Conditions and characteristics of the Global Economic Environment:

Historical evolution: Colonialism and settlement of Asia, Africa and the Americas Industrial Revolution Emergence of a whole array of new nations after World War II Classification of nations as developed and developing The recent shifts in global economic power and influence altering the dominance of the western economies International institutions to regulate World trade, monetary and financial relations among nations.
1

Emergence of free market capitalism as the most widely accepted economic system.
Four main models of capitalism today:

Entrepreneurial Big-firm (Corporatist) Oligarchic State-led

Most economies today are a combination of at least two of these. The role of global trade as central to the System - Changes over the years in global trade patterns.
Evolution of money, finance and flows of foreign investment as a critical part of the world economy and of the inter dependence of nations.

Some basic terms:

National Income: Money value of the end result of all economic activities of the nation
Can be defined from angles of: Product flows or Money flows (factor payments like wages, interest, rent and profits)

So national income may also be obtained by adding factor earnings, ie, national income at factor cost and adjusting the sum for indirect taxes and subsidies.

What is important for business:

The level of National Income: Determines the level of aggregate demand for goods and services. The distribution of National Income: Determines the pattern of demand for goods and services. The trend in National Income: Determines the trends in aggregate demand and also the business prospects. National income or a relevant component of is a vital variable considered in demand forecasting.

GNP: Most important and widely used measure of national income: Value of the final goods and services produced during a year plus incomes earned abroad by nationals minus incomes earned locally by foreigners. Same as Gross National Income. GDP: Market value of all final goods plus income earned locally by foreigners minus incomes earned abroad by nationals. Same as Gross Domestic Income.

Purchasing Power Parity (PPP): Real exchange rate based on domestic purchasing powers of the currencies concerned.
ie based on the theory that exchange rate between one currency and another is in equilibrium when their domestic purchasing powers at that rate of exchange are equivalent.

GDP (Nominal) League (In Tr.$) - 2011

GDP (PPP) League (In Tr. $) - 2011

EU
US China Japan Germany France Brazil UK Italy Russia Canada India Spain South Korea World

17.57
15.09 7.29 5.86 3.57 2.77 2.49 2.41 2.19 1.85 1.73 1.67 1.49 1.11 69.65

EU
US China India Japan Germany Russia UK Brazil France Italy

15.82
15.01 11.29 4.45 4.44 3.09 2.38 2.26 2.17 2.21 1.84

World

78.89

Developing Countries: A four fold classification: Low income per capita - $1005 or less. Lower middle income - $1006 - $3975 Upper Middle Income - $3976 - $12275 Higher income - above $12276

BRIC Countries:
At $4.6 Tr., accent for about 25% of global trade. By the 2040s, BRICS economies together could be larger than the G6 (US, Japan, Germany, France, Italy, UK) in dollar terms By 2025 BRIC could account for half of the size of G6. OECD: Grouping of developed countries Accounts for 19% of the world population.

Major Exporting Countries - 2011 EU China US Germany Japan France Netherlands South Korea Italy 2.13 Tr. 1.89 Tr. 1.51 Tr. 1.40 Tr. $800 b. $578 b. $576 b. $556 b. $522 b.

Russia
UK Canada Hong Kong 19. India

$495 b.
$495 b. $450 b. $427 b. $303 b.

Major Service Exporters - 2011 1. EU 2. US 3. Germany 4. UK 5. China 6. France 7. Japan 10.India $1553 b. $515 b. $230 b. $227 b. $170 b. $140 b. $138 b. $110 b.

Globalization: Integration of national economics into the international economy through trade, direct foreign investment (by corporations and MNEs), short-term capital flows, international flows of workers and humanity generally and flows of technology
History of Globalization: four stages 1830 1885: falling transport and communication cost plus relatively low tariffs increase in trade-global convergence of wages, land prices, rents and interest rates. 1885 1930: Intense agricultural competition among US, Australia and New Zealand caused European protectionist backlash overwhelmed by the continuing fall in transport costs.

1930-45: Strong improvement in transport technology swamped by large tariff hikes.

- Devastating fall in world trade. 1945 : Free Trade initiative led by the U.S. World commerce grew at 6.4% per year over the next half century. Between 1945 and 1998, the volume of world trade increased from 5.5% of world GDP to 17.2%

Benefits: Trade-wise:

Expands international trade and promotes trade liberalization, thereby:

Opens foreign markets and leads to economies of scale. Makes available a range of inputs at lower prices, lowering production costs. Introduces more competition from foreign firms to the domestic economy, with benefits for consumers. Stimulates efficiency of local production. Beneficially affects the rate of economic growth through various channels. Promotes fairness in trade through WTO.

Foreign Investment:
Increased FDI promotes
Opening up of markets Development of industry and business Promotion of employment Greater national income and wealth Diffusion of technology Diffusion of skills

Capital flows
Adds to local capital, promoting investment and growth Helps entrepreneurship Leads to efficiency of financial sector Promotes monetary and fiscal discipline

Government:
Can improve governance Can upgrade quality of regulation

The downside: In trade

Can lead to low wages and exploitation of labour including child labour Can depress commodity prices Can encourage anti-labour union trends Can outsource jobs to economies detriment Can limit scope for trade policy through WTO Can harm trade interests of small and weak nations.

In FDI
Can displace exports Can lead to domination of MNCs and exploitation Can lead to neglect of real development Can reduce governments control of foreign investment

In capital flows
Can lead to hot money flows and resulting problems Can make national financial systems and economies less stable The risk of financial crises like the sub prime Domination of western financial interests

Government
Less scope for taxation Less scope for welfare state policies Loss of policy autonomy Dominance of organizations like WTO

Ideology wise :
Identified with free market capitalism and generally with pre-eminence of the American model

Theories of International Trade

Mercantilism (1500-1800)
Emphasized exports as adding to national wealth and imports taking away from it. So Exports are to be maximized and imports restricted by governments for a favourable trade balance

Defects of the Theory

Theory was abandoned by 19th century, but it still influences thinking on foreign trade in many countries and situations. The view / principle that is opposed to mercantilism : FREE TRADE. What is FREE TRADE? How much of Free Trade the word actually practices? Advantages and disadvantages of Free Trade Theories of Free Trade:
Principle of Absolute Advantage Adam Smith Principle of Comparative Advantage David Ricardo

*Principle / Theory of Absolute Advantage by

Adam Smith:(1723-1790)
International trade and specialization will be beneficial when one nation has an absolute cost advantage in one good and the other has an absolute cost advantage in the other good.

Assumptions of the theory:

* Principle / Theory of Comparative
Advantage by David Ricardo, who revised Adam Smiths theory of Absolute Advantage.

Essence of the Theory: Cost differences between nations are the immediate basis for trade, but it is Comparative Advantage that makes trade between nations possible and advantageous. Assumptions of the theory of Comparative Advantage : Absolute & Comparative Advantage Models: Both have 2 countries and 2 commodities.

ABSOLUTE ADVANTAGE MODEL (Numerical)

PRODUCTION & CONSUMPTION LEVELS
BEFORE TRADE (under autarchy / closed economies) [units produced with same labour inputs]

MALAYSIA INDIA

RUBBER 50
25

TEXTILES 25
50

--------------------------------------75 75

Malaysia has absolute advantage in rubber and India in Textiles.

With Malaysia specializing in rubber and India in Textiles and exchanging surpluses there will be production and consumption gains.

Prices for such exchange are Terms of Trade eg: one unit of textile for two units of rubber or textile @ $1 vs rubber @ 50 cents.
With change of terms of trade, consumption shares can change.

COMPARATIVE ADVANTAGE MODEL

Original version of David Ricardo (1772-1823)
Cloth (Unit)
Wine (Unit)

England
Labour of 100 men for 1 year

Portugal
Labour of 90 men for 1 year

England
Labour of 120 men for 1 year

Portugal
Labour of 80 men for 1 year

for England: advantageous to employ capital for production of textiles and get more wine for that in exchange from Portugal rather than diverting a portion of capital from textile to wine. For Portugal: Same applies in respect of wine.

Comparative Advantage Model (India Malaysia / Textiles & Rubber)

Production Possibilities - with X factors of production. [UNITS] TEXTILES RUBBER Opportunity Cost Ratios INDIA 120 or 120 1:1 MALAYSIA 40 or 80 1:2

Unit cost of producing rubber is less than for textiles in Malaysia So India to specialize in Textiles Malaysia Rubber

Production Possibilities without trade under Comparative Advantage (Pre-trade equilibrium situation) :

TEXTLES UNITS

RUBBER UNITS

TOTAL UNITS PRODUCED

INDIA MALAYSIA WORLD

80 40 120 20 40 60 ------------------------------------------------100 80 180

Production Possibilities with trade (Post- trade equilibrium with specialization and production gains):

[UNITS]
TEXTILES RUBBER WORLD PRODUCTION

INDIA MALAYSIA

120 0

0 80

120 80

----------------------------------120 80 200

Note: Production gains of 20, but only for Malaysia.

But

Consumption gains from trade are for both countries as shown below [with 3:4 terms of trade for textiles to rubber].

[UNITS]
RUBBER

TEXTILES

INDIA MALAYSIA

--------------------------------------------------------------------------

90 30

40 40

TOTAL CONSUMPTION

130 70

GAINS IN CONSUMPTION

10 10

WORLD 120 80 200 20 -------------------------------------------------------------Note: with 3:4 as terms of trade both benefit equally, but change in terms can change benefits, eg: with 1:2, Malaysia will gain nothing but India will gain all.

Theory of comparative advantage is the supply version of International trade.

It tells us that gains from trade depend on terms of trade, but does not tell us how the terms of trade are themselves determined. For that demand has to be brought in to the picture - through law of demand and supply, indifference curves and offer curves TERMS OF TRADE BETWEEN COUNTRIES ARE DETERMINED BY INTERACTIONS OF DEMAND AND SUPPLY

Extensions of Comparative Advantage theory

Opportunity Costs Under this, the neo-classical model has been developed using the concepts of Opportunity Costs, Production Possibility Frontiers and Community Indifference Curves. Labour Theory is thus dropped for a more general theory of costs and production. Also geometric techniques to demonstrate International Trade Equilibrium.

Gains from Trade

Depend on terms of trade.
Free trade, based on competition, may result in unequal distribution of gains among nations, while increasing world prosperity Productivity and Comparative Advantage Changing Comparative Advantage Many Products and Countries

Illustration

Production Possibilities Schedule (PPS) / Transformation Schedule: shows maximum output possibilities of the two countries using all available production inputs. Also alternative combinations of two goods that the two countries can produce.

The slope of the schedule shows the marginal rate of transformation (MRT) of one good to another. In the figure MRT of the two countries is : US:1 auto = 0.5 bushel of wheat Canada: 1 auto = 2 bushels of wheat Production in autarchy (no trade) also no specialization: US : assume it produces and consumes at point A: 40 autos and 40 bushels of wheat @ MRT above.

Canada: assume it produces and consumes at point A: 40 autos and 80 bushels of wheat @ MRT above.
Consumption is limited to points along the domestic PPS.

Specialization and production gains: With specialization and trade the two countries consumption points outside their domestic PPS.

can

achieve

US: moves from production point A to production point B, totally specializing in autos. Canada: moves from production point A to production point B, totally specializing in wheat.

These are production gains net: 40 autos and 40 bushels of wheat.

Trade and consumption gains: In autarchy, consumption alternatives were limited to points along domestic PPS. Exact points of consumption determined by tastes and preferences. With specialization and trade the two countries can achieve consumption points outside their domestic PPS. This is shown in the figure by tt.

For a country to consume at some point outside this PPS it must be able to exchange at terms of trade more favourable than domestic terms of trade.

In the figure the terms of trade is assumed as 1:1

US: by deciding to export 60 autos for 60 bushels of wheat, its starts at post-specialization production point B and slides along the trade possibilities line tt to reach C. Net consumption for US is 20 autos and 20 bushels of wheat.

The triangle BCD showing exports horizontally and imports vertically and terms of trade is the TRADE TRIANGLE for the US.

Canada: by deciding to export 60 bushels of wheat for 60 autos, its slides along the trade possibilities line tt to reach C. net consumption for Canada is 20 autos and 20 bushels of wheat. The triangle BCD showing exports horizontally and imports vertically and terms of trade is the TRADE TRIANGLE for Canada.

Terms of trade will determine each countrys gains from trade. With change in terms, gains will change. The closer the international terms of trade is to the domestic PPS the smaller the consumption gains to the country.

Empirical evidence to support: McDougall 1951 and Stephen Gulub Dynamic Comparative Advantage Examples: Japan, South Korea Factor Endowment Theory : Hecksher Ohlin

Comparative Advantage is explained exclusively by differences in relative national supply condition. Resource endowments of countries are the key determinants of comparative advantage.

Factor Endowment (Proportions) Theory

Seeks to explain the basis of comparative advantage. Or, it is a way to explain why countries have different opportunity costs associated with producing different goods (US: machines and India: cloth) The theory suggest that:

Differences in relative factor endowments between countries determine the basis for trade
Between two nations, each nation will export the commodity intensive in use of its relatively abundant (cheap) factor and Import the commodity intensive in its use of the relatively scarce (expensive) factor

Factor Price Equalisation Theorem: is the premise that international trade will tend to equalize or reduce factor prices between two countries. Explain how: International trade and distribution of income: Stolper-Samuelson theorem: states that an increase in the relative price of a commodity raises the real price of the factor intensely used in its production.

These changes in factor prices tend to increase the percentage of national income the abundant factor receives and contrariwise decrease the percentage for the scarce factor Implications? Empirical evidence of Theory: Leontief Paradox.

Leontief found: the production of importsubstituting goods in US were more capital intensive than US exports.
Explanation?

Other theories :

Theory of Overlapping Demands Theory of Intraindustry Trade Theory of Product Cycles. Modern Trade Theory with focus on economies of scale and first mover concept Theory of national competitiveness Michael Porter The National Diamond

TRADE IN SERVICES Special characteristics of Trade in services Application of comparative advantage theory

3 CATEGORIES OF SERVICES:

Travel & Transportation Proprietary Rights: Other Business Services:

Construction Insurance Banking Medical Services Technical & Legal Services etc.

FOUR MODES OF INTERNATIONAL TRADE IN SERVICES UNDER GATS

Mode 1 :

Cross border movements of service products (eg: Internet Transmission) Movements of consumers to the country of importation

Mode 2 :

(Eg: Students going overseas for education)

Mode 3

: Establishment of commercial presence abroad (Eg: Branches of Banks / Universities abroad)

Mode 4

: Temporary movements of natural persons to another country (Eg: IT consultants / technicians travelling to other countries to provide services)

Note : In WTO negotiations on trade in services India has a special interest in mode 4.

Off-shoring Services
Widely used as a particular subcategory of outsourcing So 4 types of outsourcing based on location and control / ownership are: 1. Captive onshore outsourcing: shift of intra-firm supplies to an affiliated firm in the home country 2. Non-captive: if shift benefits a non-affiliated firm in the home economy 3. captive offshoring: when supplies sourced from an affiliated firm abroad 4. Non captive offshoring: When supplies are source from a non-affiliated firm abroad. Outsourcing is not a new phenomenon.

Potential for offshoring depends on:

technical and institutional separability to what extent the task is standardised transaction and managerial costs within the firm relative to outside suppliers production costs size of the market

The location of offshored services depends on:

labour costs trade costs quality of institutions, specially legal framework tax and investment regime quality of infrastructure esp. telecoms skills esp. language and computer skills.

Two-thirds of offshoring is estimated to be captive offshoring

Estimates of size of offshoring services in IT and Business Process: OECD (2005): $32 b. (2001) McKinsey (2003): $35 b. (2001) Indias ranking: In computer & Information Services: 1(@ $ 31 b.) In computer Information and other business services: 8 Current estimates of size of offshoring services are in the region of $165b. Analyse: Indias strengths Weaknesses

Indian IT exports FY 2011 (estimated) IT services exports $33.5 b. (57% of IT exports) BPO segment $14.1 b.

Engineering design and products development segment $9 b. Total IT exports - approx. $57 b. (26% of total exports of the country)
Nasscoms estimate of direct employment in IT&ITEs : 2.54 million

IV. WTO LIST OF SERVICES: 12 SERVICES SUB DIVIDED INTO 155 SUB SECTORS
1. Business Services

2. Communication Services
3. Construction & Engineering 4. Distribution

5. 6. 7.
8. 9. 10. 11. 12.

Educational Services Environmental services Financial (Insurance and Banking) Services Health Services Tourism and Travel Services Recreational, cultural and sporting services Transport Services Other Services.

Leading Exporters of Services

1. 2. 3. 4. 5. 6. 7. U.S U.K Germany France Japan China India $318.3b $171.8b. $133.9b. $109.5b $ 94.9b $ 62.1b $ 39.6b.

Trade policy and Economic Growth

Trade Policy: Has implications for : Volume/composition of imports & exports. Pattern of investment, direction of development. (hence allocation of resources in economy). Competitive conditions. Climate of business and industry. Pattern of consumption etc.

Classification of countries by trade strategy: (In 1980s & 1990s) Outward & Inward oriented.

Strongly outward

Singapore, Hong kong, South Korea

Brazil, Thailand, Malaysia Indonesia, Pakistan, Srilanka India, Tanzania Bangladesh.

Moderately outward: Moderately inward : Strongly inward :

Policy instruments: Import export policy, fiscal, monetary and foreign exchange policies. Industrial policy 2 examples of industrial policy : US, Japan.

Trade Policy of India

Elements

:-

Inward oriented Fitted in with industrial policy aimed at creation of a sound industrial base through high tariff and non-tariff protection to domestic industry and controls. Not export-led growth

3 Periods in evolution of Indias Trade Policy

1 Export Pessimism - 1951-61

2. Export promotion and import restriction - 1961-91

3. Open liberalizing system with significant reforms from 1991

Features of Indias Current Trade Policy

(More open, market-oriented & investment friendly regime)

After QRs removal, Customs Tariff the main policy instrument

Considerable lowering of tariff from 1991 when the simple average of all tariffs was 113% Average Tariff still high @ 15.8% i.e. High levels of protection (China 12.4%) But envisages reduction to ASEAN level Peak tariff rate 10% Tariff Dispersion

72% Bound Tariffs Complex (with numerous exemptions, duty drawbacks etc) Tariff Escalation Tariff quotas: Milk Powder e.g. Tariff preferences FTA : SAFTA Bilateral with Nepal and Bhutan. Bilateral FTA with Sri Lanka, Singapore, ASEAN, South Korea and Japan Import restrictions Export restrictions.

Policy Evolution:
Export Import Policy 1992-95

Export Import Policy - 1997-2002 Export Import Policy - 2002-2007

Export Import Policy - 2004-2009

Aims of Trade Policy (2004-09) 1. Unshackling of controls 2. Neutralizing incidence of levies/ duties on inputs for export production 3. Facilitating Indias development as a global hub for manufacturing, trading & services

4. Identifying and nurturing special focus areas to generate employment opportunities.

5. Avoiding inverted duty structures and ensuring that India is not disadvantaged in FTAs / RTAs. 6. Upgrading infrastructural network.
7. Revitalizing Board of Trade. 8. Activating Embassies in export promotion.

Aims of Current (2009-14) Trade Policy

Trade Policy not seen as on end itself, but as an instrument of economic growth and development Achievement of coherence and consistency between trade and other economic policies Exports, however continue to be a pay focus

Specific goals: Double Indias export growth of goods and services by 2014. Export growth of 25% p.a

For this, a mix of policy measures including:

Fiscal incentives Institutional changes Enhanced market access across the world and diversification of export markets Improvement in infrastructure related to exports Bringing down transaction costs Providing full refund of all indirect taxes and levies Deeper trade engagement with major economic groupings.

Strategic Trade Policy: Alteration of the terms of competition through government policy so as to favour domestic companies over foreign companies and Shift economic profits to them from foreign companies. Policy instruments: subsidies, tariff and non-tariff barriers

Tariffs

Revenue Tariff: Imposed for generation of revenue. No protective role as goods not domestically produced are also covered. Protective Tariff: to protect domestic industry from impart competition

Types of Tariff
Specific :fixed amount per unit or quantity Ad valorem: duty is fixed as a percentage of value Compound: comprising both specific and ad valorem Duties (eg. a wrist watch charged duty @ $5 per unit and 5% of value)

Basis of valuation for tariff :FOB/CIF

Rules for valuation: In India: Customs Valuation Rules 1988 National rules are generally based on (WTO) Agreement on Customs Valuation 1994.

Pattern of Customs Rules for classification of goods: Harmonized System (of commodity description and coding) Code evolved in 1983 under the World Customs Organization. It has 21 Sections consisting of 97 chapters.

e.g: Chapter 87 covers Motor vehicles and parts 87 03 Motor Cars 87 03 31 Diesel Cars HS Code up to 6 digits is followed internationally and is common to all countries.

India uses an 8 digit HS Code to suit national requirements. Such 8 digit HS Code is used by Indian Customs in shipping bills, export statistics etc. Nominal rate of tariff: the prescribed rate

Effective Rate of protection : The ratio of prescribed rate to value addition (to imported components) The less value added the more effective the protection The more the ratio of imported input to the value of final product the more the effective protection

Tariff escalation: System of import duties rising with each stage of production (Discourages value addition in raw material producing countries) Effects of tariffs :Revenue effect Redistributive effect Protective effect Consumption effect Terms-of trade effect

Protection : Pros and Cons

Pros: Protects jobs Protects against cheap foreign labour Provides a level playing field for domestic producers (in re pollution, child labour etc.) Helps maintain the domestic standard of living

Equalizes production costs by countering subsidies Protects against dumping Protects infant industry Promotes self-sufficiency, national welfare, special national economic interests

Cons

Harms consumers through higher price Burdens exporters depending on imported inputs Denies benefits of competition Leads to development of domestic monopolies Misallocates resources Goes against benefits of trade Leads to retaliatory tariffs from other nations

Non - tariff barriers (NTBs)

Import Quota
Global quota (eg. US quotas for Diary Products: global quota is allocated among different countries. ) Selective / Country quota (eg. EUs sugar quotas for individual African, Carribean and Pacific (ACP) countries.)

Note: Import quotas for manufactured goods are disallowed by WTO

Tariff Rate Quota: A specific quantity is imported at one tariff rate, higher quantities at a higher rate. Example: Indias Tariff Quota for garments imported from Sri Lanka under the Proferential Agreement.

Effects of Quotas: Quotas cause redistributive effects like tariffs: To domestic producers, importers and foreign suppliers depending on the way quotas work.

Revenue effects (with tariff-rate quotas) Quotas also cause welfare effects: The consumption loss- The net welfare loss to the quota-imposing countrys consumers and society is larger under a quota than a tariff. Quotas cause efficiency losses like tariffs

Revenue losses from quotas can be reduced by auctioning quotas

Two possible effects of quotas: exports of expensive varieties by foreign suppliers FDI by foreign exporters to overcome market access barriers (as with tariffs) Other restrictions on international trade: Government monopolies state trading in imports and exports international cartels (OPEC?)

NTBs in developed countries : Have taken the form of Orderly Marketing Agreements between exporting and importing countries known as Voluntary Export Restraints (VERs) Examples: Multifibre Agreement on quotas on textiles and clothing 1974 2004.Export quotas for Japanese cars in US 1981-1984

Note: VERs are now disallowed by WTO rules

NTBs in Developing Countries: Import licensing, Import quotas, state trading in imports. Effects of NTBs: Protection benefit; higher price for supplier on quota and deadweight welfare loss in terms of consumption.

Indirect NTBs:

Domestic Content requirements Subsidies Anti-dumping measures Customs procedures Health and product standards Government procurement policies Environmental / technical requirements Security procedures post 9/11 (like US International Container Initiative

SEZ Act 2005

Highlights: Gives legal form to SEZ, specially in re tax holiday for SEZ developer & approved units. SEZs can be developed by central or a state governement, private/public sector or on PPP basis A state can have more than one SEZ

Area specifications for SEZs: Multi product SEZ 1000 hectares Services/Apparel 100 hectares IT software, Bio-technology, gems and jewellery - 10 hectares

Benefits/ Incentives to Developer of SEZ:

Complete tax holiday for any 10 years in the first 15 years. Exempt from dividend tax. Customs/excise/central, state sales tax exempt for all materials & services purchased by developer. Also power plants for capital equipment & raw material Offshore banking, insurance and financing units can be located in SEZ

Incentives / Benefits to Enterprises in SEZ: 100% exemption from profit tax for first five years; 50% exemption for 2 additional years. exempted from excise, customs, service or state tax on raw materials, components or services SEZ units exempt from dividend tax

Other Features
Offshore Banking/Financial centers have IT exemption for 5 years Customs/excise/other taxes formalities complied with on selfcertification & regulation basis.

Administration
Each SEZ will have a development commissioner appointed by the central government with delegated responsibility in respect of Industrial Development Act and Labour issues. Meant to assure maximum freedom from bureaucratic red tape.

Estimated Gains and Losses

Of revenue on a/c foregone taxes: $39.6 b. by 2011. Commerce Ministry estimates creation of 890,000 jobs by 2009 and FDI of $13.5 b.

RTAs (Regional Trading Arrangements)

RTAs : Trade agreements between two or more countries that reduce trade barriers for only those countries that are members of the agreement (Example : AFTA (ASEAN FREE TRADE Agreement)

MTA (Multilateral Trade Agreement and other ) MTA : Under this, tariffs

trade barriers are reduced for all member countries of the WTO (ie. on a global basis).

Pros & Cons:

RTAs: easier to form as member countries are fewer, share borders or have common interests and even vision. RTAs benefit from more political support from leaders of member countries (eg: annual summits). Can evoke more popular interest. Agreements on trade reforms under MTA are more difficult to achieve because of large number of countries & diversity of interests (eg: Doha Round).

Free Trade at RTA level can prepare countries for MTAs better. RTAs can allow economies of scale, foster specialization, attract foreign investment as well as promote non economic objectives like managing immigration flows and promoting regional security. These are not within easy reach of MTA

Pros for MTAs

They are universal in principle while RTAs are discriminatory Whole world under free/liberalized trade possible under MTAs is more advantages than islands of such trading arrangements under RTAs RTAs can create regional/group vested interests and delay global trade reforms.

Strong divisions within regions can hold back economic integration. (eg: India and Pakistan in SAFTA) MTAs can counter this process. Many trade issues are more amenable to MTAs rather than RTAs

Stages of RTAs:
I. Preferential Trade Agreement (PTA) : Between two (or more) countries to abolish tariffs on a few commodities Examples: India Mauritius PTA (19 goods) India Nepal (mutually agreed products) India Bhutan (all goods) India Chile (276 for Indias exports and 136 for Chiles exports)

SAPTA- SAARC countries (now into SAFTA which is a free trade agreement). India extended preferences on 2700 tariff lines.

II. Free Trade Agreement (FTA) :

Agreement among member countries to eliminate tariffs and NTBs between each other, covering substantially all trade. But each country maintains its own national tariffs against non-members. Examples: AFTA (Asean), NAFTA (US, Canada, Mexico, SAFTA (SAARC)

(Important: Tariff concessions under PTAs, FTAs, Customs and Economic Unions are exceptions to MFN under GATT/WTO)
III. Customs Union: Agreement between countries to maintain a free trade area and a common external tariff against non-members. Examples : Southern African Customs Union, Mercosur (Latin America)

Effects of an RTA:
Static effects: Trade Creation & Trade Diversion. Success depends on factors contributing to trade creation being stronger than those creating trade diversion. Dynamic effects: Economies of scale, greater competition & stimulus to Investment Any RTAs positive effects are to be so determined (study examples of AFTA

Common Market : Where capital and labour are also free to move among member countries. Example : EU

Economic Union : An agreement among countries to maintain a free trade area, a common external tariff, free mobility of capital and labour and some unification of monetary and government policies Example : European Union with Euro as common currency replacing national currencies.

European Union : Evolution

FTA to Economic Union 1951 European Steel & Coal Community : Free trade in the two commodities was set up. 1957 Signing of the Treaty of Rome for economic integration of Europe, with the aim of eventual creation of an economic union. Signitories: France, Germany, Italy, Netherlands, Belgium &

57 68 Tariffs removed and FTA established 1970 Became a Customs Union with Common External Tariffs 1973 UK, Ireland and Denmark joined what was then called European Community(EC). Trade Creation in EC : In respect of Machinery, transport equipment, chemicals & fuels

70s to early 80sEconomic situation slowed down integration 1981 Greece joined EC. 1985 Announcement of Programme for Common Market 1987 Spain & Portugal added 1991 The Euro envisaged Maastricht Treaty

1992 Became Single Market with elimination of NTBs and border controls among member countries. 1995 Austria, Finland &Sweden admitted 1999 European Monetary Union formed. Britain, Sweden & Denmark stayed out

2002 Launch of Euro (12 member countries) 2004 10 more joined: Cyprus, Czeck Republic, Estonia Hungary, Latvia, Lithuania, Malta, Poland, Slovakia and Slovenia 2004 (Oct.)Signed Treaty on Constitution for Europe Ratified by 13 states

2005 Treaty rejected in France & Netherlands EU Today: - A Federation - A Confederation - An International Organization Now discussing a new inter governmental treaty on its political form and structure.

Indias PTAs & Rules of Origin

Regional SAPTA - (with SAARC Countries) 30% for LDCs, for others 40%. Bilateral Bhutan all goods covered No Specific rules of origin

Nepal Covers all goods except the list of sensitive Items which will be subject to TRQ For example: Acrylic Yarn (10,000 tons) Outside quota at MFN rates30% local content

INDIA SRILANKA FT AGREEMENT

Signed 1998, came into effect 2000. For creation of a bilateral FTA through elimination of import tariffs

Except for products in negative list

SL to allow free trade on designated tariff lines to India after 8 years India to allow the same to SL after 3 years Rule of origin 35% local value. Tariff quotas tea and garments from SL

India Singapore Comprehensive Economic Cooperation Agreement 2005. Tariff Reduction / Elimination: India will cut to zero tariffs on certain categories of goods from Singapore immediately On certain categories over 4 years On certain categories cut to 50% over 4 years

National treatment for each others services industries Liberalized mutual recognition of educational / professional qualifications. Rules of origin 40% local value addition & change of customs classification.

Indias Balance of Payments 2005 2006

Trade Account

Exports Imports

$105 b. $156 b.

Trade Balance

$51 b.
$42 b.

Invisibles (net)

Private transfers Non-factor services (Software services, business transportation) Investment Income Current A/c Balance External Assistance -

$24 b. $ 23 b. services, travel,

#5.56 b. 9.1 b. $1.6 b.

Commercial Borrowing Non-resident deposits Foreign Investment (net) of which FDI (net) FII
Euro equities and others Capital Account (total)

$2.72 b. $2.78 b. $17 b.

$4.7 b. $9.9 b. $2.5 b. $24.2 b.

Features: Widening of C/A deficit due to impact of oil price on trade deficit. Trade deficit climbed from 4.9 % GDP in 04-05 to 6.4% in 05 06.
Reversal from C/A surplus in 2001 04 continuing The trend of invisibles (11 % GDP) compensating trade deficit continued. Rising FI, together with increasing NR deposits maintained a strong balance in the capital account. Investment income continued to be negative reflecting the service costs of capital inflows, although receipts have been growing rapidly.

Foreign Exchange Reserves

External assets readily available to and controlled by monetary authorities for direct financing of external payments imbalances for indirectly regulating such imbalances through intervention in exchange markets (selling and buying) to affect the currency exchange rate and / for other purposes. In India RBI is the custodian and manages foreign reserves with defined objectives.

Objectives in regard to forex reserves in India:

maintaining confidence in monetary and exchange rate policies. enhancing capacity to intervene in forex markets. limiting external vulnerability by maintaining foreign exchange liquidity by absorbing shocks during times of crisis (emergencies / natural disasters). providing confidence to the markets especially credit rating agencies that external obligations can always be met. incidentally adding to the comfort of the market participants, by demonstrating the backing of the rupee by external assets.

DETERMINANTS OF EXCHANGE RATES

Short term : a few days / weeks : speculative : several months : cyclical : 1, 2 or even 5 yrs : structural

Medium term
Long term

CAUSATIVE FACTORS: Economic Variables (Market fundamentals) Market Expectations

MARKET FUNDAMENTALS: Current Account balances Real income Real interest rates Inflation rates Consumer preferences for domestic or foreign products Productivity changes affecting costs Profitability & riskiness of investments Product availability Monetary policy & fiscal policy Government trade policy MARKET EXPECTATIONS News about future market fundamentals Speculative opinion on future exchange rates FUNDAMENTAL EQUILIBRIUM PATH: Set by interaction of long & medium run forces.

GATT to WTO History

1946-47 After failure to create the International Trade Organization (with IMF & World Bank) 23 countries signed the General Agreement on Tariffs and Trade (GATT) : Provisional agreement, with a Secretariat in Geneva GATT came into force

Jan. 1948

Basic Principles of GATT System :

Non-discrimination (MFN and National Treatment) Making trade freer through negotiations (Rounds) Provide for a system of trade dispute settlement

Important
Exceptions to MFN principle Trade among members of RTAs Generalised System of Preferences (GSP):
(reduced tariff rates temporarily levied by industrial nations on designated manufacture imports from developing nations. Eg: GSP programme of the US, which also benefits India covers about 3000 items.)

GATT Rounds: 1947 Geneva on tariff reductions 1949 Annecy - do 1951 Torquay - do 1956 Geneva - do 1960-61 Dillon Round - do Geneva 1964 69 Kennedy Round Tariffs & anti-dumping measures - In Geneva 1973 79 Tokyo Round - Tariffs, non-tariff barriers, 1986 94 Uruguay Round - Tariffs, NTBs, Services, Geneva Intellectual property, Dispute settlement, agriculture Resulted in creation of WTO.

WTO 2001 2003 2005

Doha Round launched Cancun Ministerial Conference Failed Hongkong Ministerial Conference

WTO : BASIC STRUCTURE

Goods BASIC PRINCIPLES ADDITIONAL DETAILS Services Intellectual Property Disputes

GATT

GATS TRIPS DISPUTE SETTLEMENT

OTHER GOODS AGREEMENTS AND ANNEXES

SERVICES ANNEXES

MARKET ACCESS COMMITMENTS

COUNTRIES SCHEDULES OF COMMITMENTS

COUNTRIES SCHEDULES OF COMMITMENTS

WTO Agreements
WTO Legal Texts: 60 agreements, annexes and understandings. These make a three-part outline i

Broad principles

General Agreement on Tariffs and Trade (GATT) for trade in goods General Agreement on Trade in services (GATs) for trade in services The Agreement on Trade-Related aspects of Intellectual Property Rights (TRIPS) for trade in inventions and design. Understanding on Dispute Settlement rules and procedures.

ii

Extra agreements and annexes dealing with trade in agriculture, textiles and clothing; product standards, antidumping measures, customs valuation methods etc. Detailed and lengthy lists (schedules) of commitments made by individual countries on tariffs (reductions and bindings) for trade in goods and on market access and conditions for trade in services.

iii

Details: GATT

- Rules on world trade in goods contained in GATT of 1948 plus amendments, understandings and additions made through the Uruguay Round (1986 1994) GATS - Multilateral, legally enforceable rules on international trade in services which resulted from the Uruguay Round (1986 1994) Note: WTO attempts trade liberalization through tariff reductions, tariff bindings, removal of NTBs and trade facilitation all of these through multilateral negotiations based on consensus. Future tariff reductions and liberalization of trade in goods and services will be through negotiations particularly through Rounds Current Round: Doha (Development Round) launched in 2001. Efforts to conclude have not succeeded so far. * Agriculture : Agreement on Agriculture (AoA) aims to reform trade in agriculture .

Targets (1995 2005): Developed Countries: 36% cut in tariffs, 20% cut in domestic support and 36% cut in export subsidies in 6 years

Developing Countries: 24% cut in tariffs, 13% cut in domestic support and 24% cut in export subsidies in 10 years.

* Textiles and Clothing : Agreement on Textiles and Clothing (ACT) ended quotas for exports from developing countries in 4 instalments of 16,17,18, 49% between1995 and 2005.

The trade is now free and under GATT rules.

* Services :Negotiations for liberalization of trade in services through increases of commitments by member countries to open markets in specific sectors are continuing.

Negotiations for liberalization completed in specific services: in Basic Telecommunications 1997 in Financial Services in 1997

* TRIPs Provides protection to patents, copyrights, trade marks and geographic indications (IP rights)

Copyrights : For literary works, computer programmes and recordings : 50 years. Industrial Designs : 10 years

Patents :20 years. For both products and processes (affecting Indian pharma industry as old Indian Patent Law had only recognized process patents for food, drugs and chemical substances.) Governments are to ensure protection to IP rights through their laws (India has done so with the Patents Act of 2005)

* Anti-dumping, Subsidies, Safeguards :WTO Agreement allows governments to act against dumping and lays down detailed procedures for taking anti-dumping measures.

It also disciplines the use of subsidies and regulates actions by countries to counter effects of subsidies (through countervailing duties). * Technical / Procedural Agreements - on Non-tariff barriers - Customs Valuation - Pre-shipment Inspection - Rules of Origin

* Trade Policy Review Mechanism: WTO ensures transparency on trade regulations and policies of nations:

by requiring governments to inform WTO and member states of measures, policies and laws through notifications by conducting reviews of individual countries trade policies

WTO Dispute Settlement The responsible body : General Council (all members) Procedure - by establishing panels of experts to consider the case and receiving the findings for acceptance / rejection. First stage (60 days) : Consultation for bilateral settlement; if it fails reference to WTO for mediation or help Second stage (45 days) : Appointment of Panel to help 6 months for report. Main stages: First hearing, Submissions, Expert Report, First draft, Interim Report, and Final Report to the Dispute Settlement Body Third stage:If not rejected by consensus within 60 days by the body it becomes a ruling on the dispute. Appeals :Heard by 3 members of a permanent Appellate Body of the Dispute Settlement Body To be heard and settled within 60 and a maximum of 90 days.

Main effects of WTO on India

-

India reduced average tariffs from 71.4% to 32.4% (now it is less than 16%) India has bound her agricultural tariffs fully and industrial tariffs up to 71.6% India abolished Quantitative Restrictions on imports (quotas, licensed imports etc) in 2002. India has offered to open up services to foreign providers in some areas. India has agreed to liberalization of trade in financial and information technology sectors. India has amended her patent rules to recognize product patents and provide patent protection for 20 years. India has agreed to change rules about import export balancing and local content in ventures set up by foreign investors. As part of the Doha round, India is now negotiating further reduction of tariffs on industrial goods. India is also negotiating further liberalization in trade in services.

WORLD BANK
1944 Established along with IMF. WBs main purpose : make loans for longterm development. Has 5 closely associated institutions: I International Bank for Reconstruction and Development (IBRD) 184 members. Poverty reduction in developing countries thro loans, guarantees and services for sustainable development. II International Development Association (IDA). Provision of $ 6 - $ 9b. a year of highly concessional financing to the worlds 81 poorest countries. India one of top IDA borrowers.

III

International Finance Corporation (IFC) 176 members. Promotes economic development through the private sector; works with business partners and invests in sustainable private enterprises. Provides equity, long-term loans and structured finance.

IV

Multilateral Investment Guarantee Agency (MIGA). 164 members. Helps FDI promotion in DCs by providing guarantees to investors against non-commercial risks like expropriation, currency inconvertibility, breach of contract, war etc. Investments covered include equity, shareholder loans and loan guarantees.

International Centre for Settlement of Investment Disputes (ICSID). Aim: To provide facilities for conciliation and arbitration of disputes between member countries and foreign investors.

IMF
Established 1944. Responsibilities: Promoting international monetary cooperation. Facilitating expansion/balanced growth of international trade. Promoting exchange stability. Assisting in establishment of a multilateral system of payments. Making resources available to members experiencing balance of payments difficulties.

Main functions:

Surveillance of national economies. Technical assistance in areas like fiscal, monetary and exchange rate policies. Through Special Drawing Rights (paper gold) enable deficit nations in need of foreign exchange reserves to draw them from the Fund. Operate lending arrangements for members in need like compensatory and Contingency Financing Facility & Extended Fund Facility. IMF uses conditionality for loans to meet Balance of payments problems.

UNCTAD
A UN forum for discussion of and cooperation on trade-related development issues of DCs.

Main concerns: Common Fund for Commodities GSP arrangements for DCs.