn in 1995 to US$6.58 Bn in 2018. Similarly, India’s imports have increased from US$902 Mn in 1995 to US$9.43 Mn in 2018 (Figure 8). The main products India imported were Crude Petroleum and Palm oil. India is a major importer of Palm Oil from Malaysia for the past few years. India’s imports have increased from Malaysia, indicating that India benefitted from RTA. However, imports nullify export benefits, suggesting that India needs to review Malaysia’s trade agreement.

Figure 8.

Source: OEC (2018).

The agreement with Japan was initiated in 2004, negotiations were launched in 2007, and the agreement came into force in 2011. Economic relations between India and Japan have vast growth potential, given the two Asian economies’ apparent complementarities. Japan’s interest in India is increasing due to various reasons, including India’s growing market and resources, especially human resources. The signing of the historic India–Japan CEPA and its implementation from August 2011 has accelerated economic and commercial relations between the two countries.

India’s export to Japan has increased from US$2.92 Bn in 1995 to US$5.13 Bn in 2018 (Figure 9), and imports from Japan have increased from US$2.36 Bn in 1995 to US$11.4 Bn in 2018 (OEC, 2018). India imported vehicle parts and refined copper from Japan. This may be due to massive industrial investments by Japanese engineering companies in India. India and Japan are natural partners with an economic complacent that is potentially high. Japan needs growth due to its aging population and mature economy. In such a scenario, it will be necessary for Japan to expand its relationship with India. Japan has invested heavily in India’s infrastructure development, and India has high expectations from Japan as a development partner. Japan has had a recurring trade surplus with India. While India has a comparative advantage in generic drugs. Further, the number of companies entering the Indian market has grown steadily from 550 in 2008 to 1,441 in 2018 (Embassy of Japan, 2018)

Figure 9.

Source: OEC (2018).

The negotiations for CECA with South Korea launched in 2006, and the trade agreement came into force in 2010. Bilateral ties, especially in the last decade, have grown robust and multidimensional, encompassing a broad range of interests, including nuclear disarmament, maritime security, regional economic cooperation, counterterrorism, and energy cooperation. India’s exports to South Korea have increased from US$876 Mn in 1995 to US$5.37 Bn in 2018 (Figure 10). On the other hand, India’s imports have increased from US$1.04 Bn in 1995 to US$16 Bn in 2018 (OEC, 2018). The major imports were integrated circuits, Hot-rolled Iron, and Vehicle parts. In this agreement, India’s imports have increased compared to exports, which shows a negative trade balance.

Figure 10.

Source: OEC (2018).

The trade agreement with ASEAN countries, known as the CECA, was signed and came into effect in 2010. ASEAN’s objective is to accelerate growth, social progress, and cultural development among its members. India’s relationship with ASEAN is a crucial pillar of its foreign policy and the foundation of its Act East policy.

The trade between India and Vietnam has witnessed India’s exports from US$124 Mn in 1995 to US$6.7 Bn in 2018. Similarly, India’s imports have risen from US$15.3 Mn in 1995 to US$7 Bn in 2018 (OEC, 2018). However, there is a trade deficit. Imports are neutralising the export earnings, which must be reviewed in the FTA negotiations between goods and services. Further, Vietnam is the 18th largest trading partner globally and the 4th largest trading partner among the ASEAN, after Singapore, Malaysia, and Indonesia. Thailand is the second-largest economy in the ASEAN and the Greater Mekong Subregion (GMS). India’s ‘Look East’ policy and Thailand’s ‘Look West’ policy strongly contribute to consolidating bilateral relations, including economic and commercial linkages. India’s exports have boosted from US$648 Mn in 1995 to US$4.62B in 2018. On the other hand, India’s imports have risen from US$252 Mn in 1995 to US$7.68 Bn in 2018. This clearly shows a substantial negative trade deficit compared to Vietnam.

Soon after independence, India and the Philippines formally established diplomatic relations on 26 November 1949. The year 2019 marks 70 years of diplomatic relations between the two countries India’s export has risen from US$143 Mn in 1995 to US$1.83 Bn in 2018. Similarly, India’s imports have increased from US$20.2 Mn in 1995 to US$746 Mn in 2018 (OEC, 2018). The trade agreement has been beneficial to India as India’s exports are more than India’s imports, that is, India has a surplus trade balance. The trade agreement with Myanmar, the gateway of India’s ‘Look East Policy’. India’s exports to Myanmar have increased from US$30 Mn in 1995 to US$1.4 Bn in 2018. India’s imports from Myanmar have marginally increased from US$149 Mn in 1995 to US$631 Mn in 2018 (OEC, 2018). The trade between India and Myanmar has not flourished much due to the low border trade, which plays a significant role in the macroeconomic perspective of regional economic integration between South Asia and the South-East Asia region.

India and Lao People’s Democratic Republic share longstanding, friendly, and mutual relations. India’s exports to Laos have risen from US$307,000 in 1995 to US$37.5 Mn in 2018, and imports from Laos increased from US$13,300 in 1995 to US$16.1 Mn in 2018 (OEC, 2018). The trade agreement has not raised enough scope in the ASEAN trade agreement. The trade between the two countries is well below potential. On the other hand, India has granted duty-free preference schemes to Lao PDR to encourage India’s export of goods. Second, in the ASEAN agreement, Indonesia is India’s biggest trading partner in the ASEAN bloc, and the bilateral trade between the two countries has been growing at a fast pace. India’s exports risen from US$596 Mn in 1995 to US$4.92 Bn in 2018 and, imports from Indonesia increased from US$476 Mn in 1995 to US$14.5 Bn in 2018 (OEC, 2018). The main imports from Indonesia were Coal Briquettes and Palm oil for the past several years.

India and Cambodia have limited economic integration while there is no much trade exchange between them. India’s exports had increased from US$2.13 Mn in 1995 to US$179 Mn in 2018, and imports from Cambodia have risen from US$310,000 in 1995 to US$45.4 Mn in 2018 (OEC, 2018). The trade figures are not much impressive. Hence, it will not be easy to interpret the benefits of both countries’ exports and imports. The agreement between India and Brunei has historical and cultural roots, and both enjoy a fair degree of commonality in their perceptions of major international issues. However, the trade potential has not been explored at the optimum level. India’s exports to Brunei have marginally risen from US$71.5 Mn in 1995 to US$73.6 Mn in 2018 and, the imports to India were more compared to exports from India, which were from US$34,600 in 1995 to US$444 Mn in 2018 (OEC, 2018). India’s major imports were crude petroleum and oils, and alcohol. The same for Singapore and Malaysia can be seen in Figures 7 and 8. The trade has shown a positive narrative with Singapore and Malaysia, but imports are more than India’s exports.

The Indo ASEAN FTA is being revisited. After months of interactions, ASEAN members have agreed to review the trade pact amid concerns that China uses the treaty to ship goods to India. The trade deficit with ASEAN countries has widened to a large extent. Moreover, India’s trade with ASEAN in 2012–2013 was US$75.87 Bn, with a trade balance of US$9.86 Bn USD, which rose to –21.85 Bn USD with a total trade of 96.79 Bn USD in 2018–2019 (Figure 11). This is a 12% increase in trade deficit with ASEAN countries in five years (Saraswat et al., 2019).

Figure 11.

Source: OEC (2018).

The trade agreement with Sri Lanka was signed in 2001. This was the first trade agreement signed by India post-1991 trade liberalisation. India and Sri Lanka’s relationship is more than 2500 years old and built upon a shared legacy of cultural, intellectual, religious, and linguistic association. India’s exports to Sri Lanka rose from US$397 Mn in 1995 to US$4.25 Bn in 2018. Similarly, India’s imports increased from US$30.7 Mn in 1995 to US$865 Mn in 2018 (OEC, 2018). The trade surplus (Figure 12) is due to various reasons, which include India’s support to Sri Lanka in financial, defense, and economic areas. While Sri Lanka is not a very significant trading partner with India and India has traditionally been one of the most important sources of imports for Sri Lanka.

Figure 12.

Source: OEC (2018).

The trade agreement with Nepal, known as the Treaty of Trade, was signed in 2002. India Nepal relations are more than treaties and agreements as they are more comprehensive and multidimensional. India’s exports have increased from US$159 Mn in 1995 to US$7.26 Bn in 2018 (Figure 13). Similarly, India’s imports have marginally increased from US$45.7 Mn in 1995 to US$394 Mn in 2018 (OEC, 2018). India is Nepal’s largest trade partner and a source of foreign investment. However, India Nepal relations are entering a deep freeze due to China’s deep political and economic engagements with Nepal.

Figure 13.

Source: OEC (2018).

The trade agreement between India and Bhutan was signed in 2006. Diplomatic relations between India and Bhutan were established in 1968. India’s exports to Bhutan have increased from 9.7 Mn in 1995 to US$651 Mn in 2018 (Figure 14). Similarly, India’s imports from Bhutan risen from US$32.2 Mn in 1995 to US$217 Mn in 2018 (OEC, 2018). India is a strategic partner to Bhutan in various economic, social, and financial aid sources to Bhutan in crisis times.

Figure 14.

Source: OEC (2018).

The CAGR of exports with many countries increased (Appendix B, Figure 15), and the CAGR of imports with many countries reduced after FTAs (Figure 16). CAGR in imports and exports for these countries between 1995–2018 is provided in Figure 17. These tables show that FTAs have benefited most countries by increasing their trade with the signing countries. The changes in the rate of imports and exports of non-FTA countries between 1995–2018 are shown in Table 1. Non-FTA countries are taken as a control group. The behavior of imports and exports for FTA and non-FTA countries is different. The imports of non-FTA countries have risen. In contrast, the exports of FTA countries have risen. There are some exceptions too. For example, imports in some countries such as Japan, Korea, and Singapore are rising compared to exports after FTA. The probable reason for this increase might be the imports of capital goods in such countries, which helps increase the productive capacity.

Figure 15.

Source: Authors’ representation based on data from OEC (2018).

Figure 16.

Source: Authors’ representation based on data from OEC (2018).

Figure 17.

Source: Authors’ representation based on data from OEC (2018).

Table 1.

Imports and Exports Growth Rates of Non-FTA Countries Between 1995–2018.

Country	Exports	Imports
Australia	10.062	12.195
Canada	9.327	9.920
Colombia	15.763	17.893
Ecuador	17.389	20.355
Egypt	11.776	14.314
Israel	10.669	9.739
Turkey	14.320	15.907
Peru	13.860	29.710
Venezuela	6.318	30.485
New Zealand	8.028	7.347

Source: OEC (2018).

The discussion above shows that FTAs are beneficial depending upon member countries’ economic integration in trade. FTAs attract foreign direct investment and give access to foreign markets. Moreover, it also transforms and enables technological capability and a surge in the economic growth of the member states (Urata, 2014). However, some studies suggest that RTAs do not affect the growth of a country and that its benefits are unclear (Jalles, 2012; Reyes et al., 2014).

IV. Conclusion

This article investigates the effects of FTAs on the trade of member states and their growth potential. The elimination of trade barriers expects the partner countries’ trade to increase. Further, FTAs are a crucial tool to enhance India’s trade and investment in the South Asian region and play a leading role in peace and stability. The article has highlighted the changes in exports and imports between India and the RTA partner countries from 2000 through 2018. The study used ten countries as a control group and compared the growth rates of the non-FTA countries with FTA countries. Based on the CAGR of exports and imports from the FTA members, policymakers can see that the exports are increasing, but imports did not increase much when seen with the FTA members except in some cases. However, if we see the control group, it can be said that the imports are increasing much more rapidly with these countries.

Free trade has been a widely debated topic. There seems to be a consensus among leading economists that it increases economic welfare, productivity, and employment (IGM Forum, 2012). Adam Smith and David Ricardo were pioneers of free trade, and David Ricardo, expanding the work of Adam Smith, introduced the theory of comparative advantage. This theory is the main argument for the benefits of free trade and showed that free trade leads to higher economic welfare due to a country’s comparative advantage. As an example, Canada–U.S. FTA resulted in higher productivity in the United States (Trefler, 1993).

Hudgins (1995) argues that while it may be preferable to liberalise trade multilaterally, countries should take any available avenue, including bilateral or regional FTAs, even if that leads to some TD. Further, Lawrence (1996) argues that FTAs involve much more economic integration than eliminating tariffs. Bergsten (1997) supports similar views on free trade to promote global trade liberalisation. Bergsten argues for an FTA based on ‘open regionalism’, establishing the road map for free trade investment in the Asian-Pacific region for 2010/2020 among the members. Empirical evidence supports that the increase in trade positively affects welfare (Augier & Gasiorek, 2010; Bond et al., 2004; Hertel et al., 2007).

Countries prefer to sign PTAs to remain in the global market. The concern for countries signing the pacts is selecting the type of agreement, such as bilateral or multilateral. Baier and Bergstrand (2004) have recommended factors, such as the size of a country and factor endowments, that might facilitate the decisions on FTAs. Factor endowment is defined as the amount of land, labor, and capital a country possesses for its manufacturing sector. Factor endowments impact a country’s comparative advantage by affecting the opportunity cost of specialising in producing certain goods relative to others. It also leads to comparative advantages to countries participating in FTAs. The comparative advantages (Flux et al., 1934; Jones, 1993; Young, 1991) is based on the model that includes two countries, two products, and two production factors. It has been observed that countries having different capital–labor ratios tend to form FTAs (Baier & Bergstrand, 2004).

The above analysis and discussion suggest that free trade is beneficial for the country’s economic development. However, India’s export is negatively affected by weak institutions that support restrictive trade policies. India should carefully review existing FTAs in the current economic scenario before negotiating new ones. The focus should be on those products and services, which has the export potential and earnings instead of eliminating tariffs that want to boost exports.

This article has some limitations and scope for extensions too. The analysis is limited up to 2018, and the breakup of merchandise trade could not be explored due to a lack of data availability. The study can be expanded further on sectoral data for a further exploratory study on FTA. This research work can further be taken forward on the benefits of free trade to developing countries and their economic welfare gains.

Appendix A

FTAs (within and outside the region) and their stages for the member countries of the Asian Development Bank (ADB).

Country	FTA in Effect (a)	FTA Signed not in Effect (b)	FTA in Negotiations (c)	FTA Proposed (d)	FTA Discontinued/Concluded (e)	Total FTAs (a + b + c + d + e)
Afghanistan	2	-	-	1	-	3
Armenia	12	3	3	7	-	25
Australia	13	4	5	6	2	30
Azerbaijan	9	-	1	-	-	10
Bangladesh	3	1	3	6	-	13
Bhutan	2	-	1	1	-	4
Brunei Darussalam	10	-	1	9	1	21
Cambodia	7	-	2	7	-	16
China	18	4	10	15	-	47
Cook Islands	3	1	-	-	-	4
Fiji	4	1	-	1	-	6
Georgia	13	1	-	4	-	18
Hong Kong	7	1	1	1	-	10
India	13	1	16	13	-	43
Indonesia	10	4	8	17	-	39
Japan	18	-	8	6	1	33
Kazakhstan	12	3	5	9	-	29
Kiribati	3	1	-	-	-	4
Korea	17	1	14	10	-	42
Kyrgyz	12	3	3	8	-	26
Lao PDR	9	-	1	6	-	16
Malaysia	16	2	6	9	1	34
Maldives	1	2	1	-	-	4
Marshall Islands	4	1	-	-	-	5
Micronesia	4	1	-	-	-	5
Mongolia	2	-	-	3	-	5
Myanmar	7	1	2	6	-	16
Naura	3	1	-	-	-	4
Nepal	2	-	1	2	-	5
New Zealand	12	1	6	6	1	26
Pakistan	10	1	7	14	-	32
Palau	3	1	-	-	-	4
Papua New Guinea	5	1	-	2	-	8
Philippines	9	-	3	15	-	27
Samoa	3	1	-	-	-	4
Singapore	24	2	7	7	3	43
Solomon Islands	4	1	-	-	-	5
Sri Lanka	6	-	3	6	-	15
Taipei	8	-	1	5	-	14
Tajikistan	8	-	-	2	-	10
Thailand	14	1	9	15	-	39
Timor-Leste	-	-	-	-	-	-
Tonga	3	1	-	-	-	4
Turkmenistan	5	-	-	-	-	5
Tuvalu	3	1	-	-	-	4
Uzbekistan	9	-	-	2	-	11
Vanuatu	4	1	-	-	-	5
Vietnam	12	1	3	9	1	26

Source: Asia Regional Integration Centre (2019)

Appendix B

CAGR in Exports Before and After Signing the Agreement

Country	Growth Rates (%)		Effect
Country	Before FTA	After FTA	Effect
Afghanistan	12.250	12.780	Increased
Chile	12.690	11.404	Decreased
Nepal	2.344	21.580	Increased
Bhutan	34.414	8.332	Decreased
Singapore	11.726	5.536	Decreased
Malaysia	12.075	7.644	Decreased
Thailand	8.163	7.048	Decreased
Indonesia	3.564	10.233	Increased
Vietnam	12.506	19.524	Increased
Brunei	14.831	8.732	Decreased
Philippines	10.717	10.633	Decreased
Cambodia	9.453	23.132	Increased
Sri Lanka	8.228	11.100	Increased
Japan	4.060	–3.174	Decreased
Korea	10.855	–0.103	Decreased
Argentina	15.850	7.968	Decreased
Brazil	25.728	4.778	Decreased
Paraguay	13.134	14.145	Increased
Uruguay	11.628	13.161	Increased

CAGR in Imports Before and After Signing the Agreement

Country	Growth Rates (%)		Effect
Country	Before FTA	After FTA	Effect
Afghanistan	9.9213	19.2973	Increased
Chile	27.0250	–4.2975	Decreased
Nepal	33.6995	2.4521	Decreased
Bhutan	20.1248	–2.9203	Decreased
Singapore	13.4320	–17.5859	Decreased
Malaysia	12.1837	4.7885	Decreased
Thailand	17.7958	6.6843	Decreased
Indonesia	21.2643	–18.9808	Decreased
Vietnam	25.9301	23.0796	Decreased
Brunei	88.0232	10.0194	Decreased
Philippines	20.9431	6.0953	Decreased
Cambodia	19.1071	19.9982	Increased
Sri Lanka	9.9369	13.9842	Increased
Japan	8.2096	0.5622	Decreased
Korea	14.7400	4.5719	Decreased
Argentina	11.9255	9.2305	Decreased
Brazil	8.9592	1.2797	Decreased
Paraguay	36.7009	16.8834	Decreased
Uruguay	6.1552	5.7925	Decreased

Overall CAGR of Exports and Imports

Country	Exports	Imports
Afghanistan	16.652	18.196
Chile	13.127	11.732
Nepal	17.259	9.391
Bhutan	19.156	8.274
Singapore	9.730	0.981
Malaysia	10.988	10.273
Thailand	8.529	15.301
Indonesia	21.264	–18.981
Vietnam	18.085	29.077
Brunei	10.202	48.313
Philippines	11.206	16.227
Cambodia	24.211	9.193
Sri Lanka	10.382	14.924
Japan	2.376	6.782
Korea	7.848	12.063
Argentina	10.907	9.664
Brazil	14.249	10.488
Paraguay	12.563	29.768
Uruguay	10.630	7.217

Footnotes

Declaration of Conflicting Interests

The authors declared no potential conflicts of interest with respect to the research, authorship and/or publication of this article.

Funding

The authors received no financial support for the research, authorship and/or publication of this article.

ORCID iDs

Amulya Gurtu

Jestin Johny

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