India is a country of contrasts, marrying huge potential with profound and chronic challenges. Its recent high economic growth rates have improved the prospects that the world’s second most populous country will be able to raise incomes broadly for its 1.1 billion people and contribute to global economic stability and growth. And yet India remains the largest reservoir of poverty in the world, with 300 million poor people, according to the national poverty line, and more than 800 million people surviving on less than $2 per day, an international measure of poverty.

Almost two-thirds of Indians still live in rural areas and well over half of the population works in the agricultural sector, where growth has stagnated at less than 3 percent for the last decade. By contrast, India’s worldrenowned high-technology service sector has grown strongly in recent years but still employs less than 1 percent of the workforce.

Trade Policy Challenges

As India engages more deeply with the global economy, its policy makers face the challenge of devising trade policies that take into account the stunning diversity of its economy and people. While taking advantage of opportunities offered by increased economic integration, they must manage the challenges that a more open economy will pose for the majority of Indian workers and farmers.

This study seeks to contribute to the knowledge base upon which the Indian government and public and the country’s international trading partners can evaluate the difficult policy choices the country faces in the realm of trade.

The study uses a global trade model and a national model of the Indian economy to explore the effects of a range of possible trade choices on the economy, its sectors, its workforce, and its households.

The study simulates potential outcomes of the Doha Round at the WTO and several possible bilateral free trade agreements (FTAs), including a trade deal with the European Union (EU) that is currently under negotiation and possible trade pacts with the United States and China. It also considers other potential effects of closer integration with the global economy by simulating changes in the global prices for rice and wheat, the two most important food grains in India. World agricultural price changes would affect India differently if it binds its tariffs at lower levels.

The Main Results of the Study

Of the potential trade pacts simulated in the study, a multilateral agreement at the WTO has a much larger impact on the Indian economy than bilateral trade agreements with the EU, the United States, or China. Overall, India’s real income would increase by about six times as much under a Doha agreement compared with the gain from the most beneficial bilateral agreement.

Still, the gain would amount to only about $1.2 billion, or one-quarter of one percent of the current economy.

Exports would increase by about 4 percent, while imports would grow by about 3 percent. Domestic production would increase by about $4.5 billion, or one-half of one percent. A Doha agreement along the lines of the study’s simulation would be positive, albeit quite modest, for India.

The simulations of changes in the world prices of rice and wheat show potentially significant effects on the country if it binds its agricultural tariffs at levels that would prevent it from offsetting global price shocks. For example, a 50 percent decrease in the world price of rice could have a negative impact on India’s real income as large as the positive impact of the entire Doha agreement as simulated in the study. Even a 25 percent decrease in the price of rice has negative effects on all major components of the Indian economy, including private consumption, investment, exports, and imports.

Seventy-eight percent of households would experience real income losses from such a price change, and the distributional impact would be regressive, with the poorest households losing the most. These results suggest that the Indian government’s concern over the potential negative effects of a Doha agreement on poverty and rural development is well founded and that it has been correct to seek provisions such as a “special product” designation for agricultural products that are important to livelihoods and a “special safeguard mechanism” to allow it to shield domestic producers from sharp negative price shocks to key commodities.

The simulation of a free trade agreement with India’s largest trading partner, the European Union, shows that Indian exports would increase by about 5.5 percent and its imports by 3.4 percent, more than under a Doha agreement.

However the overall impact on India would be slightly negative, with overall real income and private household consumption showing small declines.

An India-U.S. free trade agreement has smaller effects on India than an agreement with the EU, which is not surprising given that the existing trade relationship is smaller. Exports and imports increase by roughly one-third as much as under a pact with Europe. The overall impact on the economy is slightly positive, while households lose slightly.

An India-China FTA, which is the subject of a feasibility study by the two governments, would produce even smaller gains for the Indian economy than would an agreement with the United States, along with smaller losses for households. Exports and imports would each increase, but by smaller amounts than under the other bilateral agreements.

Creating employment is an important goal of the Indian government, both to absorb unemployed workers, currently estimated at about 40.4 million, and also to generate opportunities for the large numbers of underemployed workers in rural areas and the estimated 7 to 8.5 million annual new entrants into the labor force. All the trade pacts simulated in this study would induce small increases in demand for unskilled labor, with a Doha agreement increasing demand by 0.9 percent (about 4 million jobs based on current employment levels). An India-EU FTA would increase demand by 0.5 percent (about 2.3 million jobs), an India-U.S. FTA by 0.3 percent (1.4 million jobs), and an India-China FTA by 0.2 percent (900,000 jobs). Although these additional positions would be welcome, they represent a very modest contribution to India’s employment needs. Clearly, employment creation will depend much more on Indian domestic demand than on export-led growth for the foreseeable future.

The results of the study indicate that continued trade liberalization, particularly at the multilateral level, can contribute to India’s growth and development. However it must be recognized that the potential gains are modest and the risks are not insignificant. Balancing the defensive interests of India’s poor households with the quest for improved efficiency and market opportunities will require careful trade negotiations and appropriate complementary measures.

—Sandra Polaski

Visit India's Trade Policy Choices Website

By  Sandra Polaski, A. Ganesh-Kumar, Scott McDonald, Manoj Panda, Sherman Robinson
Publisher: Carnegie Endowment
Carnegie Endowment Report, January 2008

Key Conclusions:

• India’s economy would grow most under a Doha agreement, although the gains would add a very modest 0.25 percent to the economy. Free trade pacts with China or the United States would produce even smaller gains. An agreement with the EU, India’s largest trading partner, would have a slightly negative overall impact on India’s economy.

• Dramatic swings in world agricultural prices—a common occurrence—could have much larger impacts on India if the country lowers its agricultural tariffs. A decrease of even 25 percent in the world price of rice, which has happened repeatedly, would negatively impact all but the top 10 percent of Indian households, with the poorest households losing the most.

• The EU, the United States, and China would each gain more from free trade agreements with India than would India itself, but in all cases, gains would be a modest and would represent a very small percentage of the affected economies. While China would gain more overall than India from a bilateral agreement, India would see a greater increase in exports than China.

• All of the proposed trade agreements would reduce India’s tariff revenue, which accounts for about 11 percent of the government’s total revenue. This would force the Indian government to either reduce spending or increase taxes at the expense of Indian households. An EU-India trade agreement would reduce revenue the most.

• The trade agreements would have a positive but very modest impact for India’s unemployed, currently estimated at 40.4 million. A Doha agreement, which has the most sizeable impact of the simulated agreements, would increase the demand for unskilled labor by 0.9 percent, about 4 million jobs. Job gains would be spread across a number of sectors, including transport, construction, apparel, textiles and a few agricultural commodities. Under free trade agreements with the EU and the United States, job creation would be concentrated in the apparel and textile sectors, with other manufacturing sectors actually shedding some workers.

Download India's Trade Policy Choices: Managing Diverse Challenges

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