Thursday, August 7, 2014

INDIA and WTO: Distinguishing GeoPolitics From Economics


    At the start of the Doha Round of WTO negotiations, I warned against confusing the Economics and GeoPolitics of WTO negotiations [Virmani(2003)]. I quote extensively from this note (below) because it remains relevant today, in the context of the decision of the Indian Government to make approval of the agreement of “Trade Facilitation” contingent on a commitment to revise the agreement on Food subsidies.  I conclude with an economic analysis of protection and subsidies that clarifies the economic issues and puts them in proper perspective

Geo-Politics Of Negotiations

 “Economic theory and empirical analysis as understood and accepted by academics in the USA, Europe and the emerging market economies, says that removal of controls, restrictions and obstacles to Imports will by and large lead to an increase in the welfare of both the importing and the exporting countries.  Then why is it that each country ignores what its own academics tell it with respect to policy reforms and focuses mostly on the import restrictions imposed by other countries on its export items (whether these are goods, services or factors)?  The answer is politics.  In every country, politics imposes a cost on the nation as a whole while benefiting some sub-set of individuals.  The geopolitics of negotiations is motivated by a desire to transfer some of the national costs of policy distortions onto other countries, while retaining as much of the benefits for sub-groups within the country.  A good example of this from the rich countries is the multi-fibre agreement (MFA).
One implication of this strategic approach to multilateral economic rules is that there can be an apparent dichotomy between our domestic reform intentions and actions and our public posture and negotiating stance at WTO.  Economic analysis must drive our (autonomous) reforms in the external sector irrespective of what happens (or does not happen) at WTO.  That is, liberalisation is beneficial to the country and must continue independent of the WTO and at a pace and timing of our choice.  Economic analysis also provides us with the true costs and benefits to our citizens, of specific policy changes.  This forms the basis of our evaluation of what rules we should be willing to accept in the negotiations- those resulting in policy change that have a higher benefit to us in any case.  Conversely it also determines which changes we should resist conceding (those that have higher cost).  The public position that we take at the negotiation need not however lay all this out publicly for other countries. In the tactics and strategy of negotiations, politics/geo-politics will inevitably play a substantial role.” Virmani(2003)

Trade Facilitation

“Trade facilitation is the global equivalent of the Indian mantra,  ‘red tape and bureaucracy’ in international trade (import-export) system.  Trade facilitation would directly address this problem on which there is a national consensus (with the exception of the customs bureaucracy).”
“From the perspective of politics/geo-politics therefore, it is quite rational for India to concede to others on any of the Singapore issues if and only if we gain concessions and benefits in other areas. In other words we must use these as counters to bargain for what would not be available to us otherwise.  It should be remembered however that these bargains are sometimes informal, on the sidelines of the formal negotiations or a meeting in another capital.” Virmani(2003)

WTO Negotiations on Agriculture

                “Agriculture is an area where the economic arguments of rich countries are very weak (because of high subsidies) while those of poor countries are relatively strong.  It is quite clear that many countries in the EU and to a lesser extent the USA are hostage to agriculture producers who constitute a small fraction of their population.  On our side a large proportion of the population is dependent on agriculture, lives in rural areas, is very poor and less educated and has little access to up to date and relevant knowledge.  This puts their lively hood and sometimes even their survival at risk from exogenous shocks.  Over the last few years we have also raised the import duties on a number of agricultural products above the peak rate.[1] The inter-ministerial expert group argued that in the interest of economic efficiency, these should be brought down to the peak rate, with an intermediate step of two times the peak rate.  In the meanwhile, we should carry out a thorough de-control and reform of the agriculture, agro-processing and food retail sectors (as detailed in a Planning commission working paper).[2]
As far as the WTO negotiations are concerned, however, offence is the best form of defence.  We should marshal the global NGOs to expose the hypocrisy of the rich countries vis-à-vis free trade and verbal concern for the poor (while giving subsidies to rich farmers that destroy poor agriculturists jobs).  The outcome of this will either be a stalemate (both rich and poor countries retain their preferred distortions) or less likely a trade-off relating to (one or more of) the Singapore issues.  A commitment to reduce rich country agricultural subsidies in return for a reduction in (bound) tariff rates on agricultural goods in poor countries the third but least likely possibility.” Virmani (2003)

Economics Of Food Subsidy

    In several articles during the last year I opposed the Food Security Bill on the grounds that it was barking up the wrong tree. As I showed the real problem is child malnutrition and this requires improved sanitation not more food.[i]  However, we now have the food security Act and the Govt. has to implement it as it stands, until it is amended or redirected.  If the pessimistic calculations of the fiscal critics of the Act come true, implementation will involve huge subsidies. There is a fear in the Indian bureaucracy, that unless the exiting WTO subsidy limits are changed, India could be constantly in the dock at the WTO, having to answer to Global agricultural exporters for domestic subsidies.  To put this fear in perspective, we need to understand the three aspects of Agricultural protection-subsidy:
(1)   Production Subsidies (Sf)
    Subsidies on agricultural inputs given to the farmer, such as fertilizer, electricity and water, that reduce the cost of production. If the subsidy per unit of output is Sf  =  s Pd  this will reduce domestic market price from Pd to Pd’ = Pd  - Sf  = (1-s) Pd  . The last WTO agreement on Agriculture puts a limit on production subsidies of 10% based on a three year average of prices prevailing at the time the agreement was signed (1986-88). This is clearly outdated and needs to be updated to current/recent price levels. Once this is done a 10% subsidy limit would mean that input subsidies cannot exceed 1.8% of GDP (as GDP from agriculture is about 18% of total GDP).  Current input subsidies are less than 1% of GDP.[ii] To pump even more than this amount into agriculture input subsidies instead of into enhancement of agricultural productivity, would be reflective of very bad agricultural policy.[iii] In the medium term, direct income transfers to poor farmers could eliminate even the need for this level of input subsidy.

(2)   Tariff Protection (t)
      Protection of domestic agricultural/food output through tariffs (and QRs). If the effective tariff rate is t this will mean that with World Price Pw ,  Pd’= (1+t) Pw  or Pd = (1+t) Pw  + Sf  =  [(1+t)/1-s)] Pw  . The effective tariff rates on Wheat and rice have varied between 5% and 10% in the recent past, without exceeding the latter.
     The WTO agreements on tariffs, stipulates that the “actual” tariff rate cannot be higher than the “bound tariff rates”. Even though our peak tariff rate on non-agricultural goods is 10%, the bound rates on agriculture are two to three times the bound rates on non-agriculture imports. Therefore elimination of input subsidies could be offset by raising the import tariffs to t’ = s +  t (1+s), thus keeping the degree of import protection to farmers unchanged.
(3)   Consumer subsidies (Sc)
    Consumer subsidies reduce the price of food paid by the consumer (Pc) below the market price. Pc = Pd’- Sc = (1+t) Pw  - Sc . There are no WTO limits on consumer food subsidies.  However, our consumer subsidies are provided through the FCI which also runs the price support system for farmers. Therefore it is not always clear what part of the subsidy given to FCI is compensation for its inefficiency and corruption and how much is a subsidy to consumers. 
       Further, foreign producers argue that the MSP acts as a subsidy to farmers and must be included in the production subsidy calculation, as the Govt. does not allow foreign agriculture producers to supply FCI imported agricultural produce at the MSP. Though this point is debatable, it could be another issue for putting Government in the dock at the WTO. If food subsidies were provided directly to consumers through a food debit/credit card or a bank account (instead of through FCI), the issue would not arise.


    The Indian Government has stated that it is willing to continue discussion on the Bali issues when the WTO meets again in September after a recess.  It seems to me that a reasonable compromise that meets the domestic political objectives of India as well as of Agricultural exporters such as the USA and Australia is possible before the end of the year given a genuine desire to reach agreement, instead of trying to scapegoat India.

[1] See references in Planning Commission Working Paper No. 4/2002-PC (April 2002), “Towards a Competitive Economy: VAT and Customs Duty Reform,” by Arvind Virmani, for a list of items (Table 3, p 30) and tariff rates (appendix table).
[2] See Planning Commission Working Paper No. 5/2002-PC (May 2002), “Excess Food Stocks, PDS and Procurement Policy,” by Arvind Virmani and P V Rajeev.

[ii] Even if highly questionable items are added from FCIs MSP operation (see below) the total agricultural subsidy is less than 10% of Agricultural GDP.

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