Can Greater Regional Economic Cooperation Unite ‘Two South Asias’?

January 5, 2011

By Katherine Loh, Nina Merchant-Vega

South Asia has seen remarkable economic growth since the 1980s, when the region began to adopt pro-growth policies such as foreign investment liberalization, privatization, and the dismantling of onerous business regulations. Since the mid-1980s, South Asia experienced an average annual growth rate of 5.6 percent in its per capita Gross National Income (GNI). As a result, private investment boomed, and progress was made across many human development indicators.

In 2010, India's economy grew at 8.2 percent, yet the rapidly growing nation struggles with high inflation and more than 400 million people living in extreme poverty. Above, visitors pass by a clothing ad in Mumbai's high-end High Street Phoenix mall. Photo by Geoffrey Hiller.

Despite these achievements, poverty still persists across the region: while India’s GNI grew from $186 billion in 1980 to $1.37 trillion in 2009, its poverty rate remains above 41 percent, with more than 400 million people living in extreme poverty. This is down from 56 percent in 1983, but the fact remains that poverty levels are unacceptably high. Similarly, Nepal saw a decline in its poverty rate, but as of 2005, more than half the population still exists on less than $1.25 a day. Bangladesh’s GNI grew from $18 billion in 1980 to $95 billion in 2009. But unlike India, which saw its poverty rate decline over this period, Bangladesh’s poverty rate has actually risen from 43 percent in 1986 to 50 percent in 2005. Indeed, there exists a phenomenon of “two South Asias,” in which leading regions (both within and across countries) are experiencing rapid GDP growth, urbanization, and integration with the global economy, while lagging regions remain overwhelmingly rural and poorly integrated with the national, regional, and global markets.

Over the past several decades, there has been growing recognition among experts that regional economic cooperation, through trade liberalization and integration, can help reduce poverty and spur even faster growth in South Asia. International trade, combined with effective domestic poverty reduction strategies, can generate accelerated growth, as well as socially equitable growth. The Association of Southeast Asian Nations (ASEAN) has experienced exactly that kind of progress. Though the two regions are not directly comparable (South Asia has three landlocked nations compared to ASEAN’s one, for example), ASEAN’s comparative economic success, partly attributable to its high level of regional integration, is a model from which the South Asian countries can gain valuable insight.

Currently, South Asia’s intraregional trade has stalled at around 2 percent of its total trade volume since 1980, and represents only a third of the region’s GDP. This is significantly less than what one would expect, given the region’s set of geographic circumstances, GDP, population, and existing trade arrangements. By contrast, East Asia’s intraregional trade constitutes approximately 15 percent of its total trade volume and represents almost three quarters of its GDP.

Beyond raising growth potential, intraregional trade could act as a stabilizing factor for some South Asian economies and help buffer them from external shocks like the 2008 global financial crisis. While South Asia’s largest economy, India, has a large domestic market not reliant on export-driven growth (trade in IT and back-office services not withstanding), this is not the case for the rest of region. For example, in Bangladesh, textiles and clothing continue to make the largest contribution to growth in exports. However, stunted economic growth in Western export markets, forecasted to continue in the immediate future, presents major challenges to this growing, but vulnerable sector. With increased intraregional trade, the economy is less reliant on the conditions of its trading partners in the rest of the world and hence can be to some extent insulated from fluctuations in those conditions.

The South Asian Association for Regional Cooperation (SAARC) made up of Bangladesh, India, Pakistan, Nepal, Bhutan, Maldives, Sri Lanka, and Afghanistan, will be the main driver of enhanced economic cooperation and trade within the region. SAFTA (the South Asia Free Trade Area), signed in 2004 and entered into force in 2006, represents SAARC member states’ mutual desire to promote and sustain trade and economic cooperation. SAFTA’s trade liberalization program included terms and timeline for tariff reductions, sensitive lists, rules of origin, revenue compensation mechanisms, and special and differential treatment for Least Developed Countries. However, the regulations stipulated under SAFTA do not have enough teeth to be effective. For example, sensitive lists, which carve out specific items not subject to tariff reduction, limit exports among SAARC countries – especially from SAARC countries to India – and thus limit the utility of SAFTA. As a result, bilateral trade agreements between South Asian countries continue to play a more prominent role than SAFTA in governing trade flows.

Some of the issues that SAARC must address to strengthen SAFTA include modification of sensitive lists and tariff reduction measures, and removal or minimization of non-tariff barriers to trade. At-the-border trade issues – burdensome customs clearance procedures, costly port fees, poor transportation infrastructure – are areas that can and should be addressed.

Also important are so-called behind-the-border issues to trade facilitation. It has been shown that just by improving the domestic business and investment environment – access to and quality of credit information, contract enforcement procedures, level of investment protection – export competitiveness should rise as well. Most South Asian countries have concentrated on lowering tariff and non-tariff barriers to trade, but have performed relatively poorly on decreasing behind-the-border barriers. As these countries strive for better regional economic integration, they have to reach a better balance between lowering traditional trade barriers and overall business facilitation.

Certainly, political barriers to regional economic cooperation exist. Those with vested interests in maintaining the status quo have contributed to SAFTA’s limited impact. For instance, sensitive lists, which hinder trade flows in the region, are the result of intense lobbying from domestic industries, such as agriculture, textiles, auto, chemicals, palm oil, coffee, and tea. With hundreds of items not subject to the reduction or elimination of tariffs, barriers to trade remain high, and potential economic gains cannot be realized. In addition, regional disputes, such as the conflict between India and Pakistan over Kashmir, continue to strain relations between SAARC member countries.

Most agree that the potential benefits of increased regional economic cooperation are considerable in terms of income generation and poverty reduction. However, as SAARC takes steps toward this process, it will need to face not only the technical challenges of reducing tariff and non-tariff barriers to trade, but also numerous domestic political economy challenges across the region. SAFTA will have to be strengthened, with less influence from powerful domestic interest groups that limit its impact. This is no small task. To succeed, SAARC will have to bring voices from non-traditional players to the table –emerging business leaders, consumer groups, and small businesses – that will ultimately benefit from increased regional cooperation.

Nina Merchant-Vega is The Asia Foundation’s assistant director for the Economic Reform and Development program and Katherine Loh is a program fellow, both in San Francisco. They can be reached at [email protected] and [email protected], respectively.

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