The Forgotten Economics of SAFTA

The current deliberations on SAFTA are striking in the silent manner in which they are being pushed through. Understanding its economics and the resultant cost and dislocations is critical to ensuring that this won’t be just another costly blunder.


With the recently concluded meeting of the SAARC Leaders in Dhaka, the debate on the South Asian Free Trade Agreement (SAFTA) has once again come into the forefront of the foreign policy discussion in the region. If this were to come true, the resultant South Asian Free Trading Area (SAFTA) would create the world’s biggest free trade area comprising 1.4 billion people, including 60 per cent of the world’s poor. The Council of Foreign Ministers of SAARC states, however, plan to go beyond SAFTA and aim to push regional integration forward to include "trade in services, enhanced investment and harmonizing of customs union and, beyond that, a South Asian Economic Union." (SAEU)

While much of this, one would assume, is likely to be merely hype and symbolics, the discussion and its portrayal in the media, however, is striking in its lack of participation of the trade experts and theorists of the region. Like war, politics and economics too are too important to be left to politicians alone. Free trading areas, and especially economic unions, whenever they come about, require tremendous commitment and impose disproportionate costs on various segments of the populations of the countries involved, that must be taken into account and catered for before moving forward, or at the very least, must be made known to those who are most likely to bear these. This article is an attempt to critically evaluate the possible effects of SAFTA in the light of the economic theory and practice of trading blocks. In a future article, I would address the broader issues and challenges in putting together an economic union of SAARC countries.

In attempting to theorize the potential benefits of SAFTA, it is important to look at the benefits realized from other similar arrangements, like EFTA, ASEAN, MERCUSOR, GCC, and NAFTA etc. The theory of international trade has come a long way from its simplistic view of Ricardian comparative advantage that advocated the welfare enhancing effects of free trade "no matter what". Paul Krugman, an influential MIT economist, having pioneered the field of strategic trade theory, acknowledges the inevitable ground reality "that everybody could gain, however, doesn’t mean that every actually does".

Several trade economists have highlighted the conditionalities that must precede the realization of substantial benefits from various kinds of free trading and economic integration agreements. Maskell, Lipsey, and Viner talk about these in the context of a customs union, for example. According to them, some of the economic characteristics of countries that are ideal to create welfare-enhancing customs unions are: complementary yet competitive economic and industrial structures; greater proportion of trade among members relative to total trade; closely coordinated exchange rates; larger economic area; less complementarity vis-à-vis protected industries; greater differences in cost structures of production of similar products among members; and greater range of products etc. The evidence from ASEAN, Mercusor, and GCC--being trading blocks between similar countries--provide confirming evidence for the sub-optimal nature of these arrangements.

Mikesell, while specifically looking at the prospects of trading arrangements between developing countries, stresses that many of the characteristics of the developing countries contemplating such arrangements, namely, intra-regional trade comprising mostly commodities (either due to complementary natural endowments or agricultural escape clauses), non-existence of trade in manufactures or industrial goods, generally import substitution orientation, disparate levels of development, and lack of proper redistribution policies make them unfavorable candidates for such arrangements, especially if undertaken amongst themselves. Maskell, however, allows for the possibilty that developing countries might, in the long-run, gain some dynamic benefits from free trade areas by encouraging greater specialization, altering consumption and investment patterns, and re-organization of domestic markets.

The relatively thin record of achievements of the three economic integration arrangements most relevant to our experience (i.e. ASEAN, Mercusor, GCC) calls into question the economic logic behind SAFTA itself. The inherent logic behind the proposed, very ambitious, deepening of economic integration in South Asia seems to be that since the lesser ambitious schemes of regional integration ( e.g. SAARC itself) don’t seem to have resulted in increase in trade between these countries, forging ahead with more ambitious ventures (such as SAFTA, SAEU etc.) might actually push things beyond a point of no-return and literally force these countries to enhance trade with each other.

This logic clearly does not internalize the idea that despite the ambitious designs of SAFTA proponents, the reality of the quite similar and even competing economic structures of these seven South Asian countries remains the same, and is not likely to change in the near future and/or without considerable expense and suffering for selected segments of population in these societies. Even if those theorized benefits were to be realized, none of these countries seem to have either a plan in place ( e.g. a social safety net for those who will lose jobs by hundreds and thousands) or even the will to share the disproportionate burden of costs that would have to be incurred if SAFTA is to ever be successful in doing what it plans to do.

If the SAARC member countries are to justify the immediate benefits that accrue to some sectors at the expense of others, it is logical that they also devise adequate mechanisms to share the costs and alleviate the suffering of those who are on the wrong side of the trade equation. Mechanisms to do this have been in place in the European Union where the more fortunate members transfer a part of their benefits to the less fortunate ones and in NAFTA where the US government has a plan to compensate and retrain displaced workers to take up other jobs. The best SAARC countries have been able to do to plan for that transition so far is to come up with long "negative lists" of items that cannot be freely traded within the proposed SAFTA which, if one thinks about it, actually kills their entire purpose anyway. At the very least, we require setting up of a revolving fund to share the cost of this transition. This fund must be funded by member country contributions in proportion to the benefits they would derive from SAFTA and would disburse these funds to specific populations to defray the cost of largest economic dislocations.

It is also important, for realizing the potential long-term dynamic benefits of SAFTA, that proper consensus building must happen before the SAARC countries embark on this venture. Unless the true costs and benefits of SAFTA are analyzed and presented, in a transparent and convincing manner, to the people of the SAARC countries, appropriate institutional and organizational arrangements are put in place to deal with short-term costs and realize the promised long-term benefits of the proposed arrangement, the expectations of various state and non-state actors are managed appropriately, and steps are taken to address the sensitivities of various countries and minimize political resistance to the plan, SAFTA would remain an unrealized dream, at best, and a costly blunder, at worst. There is a lot that we can learn from the experiences of other such arrangements as we embark upon this venture of our own.