Regional Economic Integration in South Asia

Trapped in Conflict?

Amita Batra

• Publisher: Routledge
• Year: 2012
• eBook ISBN: 9781135129835
• Edition: 1
• Topic: Politics & International Relations
• Subtopic: Politics
• Index: Politics & International Relations

South Asia today is among the most unstable regions in the world, riddled by both intra- and inter-state conflict. This book presents a comprehensive technical analysis of the trade–conflict relationship within the region, and explores how South Asia demonstrates underperformance of its potential for economic integration.

Using the gravity model framework, the book highlights quantitative estimates of the cost of conflict in terms of loss of trade for South Asia. Other variables representative of political and economic regimes are also included to make the model comprehensive, and the book goes on to discuss how the analysis reveals the overriding significance of the India–Pakistan relationship in the regional landscape. It looks at how the results of the econometric exercise reveal the extent to which a common border, when disputed, becomes a barrier rather than a facilitator to trade and, additionally, the extent to which long standing and persistent conflict can debilitate trade relationships.

The book is a useful contribution for students and scholars of South Asian studies and international political economy, and assists in formulating policy to correct the anti-home bias that is evident in trade patterns of the South Asian economies.

1 Introduction

South Asia, comprising¹ Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka, has over the last decade been the subject of many discussions and debates, primarily for two reasons. One, owing to the region having been described by many as one of the most unstable in the world, and two, on account of the unexpected and unprecedented economic dynamism of its largest economy, India. The first revolves around the phenomenon of conflict that has been long-standing and varyingly intense through the history of the region and attracted renewed attention in the wake of global repercussions of terrorist attacks in the US in September of 2001. The second is an outcome of systemic economic reforms undertaken in India since 1991 that have altered its growth trajectory such that there is a shift in the centre of gravity of the global economy to Asia. A third more interesting but not as much analyzed characterization of South Asia is through the inter-linkages between conflict and economic exchange. As a unique exception to a well-proven ‘natural trading partner’ hypothesis,² the South Asian region demonstrates how historically and geographically proximate countries, when caught in persistent conflict, lead to underperformance of a region in terms of its potential for economic exchange. This intriguing inter-linkage between conflict and economic exchange in South Asia is the subject of this book. Specifically, this book is an attempt to quantify the extent to which conflict has prevented the region from exploiting its trade potential.

The subject assumes meaning and temporal significance as India that has been at the centre of exceptional global focus in the last decade owing to its economic dynamism is also central to the South Asian economy and trade. With over 80 per cent contribution to the region’s GDP, over 60 per cent share in regional trade and 75 per cent of the regional population, India’s economic centrality in South Asia is undeniable and is further reinforced by the geography and history of the region. India is the only country in South Asia that has a common border, land or maritime with all other countries of the region. Pakistan and Bangladesh have been a part of the erstwhile Indian subcontinent. While Pakistan is an outcome of British India’s partition consequent upon its independence from colonial rule in 1947, Bangladesh was created out of Pakistan as a consequence of the 1971 war of independence. Given India’s centrality and economic dynamism, the reasonably good growth of other countries of the region over the last decade and their geographical and historical proximity, intra-regional trade that has been stagnant at only about 5 per cent of the South Asian countries’ total trade appears as a contradiction, and even more so when it is noted that the rate of global trade integration of the South Asian region has been the fastest among all the regions in the world in 2005 and 2007.³ This development assumes further significance when it is noted that South Asia accomplished establishment of the institutional process for regional cooperation over a quarter of a century ago in 1985 with the setting up of the South Asian Association for Regional Cooperation (SAARC). These apparent contradictions in South Asia make it imperative to explore and identify the costs and barriers that inhibit trade and economic exchange within the region. The analysis in this book is therefore focussed upon the cost that, among other barriers, conflict may have inflicted on the region in terms of loss of trade. The paragraphs that follow establish the context for this analysis.

Regional cooperation in South Asia: SAARC, SAPTA and SAFTA

The process of regional cooperation in South Asia began with the establishment of the institutional mechanism, the South Asian Association of Regional Cooperation (SAARC), in 1985. The SAARC secretariat, headed by a Secretary General and comprising one Director from each member country, was set up in 1986 in Kathmandu, Nepal. The institutional mechanism of the SAARC operates through the annual summit meetings of the heads of government and states, the highest decision-making body, assisted by a council of ministers. Economic cooperation and integration became a part of the SAARC work agenda seven years later when the council of ministers of the member countries signed an agreement to form the South Asian Preferential Trade Agreement (SAPTA) in April 1993. The agreement was prompted by a desire of the South Asian economies to dismantle trade barriers following the move towards unilateral liberalization and global trade integration initiated first, in a systemic manner, in India in 1991⁴ and later undertaken by the other economies of the region. The process of regional economic integration was simultaneously necessitated by the impending risk of isolation for South Asia as the rest of the world was increasingly formulating and entering into regional preferential trading arrangements.

The SAPTA that was aimed at trade liberalization and dismantling of trade barriers with no explicit objective of achieving a free trade area in the region became operational in December 1995. Four rounds of negotiations towards preferential tariff reductions were initiated, of which three were implemented and one was suspended. The three rounds, undertaken in 1995, 1996 and 1998, involved laborious and time-consuming negotiations having been restricted to product by product⁵ and sectoral approaches. The negotiations resulted in more than 4,700 tariff lines being placed under preferential access. However, this had no impact on intra-regional trade that continued to remain stagnant at 5 per cent of South Asia’s global trade. The inefficient and ineffective outcome of SAPTA’s implementation was seen to be a consequence of the tariff preferences being largely irrelevant to trading interest of the partner economies in the region, inadequate tariff cuts, restrictive rules of origin and the erection of many hidden and obvious non-tariff barriers. Long-standing animosities and consequent distrust, lack of confidence vis-à-vis each other and the fear of major benefits accruing to the largest economy prevented member countries from giving real concessions that would have been meaningful in enhancing intra-regional trade. Work on the fourth round was initiated in 1999 but was put on hold after the military takeover in Pakistan in October of the same year and the nuclear tests by India and Pakistan. Both these events led to heightened political tensions between India and Pakistan. This was followed by a slowdown in the process of economic integration in South Asia for the next few years.

As the India–Pakistan situation normalized in 2003 the heads of the SAARC member nations agreed to launch the South Asia Free Trade Area (SAFTA) at the 2004 annual Summit that was held in Islamabad. The Agreement on SAFTA entered into force on January 1, 2006. As initially designed, SAFTA was restricted to trade in goods only and aimed at creating a free trade area in South Asia in a period of ten years through gradual tariff liberalization, removal of non-tariff barriers (NTBs) and introduction, strengthening and modernizing of trade-facilitating national infrastructure. The SAFTA Agreement provided for negative list specification and its periodic revision alongside a mechanism for dispute settlement. While aiming at the creation of a free trade area the Agreement suffered from many design-specific flaws, as well as problems of implementation. Exclusion of the more dynamic services sector from the liberalization schedule, large negative lists with no target specification for their elimination as well as the long periods required for dispute settlement among others stood out as major obstacles in the way of SAFTA becoming a beneficial instrument furthering the objective of trade integration in the region.⁶ A bigger factor, though, that has contributed to undermining the SAFTA as an instrument of trade liberalization in the region was the defiance by Pakistan as it continued to specify a positive list for trade concessions vis-à-vis India, even though it is a signatory to the Agreement incorporating the provision of specification of a negative list by all members vis-à-vis their regional trade partners. Pakistan’s stance is a reflection of its political hostility towards India and the strength of pressure groups that would not want trade enhancement with India, even if it is, economically, a more efficient choice. Conflict between India and Pakistan has stalled successful implementation of the regional agreement SAFTA.⁷ Intraregional trade has been observed to increase only marginally since the implementation of SAFTA in 2006, even though the period has been coincidental with economic growth in the region, unilateral trade liberalization and increased trade orientation of the South Asian economies.

While the initial slow progress of the South Asian regional economic integration agenda could be accounted for by the autarkic policies followed by all the regional member countries, it is difficult to stretch the argument for the period of the 1990s and after. In fact during the period of implementation of SAFTA the economic scenario in the region registered a dramatic improvement. India’s 7 per cent plus average annual rate of growth over the decade 1998–2008 was the highest, while during the same period the average annual growth of GDP for all the other South Asian economies was over 5 per cent.⁸ Simultaneously the region displayed rapid integration with the global economy with South Asia experiencing one of the fastest growth rates of trade in the world, averaging 10.8 per cent in 2007 following a growth of almost 12 per cent experienced during 2005–06, which was the highest among all regions.⁹ Notwithstanding these very positive trends, regional economic integration in South Asia has been anaemic. Intra-regional trade in South Asia is about 5 per cent of its total trade and about 5 per cent of regional GDP. India’s trade with its regional neighbours is less than 3 per cent of its total trade and in contradiction with the global experience.¹⁰ As India–Pakistan hostilities appear to have repeatedly got in the way of economic rationality, gains of economic integration seem to have been foregone by South Asia.¹¹

The SAFTA has also been undermined by the successful implementation of bilateral preferential trade agreements in the region. India has bilateral trade agreements with three countries — Sri Lanka, Nepal and Bhutan — in the region and is negotiating a fourth with Bangladesh. Pakistan has a free trade agreement with Sri Lanka. The India–Sri Lanka trade relationship and bilateral FTA (BFTA) is an example of how economic rationality can assist the peace process and vice versa between two nations. The India–Sri Lanka BFTA that was implemented in 2001 helped ameliorate the tensions between the two nations that had arisen due to the perceived intervention by India in what was a domestic civil conflict in the smaller island nation. Having benefitted economically and politically, both India and Sri Lanka are keen to upgrade the bilateral trade agreement to its next stage of a comprehensive economic partnership agreement. The other long-standing bilateral trade treaties between India–Nepal and India–Bhutan, although not in the spirit of WTO defined FTA agreements, greatly facilitate trade between India and the less-developed countries of the region.¹² Trade between India and Nepal is conducted on the basis of the structure as provided by the1991 Trade Treaty. The treaty has been modified several times and most recently in October 2009. The India–Bhutan Trade and Commerce Agreement that expired in 2005 has since been renewed for a period of ten years. The provisions of these agreements are such that a de facto free trade regime exists between India and Bhutan. Negotiations are also underway for a bilateral agreement between India and Bangladesh. The India–Sri Lanka bilateral FTA was followed by a bilateral FTA between Sri Lanka and Pakistan in 2005. The major economies of South Asia have therefore either already entered into or are negotiating bilateral FTAs among themselves. The bilateral FTAs underway in the region are working effectively in contrast with the regional FTA that is constantly encumbered by bilateral hostilities and conflicts. Given these developments it may not be easy to visualize the successful implementation of the regional FTA. Given that bilateral conflicts have consistently prevented onward movement of regional economic integration in South Asia despite the physical, historical and cultural proximity and economic prosperity of its member nations, a brief review of the nature and role of conflict in South Asia and its regional economic integration agenda helps to better understand the issues under discussion.

Nature of conflict in South Asia: implications for regional economic integration

Conflict in South Asia has been longstanding and multidimensional. Border, boundary and territorial disputes between India and Pakistan, India and Bangladesh, India and Nepal, and Pakistan and Afghanistan have dominated and persisted over the years. There have also been resource disputes and many water and river sharing arrangements have been at the centre of conflict between India, Pakistan, Bangladesh and Nepal. The region has also been characterized by ethnic domestic strife with adverse external spillover effects on inter-state relations, as evident in the cases of Sri Lanka and India, India and Pakistan, India and Bangladesh, and Pakistan and Afghanistan. Terrorist threats and nuclear and missile rivalry have only added to the regional tensions. India appears to be a part of almost all facets of this phenomenon owing to its common border with all countries of the region and the natural resources that cut across India, Pakistan and Bangladesh, irrespective of the boundaries drawn at the time of partition of the sub-continent in 1947 and subsequent independence of Bangladesh in 1971. India’s large geographical and economic size coupled with its diversified production base has in addition meant that it enjoys a surplus in its trade with the other smaller economies in South Asia, much to their resentment. The inherent asymmetry has given rise to a fear psychosis among the smaller states of the region such that they have been less than forthcoming in their efforts to strengthen SAARC, anticipating and fearing larger gains for India. The asymmetry and attached fears have also simultaneously prevented India from assuming the role of a lead economy in the region. Overall a sense of commitment to common economic goals has eluded South Asia. This is in contrast with the experience of other regional organizations that have been largely driven by a common commitment to the idea of peace through economic interdependence (EU) or development through cooperation (ASEAN).

In South Asia, even though conflict is common to all the nations, it does not define the region in the sense of giving it a common purpose internally or externally. In fact, it underlies the difficulty in visualizing the region as one with a common interest – or, for that matter, a common perception – of external threat-conditions that invariably define other regional blocs and are at the core of regional leaders’ desire and efforts towards regional cooperation and the general populace’s acceptance of the loss of sovereignty that is inevitable in collaborative action. Differences are in fact more apparent and dominant in the South Asian countries’ external relations than commonalities. Internal conflicts have led South Asian countries to follow and reflect different international alliances, preferences and voting patterns at international forums.¹³ These regional differences have been further compounded by frequent changes in political regimes in member nations. In South Asia democracy has not been the norm. Only India and Sri Lanka have experienced democracy on a sustained basis. Pakistan and to some extent Bangladesh have had autarkic and military regimes with brief interludes of democracy, while Nepal and Bhutan have long histories of monarchy, with some episodes of attempted democracy in Nepal and a recent, nascent transition to democracy in Bhutan. As has been generally observed the world over that mixed political regimes such as autocracies and military regimes, unlike democracy, do not necessarily augur well for enhanced trade or peace,¹⁴ so has been true of South Asia.

The South Asian experience is unique in terms of its inability to realize or effectuate the necessary placement of cooperation above conflict, even if it has been to the detriment of the region in terms of loss of peace, stability and economic benefits. Similar and probably more difficult regional situations in other parts of the world have been resolved and settled peacefully by giving primacy to economic gains over political interests. While the EU integration process may be considered sui generis and not easily replicable, there are other regions that have been able to overcome violent historical pasts. ASEAN, for example, is considered to have facilitated a transformation of the South East Asian region into a stable and peaceful zone through consultation and cooperation. The organization at its inception had the dominant countries in a state of dispute and suspicion, but a common need to come together following the communist threat in the region helped them overcome their differences.¹⁵ Economic prosperity through cooperation was considered essential as a means of national and regional resilience to the spread of communism. Disputes were shelved, differences relegated to the background and agreements were arrived at for avoiding use of force to resolve bilateral discords.¹⁶ Economic initiatives, like the ASEAN free trade agreement (AFTA) that was introduced in 1992, complemented by the ASEAN framework agreement on services liberalization (AFAS) signed in 1995 and the agreement for creation of an ASEAN investment area (AIA) in 1998, indicate ASEAN’s commitment towards deeper economic integration. Record growth rates were experienced by these countries in the subsequent years as regional cooperation created a conducive and relatively secure environment. Diplomatic cohesion has since characterized the regional organization and was most evident when the member countries adopted a common stand on the Cambodian conflict. When the organization has been subjected to trials like the 1997–98 financial crisis, the effort has been to combat adversity by evolving regional mechanisms jointly by all member economies. The Chiang Mai Initiative (CMI) was established in 2000 as a bilateral swap arrangement in response to the currency and liquidity crisis experienced by the South East Asian economies in 1997–98. The CMI regional financial arrangement was made more substantive through its evolution into CMI multi-lateralization in March 2010 in the wake of the 2008–09 global financial crisis. The ASEAN charter released in 2007 for the establishment of the ASEAN Economic Community is the most recent evidence of the organization’s evolving regional aspirations. The attempt by the regional economies to push forward the agenda of maintaining peace and economic prosperity as primary objectives of regional cooperation has helped facilitate region-wide production networks based on progressive evolution of comparative advantage of ASEAN economies, which has in turn led to increased intra-regional trade. During the two decades from 1986–87 to 2006–07, the share of intra-regional trade in total non-oil East Asia trade increased from 34.4 per cent to 54.1 per cent.¹⁷

The South East Asian example helps spotlight the contribution of regional peace and cooperation to successful economic integration. While the export-oriented economic growth models of ASEAN economies have been facilitating in establishing the production networks, it cannot be denied that economic cooperation has been allowed to happen despite ideological differences. Additionally, conflict prevention has been built into the ASEAN way of working, as decision making is based upon principles of consensus building and voluntarism. In contrast, the SAARC has deliberately and consciously kept bilateral issues out of the purview of discussion at the forum, revealing therein a prior lack of confidence in the cooperative mechanism. Conflict has in fact been allowed to obstruct the process of regional cooperation. Many SAARC summit meetings have been called off or postponed on account of bilateral conflicts. In 25 years of its existence, SAARC has had only 16 summit meetings. The SAARC summits in 1992 and 2005 were disrupted due to poor relations between India and Bangladesh, and the 1989 Colombo summit was cancelled because of Colombo’s objections to the presence of Indian troops in Sri Lanka.¹⁸

Successful regional organizations, if not driven by a common agenda, have invariably been led by powerful motivation of either one or a pair of lead economies such that the joint determination ...

Table of contents

• Cover
• Title
• Copyright
• Dedication
• Contents
• List of figures
• List of tables
• 1 Introduction
• 2 South Asia: the region
• 3 Trade and FDI patterns of South Asian countries
• 4 Preferential trading agreements in South Asia
• 5 Conflict in South Asia
• 6 Theoretical foundations of the economic integration and conflict relationship in South Asia
• 7 Impact of conflict on intra-regional trade in South Asia: A gravity model analysis
• 8 Summary findings and an assessment of the way forward
• Appendix
• Notes
• Bibliography
• Index