South Asia: Rising to the Challenge of Globalization

SOUTH ASIA RISING TO THE CHALLENGE OF GLOBALIZATION

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SOUTH ASIA RISING TO THE CHALLENGE OF GLOBALIZATION Pradumna B Rana

Nanyang Technological University, Singapore

John Malcolm Dowling University of Hawaii, USA

World Scientific NEW JERSEY

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LONDON

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SINGAPORE

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BEIJING

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SHANGHAI

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HONG KONG

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TA I P E I

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CHENNAI

Published by World Scientific Publishing Co. Pte. Ltd. 5 Toh Tuck Link, Singapore 596224 USA office: 27 Warren Street, Suite 401-402, Hackensack, NJ 07601 UK office: 57 Shelton Street, Covent Garden, London WC2H 9HE

British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library.

SOUTH ASIA Rising to the Challenge of Globalization Copyright © 2009 by World Scientific Publishing Co. Pte. Ltd. All rights reserved. This book, or parts thereof, may not be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system now known or to be invented, without written permission from the Publisher.

For photocopying of material in this volume, please pay a copying fee through the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA. In this case permission to photocopy is not required from the publisher.

ISBN-13 978-981-281-421-0 ISBN-10 981-281-421-3

Typeset by Stallion Press Email: [email protected]

Printed in Singapore.

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“Rana and Dowling have been keen observers of the South Asian scene for over two decades. This experience and scholarship is amply demonstrated in their new book. The book has two special features that should make it a necessary reading for all those interested in Asia’s evolving economic geography. The first is its comparison of the development experience in China and South Asia. The second is the discussion of pan-Asian cooperation and the prospects of strengthening of economic cooperation between South Asia and East Asia, an idea whose time is now well within the planning horizon. Their prescription is right on the mark. The book is a welcome addition to the growing literature on pan-Asian cooperation and will strengthen the important cause of regional cooperation in South Asia.” Rajiv Kumar Director and Chief Executive Indian Council for Research on International Economic Relations

“The basic premise of Rana and Dowling’s remarkable book is that sustaining high growth in South Asia is essential for integrating Asia, and for enhancing its role in global affairs. They make many policy suggestions for pursuing inclusive high growth by South Asian countries, so the sub-region can be a growth node for the rest of Asia. The book is a welcome addition to growing literature on Asian integration in general, and to managing globalization in South Asia in particular.” Mukul G Asher Professor of Public Policy Lee Kuan Yew School of Public Policy National University of Singapore

“This book provides a thorough assessment about the developments in South Asia — a region that has risen significantly on the global stage in recent decades. As the long time observers of the Asian economies, the authors are well-positioned for tackling various challenging policy issues facing the region. Policy-makers and students alike should benefit enormously from the careful analyses and invaluable knowledge that the authors have offered in this timely book.” Wei Ge, Ph.D. Department of Economics Bucknell University v

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“There has been a proliferation of books on East Asia’s dynamism and it’s integration intraregionally as well as with the global economy. In contrast, much less has been written on South Asia which has, until recently, been a relative laggard in economic growth. There are also encouraging signs regarding the gradual integration of India and — to a lesser extent — the rest of South Asia with China and the rest of East Asia, leading some to talk about “Pan-Asian” integration. The revitalization of South Asia has also given impetus for enhanced intra-South Asian economic integration …. There has, however, been little careful and thoughtful analysis of these important trends and ongoings. The book by Rana and Dowling very ably fills this gap. The authors, both of whom have extensive policy experience in Asia, should be commended for writing a book that offers a thorough and detailed analysis of the data and provides highly useful and insightful policy recommendations.” Ramkishen S. Rajan George Mason University, USA and University of Adelaide, Australia

“Rana and Dowling have come up with an interesting analysis of South Asia, a region that has begun to emerge as one of the most dynamic by exploiting opportunities provided by globalization. They also focus on the challenges that they face in responding to globalization and regional economic integration. I hope that the book will be widely read.” Nagesh Kumar Director-General Research and Information System for Developing Countries

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Contents

Tables

ix

Figures

xiii

Abbreviations

xv

Foreword

xvii

Acknowledgments

xix

About the Authors

xxi

Chapter 1: Introduction and Summary Chapter 2: South Asia’s Global Integration

1 19

Introduction Globalization of South Asia Impact of Globalization on South Asia South Asia’s Globalization Initiatives Future Agenda for Globalization in South Asia References

19 21 31 35 45 55

Chapter 3: A Comparative Analysis of Economic Performance and Policy Reforms in South Asia and the PRC

57

Introduction Comparative Economic Performance Raising Living Standards in the PRC and South Asia vii

57 58 75

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Impact of Policy Reforms The Unfinished Agenda Future Prospects: A Comparison of India and the PRC Appendix 3.1: Chronology of Policy Reforms in South Asia Appendix 3.2: Governance Indicators Appendix 3.3: Unfinished Agenda of Reforms in South Asian Countries References Chapter 4: Economic Integration Between South Asia and East Asia: The Second Phase of Pan-Asian Integration? Introduction Quantitative Measures of Integration Economic Complementarities Ongoing Policy Efforts Conclusions and Policy Recommendations Appendix 4.1: Total Trade of South Asia with East Asia: Levels and Growth Rates Appendix 4.2: Pan-Asian Intra-regional and Interregional Trade Appendix 4.3: Revealed Comparative Advantage Indices in South Asia and East Asia, by Country Appendix 4.4: Annotated List of Free Trade Agreements (FTAs) between South Asia and East Asia References

98 110 116 125 156 162 173 175

175 178 187 201 203 213 214 216 224 227

Chapter 5: Economic Integration in South Asia

228

Introduction Economic Integration in South Asia Lessons from East Asia and Recommendations References

228 230 238 242

Author Index

244

Subject Index

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Tables

2.1

Average Per Capita Income Growth for Lowand High-Globalization Countries (percentage) 2.2 South Asia’s Total Trade, 1980, 1985, 1990, 1995, 2000, and 2005 ($ million) 2.3 Foreign Direct Investment Inflows, 1980, 1985, 1990, 1995, 2000, and 2005 ($ million) 2.4 Direct Investment and Portfolio Investment in India and Pakistan, 1991, 1995, 2000, 2005, and 2007 ($ million) 2.5a Globalization Index Rankings, 2006 2.5b Globalization Index Rankings, 2001 and 2006 2.6 Globalization Indices, 1975, 1990, and 2000 (Rankings for Selected Asian Countries Only) 2.7 Openness Factor and Indigenous Factor Indicators (1998–2002 Average) 2.8 Globalization Rankings 2.9 Regressions of Per Capita GDP on Trade and Foreign Direct Investment 2.10 South Asian Free Trade Agreements with Non-Asian Countries 2.11 Mean Tariff Rates in East Asia and South Asia, 1985, 1990, 1995, 2000, and 2004 (percentage) 2.12a World Competitiveness Indicators, 1995 and 2006 (rankings) 2.12b World Competitiveness Factors, 2000 and 2006 (rankings) ix

20 22 24 25

26 26 27 28 30 35 37 39 41 41

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2.13

2.14 2.15 2.16 2.17 3.1 3.2 3.3 3.4 3.5

3.6 3.7 3.8 3.9 3.10 3.11 3.12 3.13

Workers’ Remittances and Receipts (Balance of Payments), 1980, 1985, 1990, 1995, 2000, and 2004 ($ million) Effective Rate of Duty on Imports into the US, 2005 (percentage) Intra-regional Export Shares, 1990 and 2001 (percentage) Interregional and Intra-regional Portfolio Investments, 2003 ($ billion) Corporate Governance Ratings, 2000 and 2004 GDP Per Capita, 1980, 1985, 1990, 1995, 2000, and 2006 (constant 2000 $) Poverty Head-Count Ratio at $1-a-Day, in PPP (percentage of population) Exports of Goods and Services, 1978, 1991, 2004, and 2005 (percentage of GDP). Taxes on International Trade, 1990 and 2005 (percentage of revenue) Foreign Direct Investment Inflows and Outflows, 1980, 1985, 1990, 1995, 2000, and 2005 ($ million) Cash Surplus/Deficit, 1990, 1995, 2000, 2004, and 2005 (percentage of GDP) Current Account Balance, 1980, 1985, 1990, 1995, 2000, and 2004 (percentage of GDP) Money and Quasi Money (M2), 1978, 1991, and 2005 (percentage of GDP) Sectoral Share of Employment (percentage of total employment) Total Reserves minus Gold, 1980, 1985, 1990, 1995, 2000, and 2006 ($ million) Total Life Expectancy at Birth, 1980 and 2004 (years) Infant Mortality Rate, 1980 and 2004 (per 1,000 live births) Total Adult Literacy Rate, 1990 and 2004 (percentage of people 15 and above)

44

46 48 52 53 59 61 62 63 64

65 66 67 68 69 70 71 72

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Tables

3.14 3.15 3.16

3.17 3.18

3.19 3.20 3.21 3.22 3.23 3.24 3.25

3.26 3.27 3.28 4.1

4.2 4.3

Share of World GDP (in PPP), 1980, 1990, 2000, and 2005 (percentage) Gross Capital Formation, 1980, 1985, 1990, 1995, 2000, and 2005 (percentage of GDP) Economically Active Population, Age 15 and above 1980, 1985, 1990, 1995, 2000, and 2005 (percentage) Sectoral Output Growth in the PRC (percentage) Industrial Output Share, by Form of Ownership, 1980, 1984, 1988, 1992, 1996, and 2002 (percentage) Rigidity of Labor Market Indices, 2005 Average Growth in GDP and Per Capita GDP (percentage) Selected Doing Business Indicators, 2005 Sectoral Share of Value Added, 1980 and 2005 (percentage) Average Share of Trade in GDP (percentage) Growth in Labor Force and Income and Total Factor Productivity Composition of Manufactured Output in the PRC, 1970, 1980, 1990, and 1997 (percentage of total output of manufactured goods) Export Share of Selected Two-Digit Manufacturing Industries in the PRC (percentage) Export Share of Selected Two-Digit Manufacturing Industries in India (percentage) Poverty Levels in India and the PRC (percentage of people in poverty) World Foreign Direct Investment Inflows into South Asia and East Asia, 1990, 1995, 2000, and 2005 ($ million) Top 10 Exports of South Asia to East Asia, 1990 and 2004 Top 10 Exports of East Asia to South Asia, 1990 and 2004

xi

73 77 78

81 85

96 99 101 102 105 110 117

117 118 123 183

187 188

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4.4 4.5 4.6 4.7 4.8

4.9 4.10 4.11

4.12 4.13 4.14 5.1

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Revealed Comparative Advantage Indices for South Asia, 1993 and 2004 Commodities in Which Various South Asian Countries Have Comparative Advantage, 2004 Revealed Comparative Advantage Indices for East Asia, 1993 and 2004 Commodities in Which Various East Asian Countries Have Comparative Advantage, 2004 Spearman Rank Correlation Coefficients for Revealed Comparative Advantage Indices, 1993 and 2004 Trade Complementarity Indices between South Asia and East Asia, 1993 and 2004 Exports of Commercial Services, 1990, 1995, 2000, and 2005 ($ million) Commercial Service Exports for India and the PRC by Sector, 1990, 1995, 2000, 2003, and 2004 ($ million) Revealed Comparative Advantage in Services, 2004 Trade Restrictiveness Indices (percentage) Ease of Doing Business Index: Rankings for Asian Countries, 2005 Share of South Asian Intra-regional Trade in World Trade, 1980, 1985, 1990, 1995, 2000, and 2006 (percentage)

190 191 192 193 195

197 198 199

200 204 206 229

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Figures

2.1 2.2 2.3 3.1 3.2 3.3

4.1 4.2 4.3

4.4

4.5 4.6a

4.6b

Total Trade and GDP Growth Foreign Direct Investment and GDP Growth Poverty Head-Count Ratio and Level of Per Capita Income Per Capita GDP, 1980–2006 (constant 2000 $) Share of Value Added in GDP, 1980 (percentage) Average Firm Size in India and Comparator Countries, 1990 (value added in $ million per establishment) Total Trade between South Asia and East Asia, 1990–2006 ($ billion) Pan-Asian Intra-regional and Inter-regional Trade, 2006 Inter-regional Trade between South Asia and East Asia (as a percentage of South Asia’s Total Trade with the World), 1990–2006 Inter-regional Trade between South Asia and East Asia (as a percentage of East Asia’s Total Trade with the World), 1990–2006 Total Trade Intensity Index between South Asia and East Asia, 1990–2006 Foreign Direct Investment Flows from Selected East Asian Countries to India, 2002/03–2006/07 ($ million) Foreign Direct Investment Flows from Selected East Asian Countries to Pakistan 1999/00–2005/06 ($ million) xiii

32 33 34 60 79 120

178 180 180

181

182 184

184

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4.7a

4.7b

4.8a 4.8b 4.8c 4.8d 5.1

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Foreign Direct Investment Flows from Selected South Asian Countries to ASEAN, 1995–2006 ($ million) Foreign Direct Investment Flows from Selected South Asian Countries to the PRC, 1994–2006 ($ million) Infrastructure: Southern Corridor: Shipping Infrastructure: Central Corridor: Air Freight Hubs Infrastructure: Northern Corridor: Asian Highway Infrastructure: Northern Corridor: Trans-Asian Railways Total World and Intra-regional Exports of East Asia, 1980–2006 ($ billion)

185

185

209 210 210 211 239

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Abbreviations

ASEAN ASEAN + 3 BIMSTEC CMI FDI FTA GATT GDP ICT ILO IMF IT MFN NAFTA NGO NPLs NTBs OECD PPP PRC PTAs QRs RCA SAARC

Association of Southeast Asian Nations ASEAN plus the People’s Republic of China, Japan, and the Republic of Korea Bay of Bengal Institute for Multi-Sectoral Technical and Economic Cooperation Chiang Mai Initiative foreign direct investment free trade agreement General Agreement on Tariffs and Trade gross domestic product information and communication technology International Labour Organization International Monetary Fund information technology most favored nation North American Free Trade Agreement nongovernment organization nonperforming loans nontariff barriers Organisation for Economic Co-operation and Development purchasing power parity People’s Republic of China preferential trading arrangements quantitative restrictions revealed comparative advantage South Asian Association for Regional Cooperation xv

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SAFMs SAFTA SAGQ SAPTA SASEC SEZ SITC SOE TFP TVEs UNDP VAT WTO

South Asian finance ministers South Asia Free Trade Agreement South Asian Growth Quadrangle SAARC Preferential Trading Arrangement South Asia Subregional Economic Cooperation special economic zone Standard International Trade Classification state-owned enterprise total factor productivity township and village enterprises United Nations Development Programme value-added tax World Trade Organization

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Foreword

After adopting rigid import substitution policies for four decades, beginning in the 1980s and the 1990s the South Asian countries started to opt for greater economic openness and began the long process of aligning their economies with those of the rest of the world. This important book, authored by two acknowledged experts on Asia with many years of experience working at the Asian Development Bank (ADB), is devoted to analyzing the recent economic dynamism of South Asia and the challenges that the region faces in a globalizing world. The book examines the South Asian experience of globalization through several different lenses. The book compares South Asia’s globalization efforts with those of East Asia and the rest of the world, giving the reader a broad overview of globalization progress, impact, and potential in South Asia. This comparison demonstrates how, despite recent successes, India and the rest of South Asia are lagging behind the People’s Republic of China (PRC) in various areas. The book then presents a penetrating comparative analysis of economic performance and policy reforms in the PRC and South Asia. The major premise is that policy does matter. Good policies can help lift income growth rates and lower poverty, while poor policies retard growth and stall poverty reduction. Both the PRC and South Asia have been growing rapidly in the past few years, faster than most other developing countries in Asia and the rest of the developing world, raising living standards for more than two billion people. This is a major accomplishment and to be applauded and it owes much of its success to policy reforms. The book moves on to examine the evolving trade relationship between South Asia and East Asia, including the trade relationship xvii

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between the PRC and India. This relationship has important implications for other countries in the region and the global economy. The final chapter of the book turns to a discussion of mechanisms and modalities for increasing intra-regional trade and fostering regional cooperation in South Asia. Among these are developing cross-border infrastructure, fostering international trade and investment, and increasing regional financial sector cooperation. Among the important questions answered in the book are: • How globalized is South Asia? Has global integration been beneficial? • Economic reforms in South Asia have borne fruit. What does each country still have to do? • The PRC began the reform process with a lower per capita GDP than South Asia, but by 2005 its per capita income was more than twice that of South Asia. Why? • India has the potential to grow as fast as the PRC over the next two decades. What policy actions are needed to realize this potential? • After falling dramatically after 1947, trade integration among the South Asian countries is now starting to increase. Can South Asia be as well integrated in the future as it was before 1947? • South Asia’s economic relations with East Asia are starting to surge. Could this eventually lead to an integrated Pan-Asia, similar to what has been achieved in Europe? This book is timely and helps enhance the understanding of recent South Asian economic development and how the surge in South Asia’s trade and investment relations with East Asia could pave the way for an integrated Asia. The book will be of value to a wide spectrum of readers — academics, policy makers, development institutions, students of economics, and the general public. Professor Lim Chong Yah Albert Winsemius Chair Professor of Economics Director of Economic Growth Centre Nanyang Technological University Singapore November 2008

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Acknowledgments

If Rip van Winkle had gone to sleep in the 1980s and awakened two and a half decades later, he would have been surprised by the changes that have occurred in the South Asian economies and their linkages with the rest of the world. The changes have been most significant in India, but other South Asian countries have also shown economic dynamism. This book seeks to systematically document these changes. The idea for the book arose when both of the authors were involved in the ADB’s Study on Economic Cooperation between East Asia and South Asia. We would therefore like to thank the ADB for this opportunity. In addition, Dr. Rana would also like to thank the Nanyang Technological University, where he completed work on the book, and Neeru, Abhi, and Ayush for their inspiration. Dr. Dowling would like to thank the University of Hawaii, where he completed work on the book, and Maribeth Boritzer for her helpful comments and suggestions. Our colleagues and collaborators have also given us much encouragement throughout the project, especially Professor Lim Chong Yah, and Professor Euston Quah. Benjamin Endriga provided excellent research assistance. Wilhemina Paz provided administrative support. Pauline Chan and Sandhya of World Scientific provided editorial support. We are grateful to them.

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About the Authors

Pradumna B. Rana Dr. Pradumna B. Rana is currently a Senior Fellow at the Nanyang Technological University in Singapore. He was the Senior Director of the Asian Development Bank’s (ADB’s) Office of Regional Economic Integration which spearheaded the ADB’s support for regional cooperation and integration in Asia. He joined the ADB in the early 1980s and held senior positions at the research and various operational departments. Earlier he was a Lecturer at the National University of Singapore and the Tribhuvan University (Nepal), a researcher at the Institute of Southeast Asian Studies in Singapore, and a consultant to the World Bank in Washington D.C. He obtained his PhD from Vanderbilt University where he was a Fulbright Scholar and a Masters in Economics from Michigan State University and Tribhuvan University where he was a gold medalist. He has published widely in the areas of Asian economic development and integration, Asian financial crisis, business cycle co-movements, early warning systems of financial crisis, and policy reforms in transition economies. These include half a dozen books and numerous articles in international scholarly journals including Review of Economics and Statistics, Journal of International Economics, Journal of Development Economics, Journal of Asian Economics, World Development, Developing Economies, and Singapore Economic Review. Currently, in addition to this book, he is co-editing books on Pan-Asian Integration: Linking East and South Asia (forthcoming Palgrave Macmillan) and National Strategies for Regional Integration (forthcoming ADB, Manila).

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John Malcolm Dowling Professor Dowling received his Ph. D in Economics from the University of Pittsburg and taught at the University of Colorado for 15 years where he became a full professor in 1976. He moved to the Asian Development Bank in the early 1980s where he served as Assistant Chief Economist for many years. After retiring from the Asian Development in 1996 he taught at the University of Melbourne in Australia, Singapore Management University in Singapore and, most recently, the University of Hawaii at Manoa. Professor Dowling has been the recipient of two Fulbright Fellowships (Iran and Thailand) and a Rockefeller Foundation fellowship. He is the author of numerous articles in professional journals and several books on Asian development topics.

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Chapter 1

Introduction and Summary

India and the People’s Republic of China (PRC) were by far the richest countries in the world 2,000 years ago. Even in the early 19th century their share of global gross domestic product (GDP) was nearly 50%. However, by 1950 this share had fallen to a mere 8% as the industrialized countries in Europe, North America, and Australasia developed further. This balance persisted until the 1970s (Maddison, 2001). As India, after the mid-1980s and early 1990s, and the PRC, after 1978, began to open up and liberalize, their share of world income began to rise again. By 1998 it had risen to 16% and by 2005 to 21%. As the PRC and India continue to grow and integrate further into the global economy, their economic prospects will depend more and more on how they manage globalization. The muchquoted 2003 Goldman Sachs study (Wilson and Purushothaman, 2003) forecasts that by 2050 three of the four largest economies in the world will be in Asia and in this order: the PRC, the United States, India, and Japan. The 2007 Goldman Sachs report (Poddar and Yi, 2007) forecasts that India will overtake the United States faster than expected and be the second largest economy in the world by 2050 after the PRC. During the 1980s and 1990s, other South Asian countries also started to opt for greater openness and began the long process of realigning their economies with those of the rest of the world.1 1

South Asia in this book refers to the seven members of the South Asia Association for Regional Cooperation (SAARC), which are Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka. Afghanistan, which became the eighth member of the SAARC in 2007, is not included here. 1

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The benefits of globalization are many and varied. By opening up to international trade and investment, countries can acquire technology and some essential inputs that help to raise productivity and increase economic efficiency. Greater access to a wider market through globalization helps to reduce the risk of fluctuations in external demand and provides greater scope for exporting a broader range of exports. Greater openness also helps countries to attract foreign direct investment (FDI), which brings with it new technology and innovation and greater access to industrial country markets. In addition, globalization increases export demand, generates employment, and raises living standards. More open financial markets result in increased competition, lower costs of financial intermediation, better resource allocation, and deepening of financial markets. More open labor markets bring new flexibility, skills, and expertise. Skilled labor migration offers benefits to the economy as returning migrants bring improved skills and knowledge and a deeper understanding of science, engineering, technology, and business, which can make the local economy more productive and open new lines of international communication. But globalization also has associated costs. Maximizing the benefits and minimizing the potential costs of globalization requires implementing appropriate policies at the national, regional and global level. These require good governance, transparency, and a consistent policy environment. An appropriate response to globalization requires a threepronged approach. First, countries need to integrate with the world economy through the multilateral initiatives for trade and finance. De-linking is not an option, as multilateral initiatives provide frameworks that are fair and equitable for all countries and convey immense benefits. Domestic policies must be adjusted to take full advantage of the benefits of multilateral liberalization. This brings us to the second point. National policy reforms — in trade and finance, the exchange rate, industrial and financial sectors, and labor policies — have to be developed and implemented within the broad context of globalization. These will improve international competitiveness, productivity, and economic efficiency and resilience. Third, regional policies have to be considered, not only to increase the connectivity

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of countries to regional groupings but also to bring smaller and perhaps isolated economies under the umbrella of a larger regional grouping. The greater economies of production and export diversification these smaller economies can thus achieve may not be possible otherwise, even within the broader framework of global integration. Such regional agreements can also be stepping-stones to wider globalization. Hence, to respond to globalization, national, regional (interregional), and global policies and actions must be implemented. At the national level, a number of macroeconomic issues, such as exchange rates, monetary stabilization, and fiscal policies, need to be considered. Financial markets must also be developed, and the possible contagion effects of actions in other countries, contained. Capital account liberalization needs to be sequenced properly. Other structural reforms have to be addressed as well. Regional actions offer another effective way to address and manage globalization. These have become an important component of the development strategy in East Asia since the financial crisis of 1997 and 1998.2 The Association of Southeast Asian Nations (ASEAN) and ASEAN+3 (ASEAN plus the PRC, Japan, and the Republic of Korea) have become more active, and several new initiatives have been started to stimulate trade and financial integration. There has also been a proliferation of bilateral and subregional free trade agreements (FTAs), both within the Asian region and between Asian economies and other regions. In the area of monetary and financial cooperation, regional policy dialogues have begun through various forums comprising ASEAN and ASEAN+3 finance ministers and their deputies. A regional resource-pooling scheme, the Chiang Mai Initiative, has been established and efforts are being made to develop multilateral swaps as well as bond markets denominated in local currencies. Bridges are also starting to be built across the Asian subregions especially between South Asia and East Asia. East Asia’s momentum of integration with the global economy, including its role in various international forums, is also being strengthened. 2

See Chapter 5.

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After independence from the British in 1947, both India and Pakistan (with what is now Bangladesh) had adopted importsubstituting policies and erected high walls of protection on all sectors of the economy. This had meant not only high tariffs but also various forms of licensing to control entry into industries. The resulting “license raj” in both countries had created inefficiencies, promoted public sector corruption, and constrained the rate of economic growth. The smaller South Asian countries — Bhutan, Maldives, and Nepal — had also adopted a similar development strategy. It was basically only in the 1980s and the 1990s — the 1980s in the case of Sri Lanka, the mid 1980s in the case of India and Bangladesh, and the 1990s in the case of Pakistan and Nepal — that the South Asian countries started the reform process (Devarajan and Nabi, 2006). In many cases reforms have been proceeding in spurts because vested interests have applied pressures to slow the reform process. Since its independence 60 years ago, India has consolidated a vibrant and competitive form of democracy, banished famine, more than halved its absolute poverty rate and dramatically improved literacy and health conditions. It has also achieved global competitiveness in information technology (IT), outsourcing, telecommunications, and pharmaceuticals; acquired de facto membership in the club of nuclear powers; created more billionaires than any other country in Asia and became one of the most dynamic and fastest-growing countries, ranked the world’s fourth-largest in purchasing power parity. It has also acquired a new geo-strategic importance. On the economic side, however, India’s success is relatively recent. Some changes occurred slowly and the growth rate of the economy rose to 5% a year in the 1980s, much higher than during the earlier decades of independence (when the growth rate was 3% per year). But the decisive change occurred after the reforms of the early 1990s. During the period 1991–2005, the growth rate averaged 6%, compared to 4.9% in 1976–1990. The reforms of the 1980s in Sri Lanka and in the 1990s in other South Asian countries have also borne fruit, and other South Asian countries have also shown economic dynamism. The Bangladeshi economy grew by an average of 5% in 1991–2005, compared to 3.9% in 1976–1990, and the

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Sri Lankan economy, by 4.8% and 4.6%, respectively. The economy of Nepal, which has been ravaged by political problems, grew by an average of 4.3% in 1991–2005. The Pakistani economy has, however slowed, from an average of 6.3% in 1976–1990 to 4.3% in 1991–2005. This economic dynamism of the South Asian countries is expected to continue in the future, and South Asia’s share of global income is expected to increase further. For example, the Planning Commission projects that the Indian economy will grow by 10% per year in 2007–2012. However, as the East Asian crisis has shown, a financial crisis can be a major setback to an economy, entailing huge economic and social costs but without derailing it. The recovery of the crisisaffected countries in East Asia was swift, but the investment rates have not recovered yet and the post-crisis growth rates are significantly lower than the pre-crisis ones. South Asia was spared from the contagion of the 1997 East Asian financial crisis mainly because it had not deregulated its capital account. However, in the future, as South Asia continues its economic reforms and deregulates its capital account and enhances its integration with the world, a financial crisis cannot be ruled out. Capital account deregulation is necessary in order to attract foreign capital into local stock and bond markets. Financial sectors in South Asia continue to be weak and the system of corporate governance is less than fully transparent. Like those in East Asia, banks continue to bear the brunt of the required financing, and capital markets are less developed. This could create the so-called “double mismatch” problem, which led to the Asian financial crisis. The region can also be buffeted by other types of real and financial shocks. A major lesson for South Asia from the post-crisis experience of East Asia is that globalization can convey large amounts of benefits but also presents some challenges, which have to be addressed effectively. This book reviews how South Asia is rising to the challenge of globalization. How are South Asian countries maximizing the benefits of globalization while minimizing its costs? What actions have they taken at the national, regional (inter-regional), and global level? What lessons have the South Asian countries learned from the

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East Asian financial crisis and how are they preparing for financial globalization? This book comprises five chapters. This chapter contains the introduction and summary. In Chapter 2, the current status of the region is compared to that of countries in East Asia and the rest of the world, against a variety of globalization indicators. The chapter gives the reader a broad overview of progress, impact, and potential for globalization in South Asia. Since globalization has generally been a positive force for greater economic growth throughout the world, the chapter analyzes the globalization experience of South Asia using the various indices developed, among others, by Kearney (2006) and the Carnegie Endowment for International Peace (2006) and Dreher (2005). South Asia has opened up its economy to foreign investment and provided stimulus for growth in international trade since the 1980s and the 1990s and has become more globalized. There has been a shift in emphasis from an inward-looking import substitution strategy to more outward-looking international policies with a role for the private sector. A variety of indicators of economic growth and international trade and finance and others reflect this new look. Among these are the share of FDI in total investment and income, the share of trade in GDP, the growth in trade, and the inflow of portfolio capital into the stock market. Although the globalization scores for South Asia are increasing, they are lower than those for East Asia and the PRC mainly because of poor health and education, quality of labor force, and institutional strength indicators. By looking at how these indicators are related to economic growth, the chapter draws a clearer profile of the impact of globalization on economic growth and poverty reduction. Globalization initiatives in South Asia, such as lowered barriers to trade, FTAs signed and under negotiation, international migration, and FDI and capital flows, are examined. The chapter ends with a discussion of an agenda for enhancing globalization — trade policy, improved competitiveness, policies to encourage inflows of FDI, increased financial integration, and an appropriate international migration policy. Integrating further into the global economy would benefit South Asia. Initiatives taken since the 1980s and 1990s have borne fruit, both in accelerating economic

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growth and reducing poverty. South Asia must build on this foundation to become even more competitive internationally and to accelerate economic growth. South Asia can integrate further into the global community in several ways. Many of these initiatives relate to international trade in goods and services and in the flow of capital, such as reducing trade barriers, improving international competitiveness, attracting FDI, developing new trade agreements, and increasing capital account convertibility. The flow of labor and issues of financial integration must also be addressed. Recent data on FDI inflows into India are encouraging. According to the United Nations Conference on Trade and Development (UNCTAD), India ranked second only to the PRC as the most preferred destination for global FDI, receiving $17 billion of FDI in 2006, an amount equivalent to the combined flows for the previous three years. On the trade front, the chapter recommends further reductions in tariffs and nontariff barriers (NTBs). The overall assessment of various competitiveness indicators for South Asia is positive but there is scope for further improvement, through reforms in business and government efficiency by reducing bureaucratic procedures and increasing competition. In increasing competitiveness, infrastructure improvements are critical. Despite recent improvements, including efforts to involve the private sector, the lack of a modern and efficient infrastructure foundation continues to inhibit the growth of industry and the private sector in South Asia. The removal of road transportation bottlenecks can be extremely effective in increasing efficiency, by reducing costs and time to market as well as facilitating the movement of temporary labor throughout the country. Cross-border links should also be improved as part of the Asian highway network and the trans-Asian railway system. Additional measures should be adopted to attract FDI. Among these are various institutional and procedural improvements that can demonstrate the attractiveness of South Asia as an FDI destination. First, measures can be taken to harmonize FDI regulations and incentives to stop a “race to the bottom,” develop regulations to stop double taxation, pool experience among South Asian countries to determine a strategy for attracting FDI into different sectors, and

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establish a regional research center devoted to studying the pattern and effectiveness of FDI in the region and elsewhere and disseminating the results. Second, a series of procedures can be developed to simplify entry and exit procedures, set up a fast track for approvals of FDI investment, allow repatriation of profits, and encourage free flow of FDI within the region. Harmonization of financial regulations is another key area of need in South Asia. This should be combined with deepening of the financial infrastructure and financial markets, perhaps using the Asian Bond Market Initiative proposed for East Asia as a model. Capital account convertibility should not be eschewed; liberalization should, however, be sequenced properly. Many impediments to increasing migration from South Asia rest with recipient countries in Europe, North America, and Australia. Bilateral negotiations to enhance personal safety and improve working conditions for short-term guest workers should be intensified. Given the increasing importance of remittances in South Asian countries, facilitation of these flows can also be improved. Further integration into the global information and telecommunications labor market can be encouraged and promoted in a number of ways. Giving support to the private sector by upgrading physical infrastructure in service sectors specializing in IT and communications should be a major priority as the demand for outsourcing and migration of skilled professionals in the IT industry continues to grow. Better coordination between shifting job openings in industrial countries and skill development in South Asian countries can be developed by encouraging private sector involvement in IT and communications training in South Asia as well as facilitating migration programs that allow skilled and professional workers to migrate for a year or two and then return to use their expertise at home. Chapter 3 presents a comparative analysis of economic performance and policy reforms in the PRC and South Asia. There are several reasons for this. First, nearly half of the world’s population has a stake in the ability of both to sustain high rates of growth and raise living standards. Second, the PRC and South Asia can benefit from each other’s experiences. Their unique features make mutual dialogue and discussions important. The two are at similar stages of economic

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development with diverse policy challenges. They both have huge land masses, diverse climates and geography, similar demands on the environment, and, of course, large populations. The major premise of this chapter is that policies are important. Good policies can help lift income growth rates and lower poverty, while poor policies retard growth and stall poverty reduction. The chain of events leading from policy reforms to growth is not the same for all economies. Special circumstances in each economy have to be analyzed as well. History, government, and institutions are also important because they serve as the background for policy adjustments. In both India (and its neighbors in South Asia) and the PRC growth has been rapid in the past few years, faster than in most other developing countries in Asia and the rest of the developing world. The fact that living standards have swiftly improved for the more than 2 billion people in these countries is a major accomplishment to be lauded. While the PRC has grown rapidly for more than three decades, growth in India and the rest of South Asia has accelerated only recently. To provide a better grasp of the details of recent economic development, the chapter begins with a short review of economic performance indicators for South Asia and the PRC: the pattern of growth in per capita income; modifications in sector shares in agriculture, industry, and services; inflation, FDI, and current account balances, along with international reserves; and human resource indicators such as the incidence of poverty. This review is followed by a discussion of why living standards have been rising faster in the PRC than in South Asia. PRC began the reform period with a lower per capita GDP than all the countries in South Asia with the exception of Nepal. But by 2005 per capita income was more than twice as high in the PRC than in all of South Asia with the exception of Sri Lanka. Furthermore, poverty reduction has been more dramatic and human development indicators have improved more rapidly. The differences in initial conditions as well as the design and sequencing of reforms explain this outcome. Reforms in agriculture and industry took center stage at the start of the reform process in the PRC. This facilitated the development of relatively efficient commodity markets and the encouragement of quick supply

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responses early in the reform process. Macroeconomic reforms (e.g., fiscal, financial, trade and investment, and exchange rate reforms) and other microeconomic reforms (e.g., industrial policy and public enterprise, public administration, labor market, and infrastructure reforms) were undertaken later, sometimes in response to distortions and bottlenecks that resulted from reforms in the productive sector. South Asia, on the other hand, generally put macroeconomic reforms ahead of microeconomic reforms mainly because reforms were undertaken in response to adverse macroeconomic situation and required belttightening measures with high social costs. Although South Asia put macroeconomic reforms ahead of microeconomic ones, more remains to be done at this level. Tariffs have been lowered, yet they are still higher than rates in Southeast Asia and East Asia. In India, export processing zones are relatively recent and small compared with those in the PRC, and they lack efficient and cheap connectivity with major ports. Regulations are still cumbersome and are a disincentive to foreign investors. In other countries in South Asia, similar reforms are needed in trade, foreign investment, and the financial sector, although the details differ from country to country. Additional reforms at the microeconomic level or the so-called second-generation reforms are needed to make markets work better. These comprise continued reforms of the agriculture and industrial sectors; reform of public institutions for improved goverence (civil service, bureaucracy, and public administration); reform of institutions that create or maintain human capital (education and health); and, improving the environment affecting the private sector (regulatory environment, flexibility in labor markets, legal and physical infrastructure, and clearly-defined property rights). Unlike macroeconomic reforms, however, successful implementation of secondgeneration reforms requires a wider consences in the countries. This chapter also provides a discussion of the unfinished agenda for South Asian countries at a country level and concludes with an analysis of future growth prospects for the region, which are fairly encouraging provided reforms remain on track. The unfinished agenda includes, among others, restructuring private enterprises in most countries, improving tax administration in Nepal and Pakistan, implementing

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various standards and codes and best practices for the financial sector, improving labor market flexibility, and upgrading governance and infrastructure throughout the region (see Chapter 3, Appendix 3, for further details). A review of the pattern of economic growth and sectoral changes in the PRC and India brings out several aspects that are important in assessing the future prospects for these two giant economies. First is the overwhelming importance of industrial growth in the PRC. Industry in 2005 accounted for 40% of the country’s GDP, up from a negligible amount only 30 years ago. This growth has not only been spectacular but has been concentrated for the most part in a few sectors, primarily Standard International Trade Classification (SITC) categories 5–8 (office machinery, electrical machinery and appliances, telecommunications equipment, and miscellaneous manufactured goods). Second, although it is starting to improve, the performance of the industrial sector in India has been anemic. The sector has not grown as fast as the rest of the economy and has therefore provided little impetus for economic expansion. The sector share is only 26% of GDP, versus 40% in the PRC. Even accounting for some estimation errors, this is still a very big difference. The acceleration in growth of the Indian economy since the mid-1990s has been led by the services sector, with a small contribution from agriculture. Since the middle of this decade, there has also been some turnaround in manufacturing productivity, mainly because of private sector activities and responses to reforms. FDI is only one-tenth the level of the PRC’s and export growth has been slow. Merchandise exports are only about 10% of GDP and are not nearly as well focused on labor-intensive industries as they are in the PRC. The PRC can easily continue to grow rapidly and increase its export domination in manufactured goods categories 75–77, and perhaps expand into 78 (road vehicles). By 2001–2004 this subsector’s share of total manufactured output was already 34%, up from a negligible amount in the 1990s. Whether this continued growth in industry is in the best interest of the country is another matter, however. A more appropriate strategy would be to put less emphasis on industry

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and more on services and the rural development of the backward interior provinces. Much of the current emphasis in India is to leapfrog over the industrialization phase of development and focus on a wide variety of both high- and low-technology services, primarily in IT and communications. To sustain rapid growth, there has to be an added push to develop labor-intensive industry as in East Asia and the PRC. Such a strategy would also benefit rural areas as growth would trickle down to the poor. India has the potential to develop a vibrant, efficient, and internationally competitive industrial sector, but this requires better infrastructure as well as labor and industrial policies that are flexible and allow large-scale industry to operate in labor-intensive industries. The recent Goldman Sachs report (Poddar and Yi, 2007) argues that growth acceleration in India since 2003 represents a structural increase rather than simply a cyclical upturn. India could grow by 8% yearly until 2020 (from the 5.7% forecast for 2003), the report adds. But to do this, India needs to address supply-side constraints on business, infrastructure development (health and education, among others), and the labor market. There are encouraging signs that such a takeoff is near in India; however, FDI growth in manufacturing is still slow, labor markets are still constrained, and business investment in new plant and equipment is weak. For the outlook for the next decade to change, the Government will have to remove all of these bottlenecks. Then it will definitely be possible for the industrial sector to exhibit the dynamism that the IT and related service sectors have been showing in the last few years. If this materializes, India could well grow as fast as PRC in the next two decades, particularly if it is able to raise investment rates so that they are closer to the rates achieved by the PRC. Chapter 4 looks at the evolving economic relationship between South Asia and East Asia. Recently, there has been growing interest in the economic relationships between these two regions. There are, at least, three reasons for this interest. First, two of the most dynamic countries in the world, namely, the PRC and India, are in these regions and the evolution of these giant economies, together with growing economic interrelations between the two, could have important

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implications for other countries in the regions and the global economy. Second, with the surge in regionalism in post-crisis East Asia, a question that is frequently being asked is: will growing economic relations between South Asia and East Asia be the second phase and eventually lead to an integrated Pan-Asia similar to the integration achieved in Europe sometime in the future? Third, during the pre-colonial period, Asia not only dominated the global economy but was one of the most integrated regions in the world, will this happen once again? The chapter highlights the recent surge and the potential for increased integration in the future between the two regions. It also recommends a set of policies to further enhance integration between South Asia and East Asia. The chapter begins by reviewing trends in economic integration between South Asia and East Asia. South Asia’s merchandise trade with East Asia has grown significantly in absolute terms. This trade is the second-largest component of Pan-Asian trade, suggesting that South Asia–East Asia economic relations could be labeled as the “second phase of Pan-Asian integration.” The chapter also reviews quantitative measures of economic integration between South Asia and East Asia, and assesses economic complementarities between the two regions by looking at the pattern of exports and comparative advantage. A large part of the increase in South Asia–East Asia trade is accounted for by the bilateral trade between the two giant economies of India and the PRC; trade between them has also increased rapidly in recent years. The trends show as well that East Asia is a more important trading partner for South Asia than vice versa. Trade shares are not sufficient to assess the extent to which countries prefer to trade with each other than with other trading partners. Trade intensity indices are a better way of measuring whether trade between two regions is greater relative to their importance in world trade. The trade intensity indices between South Asia and East Asia declined in the 1990s but have increased since then. This increase reflects mainly the increasing trade intensity between South Asia and ASEAN and the PRC. Despite overlaps, exports between the two regions have some complementarities. South Asia exports mainly agricultural, primary, and labor-intensive manufactured goods to

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East Asia. East Asia’s exports to South Asia, on the other hand, comprise mainly of capital- and knowledge-intensive products such as telecommunications and sound recording equipment, electrical machinery, road vehicles, and industrial machines. Policies in South Asia, particularly in India, have recently sought to establish trade and investment links with ASEAN and East Asian countries. India’s engagement with ASEAN began in 1992, and since 2005 India has also participated in various East Asia Summits as well as other meetings with European finance ministers. South Asia and East Asia have signed a number of FTAs as well. Which policy actions would increase South Asia–East Asia integration? First, while tariffs and NTBs are already low in many East Asian countries and while South Asia has made encouraging progress in the same direction, further reductions can be made (especially in NTBs in East Asia, where tariffs are already low). Second, trade liberalization efforts need to be embedded in a wider program of economic reforms. South Asian countries and several East Asian countries need to make progress in implementing reforms at the microeconomic level and the so-called second-generation reforms to enhance transparency, good governance, and human captial. Among these reforms are reform of the civil service and of the delivery of public goods, to strengthen competition, regulations, and property rights and thus create an environment conducive to private sector opportunities. The reform of institutions that create human capital, in health and education among others, is also required. Third, South and East Asian countries need to consolidate their FTAs into an Asia-wide FTA. To make the proliferation of FTAs between South Asia and East Asia stepping-stones rather than stumbling blocks to multilateralism and to reduce economic inefficiencies due to overlapping rules of origin and others, policy makers in the region may wish to adopt the concept of “open regionalism” and broaden FTAs by creating as large and wide a market as possible. Deepening FTAs by extending their coverage beyond trade in goods into services, investment, technology, etc., may reduce the problem of trade diversion. Quantitative estimates suggest that a broad regional approach will, for the most part, forestall largely adverse effects on individual Asian countries that may follow

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when countries and subregions are otherwise left out (Francois, Rana, Wignaraja, forthcoming). The fourth measure that could significantly affect trade between South Asia and East Asia is reduction of trading costs. This could be brought about by investment in trade-related infrastructure and the streamlining of cross-border procedures (such as customs procedures and logistic costs) to minimize delays in customs inspection, cargo handling and transfer, and processing of documents. Finally, trade promotion through skillful economic diplomacy, regular exchange of business delegations, and civil society participation could be given much more encouragement. People-to-people contacts can go a long way toward enhancing trade and investment between countries. Chapter 5 considers the broad topic of regional integration within South Asia and draws lessons from the experience of East Asia. South Asia was a well-integrated region of the British Empire in the 19th and early 20th century before World War II. In 1947, when Pakistan and India became independent, more than half of Pakistan’s imports came from India and nearly two-thirds of its exports went to India. Then, after Pakistan was partitioned, tensions between the two countries grew as they bickered over water rights, territory, and currency valuation. These, together with the adoption of international trade policies that emphasized import substitution, led to a dramatic reduction of trade among South Asian countries. Whatever limited international trade that took place was with industrial countries, particularly the United States. Consequently, after independence from British rule, trade among the South Asian countries fell from around 20% of total trade to about 4% by the end of the 1950s, and to 2% by 1967 (World Bank, 2004). The share of intra-regional trade in total trade began to increase only after the countries abandoned import substitution polices in the 1980s and the 1990s. It now stands at about 4% of total trade. This chapter explores how the previous strong pattern of trade can be revitalized. There are several mechanisms and modalities for increasing intra-regional trade and fostering regional cooperation, such as developing cross-border infrastructure, fostering international trade and investment (including services), and increasing

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cooperation in the financial sector. In infrastructure, under the South Asia Subregional Economic Cooperation (SASEC), six priority sectors have been identified: transport; energy and power; tourism; environment; trade, investment, and private sector cooperation; and information and communication technology. Progress is still in the early stages, although projects are being identified and preliminary work is being done. The South Asian Association for Regional Cooperation (SAARC) with its trade initiatives — the SAARC Preferential Trading Arrangement (SAPTA) and the South Asia Free Trade Agreement (SAFTA) — is the major institutional entity charged with promoting free trade in South Asia. SAFTA aims to reduce tariffs among members to 0%–5% by 2016 and establish a free trade area. However, progress has also been slow. Each country has a list of products that are not part of the agenda for tariff reduction and these products are hard to eliminate. The hope is that all countries are more committed to free trade than they have been in the past and will be willing to make mutual concessions to make trade agreements work. With regard to free trade agreements, two current bilateral agreements involve South Asian countries — those between Sri Lanka and India and between Nepal and India. Although the World Bank (2004) argues that even with free trade the amount of trade within South Asia would be relatively small (although certainly bigger than the current flows), opportunities for more trade within South Asia are confirmed by a number of studies that consider comparative advantage and geographic proximity. The level of intra-regional trade is expected to increase in the future but not to the pre-partition level as patterns of comparative advantage have changed. Integration with East Asia (discussed in Chapter 4) will provide additional opportunities for both South Asia and other regions of Asia to reap the benefits of globalization. As Chandra and Kumar (2008) note, South Asia can benefit from a twin-track approach: integration within itself and better integration with the rest of the world. Integration within South Asia is more likely to succeed if undertaken as part of broader Pan-Asian cooperation. Increased integration in South Asia could also help build bridges between Central Asia and East Asia.

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Regarding financial integration, several institutional developments in the past decade were designed to promote greater monetary and financial integration in South Asia. Among these is the recent formation of a network of central bank governors and finance secretaries of the SAARC region and a forum of SAARC finance ministers. These groups discuss and exchange views on macroeconomic issues, and possibilities for harmonizing strategies for the environment and natural disaster relief. A South Asian Development Fund (SADF) has been set up to identify regional projects in industry, energy, agriculture, and services, as well as infrastructure and social development projects. The SADF has also financed feasibility studies. For financial and monetary integration within South Asia to progress beyond these steps, more work must be done to assess whether enough macroeconomic convergence and political will has been developed before the idea of a common market can be entertained. This work is ongoing. An important lesson for South Asia from East Asia’s experience is that regionalism can help maximize the benefits of globalization while minimizing its costs. South Asia should strengthen its efforts to enhance cooperation within the region and with East Asia. The recent observer status given to the PRC and Japan in SAARC should have a catalytic impact on South Asian integration. Second, expeditious implementation of SAFTA is necessary. Nontariff barriers to trade should be removed. SAFTA should also be deepened to cover the service trade and the movement of labor. Third, efforts should be made to strengthen monetary and financial cooperation in South Asia. The region could join ongoing efforts in East Asia (such as the Chiang Mai Initiative and local currency bond markets).1 Fourth, in infrastructure cooperation, the SASEC initiative could benefit from interaction with the Greater Mekong Subregion program.

1

Recently a $3 billion bilateral swap agreement was signed between India and Japan.

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References Chandra, R and R Kumar (2008). South Asian Integration Prospects and Lessons from East Asia. Indian Council for International Economic Relations. Devarajan, S and I Nabi (2001). Economic Growth in South Asia, Promising, Unequalizing, Sustainable? Economic and Political Weekly, August 19. Dreher, A (2005). Does Globalization Affect Growth? Evidence from a New Index of Globalization. Thurgauer Wirtschaftsinstitut Research Paper Series No. 6. April. Francois, J, PB Rana and G Wignaraja (eds.) (forthcoming). Pan-Asian Integration: Linking East and South Asia, Chapter 1, Palgrave Macmillan. Kearney, A. T. Inc. and the Carnegie Endowment for International Peace (2006). The Globalization Index. Foreign Policy (November/December), 74–81. Maddison, A (2001). The World Economy: A Millennial Perspective. OECD. Poddar, T and E Yi (2007). India’s Rising Growth Potential. Global Economics, Paper 152. Goldman Sachs. United Nations Conference on Trade and Development (UNCTAD) (2007). World Investment Report 2007. Wilson, D and R Purushothaman (2003). Dreaming with the BRICS: The Path to 2050. Global Economic Paper No. 99. Goldman Sachs. World Bank (2004). Trade Policies in South Asia: An Overview. Report No. 29929, Washington, DC.

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Chapter 2

South Asia’s Global Integration

Introduction Globalization is a contentious word that means different things to different people. While the general public has grown skeptical of globalization, fearing foreign competition and loss of jobs, most economists are optimistic about the longer-term prospects for the world economy and for countries that are joining the global community. For them the net effect of globalization is definitely positive. For others, where local producers are threatened by lower-cost imports, the net impact is negative. Empirical studies on globalization have measured its impact on economic growth and development. Many of these have used international trade flows, direct foreign investment, and other capital flow as measures of globalization. Dollar (1992) and Frankel and Romer (1996) find that trade and openness to trade have both had a positive and significant impact on economic growth for many countries. The impact of capital account liberalization on growth is more debatable. Rodrik (1998) and Alesina, Grilli, and Milesi-Ferretti (1994) do not find a significant relationship between capital account openness and economic growth, and Chandra (2001) finds that there are more developing countries that have suffered than those that have gained from globalization. However, Dollar and Kray (2001) find a positive relationship between FDI flows and growth. Several other studies have expanded the definition of globalization beyond FDI, openness to trade, and trade flows. These studies (reviewed in the next section of this chapter) look at a much wider range of indicators to assess the degree of globalization in different economies. 19

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Table 2.1 Average Per Capita Income Growth for Low- and High-Globalization Countries (percentage). Degree of Globalization Low globalization High globalization

1970– 1975

1976– 1980

1981– 1985

1986– 1990

1991– 1995

1996– 2000

2.62 (68) 2.99 (38)

2.08 (71) 3.02 (38)

0.35 (80) 0.79 (36)

0.68 (83) 2.64 (36)

0.14 (64) 1.24 (59)

1.16 (40) 2.04 (82)

Note: Figures in parentheses refer to sample size. Source: Dreher (2005).

The results of these studies generally find that globalization is positively related to growth in per capita income, using panel data for a variety of industrial and developing countries. Dreher (2005) finds that countries with high rates of globalization grew faster than countries with low rates of globalization (see Table 2.1). His regression results imply that the PRC’s growth rate was 2.33 percentage points higher in 2000 than in 1975 as a result of greater integration with the rest of the world. Li, Pang, and Ng (2006) find that openness and local domestic factors like governance, human resources, and the quality of the labor force both contribute to more rapid economic growth. Since globalization has generally been a positive force for greater growth throughout the world, we can turn to an analysis of the globalization experience of South Asia. South Asia has opened up its economy to foreign investment and provided stimulus for the growth in international trade essentially sometime in the 1980s and the 1990s. This shift emphasizes the move from an inward-looking import substitution strategy to more outward-looking international policies and the role of the private sector. A variety of indicators of economic growth and international trade and finance reflect this new look. Among these are the share of trade in GDP, the growth in trade, the share of FDI in total investment and income, and the inflow of portfolio capital into the stock market. By looking at how these indicators are related to economic growth we can draw a better profile of the impact of globalization on economic growth and poverty reduction.

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It is also useful to analyze the changing placement of South Asia on various indices of globalization. The most popular index is the Kearney’s Index (2006), which has four separate categories of globalization: economic integration, personal contact, technological connectivity, and political engagement.3 Each of these dimensions is reflected in a number of different variables. A slightly different series of three categories is reported by Dreher (2005). These categories are economic integration, social globalization, and political engagement. A paper by Heshmati (2003) uses principal component analysis to derive an index of globalization with the four Kearney variables. Another approach adopted by Li, Pang, and Ng (2006) adds a set of indigenous factors including health and education, quality of the labor force, and effectiveness of government and amount of corruption. These indigenous factors enable countries to take advantage of the opportunities that globalization offers. In the next section we review the trends in South Asia’s external economic relations and relative country rankings with respect to various globalization indicators. Simple assessments of the economic impact of globalization on South Asian economic performance are also provided. After that we explore possible policy initiatives for increasing the integration of South Asia into the global economy.

Globalization of South Asia We begin this section by reviewing trends in South Asia’s globalization using the more traditional measures. From 1980 to 1990, South Asia’s share of world trade remained at 1%, even though the value of trade grew strongly from 1985 to 1995 (see Table 2.2). Trade in other

3

The economic variable includes trade and FDI. The personal contact variable includes factors such as international travel and tourism, international telephone traffic, and workers’ remittances. The technological connectivity variable includes the number of Internet users, Internet hosts, and secure servers. The political engagement variable includes membership in international organizations, contributions to United Nations peacekeeping missions, international treaties ratified, and government transfers.

1995

2000

2005

3,400.7 23,263.0 0.0 0.0 7,969.1 3,067.8 37,700.7

3,525.1 24,594.4 93.2 430.0 8,627.0 3,096.7 40,366.2

5,326.6 41,804.4 190.0 797.9 12,970.4 4,531.7 65,621.0

9,625.2 65,024.5 406.5 1,090.9 19,452.3 8,282.0 103,881.4

14,590.4 92,961.9 465.2 1,734.1 19,598.4 12,146.8 141,496.7

22,345.3 238,590.6 948.2 2,551.7 40,561.4 16,474.7 321,471.9

1.0%

1.0%

1.0%

1.0%

1.1%

1.5%

–

1.4%

12.5%

11.7%

7.2%

25.4%

Source: International Monetary Fund, Direction of Trade Statistics CD-ROM, July 2006.

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Bangladesh India Maldives Nepal Pakistan Sri Lanka South Asia

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Country

South Asia’s Total Trade, 1980, 1985, 1990, 1995, 2000, and 2005 ($ million).

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Table 2.2

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23

parts of the world also increased during this period. However, as reforms began to take hold after 1990 and tariff barriers were lowered, South Asia’s participation in international trade accelerated even faster, and by 2005 its share of world trade had increased by 50%, to 1.5%. More importantly, the average rate of growth of world trade per year also rose rapidly, more than doubling from 2000 to 2005 after growing by nearly 40% from 1995 to 2000. India was responsible for the bulk of the increase. Its total trade (exports plus imports) increased by 2.5 times from 2000 to 2005. Trade in other economies also accelerated after 2000. Pakistan’s total trade more than doubled and that of other countries increased by healthy amounts. From 2000 to 2005, South Asia’s total trade grew by an average of more than 25% yearly, one of the highest rates in the world. FDI is another important index of globalization. It reflects the interest of industrial countries in developing countries and is a key ingredient of technological transfer and innovation. Before reforms were introduced in the 1980s and the 1990s, FDI in South Asia was only a trickle and its pace was slow, actually falling between 1980 and 1985. South Asia’s share of world FDI flows was less than one-half of 1% (see Table 2.3). As reforms began in India and Pakistan, FDI flows accelerated somewhat, although they remained small relative to total world inflows. From 2000 to 2004, South Asia’s share of world FDI flows increased from 0.22% to 1.04%, still a small amount but more than a fourfold increase in 6 years. India and Pakistan were the big recipients. It is notable that from 2000 to 2005 the total global flow of FDI fell by about 48% as global flows from the US declined. However, inflows into South Asia more than doubled. This pattern of acceleration in the flow of FDI is a strong sign that South Asia is becoming further integrated into the global economy. Portfolio investment and other capital flows are yet another indication of the pace of globalization of capital markets in South Asia. According to data from the Institute of International Finance, equity investment in India has increased quite dramatically since liberalization began in the late 1980s and early 1990s (see Table 2.4). In India, direct investment went from $129 million in 1991 to just over $6 billion in 2006 and was forecast to reach $8 billion in 2007. Portfolio

1995

2000

2005

8.5 n.a. 79.2 −0.1 0.3 63.6 42.9 194.4 55,108.1

−6.7 n.a. 106.1 1.2 0.7 47.4 24.4 173.1 57,644.9

3.2 1.6 236.7 5.6 5.9 250.0 43.4 546.4 207,878.4

1.9 0.1 2,151.0 7.2 8.0 719.0 65.0 2,952.2 341,085.9

280.4 −0.1 2,319.0 13.0 −0.5 308.0 173.0 3,092.8 1,396,538.6

692.0 9.0 6,676.0 9.5 2.4 2,201.0 272.0 9,861.9 945,795.0

0.35%

0.30%

0.26%

0.87%

0.22%

1.04%

n.a. = not available. Source: UNCTAD FDI database online.

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1985

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Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka South Asia World

1980

South Asia: Rising to the Challenge of Globalization

Country

Foreign Direct Investment Inflows, 1980, 1985, 1990, 1995, 2000, and 2005 ($ million).

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Table 2.3

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Table 2.4 Direct Investment and Portfolio Investment in India and Pakistan, 1991, 1995, 2000, 2005, and 2007 ($ million).

Country

1991

1995

2000

2005

2007 (forecast)

129 4 3,385

1,954 2,784 −2,936

3,066 2,590 5,842

6,093 12,489 15,052

8,000 6,000 12,000

0 323 −112

439 1,098 333

471 73 1,254

750 −30 1,150

n.a. n.a. n.a.

India Direct investment Portfolio investment Increase in reserves Pakistan Direct investment Portfolio investment Increase in reserves

n.a. = not available. Source: Institute of International Finance website.

flows started more slowly, beginning only in 1993 after some liberalization of inflows. There was a big spurt in 1993 and 1994, followed by fluctuations over the next decade including negative flows in 1998 (not shown in the table). Since 2000, portfolio inflows have accelerated further, but with some fluctuation, reaching over $12 billion in 2005 before receding somewhat since then. Since 1991, foreign exchange reserves have also increased in every year except 1995. In Pakistan, direct equity investment has fluctuated since the late 1980s with a slight upward trend, peaking in 1998 at $1.5 billion and then falling back to around $700 million in the last few years. Portfolio investment has been anemic, and there has been a small outflow in most years since 2001. International reserves have also increased, but not at the same rate as in India. Much of the acceleration in FDI has been the result of policy changes that have made it easier for foreign investors to develop partnerships with South Asian firms and also to make portfolio investments in South Asian stock and bond markets. The Kearney’s Index (2006) has been compiled for the past several years. Its components are listed in Table 2.5a along with the rankings of selected countries (from a total of 62 countries) for 2001 and

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South Asia: Rising to the Challenge of Globalization Globalization Index Rankings, 2006.

Table 2.5a Country Bangladesh India Pakistan Sri Lanka PRC Indonesia Korea, Republic of Malaysia Singapore Taiwan Thailand

Economic

Personal

Technological

Political

61 59 60 38 28 52 32 3 1 12 16

37 51 34 27 55 59 39 19 3 33 49

62 57 59 58 50 51 19 28 12 18 41

49 60 55 58 47 50 33 48 29 62 57

Source: Kearney (2006).

Table 2.5b

Globalization Index Rankings, 2001 and 2006.

Country

2001

2006

Bangladesh India Pakistan Sri Lanka PRC Indonesia Korea, Republic of Malaysia Singapore Taiwan Thailand

48* 49* 56* 32* 48* 38* 31* 20* 1 32* 30*

58 61 56 46 51 60 29 19 1 35 45

*2002 figures. Source: Kearney (2006).

2006 (Table 2.5b). Except for Sri Lanka, the South Asian economies ranked near the very bottom of the overall ranking in 2006. The PRC also ranks low on the list. India ranks very low in three categories. It ranks higher in personal contact because of the size of remittances.

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Pakistan and Bangladesh have a similar profile and a surprisingly higher political engagement coefficient than India. Sri Lanka ranks higher because of its high score on the economic and personal categories. The data show that, aside from Pakistan, all countries in South Asia fell in the rankings from 2001 to 2006. But so did other East Asian countries (except the Republic of Korea and Malaysia). This perhaps could be due to the inclusion of additional middle-income countries in the sample during the period 2001–2006. The next ranking by Dreher (2005), which has only three categories — economic integration, political engagement, and social globalization — includes compiled estimates for 1975, 1990, and 2000. The rankings for South Asia and the PRC out of 123 countries are shown in Table 2.6. In this analysis there is a greater spread of rankings within South Asia than in the Kearney’s Index. India is ranked 62nd, Bangladesh 72nd, Pakistan 81st, and Sri Lanka 91st. Comparisons with previous years show an upward movement in the scores for all the countries in South Asia and also for the PRC, suggesting a definite trend toward greater globalization. This is particularly evident in the PRC, which shows a more dramatic increase resulting from various policies to open up the economy after 1975 and the rapid acceleration in growth from 1975 to 2000. This result implies a higher level of per capita income because of globalization. The case of India is also interesting. After its ranking fell in 1990 Table 2.6 Globalization Indices, 1975, 1990, and 2000 (Rankings for Selected Asian Countries Only). Rating Rank 52 62 72 81 91

Country

Economic

Political

Social

1975

1990

2000

PRC India Bangladesh Pakistan Sri Lanka

3.23 2.26 2.56 1.58 3.10

1.17 1.01 1.03 1.12 1.10

5.36 5.86 4.76 5.30 2.16

0.90 1.85 1.08 1.54 1.08

1.60 1.55 1.31 0.99 1.31

3.04 2.78 2.59 2.43 2.09

Note: Indices for economic, political, and social factors are for 2000. Source: Dreher (2005).

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relative to 1975, reflecting a tendency to become more insular, India accelerated its rate of globalization almost as dramatically as the PRC, raising its rating from 1.55 in 1990 to 2.78 in 2000, compared with a movement from 1.60 to 3.04 for the PRC over the same period. There was also substantial progress in globalization in the other countries in South Asia, particularly in Bangladesh and Pakistan. Rankings on both openness and indigenous factors are compiled by Li, Pang, and Ng (2006) and are shown in Table 2.7 for selected countries from a total of 62 countries. The indigenous factors are Table 2.7 Average).

Openness Factor and Indigenous Factor Indicators (1998–2002

Openness Factor Indicators Economies PRC Turkey Romania South Africa Indonesia Ukraine Botswana India Tunisia Colombia Peru Senegal Venezuela Nigeria Egypt Kenya Morocco Pakistan Sri Lanka Uganda Saudi Arabia Source: Li et al. (2006).

Indigenous Factor Indicators

Ranking

Economies

Ranking

40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

Iran Bangladesh Sri Lanka Turkey Peru Mexico Venezuela Colombia Russia Philippines India Iran PRC Indonesia Ukraine Senegal Kenya Pakistan Uganda Bangladesh Nigeria

61 62 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 61

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domestic characteristics that provide an enabling environment for globalization to take hold and thrive. These include 17 factors that are classified under the three broad categories of institutional establishment, education and health, and quality of the labor force.4 The openness rankings are for the same group of countries compiled by Kearney. While all of the South Asian countries are ranked toward the bottom of the scale, there are differences in the intra-regional rankings between Kearney and Li, Pang, and Ng. Bangladesh is ranked low in both but the other countries shift around. Sri Lanka is a relatively high 43rd in the Kearney ranking and 58th in Li, Pang, and Ng, while India is 47th in the Li, Pang, and Ng rankings and 61st in Kearney. As a comparator country, the PRC also ranks lower in Li, Pang, and Ng. Clearly the rankings are sensitive to the survey year and the different variable definitions. Therefore, the exact placement in the rankings should not be given too much weight. The more important point is the relatively low placement of South Asia in the rankings. A paper by Heshmati (2003) uses principal components to derive a weighted index of globalization for the same 62 countries as those used by Kearney. These rankings for Asia are found in Table 2.8. The rankings are closer to those of Li, Pang, and Ng than to those of Kearney. Sri Lanka is rated toward the bottom of the list; India is ranked 46th (47th in Li, Pang, and Ng) and the PRC is ranked 42nd (40th in Li, Pang, and Ng). Drawing conclusions from the overall analysis, Heshmati finds that low rank is often associated with lower personal and political factors and that technology factors are important in raising globalization connectivity.

4

The institutional factors are patent applications, corruption perception index, voice and accountability, political stability, government effectiveness, regulatory quality, rule of law, control of corruption, property rights protection, and regulatory scores. The education and health category consists of primary school enrollment, public spending on education, primary school pupil-teacher ratios, total health expenditure, and number of physicians per thousand households. The quality of the labor force includes youth employment and size of the child labor force.

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South Asia: Rising to the Challenge of Globalization Table 2.8

Globalization Rankings.

Country Bangladesh India Pakistan Sri Lanka PRC Indonesia Malaysia Singapore Taiwan Thailand

Rank 52 46 41 56 42 47 21 2 55 51

Source: Heshmati (2003).

An interesting result is that his index also shows that Indonesia, Taiwan, and Thailand are not much more globalized than Sri Lanka and Bangladesh and less so than India, Pakistan, and Sri Lanka. However, Singapore still gets high marks. Heshmati’s findings are significantly different from those of the other globalization studies and the conventional wisdom regarding globalization, showing a smaller gap between South Asia and East Asia. Indonesia, the Philippines, and Thailand, however, also rank low in the Dreher and Li, Pang and Ng studies but not in the Kearney study. From this review of globalization studies, it is evident that richer countries have higher globalization coefficients and that globalization and high incomes move together. However, it is hard to establish causality. The analysis has also shown that South Asia has only lately begun to globalize rapidly. Of the four indices constructed to reflect the economic, personal, technological, and political aspects of globalization, it is in the personal aspect that South Asia scores most heavily, primarily because of strong remittances. South Asia also scores poorly on the indigenous factor indicators, which include health and education, quality of the labor

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force, and institutional strength. The last-named variable includes indices of corruption, the effectiveness of the regulatory apparatus, voice in government and accountability, and government effectiveness and adherence to the rule of law. These indigenous factors change only slowly in response to a variety of social developments including openness and more rapid economic growth, which makes available resources for raising health and educational performance and for developing a more transparent and efficient government. Comparisons between South and East Asia including the PRC show that average scores in the PRC and East Asia reflect a higher level of globalization than in South Asia. Occasionally one of the East Asian economies registers a poor globalization score that could put it in the same globalization camp as South Asia, e.g., Indonesia in the Kearney rankings, Thailand in the Dreher, and Taiwan in the Heshmati rankings. Nevertheless, all four ranking schemes show that, on average, South Asia ranks below the PRC and East Asia in the extent of globalization.

Impact of Globalization on South Asia The relationship between economic growth and openness, and between economic growth and FDI inflows, was analyzed; the results are shown in Figs. 2.1 and 2.2. In addition, we explored the relationship between income growth and poverty reduction. Openness, as measured by the level of total trade, is positively related to economic growth. India dominates this relationship. For the other countries, openness and GDP growth are not as closely related. FDI and GDP growth are also positively related, and again the relationship is dominated by India. The level of GDP per capita is also positively related to reductions in the head-count ratio of poverty (Fig. 2.3). The evidence is limited and should be viewed with some caution since it is based on a small sample of poverty observations in South Asia over the past two decades. The extreme examples of Sri Lanka, India, and Pakistan demonstrate this relationship. Sri Lanka has historically had

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South Asia: Rising to the Challenge of Globalization 12 10

GDP growth (%)

8 6 4 2 0 -2 -4 0

50

100

150

200

250

300

Total trade (billion USD) Bangladesh

India

Fig. 2.1

Nepal

Pakistan

Sri Lanka

linear trend

Total Trade and GDP Growth.

Note: Authors’ calculation based on data for 1980–2005. Bangladesh, India, Pakistan, and Sri Lanka cover data for 1980–2005; Nepal, for 1981–2005. Source: World Bank, World Development Indicators Online.

a higher level of per capita income and also lower poverty ratios, while India and Pakistan have lower levels of per capita income and higher poverty ratios. More comprehensive studies of the growth-poverty nexus point to more robust results. Hasan and Quibria (2004), for instance, find evidence that growth reduces poverty in East Asia, Latin America, South Asia, and sub-Saharan Africa. Their estimates show that for South Asia, a 1% increase in per capita income would reduce the incidence of absolute poverty by 0.8%. Ravallion and Datt (1996) also note similar poverty-reducing effects of growth for India. We also carried out a more formal analysis by applying the model developed by Dollar and Kraay (2001) to South Asia. Following them, we computed similar (but simpler because of data limitations)

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12 10

GDP growth (%)

8 6 4 2 0 -2 -4 -6 -0.2

0

0.2

0.4

0.6

0.8

1

1.2

1.4

FDI (% of GDP) Bangladesh

Fig. 2.2

India

Nepal

Pakistan

Sri Lanka

linear trend

Foreign Direct Investment and GDP Growth.

Note: Data for Bangladesh, India, Pakistan, and Sri Lanka are based on figures from 1975, 1980, 1985, 1990, and 2000–2004. Data for Nepal are from 1980, 1990, 1995, and 2000–2004. Source: UNCTAD FDI statistics online; and World Bank, World Development Indicators Online.

growth regressions using lagged per capita GDP, trade, and FDI as explanatory variables. The following equations were used to estimate the coefficients: yct = β0 + β1 • yc, t−k + β2 • Tct + β3 • Ict + vct

(2.1)

yct − yc,t−k = β1 • (yc, t−k − yc, t−2k) + β2 • (Tct − Tc,t−k) + β2 • (Ict − Ic,t−k) + (vct − vc,t−k)

(2.2)

where yct is log-level of per capita GDP in country c at time t, yc, t−k is its lag in k years, Tct is the ratio of total trade to GDP, and Ict is the log of FDI. The variables Tc,t−k and Ic,t−k are the lagged values of trade

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GDP per capita (current $ PPP)

4000 3500 3000 2500 2000 1500 1000 500 0 0

10

20

30

40

50

60

Poverty Head-count Ratio Bangladesh

Fig. 2.3

India

Nepal

Pakistan

Sri Lanka

trend line

Poverty Head-Count Ratio and Level of Per Capita Income.

PPP = Purchasing Power Parity. Source: Poverty head-count ratios at $1 per day (PPP) from World Development Indicators database for 1984–2004. Bangladesh 1984, 1989, 1992, 1996, 2000; India 1987, 1993, 2000; Nepal 1985, 1996, 2004; Pakistan 1987, 1991, 1993, 1999, 2002; Sri Lanka 1985, 1990, 1996, 2002. GDP per capita from World Bank, World Development Indicators Online.

and FDI, respectively. We used a lag of k = 5 years rather than 10 because we had fewer observations than Dollar and Kraay (2001). Equation 2.1 is the standard cross-country growth regression. Equation 2.2 is an alternative specification in difference form to correct for problems of measurement error, omitted variables, and possible endogeneity. Equation 2.2 is a regression of growth on lagged growth and on changes in trade and FDI. Table 2.9 shows that the independent variables are positive and statistically significant in explaining growth. The lagged per capita GDP variable indicates that there is convergence of growth rates since the coefficient is less than 1. The positive relationship between growth and trade and FDI is consistent with other findings (Dollar and Kraay, 2001, for example) that

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South Asia’s Global Integration Table 2.9

35

Regressions of Per Capita GDP on Trade and Foreign Direct Investment.

Item Lagged per capita GDP Trade-to-GDP ratio FDI Constant No. of Observations F-statistic Adjusted R2

Equation 2.1

Equation 2.2

0.939 (57.84)*** 0.001 (5.03)*** 0.017 (6.85)*** 0.359 (4.49)***

0.437 (5.41)*** 0.001 (2.24)** 0.008 (1.82)* 0.068 (5.67)***

118

92

4,053.25

14.20

0.991

0.30

Note: Figures in parentheses are t-ratios. Results shown include Bangladesh, India, Nepal, Pakistan, and Sri Lanka. *** Significant at 1%, ** at 5%, * at 10%. Source: Computed from World Development Indicators Online and UNCTAD FDI Database online using Stata Package 9.0.

policies, encouraging greater trade openness and investment integration help promote growth.5

South Asia’s Globalization Initiatives South Asian countries have taken a number of initiatives to open up their economies to international trade in goods and services. There have also been initiatives to increase participation in international organizations and encourage international migration of labor. Each of these initiatives is described in the rest of this section. We begin with international trade initiatives to lower tariff barriers and then move on to 5

We also estimated Equation 2.2 by including government-consumption-to-GDP ratio, M2, and inflation as controlling variables. The results for trade and FDI were similar to those reported in Table 2.9, although the FDI coefficient turned out to be insignificant in one of the difference equations that included government consumption and inflation. The coefficients for the controlling variables were mostly insignificant.

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a discussion of regional trade agreements. We then examine the efforts made to participate in international organizations. We also look at the international competitiveness of South Asian economies and the role of financial integration and capital account liberalization in promoting globalization. Finally, we discuss labor migration policies and initiatives. Free Trade Agreements There are three possible ways to focus efforts on lowering barriers to international trade in goods and services. First is by granting trade preferences to all countries unilaterally — the so-called most-favorednation (MFN) approach. Unilateral lowering of trade barriers is a generous approach to increasing international trade since it does not require reciprocity from other countries. A second approach is to enter into negotiated FTAs with individual countries bilaterally. A third approach is to negotiate preferences as part of an association of nations that then negotiates tariff reductions among the member countries and with other countries or associations. This is the plurilateral FTA approach. We explore trade agreements between South Asia and East Asia in Chapter 4, and between countries in South Asia — such as initiatives by the SAARC and the Bay of Bengal Institute for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC)6 countries — in Chapter 5. In this section we focus on FTAs that have been negotiated between South Asian and non-Asian countries. South Asia has signed or is negotiating free trade or preferential trade agreements with a number of countries outside Asia (see Table 2.10). India and Pakistan have either signed or are negotiating the most agreements (14 for India and 11 for Pakistan). Only a few had been signed as of June 2007. Most of these FTAs are with developing countries with large Islamic populations, although Pakistan and Sri Lanka are negotiating pacts with the US. To date, Bangladesh has signed an agreement with the Group of Eight Developing Countries, of which it is also a member. India has signed agreements with Chile and Mercosur 6

BIMSTEC comprises Bangladesh, Bhutan, India, Myanmar, Nepal, Sri Lanka, and Thailand.

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South Asia’s Global Integration Table 2.10 Bangladesh

India

Pakistan

37

South Asian Free Trade Agreements with Non-Asian Countries. • Preferential-Tariff Arrangement — Group of Eight Developing Countries (signed) • Preferential Trade System of the Organization of the Islamic Conference (FA/signed/FTA under negotiation) • India–Australia Free Trade Agreement (proposed/under consultation and study) • India–Chile Preferential Trading Agreement (signed) • India–Colombia Preferential Trading Arrangement (proposed/under consultation and study) • India–Egypt Preferential Trade Agreement (under negotiation) • India–European Union Free Trade Agreement (proposed/under consultation and study) • India–Gulf Cooperation Council Free Trade Area (FA signed/ FTA under negotiation) • India–Israel Preferential Trade Agreement (proposed/under consultation and study) • India–Mauritius Comprehensive Economic Cooperation and Partnership Agreement (under negotiation) • India–Mercosur Preferential Trade Agreement (signed) • India–Southern African Customs Union Preferential Trade Agreement (FA signed/FTA under negotiation) • India–Uruguay Preferential Trading Arrangement (proposed/ under consultation and study) • India–Venezuela Preferential Trading Arrangement (proposed/ under consultation and study) • New Zealand–India Free Trade Agreement (proposed/under consultation and study) • India–Russian Federation Comprehensive Economic Cooperation Agreement (proposed/under consultation and study) • Economic Cooperation Organization Trade Agreement (signed) • Pakistan–Gulf Cooperation Council Free Trade Agreement (FA signed/FTA under negotiation) • Pakistan–Iran Preferential Trade Agreement (signed) • Pakistan–Jordan Free Trade Agreement (proposed/under consultation and study) • Pakistan–Mauritius Preferential Trade Agreement (under negotiation) • Pakistan–Mercosur Preferential Trade Agreement (FA signed/ FTA under negotiation) (Continued)

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Sri Lanka

(Continued)

• Pakistan–Morocco Preferential Trade Agreement (under negotiation) • Pakistan–Turkey Preferential Trade Agreement (FA signed/FTA under negotiation) • Preferential Tariff Arrangement — Group of Eight Developing Countries (signed) • Preferential Trade System of the Organization of the Islamic Conference (FA signed/FTA under negotiation) • United States–Pakistan Free Trade Agreement (proposed/under consultation and study) • Sri Lanka–Iran Preferential Trade Agreement (signed) • United States–Sri Lanka Free Trade Agreement (proposed/under consultation and study)

FA = Framework Agreement, FTA = Free Trade Agreement. Note: Bangladesh, Egypt, Indonesia, Iran, Malaysia, Nigeria, Pakistan, and Turkey are in the Group of Eight. The Economic Cooperation Organization comprises Afghanistan, Iran, Pakistan, Tajikistan, and Turkey. The organization of the Islamic Conference has 56 Islamic member states. Source: ADB, Asian Regional Integration website: http://www.aric.adb.org.

(the Southern Common Market). Pakistan has signed agreements with the Economic Cooperation Organization, the Group of Eight, and Iran. Sri Lanka has signed a pact with Iran. The rest are under negotiation. Only India is negotiating with a large number of countries that are not Islamic and outside West Asia. Since most of these FTAs or preferential trading arrangements (PTAs) are still under negotiation, it will take some time before their impact on the pattern of South Asian trade and economic development can be assessed. International Trade Liberalization Tariff reduction is the primary way to liberalize international trade, and tariff and nontariff barriers in South Asia have been lowered rather dramatically over the past two decades. Mean tariff rates are substantially lower than they were in 1985 — from around 80% or more in Bangladesh, India, and Pakistan to under 20% in all countries except India (Table 2.11).

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Table 2.11 Mean Tariff Rates in East Asia and South Asia, 1985, 1990, 1995, 2000, and 2004 (percentage). Country

1985

1990

1995

2000

2004

Bangladesh India Nepal Pakistan Sri Lanka Korea, Rep. of Indonesia Malaysia Philippines Thailand

86.0 98.8 22.6 78.0 29.0 23.0 18.1 13.5 27.6 31.2

102.2 79.2 22.6 58.8 26.9 13.3 20.3 13.0 24.3 40.8

81.2 55.2 16.1 61.1 26.1 11.5 17.0 12.8 27.6 36.0

21.6 32.5 14.7 46.6 9.9 8.7 8.4 9.2 7.6 17.0

16.4 28.1 14.8 16.1 9.8 9.3 6.4 7.4 4.4 13.3

Source: Economic Freedom of the World 2006 Annual Report, Chapter 3.

It is hard to assess the amount of protection afforded by NTBs such as cumbersome procedures, import restrictions, trading monopolies, quota restrictions, as well as import taxes and restrictive licensing of imports. Some of these NTBs have been outlawed by the World Trade Organization (WTO), but others are still in effect. Some empirical work by Littellvin (1994) and Deardorff and Stern (1997) suggest that the negative impact of NTBs on international trade is greater than that of import tariffs. Many other observers think that NTBs offer more protection than tariffs and that greater efforts should be made to reduce these barriers further. Role in Global Organizations India and South Asia play a major role in global organizations. India is one of the largest developing countries and a member of the Group of Twenty (G20) and other groups representing developing countries. The G20 is an informal meeting of the finance ministers and central bank governors of 19 countries: Argentina, Australia, Brazil, Canada, the PRC, France, Germany, India, Indonesia, Italy, Japan, Republic of Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey, the United Kingdom, and the United States, plus the European Union Council presidency and the European Central Bank. The managing director of

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the International Monetary Fund (IMF) and the president of the World Bank, plus the chairs of the International Monetary and Financial Committee and Development Committee of the IMF and World Bank, also participate in G20 meetings as ex officio members. The G20 is an interface between the G7 and the broader global economic community. India’s share in the IMF is second only to that of the PRC among developing countries. However, its share declined slightly to 1.91% in 2006 from 1.95%. Shares are adjusted under a new formula to show a country’s relative position in the world economy, as reflected in the openness of its economy and the size of GDP. Following this formula, it is recommended that India’s share be revised upward in the future. In the United Nations, India was an elected member of the UN Security Council in 1991 and 1992. Other countries in South Asia have also served on the Security Council. Bangladesh was an elected member in 2000 and 2001, while Pakistan was an elected member in 2003. In July 2005, Brazil, Germany, India, and Japan — known as the Group of Four (G4) — submitted a resolution to the Security Council proposing that the council be expanded to include six new permanent non-veto-holding seats and four rotating seats. Debate on this proposal continues in the UN. India was a founding member of the General Agreement on Tariffs and Trade (GATT) and of the WTO. India has also been actively engaged in different formats within the WTO (G4, G20, G33, Core Group on Services, group on processing standards, the “five interested parties” [FIPS] working to break the deadlock in agriculture) and will continue to play a constructive role in pursuing its national interests. In fact, India, along with Brazil, is a representative of the G20 in the FIPS. International Competitiveness Increasing international competitiveness is important in enhancing trade performance and raising incomes. Increased competitiveness means that policies to promote exports, lower trade barriers, and open up the economy are helping to increase the ability of South Asia to compete in international markets. The World Competitiveness Yearbook provides assessments of competitiveness in the global economy over the past decade (Tables 2.12a and 2.12b). Several indicators

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Table 2.12a World Competitiveness Indicators, 1995 and 2006 (rankings). Country India Indonesia Korea, Republic of Malaysia Singapore Taiwan Thailand Maharashtra Zhejiang

1995

2006

36 33 25 22 2 14 26 n.a. n.a.

29 60 38 23 3 18 32 37 33

n.a. = not available. Source: World Competitiveness Yearbook, 1996 and 2006.

Table 2.12b

Country India Indonesia Korea, Rep. of Malaysia Singapore Taiwan Thailand Maharashtra Zhejiang

World Competitiveness Factors, 2000 and 2006 (rankings). Economic Performance

Government Efficiency

2000

2006

2000

2006

2000

2006

2000

2006

23 39 13 10 8 26 15 n.a. n.a.

7 61 41 11 4 27 21 19 10

44 41 33 24 1 18 30 n.a. n.a.

35 51 47 20 2 24 21 36 29

38 45 27 31 6 20 42 n.a. n.a.

19 57 45 20 7 14 28 27 36

43 47 28 32 3 21 37 n.a. n.a.

54 61 24 31 5 20 48 57 49

Business Efficiency

Infrastructure

Note: Low scores are good; high scores are less satisfactory. Total number of countries (world): 2006 Yearbook — 53 industrialized and developing countries and 8 national zones (Bavaria, Catalonia, Île-de-France, Lombardy, Maharashtra, Scotland, State of Sao Paulo and Zhejiang); 2001 Yearbook — 49 industrialized and developing countries; 1996 Yearbook — 46 countries. Source: World Competitiveness Yearbook, 2001 and 2006.

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are used to compile an overall index of competitiveness. These include the four categories of economic performance, government efficiency, business efficiency, and quality of infrastructure. An analysis of these scores for South Asia in comparison with other Asian economies can give some guidance for future policy reform. India, which was the only South Asian economy included, moved up in the rankings by seven places from 1995 to 2006, a strong improvement. In contrast, other Southeast and East Asian economies lost competitiveness and fell in the rankings. The loss of competitiveness in East Asia corresponds closely with the intensity of the impact of the financial crisis in Southeast and East Asia. Indonesia was the worst hit, followed closely by the Republic of Korea and Thailand. There was less impact on Malaysia, Singapore, and Taiwan. In 2006, India ranked higher in competitiveness than three East Asian and Southeast Asian economies: Indonesia, Republic of Korea, and Thailand. This was a dramatic improvement from the rankings in 1995, when India placed last among Asian economies. In 2006, the World Competitiveness Index also developed rankings for different national zones that specialize in the production of industrial exports. There were two zones in Asia, Maharashtra (where Mumbai is located) in India and Zhejiang in southern PRC. Maharashtra compares favorably with Zhejiang, slightly lower in the rankings but higher than India as a whole. In a comparison of the countries in the four areas of economic performance, government efficiency, business efficiency, and infrastructure, India showed the biggest gains in economic performance, jumping to 7th place in 2006 from 23rd in 2000. Its efficiency rankings (government and business) also improved, while infrastructure deteriorated. In business efficiency, India now ranks behind Singapore and Taiwan, but ahead of Thailand, Republic of Korea, Malaysia, and Indonesia in East Asia. In 2000, India ranked last in government efficiency. By 2006, it had moved up several notches ahead of Indonesia and Republic of Korea. Maharashtra lagged behind Zhejiang in the three categories of economic performance, government efficiency, and infrastructure but came out ahead in business efficiency.

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The overall results of this global competitiveness survey are encouraging. The business efficiency ratings reflect a sharp improvement in the international competitiveness of Indian businesses. They indicate that India has been partially successful in streamlining business procedures and can improve even more by undertaking further reforms — reducing bureaucratic procedures and increasing competition — to improve business and government efficiency. There is scope for improving performance in the other areas, particularly infrastructure. However, once the regulatory environment in India improves and infrastructure bottlenecks are removed, overall efficiency will certainly improve and India will be able to compete effectively in a wide array of goods and service export markets. Compared to the PRC, for example, India has a much longer mercantilist and business history and it can exploit this advantage. Other countries in South Asia also have good business experience and acumen and can use this to develop their export capabilities. On the other hand, the PRC can benefit from India’s experience to improve the efficiency of its business operations. International Migration and the Pattern of Remittances International flows of labor and remittance income are an area where there has been limited policy dialogue. Along with rates of overseas migration, remittance flows are a useful index of labor market integration and are easier to track. The two variables also tend to move together. Furthermore, the indices of globalization reported in the previous section incorporate the level of remittance as a measure of labor market integration. Labor migrants tend to make up two distinct groups: professionals who migrate for an extended period or even permanently, and manual and other unskilled and semi-skilled workers who work overseas for short periods on a contract basis, often in the Middle East. The potential contribution of professionals to globalization is higher since they can bring back skills and education from their overseas experience and even networks that enable them to establish start-up businesses in their home countries. Returning South Asian migrants from the USA and Europe, for example, and the communications links developed between them have provided stimulus

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for recent developments in IT, particularly in India and Bangladesh. Aside from the remittance flows that contribute to family income and help reduce poverty in the home country, unskilled and semi-skilled workers may bring back additional work experience that will contribute to their labor productivity when they return home. Remittances in South Asia, although relatively flat during the 1980s, are now increasing rapidly (see Table 2.13). The slowdown in economic growth in the Middle East after the second oil shock in the late 1970s and early 1980s lessened the demand for overseas workers. In the 1990s, the flow of remittances accelerated dramatically, and by 2000 the overall flow had more than tripled in value since 1990. During this decade there was solid growth in income in industrial countries and some recovery in the Middle East. The demand for overseas workers thus continued to accelerate in industrial countries. The demand for scientists, doctors, and other health professionals picked up as the domestic supply of new entrants into these professions in industrial countries failed to keep pace with demand. The demand for unskilled and semi-skilled workers also increased as the construction industries in the Middle East grew and domestic residents in industrial countries kept away from jobs in these occupations. With the onset of the global slowdown in 2001 and 2002, workers’ remittances weakened from lack of growth in demand in industrial countries and the Middle East.

Table 2.13 Workers’ Remittances and Receipts (Balance of Payments), 1980, 1985, 1990, 1995, 2000, and 2004 ($ million). Country Bangladesh India Nepal Pakistan Sri Lanka South Asia

1980

1985

1990

1995

2000

2004

338.7 2,755.7 0.0 2,047.6 151.7 5,293.7

502.5 2,466.9 0.0 2,537.1 291.7 5,798.1

778.9 2,351.9 0.0 2,006.3 400.8 5,537.8

1,201.7 6,139.0 56.8 1,712.2 789.8 9,899.5

1,958.1 12,744.9 111.5 1,075.0 1,142.3 17,031.8

3,572.2 21,595.1* 792.6 3,943.0 1,563.9 9,871.7

*2003 figure. Source: World Bank, World Development Indicators Online.

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Countries in South Asia have implemented policies for monitoring, regulating, and encouraging the flow of workers in both categories of skill. In India efforts are being made to encourage skilled workers to return home, and measures are also being taken to streamline the inflow of remittances. One approach to dealing with these issues is to encourage temporary, instead of permanent, migration. Several industrial countries have developed visas that encourage this migration route (see Khadria, 2006). Migration policies range from unregulated regimes (where the migration decisions and flows are left to the market) to more regulated and state-managed policies. In the case of regulation, the state establishes a legal framework to control and license the recruitment agencies that hire workers for overseas positions. These recruitment agencies coordinate with firms and agencies in receiving countries, and the markets do the rest. This is the typical system in most Asian countries including Bangladesh, India, and Pakistan, where most placements are made by private agencies. In some countries, state-managed firms are set up to recruit workers and subsidies can be given to encourage particular kinds of migration. In South Asia, only Pakistan follows this model, which allows for some private sector participation. In the PRC, the state controls the entire migration process (see Waddington, 2003, for details).

Future Agenda for Globalization in South Asia It will be beneficial for South Asia to further integrate into the global economy. As our analysis has shown, initiatives taken since the 1980s and the 1990s have borne fruit, both in accelerating economic growth and reducing poverty. South Asia needs to build on this foundation to improve its international competitiveness further and to accelerate economic growth. There are several ways in which South Asia can integrate further into the global community. Many of these initiatives relate to international trade in goods and services as well as the flow of capital. These aspects are covered in the rest of this section, which deals with reducing trade barriers (including the role of SAARC), improving international competitiveness, attracting FDI,

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developing new trade agreements, and increasing capital account convertibility. There is also a need to address the flow of labor and issues of financial integration, which are discussed in the second part of this section. Further Reduction in Trade Barriers While tariffs have been reduced in South Asia, they need to be lowered further if the region is to stay competitive with East Asia and Southeast Asia in export markets. The average tariff rates in South Asia are higher than those in East and Southeast Asia. Furthermore, the USA and other industrial countries impose higher tariffs on products from South Asia than on goods exported from East and Southeast Asia. The effective rate of import duty to the USA (measured as a percentage of customs value of shipments to the USA) is shown in Table 2.14 for selected countries in East Asia and South Asia. With the exception of Viet Nam, tariff rates on South Asian products are significantly higher than for other countries. Furthermore, countries that have a free trade agreement with the USA, including members of the North American Free Trade Agreement (NAFTA), Australia, and Singapore, have duties of less than 1%. Deeper integration within the South Asian community can be an important force for globalization as well as further cooperation within

Table 2.14 Effective Rate of Duty on Imports into the USA, 2005 (percentage). Country Bangladesh Nepal Pakistan Sri Lanka Indonesia Philippines Viet Nam

Effective Duty Rate 14.7 8.8 10.1 13.3 5.5 4.0 9.0

Source: Asian Development Bank (2006) and US International Trade Commission.

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South Asia. One way to achieve these objectives is to pursue a globalization agenda through SAARC. This could complement individual country initiatives and would enhance globalization and increase economic efficiency by reducing high trading costs. There are several areas where this is possible. Trade facilitation with the SAFTA treaty can be achieved through harmonized standards, as well as customs procedures and evaluation methods, and increased efficiency in transporting goods across borders and within individual countries. Cost reductions can be dramatic and can even dwarf the gains from tariff reduction. Trade in services, including the movement of labor, should be part of an expanded agenda for SAFTA. Illegal migration and human rights violations could be covered, as could a review of migration laws and restrictions. The removal of constraints on investment flows across borders can also be addressed, as well as the promotion of investment from countries in other regions. One proposal that makes sense is to create a common investment area that would develop a harmonized investment policy setting out common guidelines for foreign investors. This move would be in step with the removal of restrictions on investment in stock markets, perhaps leading to the setting up of a common stock exchange under the auspices of SAARC. Trade negotiations with other regional groupings outside Asia should be pursued as well. These groups are also looking for closer relationships outside their regions as they grapple with some of the same problems that face SAARC. Table 2.15 shows that intra-regional trade has also increased within these groups even as they try to increase total trade. Generally, with the exception of the Common Market of Eastern and Southern Africa (COMESA), these groups have been able to raise intra-regional trade more than SAARC in the 1990s. Enhanced International Competitiveness The overall results of competitiveness surveys reported in Table 2.12a are encouraging. India is becoming more efficient and competitive, particularly in business efficiency. Compared to the PRC, for example, India has a much longer mercantilist and business history and it can exploit this advantage in the future. There is scope for more

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Intra-regional Export Shares, 1990 and 2001 (percentage).

Group

1990

2001

Andean group Mercosur COMESA SADC UEMOA ASEAN/AFTA SAARC

4.2 8.9 6.3 3.1 12.1 19.0 3.2

11.2 20.8 5.2 10.9 13.5 22.4 4.9

AFTA = ASEAN Free Trade Area, ASEAN = Association of Southeast Asian Nations, COMESA = Common Market of Eastern and Southern Africa, SAARC = South Asian Association for Regional Cooperation, SADC = South African Development Community, UEMOA = West African Economic and Monetary Union. Note: The Andean group is a South American trade organization with Bolivia, Colombia, Ecuador, and Venezuela as members. It created a free trade area, the Andean Pact, in 1992. Mercosur, the Southern Common Market, was created by Argentina, Brazil, Paraguay, and Uruguay in 1991. Source: Mehta and Kumar (2004).

improvement, through further reforms in business and government efficiency by reducing bureaucratic procedures and increasing competition. On the other hand, the PRC can benefit from India’s experience to improve the efficiency of its business operations. Other countries in South Asia also have good business know-how and acumen and can use this to develop their export capabilities. In increasing competitiveness, infrastructure improvements are critical. The lack of a modern and efficient infrastructure foundation is inhibiting the growth of industry and the private sector in South Asia. The removal of road transportation bottlenecks can be extremely effective in increasing efficiency by reducing costs and time-to-market as well as facilitating the movement of temporary labor throughout the country. Cross-border links should also be improved through the Asian highway network and the trans-Asian railway system. These are components of the Asian land transportation infrastructure system, which includes capital-to-capital links and connections between industrial centers,

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agricultural centers, and growth zones, besides connections to major sea and river ports and inland terminals. Some important components of this network are the Jamuna bridge in Bangladesh; the removal of transit restrictions between India, Bhutan, Nepal, and Bangladesh; and the rehabilitation of the Arakan road linking Myanmar and Bangladesh. The power network in India is overloaded and subject to periodic interruptions of service, with severe adverse effects on industrial productivity. India’s higher power costs than those of countries in East Asia put it immediately at a competitive disadvantage. Water supply and sewerage is also a constraint, as is irrigation water in agriculture. More effective water pricing in rural areas is a key to more efficient water use in agriculture. In urban areas, access to clean water and proper sewerage is critical. Many lives are lost to dysentery, cholera, and other water-borne diseases. The implications regarding globalization that flow from the analysis of the competitiveness index are somewhat at odds with the globalization indices presented earlier, which had South Asia near the bottom in most categories. The most plausible explanation is that the two indices measure different aspects of globalization and development. For the most part, globalization figures capture the macroeconomic aspects of development achievements, although there are broader political and social performance indicators reported. On the other hand, the competitiveness index focuses on a number of economic characteristics that have to do with economic performance. This is the area where India has been doing a better job in recent years. If this pattern continues, the competitiveness index will improve as well. It should be noted, however, that the competitiveness survey results apply only to India, though it is likely that other countries in the South Asian region have also improved their competitiveness. Increased Foreign Direct Investment Additional measures can be adopted to attract FDI. These include a variety of institutional and procedural improvements that can demonstrate the attractiveness of South Asia as an FDI destination. First, measures can be taken to harmonize FDI regulations and incentives to stop a “race to the bottom,” develop regulations to

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stop double taxation, pool experience among South Asian countries to determine a strategy for attracting FDI into different sectors, and establish a regional research center devoted to studying the pattern and effectiveness of FDI in the region and elsewhere and disseminating the results. Second, a series of procedures can be developed to simplify entry and exit procedures, fast-track approvals of FDI investment, allow repatriation of profits, and encourage free flow of intra-regional FDI. New Free Trade Agreements Free trade agreements between South Asia and other countries can involve other regional groups and large countries in addition to individual countries and groups of countries. Among these new initiatives could be agreements with the European Union, NAFTA or the USA, and Mercosur. India has signed agreements with Chile and Mercosur and has several FTAs under consideration with several Latin American countries. Sri Lanka and Pakistan are in negotiation with the USA, and India is holding talks with the European Union. Further steps could be taken to accelerate these negotiations and to begin new negotiations, perhaps between SAARC and ASEAN or between SAARC and the European Union. Bilateral negotiations between individual South Asian countries and these larger groupings are also possible. Also, South Asian countries will definitely continue to participate in ongoing global negotiations of the WTO. Properly Sequenced Capital Account Convertibility Capital account liberalization has come under serious scrutiny among developing countries since the Asian financial crisis. The conventional wisdom is that capital account convertibility should follow current account convertibility once the preconditions for liberalization are in place. These conditions would include a flexible exchange rate and appropriate exchange rate policies, acceptable fiscal deficits, restructuring and recapitalization of domestic banks, greater domestic competition to encourage efficient operation of the financial sector, and

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satisfactory macroeconomic and external indicators like inflation, debt service, and foreign exchange reserve position. There would also have to be progress in secondary or microeconomic reforms such as better governance, greater transparency and accountability, enhanced competition in the productive sectors, and labor reforms. Despite this wisdom, many East Asian countries deregulated their capital account early in their reform program (Indonesia did so in the early 1970s), and the resulting vulnerability eventually precipitated the Asian financial crisis. An important lesson for South Asia is, therefore, to properly sequence capital account liberalization. A pragmatic approach is necessary. Jadhav (2003) provides an excellent summary of the current state of capital account liberalization in India. The primary aim of capital account liberalization after the 1991 financial crisis was first to gradually liberalize foreign investment and portfolio investment inflows. Capital outflows were still controlled. The liberalization of inflows was considered possible only after some of the preconditions discussed above were met, namely, low inflation, deregulation of interest rates, and better risk management, auditing, and disclosure. Fiscal consolidation and reduction of non-performing loans have lagged behind, however. On the inflow side, FDI is still on a two-track system, where the second track has to be approved case by case. Portfolio investments are still restricted to certain institutional investors and non-resident Indians (NRIs). Other inflows such as overseas borrowing are confined to businesses and development finance institutions; banks are excluded. There are also ceilings on long-term external borrowing. Short-term external debt is heavily regulated and limited to trade finance. Short-term debt as a proportion of foreign currency assets is now less than 10%. The Government has liberalized capital outflows gradually by lifting controls on the convertibility of domestic assets by residents as well as dollarization of domestic assets. Corporations have the fewest regulations relating to outflows, followed by financial intermediaries and then individuals. Convertibility of assets by individuals is likely to be low on the list of priorities, however, since there is a fear that an anticipated currency depreciation of the rupee would result in capital

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flight and further rupee depreciation. Since the current rupee money supply is four times the level of foreign exchange reserves, rupee assets are still unlikely to be made fully convertible anytime soon. Residents are prohibited from dollarizing rupee accounts for the same reason. Deeper Financial Integration Harmonization of financial regulations is a primary goal of further financial integration in South Asia. This should be combined with deepening of the financial infrastructure and financial markets, perhaps using the ASEAN + 3 Asian Bond Market Initiative of East Asia as a model. Currently the flow of inter- and intra-regional portfolio investments in South Asia is still quite small (see Table 2.16). Investments from NAFTA are the largest single component, at $20 billion. Other flows are smaller. Total flows to the region are an Table 2.16

Interregional and Intra-regional Portfolio Investments, 2003 ($ billion). Investment From South Asia

Rest of the World

Total

751 801 95 2

0 0.006 0 0.008

1,620 1,452 159 16

4,703 10,001 1,049 49

1,316

585

0.054

487

3,241

9,620

2,233

0.068

3,246

19,044

Investment in

NAFTA

EU15

NAFTA EU15 East Asia South Asia (India, Pakistan, Sri Lanka) Rest of the World

548 1,617 419 20

1,784 6,132 376 12

858

Total Global

3,462

East Asia

NAFTA = North American Free Trade Agreement. Note: EU15 = Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Sweden, Spain, and United Kingdom. East Asia = People’s Republic of China; Hong Kong; Indonesia; Japan; Republic of Korea; Malaysia; Philippines; Singapore; Thailand; and Viet Nam. Source: International Monetary Fund, Coordinated Portfolio Investments Survey.

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order of magnitude smaller than flows to East Asia ($49 billion, compared just over $1 trillion to East Asia and $19 trillion in global flows in 2003). Flows out of South Asia are also close to zero. Outflows of portfolio investment from India are prohibited, and the investments of the other countries are very limited — less than a few million dollars. Integrating further into global money markets requires the region to explore new financial instruments with a regional as well as local flavor, including insurance and other financial instruments that would help to reduce the region’s focus on bank lending. It would also include developing a region-wide rating agency, a clearing and payments system for South Asia, and pension systems, which are woefully lacking in the region, and strengthening corporate governance. As an aside, corporate governance, to the extent that it is related to the financial sector, is also essential for financial market development. India is already well placed compared with other countries in the Asian region (see Table 2.17) and can build on this foundation as it develops deeper reforms to protect minority shareholders, increase the transparency of closely held companies, and develop legal channels for legal redress for shareholders.

Table 2.17

Corporate Governance Ratings, 2000 and 2004.

Country People’s Republic of China Hong Kong, China India Indonesia Korea, Republic of Malaysia Philippines Singapore Thailand

2000

2004

3.6 7.1 5.6 2.9 5.2 3.2 2.9 7.5 2.8

4.8 6.7 6.2 4.0 5.8 6.0 5.0 7.5 5.3

Note: High scores reflect better corporate governance. Source: Cowen et al. (2006).

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Migration and Remittance Facilitation Some migration patterns and remittance flows are amenable to policy reform only after extensive consultation with recipient governments. Many impediments to further migration rest with recipient countries in Europe, North America, and Australia. Negotiations to enhance personal safety and improve working conditions for short-term guest workers should be intensified on a bilateral basis. Facilitation of remittance flows can also be improved. Further integration into the global information and telecommunications labor market can be encouraged and promoted in a number of ways. Giving support to the private sector by upgrading physical infrastructure in service sectors specializing in IT and communications should be a major priority area as the demand for outsourcing and migration of skilled professionals in the IT industry continues to grow. Better coordination between shifting job openings in industrial countries and skill development in South Asian countries can be developed by encouraging private sector involvement in IT and communications training in South Asia as well as facilitating migration programs that allow skilled and professional workers to migrate for a year or two and then return to use their expertise at home. The key to a successful migration policy is flexibility, allowing competition to flourish while at the same time ensuring protection of the rights and well-being of migrants. Important components of the latter are predeparture training and provision of information, including the person or office to contact to report contract violations, physical abuse, or other problems or issues. These policies can be the subject of bilateral and multilateral talks between source and host countries in the region and in other regions. Experience in such negotiations is not extensive. Abella and Lonnroth (1995) report that there are virtually no agreements regarding labor migration between source countries and host countries. Furthermore, internationally agreed standards under the UN International Covenant on Economic, Social, and Cultural Rights have been difficult to enforce for migrants. Host countries are often not interested, and sending country governments have little leverage. To bridge this gap, the UN adopted a special treaty in 2003 to protect migrants’

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rights and privileges. These rights need to be followed up with recipient countries, particularly in the Middle East.

References Abella, M and K Lonnroth (1995). Orderly International Migration of Workers and Incentives to Stay: Options for Migration to the Arab World — Experience of Returning Migrants. Japan: United Nations University Press. Alesina, A, V Grilli and GM Milesi-Ferretti (1994). The Political Economy of Capital Controls. In Capital Mobility: The Impact on Consumption, Investment and Growth, Leonardo Leiderman and Assaf Razin. Cambridge University Press. pp. 289–321. Asian Development Bank (2006). Asian Development Outlook 2006. Chandra, A (2001). The Influence of Capital Controls on Long Run Growth: Where and How Much? North Carolina State University. Mimeo. Cowen, D, R Salgado, H Shaw, L Teo and A Zanello (2006). Financial Integration in Asia: Recent Developments and Next Steps. Part II. IMF Working Paper WP/06/196. Deardorff, AV and RM Stern (1997). Measurement of Non-Tariff Barriers. Economics Department Working Paper 179. OECD, Paris. Dollar, D (1992). Outward-Oriented Developing Economies Really Do Grow More Rapidly: Evidence from 95 LDCs, 1976–85. Economic Development and Cultural Change, pp. 523–544. Dollar, D and A Kraay (2001). Trade, Growth, and Poverty. World Bank Discussion Paper. Washington, DC. Dreher, A (2005). Does Globalization Affect Growth? Evidence from a New Index of Globalization. Thurgauer Wirtschaftsinstitut Research Paper Series No. 6. April. Frankel, JA and D Romer (1996). Trade and Growth: An Empirical Investigation. NBER Working Paper 5476. Hasan, R and MG Quibria (2004). Industry Matters for Poverty: A Critique of Agricultural Fundamentalism. Kyklos 57, pp. 253–264. Heshmati, A (2003). Measurement of a Multidimensional Index of Globalization and Its Impact on Income Inequality. United Nations University Wider Institute of Development Economics Research Discussion Paper No. 2003/69. IMD. (1996). The World Competitiveness Yearbook 1996. ———. (2001). The World Competitiveness Yearbook 2001. ———. (2006). The World Competitiveness Yearbook 2006. Institute of International Finance website. www.iif.com International Monetary Fund (2006). Direction of Trade Statistics. CD-ROM. July.

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Jadhav, N (2003). Capital Account Liberalisation: The Indian Experience. Paper presented at the conference A Tale of Two Giants: India’s and China’s Experience with Reform and Growth, New Delhi. Kearney Inc. (2006). Foreign Policy Magazine Globalization Index 2006. http://www. atkearney.com/. Khadria, B (2006). Uncharted Contours of a Changing Paradigm: Skilled Migration and Brain Drain in India. Harvard International Review. http://hir.harvard.edu/ articles/print.php?article=1445. Li, KW, IAJ Pang and MCM Ng (2006). The Impact of Openness and Indigenous Factors on Economic Growth and Globalization among World Economies. APEC Study Center Consortium Conference, Ho Chi Minh City, Viet Nam, 23–24 May. Littellvin, E (1994). Intra-industry Trade in Asia. International Economic Journal, 8(4), Winter. Mehta, PS and P Kumar (2004). RTAs and South Asia: Options in the Wake of the Cancun Fiasco. Australian South Asia Research Center Working Paper 11. Ravallion M and G Datt (1996). How Important to India’s Poor is the Sectoral Composition of Growth? The World Bank Economic Review, 10(1): 1–25. Rodrik, D (1998). Who Needs Capital Account Convertibility? In Should the IMF Pursue Capital Account Convertibility? Essays in International Finance 207, edited by Stanley Fischer, Department of Economics, Princeton University, Princeton, NJ. pp. 55–65. Waddington, C (2003). International Migration Policies in Asia. Paper presented at the Regional Conference on Migration, Development and Pro-poor Policy Choices in Asia, Department for International Development, UK . www.livelihoods.org.

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Chapter 3

A Comparative Analysis of Economic Performance and Policy Reforms in South Asia and the PRC

Introduction Both India, along with its neighbors in South Asia, and the PRC have been growing rapidly in the past few years, faster than most other developing countries in Asia and the rest of the developing world. The fact that these countries have been rapidly raising living standards for more than 2 billion people is a major accomplishment to be applauded. While the PRC has been growing rapidly for more than three decades, growth in India and the rest of South Asia has accelerated only recently. It is important to compare the performance and policies of these two mega-economies for several reasons. First, nearly half of the world’s population has a stake in the ability of both countries to sustain high growth rates and raise living standards. Second, each country can benefit from the experience of the other. Both have features that are unique, making mutual dialogue and discussions important. They are both dynamic and at similar stages of economic development with diverse policy challenges. They both have huge land masses, diverse climates and geography, similar demands on the environment, and, of course, large populations. This chapter explores the importance of policy reforms in the PRC and South Asia. The major premise is that policy does matter. Good policies can help lift rates of income growth and lower poverty.

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Poor policies retard growth and stall poverty reduction.7 The chain of events leading from policy reforms to growth are not the same for all economies. Special circumstances that are particular to each economy have to be analyzed as well. History, government, and institutions are also important because they serve as the background for policy adjustments. To get a better grasp of the details of recent economic development, we begin the chapter with a short review of economic performance indicators for South Asia and the PRC. This is followed by a discussion of the reasons why living standards have been rising much faster in the PRC than in South Asia. The role of initial conditions and the timing and sequencing of policy reforms are highlighted. The impact of policy reforms on economic performance and the remaining agenda for policy reforms are discussed in the two succeeding sections. The chapter concludes with an analysis of future growth prospects for South Asia and the PRC.

Comparative Economic Performance Per Capita Income The PRC and the economies of South Asia were at comparable levels of income per capita in 1980 (see Table 3.1). Sri Lanka had the highest GDP per capita (in constant 2000 US dollars) at $442, followed by Pakistan ($327), Bhutan ($257), Bangladesh ($240), India ($224), the PRC ($186), and Nepal ($140). The difference between the South Asian average of $237 and the PRC’s was $51, or about 20%. By 2005, the PRC’s per capita GDP was $1,445 and the South Asian average was $570. The PRC’s GDP per capita had grown to 2.5 times the South Asian average. In a little more than a decade it had passed all the South Asian economies except Sri Lanka, which it overtook in 1997.

7

Early on, DeLong (2003) had argued that reforms in India could not be credited with higher growth. But now there is ample evidence to refute this view.

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A Comparative Analysis of Economic Performance and Policy Reforms Table 3.1 2000 $).

59

GDP Per Capita, 1980, 1985, 1990, 1995, 2000, and 2006 (constant

Country

1980

1985

1990

1995

2000

2006

Bangladesh Bhutan PRC India Maldives Nepal Pakistan Sri Lanka

240.1 257.0 186.4 223.9 n.a. 139.9 327.4 441.9

255.1 322.0 289.7 261.1 n.a. 158.5 396.6 523.7

273.3 463.8 391.7 318.1 n.a. 175.7 461.4 577.2

302.7 477.7 658.0 373.6 1,661.3 200.0 510.4 704.4

352.5 555.2 949.2 454.1 2,151.3 224.7 531.0 843.6

453.6 1,069.0 1,594.9 633.7 2,811.0 233.8 622.8 1,075.9

n.a. = not available. Source: World Bank, World Development Indicators Online.

Growth in Per Capita Income Per capita income in the PRC and South Asia was between $200 (the PRC, India, and Nepal) and $400 (Sri Lanka) in 1980. By 2006, the PRC’s per capita income was much higher (Fig. 3.1). Growth in per capita income was also substantially higher in the PRC (an average of 8.6% per year from 1980 to 2006) than in India (4% for the same period). Growth rates for the other South Asian economies were slightly lower. Poverty Head-Count Ratios The World Bank has collected two measures of poverty — $1 per day and $2 per day — systematically but intermittently. Pakistan and Nepal had the best record in reducing poverty in terms of percentage point reductions. In Pakistan, $1-a-day poverty fell from just below 50% in 1987 to 17% in 2000 — a whopping 33 percentage point decline. Such figures, however, must be viewed with some caution. There have been wide divergences in poverty estimates for Pakistan: in the 1990s its $1-per-day poverty ratios declined while its national estimates showed an increase (see ADB, 2004). In Nepal, poverty levels dropped nearly

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1800 1600 1400 1200 1000 800 600 400 200

19 80 19 81 19 82 19 83 19 84 19 85 19 86 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06

0

PRC

Bangladesh

Fig. 3.1

Bhutan

India

Nepal

Pakistan

Sri Lanka

South Asia

Per Capita GDP, 1980–2006 (constant 2000 $).

Source: World Bank, World Development Indicators Online.

16 percentage points over a slightly longer period, from 39.7% in 1985 to 24% in 2004. The PRC had the next-best record in reducing poverty, although starting from a much lower level. The $1-per-day head-count poverty ratio in the PRC declined steadily from 28.5% in 1987 to 16.6% in 2001 — a decline of nearly 12 percentage points in 15 years. India did nearly as well but from a much higher initial level: $1-per-day poverty dropped by 10 percentage points, from 46.3% in 1987 to 36% in 2000. In Bangladesh, the ratio hovered around 36% for the decade of the 1990s, increasing from 26.2% in 1984, while in Sri Lanka poverty levels were below 10% in 1985 and declined somewhat over the next 15 years. Details are given in Table 3.2. Inflation The PRC had two bouts of inflation in the late 1980s and mid-1990s as GDP growth shot into double digits, creating strong excess

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Poverty Head-Count Ratio at $1 a Day, in PPP (percentage of population).

Country

From (Year)

Bangladesh PRC India Nepal Pakistan Sri Lanka

26.2 28.5 46.3 39.7 49.6 9.4

(1984) (1987) (1987) (1985) (1987) (1984)

To (Year) 36.0 16.6 36.0 24.1 17.0 5.8

(2000) (2001) (2000) (2004) (2002) (2002)

PPP = Purchasing Power Parity. Source: World Bank, World Development Indicators Online.

demand pressures. Prices fell in 1998, 1999, and 2002, and inflation has been held in check in recent years. Inflation in India has been relatively stable at around 4% for the last 7 years. Previous bouts of inflation were experienced after the second oil shock in the early 1980s and in the early and mid-1990s. Pakistan and Sri Lanka also had inflationary episodes lasting nearly a decade in the 1990s. Inflation moderated for several years in both countries but has increased in the last couple of years. Bangladesh has had more stable prices than other South Asian economies except in 1987 and 1995, when inflation surged to double-digit rates. Nepal’s inflation rate tends to track prices in India, since there is so much border trade with its southern neighbor. Exports and International Trade In a truly amazing reflection of the opening up of the economy in the last 30 years, the exports of the PRC as a share of GDP increased from 6.6% in 1978 to 34% in 2004 (Table 3.3). The increase is all the more interesting because large developed open economies such as the USA and Japan have smaller export shares in GDP. In South Asia, Sri Lanka has had the most open economy. This is reflected in its export share of GDP, which has fluctuated between 25% and 39% for the past 30 years. Since 1995, exports have averaged over 35% of GDP. India, a country comparable in land size, population, and geographic diversity

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Table 3.3 Exports of Goods and Services, 1978, 1991, 2004, and 2005 (percentage of GDP). Country

1978

1991

2004

2005

Bangladesh Bhutan PRC India Maldives Nepal Pakistan Sri Lanka

5.6 n.a. 6.6 6.2 n.a. 10.6 9.2 34.8

6.7 32.1 21.0 8.6 n.a. 11.5 17.0 28.2

15.5 28.2 34.0 19.0 89.3 17.6 16.0 36.4

16.1 n.a. n.a. n.a. n.a. 16.1 15.3 34.0

n.a. = not available. Source: World Bank, World Development Indicators Online.

to the PRC, had a much smaller export share, which remained stuck at around 6%–7% of GDP from 1975 to 1990, even dipping to 5.3% in 1986. But since 1992, India’s export share of GDP has nearly doubled, from around 10% of GDP to 19% in 2004. Bangladesh followed a similar pattern of export performance as did Pakistan, although Pakistan’s export share started at a higher 9%–10%, increasing to 15%–16% in the later years of the sample period. The sum of exports and imports exhibits a similar pattern to that of exports (not shown in the table). By 2004 and 2005, trade was nearly 80% of GDP in Sri Lanka, 35% in Pakistan and Bangladesh, 40% in India, and 46% in Nepal, compared to 11% for Bangladesh, 13% for India, 33% for Pakistan, and 62% for Sri Lanka in 1975. India and Bangladesh show the largest increase in openness in South Asia. For the PRC, the relevant comparison is 9.2% in 1975 and 65% in 2004, a more than sixfold increase. Taxes on International Trade Mean tariff revenues have declined during the reform period along with mean tariff rates. Table 3.4 shows that taxes as a percentage of revenue fell from 28% or 29% to 13% in India and Pakistan from

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Table 3.4 Taxes on International Trade, 1990 and 2005 (percentage of revenue). Country

1990

2005*

Bangladesh Bhutan PRC India Maldives Nepal Pakistan Sri Lanka

n.a. 0.2 9.8 28.6 32.7 25.6 29.6 26.0

32.6 1.5 −8.4 13.8 28.6 19.8 13.6 11.9

n.a. = not available. * 2004 figures for Bangladesh, Bhutan, and India; 2003 for the PRC; 2002 for Sri Lanka. Source: World Bank, World Development Indicators Online.

1990 to 2005, and from 26% to 12% in Sri Lanka. In Nepal the reductions were smaller, while data for Bangladesh cover too short a period to allow any conclusions to be drawn. Mean tariff rates also fell dramatically, from close to 50% in the PRC to below 20% in 1999, and from over 70% in India and Pakistan to around 30% in 1999. Further reductions to the 15% range took place in India between 1999 and 2004 (Ahluwalia, 2002). However, customs duties are still higher in South Asia than in the PRC and Southeast Asia. Foreign Direct Investment FDI inflows into South Asia and the PRC have fluctuated over the past 30 years in most countries. However, the trend has been strongly upward. The PRC and India started with comparable levels of FDI in 1980 ($57 million and $79 million, respectively). By 2005, FDI flows to the PRC had exceeded $70 billion, while India had attracted $6.6 billion (Table 3.5). Other countries in South Asia received much lower inflows, although the inflows have accelerated in the past few years. By 2005, Sri Lanka had attracted $272 million, Bangladesh

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Table 3.5 Foreign Direct Investment Inflows and Outflows, 1980, 1985, 1990, 1995, 2000, and 2005 ($ million). Country

1980

1985

1990

1995

2000

2005

FDI inflows Bangladesh Bhutan PRC India Maldives Nepal Pakistan Sri Lanka

8.5 n.a. 57.0 79.2 −0.1 0.3 63.6 42.9

−6.7 n.a. 1,956.0 106.1 1.2 0.7 47.4 24.4

3.2 1.6 3,487.1 236.7 5.6 5.9 250.0 43.4

1.9 0.1 37,520.5 2,151.0 7.2 8.0 719.0 65.0

280.4 −0.1 40,714.8 2,319.0 13.0 −0.5 308.0 173.0

692.0 9.0 72,406.0 6,676.0 9.5 2.4 2,201.0 272.0

FDI outflows Bangladesh Bhutan PRC India Maldives Nepal Pakistan Sri Lanka

n.a. n.a. — 4.0 n.a. n.a. −4.8 n.a.

n.a. n.a. 629.0 3.0 n.a. n.a. 24.8 1.4

0.5 n.a. 830.0 6.0 n.a. n.a. 2.0 0.8

1.7 n.a. 2,000.0 119.0 n.a. n.a. 0.0 5.6

2.0 n.a. 915.8 509.0 n.a. n.a. 11.0 2.0

1.9 n.a. 12,261.2 2,495.0 n.a. n.a. 44.0 38.0

n.a. = not available. Source: UNCTAD FDI Database Online.

nearly $0.7 billion, and Pakistan over $2 billion. Both the PRC and India have also been investing abroad. FDI outflows from the PRC have been quite volatile, ranging from nearly $7 billion in 2001 to $2.8 billion in 2003, and reaching more than $12 billion in 2005. In India, FDI outflows have been rising more steadily, reaching $2.5 billion in 2005. Fiscal Balance The World Bank has reported overall budget balances on its World Development Indicators Database since 1990 under the heading “cash surplus/deficit.” The difference between the earlier budget balance and this new cash surplus/deficit is lending minus repayments,

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Cash Surplus/Deficit, 1990, 1995, 2000, 2004, and 2005 (percentage

Country

1990

1995

2000

2004

2005

Bangladesh Bhutan PRC India Maldives Pakistan Sri Lanka

n.a. −5.8 n.a. −3.4 −7.5 −2.5 −5.2

n.a. −0.1 n.a. −2.2 −6.6 −5.3 −7.6

n.a. −2.4 n.a. −3.9 −5.0 −4.1 −8.4

−0.7 1.9 −2.5 −3.6 −3.5 −2.0 −7.6 (2002)

n.a. n.a. n.a. n.a. −5.1 −3.2 n.a.

n.a. = not available. Source: World Bank, World Development Indicators Online.

which appears in another ledger. All the countries in South Asia and the PRC have been running cash deficits (Table 3.6). As a percentage of GDP these deficits have been in the range of 2%–4% of GDP in India; 2.5% in the PRC; 5.5%–6.5% in Pakistan in the 1990s, falling to 2%–3% after 2001; less than 1% in Bangladesh; and 5%–7% in Sri Lanka but increasing to 8% or 9% from 2000 to 2002. The deficits in Sri Lanka are the most worrisome. They are large and increasing, partly because of defense spending to deal with the Tamil separatist movement. Current Account Balance The PRC’s current account balance has been strongly positive with the exception of the two periods in the late 1980s and the mid-1990s when inflation accelerated along with economic growth. Since 1997 the balance has fluctuated between 1.3% and 3.6% of GDP. India has been running a current account deficit — up to 2.2% of GDP in 1990 and 1.6% in 1995 (Table 3.7). In the 1990s the deficits were in the range of 1%–1.5% of GDP, lower than in the late 1980s, when they were over 2% of GDP in the run-up to the fiscal crisis of 1991. The current account balance in Bangladesh improved in the 1990s and after 2000 with some years of surplus and some small deficits.

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Table 3.7 Current Account Balance, 1980, 1985, 1990, 1995, 2000, and 2004 (percentage of GDP). Country

1980

1985

1990

1995

2000

2004

Bangladesh PRC India Maldives Nepal Pakistan Sri Lanka

−3.9 n.a. −1.0 −52.3 −2.0 −3.7 −16.3

−2.1 −3.7 −1.8 −4.3 −4.6 −3.4 −7.0

−1.3 3.4 −2.2 4.6 −8.0 −4.2 −3.7

−2.2 0.2 −1.6 −4.6 −8.1 −5.5 −5.9

−0.7 1.7 −1.0 −8.2 −2.4 −0.1 −6.4

−0.5 3.6 1.1 −16.7 2.9 −0.9 −3.2

n.a. = not available. * 2003 for India. Source: World Bank, World Development Indicators Online.

This contrasts with the 1970s and 1980s, when deficits were in excess of 2% in most years and as high as 5% in 1981. Sri Lanka’s deficit has been smaller in the past few years, ranging between 2% and 3% of GDP. In the 1980s and 1990s, deficits were much higher. Financial Liberalization There are several indices of financial liberalization including interest rate deregulation, reduction in the allocation of targeted lending by commercial banks, and the degree of competition within the banking system. The monetization of the banking system as reflected in the ratio of the money supply to GDP is another broad overall measure of economic progress in financial liberalization (see Table 3.8). In South Asia, financial liberalization has been slow, despite some changes in interest rate regulations, directed lending, and increased bank competition. Money-to-GDP ratios are small and have not been increasing very rapidly — in the range of 25%–30% from 1991 to 2005 in Nepal, Pakistan, and Sri Lanka. By 2005, the money-to-GDP ratio was only 35%–40%. Liberalization has been a bit more successful in Bangladesh and India, with larger increases in the money-toGDP ratio and also higher levels in 2005 of 41.4% in Bangladesh and 62.8% in India. In the PRC the increase in the money-to-GDP ratio

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Money and Quasi Money (M2), 1978, 1991, and 2005 (percentage

Country

1978

1991

2005

Bangladesh Bhutan PRC India Maldives Nepal Pakistan Sri Lanka

12.2 n.a. 24.1 30.8 n.a. 18.9 36.7 23.9

22.7 21.8 77.0 40.6 24.0 30.0 36.1 27.1

41.4 46.9 122.9 62.8 60.6 38.2 45.2 35.0

n.a. = not available. Source: World Bank, World Development Indicators Online.

in 2005 was 60% and the ratio of money to GDP was 122.9%, substantially higher than the ratio in South Asia. Sectoral Share of Employment The sector shares of employment are not up to date for South Asia, the most recent figures being those for 1990 to 1995 in India and Nepal and 2000 or 2002 in the remaining countries. There have been shifts out of agriculture and into the service sector in all countries in the region and less of a shift into industry, as Table 3.9 shows. Agricultural employment fell most dramatically in Sri Lanka, from 48.7% of the workforce to 34.3%. Declines were less than 5 percentage points in Nepal and India and 9 percentage points in Pakistan. Employment in industry went down in Bangladesh, India, Pakistan, and Sri Lanka and went up only slightly in Nepal from very low levels. The remainder of the shift out of agriculture was absorbed by the service sector. In the PRC the story is much the same. From 1981 to 2002 there was a 6.6% decline in agricultural employment and a 0.5% decline in industrial employment, which was offset by an 8.6% increase in service sector employment. It is a myth that industrial sector growth in the PRC and India was labor-absorbing

64.9 68.7 69.1 25.2 83.3 52.7 45.9

(1989) (1980) (1990) (1990) (1990) (1980) (1981)

To (Yr) 62.1 44.1 66.7 13.7 78.5 42.1 34.3

(2000) (2002) (1995) (2000) (1995) (2002) (2003)

From (Yr) 15.4 18.2 13.6 22.4 2.3 20.3 18.6

Source: World Bank, World Development Indicators Online.

(1989) (1980) (1990) (1990) (1990) (1980) (1981)

To (Yr) 10.3 17.7 12.9 19.0 5.5 20.8 23.4

(2000) (2002) (1995) (2000) (1995) (2002) (2003)

From (Yr) 14.8 11.7 17.3 48.5 13.7 26.8 29.3

(1989) (1980) (1990) (1990) (1990) (1980) (1981)

To (Yr) 23.5 16.1 20.3 50.2 21.0 37.1 38.7

(2000) (2002) (1995) (2000) (1995) (2002) (2003)

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Bangladesh PRC India Maldives Nepal Pakistan Sri Lanka

From (Yr)

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Sectoral Share of Employment (percentage of total employment).

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Table 3.9

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and consistent with the relatively slow change in value added in the industrial sector. International Reserves The PRC has been rapidly building up its foreign exchange reserves in recent years (see Table 3.10). In 30 years, reserves increased more than 40-fold (Dowling, 2008). By the end of 2006, reserves exceeded $1 trillion. In 1977, at the start of the reform period, foreign reserves were just $2.3 billion. The buildup of reserves in India has not been as rapid. From modest levels at the start of reform in the mid-1980s, reserves had grown to more than $170 billion by 2006. Foreign exchange reserves have been growing for some of the other countries in South Asia as well. Several countries hold reserves that are substantially larger than required as a precaution against a fall in exports or to maintain liquidity. The PRC’s reserves in 2006 were equal to 15 months of imports (Economist, 2006), compared to an international benchmark of 3 months. Reserves were also six times the level of short-term debt. In South Asia, India’s reserves in terms of months of imports are also quite high. They were equivalent to 12 months of

Table 3.10 Total Reserves minus Gold, 1980, 1985, 1990, 1995, 2000, and 2006 ($ million). Country

1980

1985

1990

1995

2000

2006

Bangladesh 299.7 336.5 628.7 2,339.7 1,486.0 3,805.6 Bhutan n.a. 53.3 88.8 130.5 317.6 545.3 PRC 2,545.2 12,728.1 29,586.2 75,376.7 168,278.0 1,068,493.0 India 6,943.9 6,420.4 1,521.0 17,921.8 37,902.2 170,738.0 Maldives 1.0 4.6 24.4 48.0 122.8 231.4 Nepal 182.8 56.0 295.3 586.4 945.4 1,499.0* Pakistan 495.8 807.5 295.9 1,732.8 1,513.4 11,543.1 Sri Lanka 245.5 451.2 422.9 2,087.7 1,039.0 2,836.7 n.a. = not available. * 2005 for Nepal. Source: World Bank, World Development Indicators Online.

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imports in 2003 and are even higher now. Reserves in Pakistan and Nepal are equivalent to 5 months and 8 months of imports, respectively. Other countries have the equivalent of less than 3 months of imports in reserves. Labor Force Participation Rates One aspect of differences in cultural and religious preferences is reflected on large differences in labor force participation, particularly among women. Labor force participation rates are lower in South Asia than in the PRC. The International Labour Organization (ILO) estimates overall labor force participation rates in South Asia to be around 60%. Only a small number of women are in the labor force, although the figures are rising. Education and Health Life expectancy has increased at different rates in South Asia and the PRC (see Table 3.11). In South Asia, Nepal and Bangladesh had the lowest life expectancy in 1980 of around 48 years, followed by India and Pakistan at around 55 years. Sri Lanka had a much higher life expectancy of 67.6 years, somewhat higher than the PRC’s 66.8.

Table 3.11 Total Life Expectancy at Birth, 1980 and 2004 (years). Country

1980

2004

Bangladesh Bhutan PRC India Maldives Nepal Pakistan Sri Lanka

48.8 44.8 66.8 54.2 56.1 48.4 55.1 67.6

63.5 63.5 71.4 63.5 67.2 62.2 64.9 74.4

Source: World Bank, World Development Indicators Online.

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Twenty-five years later, life expectancy had increased by about 14 years in Nepal and Bangladesh and 9–10 years in India and Pakistan. Starting from a higher level, gains in Sri Lanka and PRC were lower. Still, life expectancy in these two countries was not much lower than the levels in Organisation for Economic Cooperation and Development (OECD) countries — 77 in the USA and 78 in the United Kingdom. Sri Lanka ranked 78th in the world in 2006, ahead of all the Southeast Asian countries. Infant mortality (see Table 3.12) was high in 1980 and remained high in South Asia relative to the industrialized countries in 2004 and 2005. However, declines were substantial in Bangladesh and Nepal, while there were smaller gains in Pakistan and Sri Lanka. The result for Pakistan is a bit disturbing. It started at about the same level as India but made significantly less progress in the 25 years after the start of reforms. Sri Lanka and the PRC made smaller absolute gains in reducing infant mortality from already relatively low rates. Sri Lanka ranks 84th out of 225 countries listed on the Central Intelligence Agency website, lower than Russia and most other developing countries in Asia. Literacy rates increased from already high levels in Sri Lanka and the PRC, while progress from lower levels was made in other countries (see Table 3.13). The PRC and Sri Lanka achieved more than 90% literacy by 2004, from 67% and 85%, respectively, in 1990. Less than 50% of the population

Table 3.12 Infant Mortality Rate, 1980 and 2004 (per 1,000 live births). Country

1980

2004

Bangladesh Bhutan PRC India Maldives Nepal Pakistan Sri Lanka

129 135 49 113 115 133 110 36

56.4 67.4 26.0 61.6 35.4 58.6 80.2 12.0

Source: World Bank, World Development Indicators Online.

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South Asia: Rising to the Challenge of Globalization Table 3.13 Total Adult Literacy Rate, 1990 and 2004 (percentage of people 15 and above). Country

1990

2004

Bangladesh PRC India Maldives Nepal Pakistan Sri Lanka

34.2 78.3 49.3 94.8 30.4 35.4 88.7

n.a. 90.9 61.0 96.3 48.6 49.9 90.7

n.a. = not available. Source: World Bank, World Development Indicators Online.

is literate in the remaining countries in South Asia except India, where the literacy rate is now 61%. While this is a distinct improvement from the 20%–30% in 1980, these countries still have a long way to go before they have a highly literate population and labor force. Bangladesh ranks 165th and Nepal 159th out of 175 countries surveyed by the United Nations Development Program (UNDP) for its 2006 Human Development Report. World Share of GDP From just under 7% of world GDP in 1980, by 2005 the PRC and South Asia had increased their share to 21.4% (using purchasing power parity [PPP] weights). The PRC’s share of world GDP increased to 15.4%, and India’s to 6.0%. The PRC and India started off on an equal footing in the late 1970s and 1980s. At the beginning of the reform period, the PRC and India had about the same share of world GDP — 3.5% and 3.3%, respectively (Table 3.14). Governance Good governance can be broadly defined as a strong commitment to the rule of law, effective government and regulation, control of corruption,

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Share of World GDP (in PPP), 1980, 1990, 2000, and 2005 (percentage).

Country

1980

1990

2000

2005

Bangladesh Bhutan PRC India Maldives Nepal Pakistan Sri Lanka

0.38 0.00 3.45 3.34 0.00 0.05 0.45 0.11

0.40 0.00 6.07 4.26 0.00 0.06 0.58 0.12

0.47 0.00 11.83 5.35 0.00 0.07 0.62 0.14

0.50 0.01 15.41 5.95 0.00 0.06 0.66 0.14

PPP = Purchasing Power Parity. Source: International Monetary Fund, World Economic Outlook Database Online.

and an attractive investment climate. It can also include political stability and the absence of violence, and the extent to which citizens are able to participate in selecting their government, as well as freedom of expression and a free media. Many of these indicators have been developed in the past decade by the World Bank. Summary statistics are given in Appendix 3.2. South Asia scores relatively low on political stability and violence. Domestic unrest in Sri Lanka and tensions in Pakistan with Afghanistan and India over Kashmir, along with the Mao rebels in Nepal, keep scores in the region far below the world average and also well below scores for East Asia. Voice and accountability scores are higher. India has the highest score, although it is still only a bit above the mean, followed by Sri Lanka and Bangladesh. Less democratic systems in Pakistan and Nepal result in lower scores. There are no strong trends in either of these variables within the region over the past decade. Government effectiveness is high in Bhutan and the Maldives. It has been improving in India, although the country still scores low relative to East Asia and just above the world average of 50. Aside from Sri Lanka, where effectiveness has deteriorated somewhat in the past few years (to a ranking of 40), the other countries in the region received low marks ranging from 15 for Nepal to 21 for Bangladesh (where effectiveness has deteriorated) and Pakistan (which ranked 34th in 2005). The ability of the government

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to formulate sound policies is highest in Sri Lanka, where the index has been trending upward somewhat, followed by Maldives and India. The other countries have lower ratings. There has been substantial improvement in Bangladesh, some progress in Nepal, and little progress in Pakistan. The rule-of-law variable, which reflects the extent to which people have confidence in and abide by the rules of society, including the quality of the policy and the judicial system, has been trending downward in Bangladesh, Nepal, Pakistan, and Sri Lanka. It has remained relatively stable in India. For the region as a whole, the variable is below the world average. The control-ofcorruption variable, which means control over the extent to which public power is exercised for private gain and includes both petty and extensive corruption, is highest, for Bhutan, the Maldives, and Sri Lanka followed by India, meaning that corruption is lowest in those countries. The other countries have lower scores. Bangladesh recorded a dramatic drop in 2003, suggesting an increase in corruption, and has remained at a very low level (less than 10) for the past 2 years. The variable has also declined in Nepal and Pakistan. The region’s scores are below the world average and lower than East Asia’s. In summary, for all indicators of governance, South Asia scores lower than other regions and, with some exceptions, has not improved significantly in the past decade. In the PRC, voice and accountability are in the lowest decile while the political stability variable averaged around 40 over the 10-year sample period. This is higher than the average for South Asia but still below the world average and East Asia’s average. The rating of government effectiveness has fallen over the decade from over 60 to 52, while regulatory quality has fluctuated around 40, in the same range as India’s. The ruleof-law variable is lower than in India and fell from 47 in 2002 to 40 in 2005. Finally, corruption has increased quite dramatically. The index has fallen continuously, from 60 in 1996 to 30.5 in 2005. Corruption is also high in East Asia with the exception of Hong Kong, China; Singapore; and Taiwan. Even if these countries and Japan were included, the index for East Asia would still be lower than the world average.

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Raising Living Standards in the PRC and South Asia It is generally agreed that the PRC has been more successful than South Asia in raising living standards. Looking at the level of GDP per capita, we noted in the previous section that the PRC began the reform period with a lower per capita income than all the countries in South Asia with the exception of Nepal. By 2005 its per capita income was more than twice as high as that of all of South Asia, with the exception of Sri Lanka. Furthermore, poverty reduction has been more dramatic and human development indicators have improved more rapidly. There are two general reasons why the PRC has been doing better at raising living standards. The first is the set of initial conditions that prevailed in the PRC and South Asia at the start of the reform process. The second is the policy environment and policy changes that were adopted and implemented during the reform process. In particular, the design of policies and their sequencing are critical to understanding the nature and dynamics of the growth trajectory that followed. We begin this section with a discussion of initial conditions. For the PRC, reforms began in 1978 following the landmark speech by Deng Xiaoping in December, when he announced a new open-door policy. In India, initial reforms began in the mid-1980s and intensified in the early 1990s. In the other South Asia countries, reform process in South Asia also dates to the 1980s and the 1990s. We begin our discussion of initial conditions with these benchmark dates in mind.

Initial Conditions There were a number of similarities and differences in the initial conditions in South Asia and the PRC at the beginning of the reform period. These geographic regions — among the world’s largest as well as its most populous — have diverse climates and topography. Within their boundaries live the bulk of the world’s poor, with low per capita incomes particularly at the start of the period. But these two were also different in many ways.

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Form of Government The PRC is a communist state. There is no private property, there are no popular elections for public officials, and the Government is controlled by the Communist party. In contrast, the major countries in South Asia are democracies with duly elected government officials. These differences in political systems are reflected in the ability to develop and implement policies and, hence, have a direct impact on economic growth and development. Size of the State Sector The size of the state sector differs from country to country, depending on the form of government and historical precedents for the relationship between the private and public sectors. In the PRC, the State’s share of industrial activity was 57% in 1992, more than a decade after reforms began. Before that the state sector’s share was probably close to 100%. The agricultural sector was fully controlled by the state before reforms began and collectivization ended in 1978. The state sector’s share in agriculture was minimal by the late 1980s. Data on the service sector have been collected only recently, since this sector did not exist under the Soviet accounting scheme, which was formerly used by the PRC. Overall, we would guess that the state sector in 1978 was close to 100% of total output. In India in 2002, after a decade of reforms, the state sector’s share of output was 35%. At the start of reforms, it was undoubtedly much higher, probably as much as 50%. In other countries in South Asia, the size of the state sector was also significant, although firm estimates of the proportion of GDP at the start of the reform era could not be found. World Share of GDP As noted earlier, at the start of the reform period the PRC and India had about the same share of world GDP — 3.5% and 3.3%, respectively, using PPP weights (Table 3.14). This share increases about a percentage point to 4.3% of global GDP when the rest of South Asia is added.

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Investment Rates The PRC had gross capital formation rates of more than 35% of GDP in 18 of the 27 years since reforms began in 1978, and more than 30% in the remaining 9 years. Investment rates have been substantially lower in South Asia, averaging around 24% in India and Sri Lanka since 1985 and somewhat lower for Pakistan and Bangladesh. This amounts to a sustained investment rate that is at least a third higher in the PRC than in South Asia. Table 3.15 shows capital formation as a share of output in these countries. Literacy and Health Sri Lanka aside, literacy, life expectancy, and infant mortality rates were low at the start of the reform period in South Asia (Tables 3.11–3.13). Life expectancy at birth in 1980 was 48 in Nepal, 49 in Bangladesh, 54 in India, and 55 in Pakistan. The PRC and Sri Lanka had substantially higher rates, at 67 and 68, respectively. Infant mortality tells a similar story. Infant mortality was more than 100 per 1,000 live births in all of South Asia except Sri Lanka, where it was 35. The PRC had a slightly higher level of 49. Adult literacy in 1980 was less than 30% in Bangladesh, Table 3.15 Gross Capital Formation, 1980, 1985, 1990, 1995, 2000, and 2005 (percentage of GDP). Country

1980

1985

1990

1995

2000

2005

Bangladesh Bhutan PRC India Maldives Nepal Pakistan Sri Lanka

14.4 31.0 35.2 18.7 n.a. 18.3 18.5 33.7

16.3 42.8 37.8 23.7 n.a. 22.6 18.3 22.2

17.1 32.5 34.7 24.1 n.a. 18.1 18.9 22.6

19.1 45.7 39.3 26.5 31.3 25.2 18.5 25.7

23.9 47.4 32.8 24.2 26.3 24.3 17.4 28.0

24.4 61.0* 38.7* 30.1* 34.0* 25.7 16.8 26.2

*2004 figures. Source: World Bank, World Development Indicators Online.

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Nepal, and Pakistan and 41% in India. In the PRC, it was 67%, and in Sri Lanka, 85%. Labor Force Participation Rates Cultural and religious differences manifest themselves in large differences in labor force participation, especially by women. Hence, labor force participation is lower in South Asia than in the PRC. The ILO estimates that overall labor force participation rates in South Asia are around 60%. Women in the labor force constitute a small number, although the figures are rising. As a proxy for labor force participation, the ILO compiles a series for the economically active population. These figures are consistent with the 60% figure in 1980 (61.9% in India, 66% in Nepal, 58% in Pakistan, and 61% in Sri Lanka) (Table 3.16). Participation rates are higher in Bangladesh, despite its Islamic population, perhaps because women in poor families have to work. In the PRC, on the other hand, women have higher participation in the labor force, raising the rate of the economically active population to around 80% in 1980. Composition of GDP Before reforms were introduced in the 1980s and the 1990s, the poorer countries of Asia were still dominated by agriculture, although

Table 3.16 Economically Active Population, Age 15 and above, 1980, 1985, 1990, 1995, 2000, and 2005 (percentage). Country

1980

1985

1990

1995

2000

2005

Bangladesh Bhutan PRC India Maldives Nepal Pakistan Sri Lanka

77.3 60.7 79.5 61.9 51.0 66.0 58.0 61.2

77.9 60.5 79.0 61.6 52.4 65.2 58.7 60.1

76.3 60.0 79.2 61.2 49.9 64.1 57.9 62.9

72.9 59.3 79.0 60.5 51.8 63.4 57.1 56.4

71.1 60.3 77.8 59.2 55.4 63.6 57.6 57.1

69.8 63.4 75.7 58.5 60.1 63.6 58.8 56.4

Source: World Bank, World Development Indicators Online.

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Fig. 3.2

79

Share of Value Added in GDP, 1980 (percentage).

Source: World Bank, World Development Indicators Online.

not to the same extent as they were in the early years after World War II. In 1980, the poorest countries, particularly Nepal, had the largest agricultural sectors (61.8%). Bangladesh, India, and the PRC were grouped fairly closely, with agricultural shares of GDP in the 30% range (see Fig. 3.2). Pakistan and Sri Lanka had slightly lower shares. This is because both countries had developed an outward-looking trade policy and shifted toward labor-intensive industries earlier than the rest of South Asia. In the industrial sector (see Fig. 3.2) the South Asian countries had GDP shares of between 20% (Bangladesh) and 30% (Sri Lanka). Pakistan and India had nearly identical shares of 24%–25%. The PRC was the outlier, with an industrial share of close to 50%. However, this may be an overstatement resulting from measurement error, since services associated with industrial development were probably underreported. Nevertheless, even in this early period it is likely that the PRC still had a larger industrial sector than the countries of South Asia.

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Policies The PRC and South Asia had to undergo economic reform to take full advantage of their resource endowments in the development process and to improve standards of living. Both the PRC and South Asia realized that the policy environment in the countries of East Asia was much more conducive to rapid growth than their own economic regimes. In the PRC, central planning had not led to efficient use of resources or sustainable development and less poverty. The move away from the central planning model began with agriculture and gradually continued in other sectors of the economy, grafting marketoriented reforms and policies onto a system that still contained a large state sector. India had been following a Soviet-style system with capitalist components featuring a large state sector, and inward-looking trade and industrial policies within a socialist market framework. As reforms were put in place, there was a spirit of liberalization and private sector initiatives, although the basic philosophy of balancing the private and public sectors remained on center stage. On balance, the reforms in the PRC were more comprehensive and wider-ranging than those in India. In this section we look first at the design and sequencing of policy reforms in the PRC and South Asia and then draw some comparisons. In the next section we discuss how effective the reforms were, and in the section after that, we go into the impact of policy reforms on the indicators of economic development discussed above. PRC Reforms in agriculture and industry took center stage at the start of the reform process in the PRC. This facilitated the development of relatively efficient commodity markets and the encouragement of quick supply responses by helping to establish market-oriented enterprises capable of responding to market incentives. Macroeconomic reforms and other microeconomic reforms were undertaken later, sometimes in response to distortions and bottlenecks that resulted from reforms in the productive sectors. Therefore, we consider real

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sector reforms first, followed by a discussion of other microeconomic and macroeconomic reforms. Agriculture In 1978 the PRC began to reform the agriculture sector with the twin objectives of increasing the supply of agricultural products and reducing poverty. Historically, agricultural collectives had output quotas that were sold at predetermined prices. There were few incentives for increasing productivity, innovating, or increasing output. Output growth in agriculture stagnated and rural poverty was high. To reform the sector, the PRC began replacing these large agricultural collectives with smaller units and introducing a mixed system where farmers sold a set amount to the state at controlled prices. Anything above this quota could be sold in the market to other buyers at prices responsive to market forces. Land tenure rights under the new system could be transferred from one farmer to another. These reforms led to a surge in agricultural output growth, from 2.7% per year from 1970 to 1978 (Table 3.17) to more than 7% from 1979 to 1984, before slowing to 3%–4% from 1985 to 2005. Industry In the early 1980s, the focus of reforms shifted to rural light industry, which began to absorb labor released by productivity improvements Table 3.17 Item GDP growth Agriculture Industry Non-farm rural enterprises (TVEs)

Sectoral Output Growth in the PRC (percentage).

1970–1978 1979–1984 1985–1995 1996–2000 2001–2005 4.9 2.7 6.8 n.a.

8.5 7.1 8.2 12.3

9.7 4.0 12.8 24.1

8.2 3.4 9.6 14.0

n.a. = not available, TVEs = township and village enterprises. Source: Anderson (2003) and Asian Development Bank (2006).

9.5 3.9 10.7 n.a.

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in agriculture. These industries were small and medium scale and were owned by local communities. These non-farm rural enterprises are commonly known as township and village enterprises (TVEs). The output of TVEs increased by 12.3% from 1979 to 1984, and grew more rapidly, by more than 24%, from 1985 to 1995, before slowing to 14% from 1996 to 2000 (see Table 3.17). TVEs operate outside the web of price and output controls that circumscribe the activities of state enterprises. They contribute more than 50% of industrial output, 30% of GDP, and more than 50% of exports. There are 22 million TVEs across the PRC, generally employing fewer than 100 workers. The importance of TVEs began to wane as more private enterprises and greater emphasis on foreign trade developed with the formation of special economic zones (SEZs). Industrial reform in the PRC reflected the continued retention of a large and mostly inefficient state sector operating side by side with a more efficient private sector. The latter comprised TVEs and later on jointly-owned companies with extensive foreign participation. The state-owned enterprises (SOEs) were still heavily subsidized, while the newly competitive (both internationally and domestically) private sector was not. This was a pragmatic and cautious approach to market liberalization, particularly when contrasted with the approach taken by counterpart socialist transition economies in Eastern Europe. This cautious approach was evident in foreign and commercial policy as well. In addition to the SEZs, export promotion policies included decentralization of foreign trade companies, export retention, and foreign exchange contracting schemes. Trade The main concern of international trade reform was the development of SEZs and the relaxation of export and import tariffs in these zones to facilitate international trade and to attract FDI. The Government established SEZs in several southern provinces in 1980 including Shenzhen, Zhuhai, and Shantou in Guangdong Province, and Xiamen in Fujian Province. It also designated the entire province of Hainan as an SEZ. In 1984, the PRC further opened 14 coastal cities

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to overseas investment, and in 1985 it extended the open economic zones of the Yangtze River Delta, Pearl River Delta, the XiamenZhangzhou-Quanzhou Triangle in south Fujian Province, the Shandong Peninsula and the Liaodong Peninsula, Hebei, and Guanzxi into an open coastal belt. In 1990 the PRC further opened the Pudong New Zone in Shanghai to overseas investment including more cities in the Yangtze River valley. In 1992 this area was further expanded to include all the capital cities of inland provinces and autonomous regions. In addition, 15 free trade zones and 32 statelevel economic and development zones were opened, as well as 53 industrial development zones. These SEZs had different rules and regulations for tariffs on imports and exports and as such constituted extensive reforms of the international trade regime. Basically, export and import taxes were eliminated for goods produced in SEZs to increase their export competitiveness. In the rest of the country tariffs were lowered. Taxes on trade as a share of exports and imports fell to a low of 1% by the end of the 1990s although the mean tariff rate remained a relatively high 17.5% in 1999. The capital account remains closed and foreign exchange transactions are regulated. The development of inland cities has been a further step in SEZ development designed to link the coastal areas with inland areas via river transport. The Government has invested significant resources in developing and improving the infrastructure within and in support of the SEZs. Businesses that locate in the SEZs are afforded tax breaks and waiver of import and export taxes and other restrictions. The SEZs have been a spectacular success in achieving their stated purpose, namely, to attract FDI and to develop export platforms for a variety of industries. They have also attracted new technology and managerial expertise as foreign firms have brought these into the SEZs. In the case of the Pudong New Zone, the State also permits the zone to open financial institutions and run tertiary industries. The Pudong area has also spearheaded capital and skill-intensive industries in automobiles, microelectronics, household electrical appliances, biomedicine, and optical, mechanical, and electrical products. The development of SEZs and the foreign investment they have attracted have sustained rapid growth in production and exports for

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the past 25 years. About half of the country’s exports are from foreign-funded enterprises, primarily in the SEZs in the southern provinces. FDI has grown, from almost nothing in 1980 to more than $50 billion annually in 2003. The stock of FDI is about 35% of GDP. The upturn in FDI began in earnest in the early 1990s and continued at an unrelenting pace until the Asian financial crisis, when it dipped a bit, only to resume its upward trend in 2000. Exchange Rate For most of the reform period, the PRC followed a fixed exchange rate policy with the renminbi tied to the US dollar. After pressure from the USA and other OECD countries, the PRC revalued its currency by 2% in July 2005 and moved to a managed float based on market supply and demand with reference to a basket of currencies. Since then the renminbi has not been tied to the US dollar and has been appreciating gradually. While exchange rates in South Asia are market-determined, there are elements of a managed float arrangement as currency values are still not permitted to fluctuate freely. Public Enterprise The state sector dominated the PRC economy at the start of the reform period. Since then, there have been consistent efforts to boost the role of the private sector while downsizing the state sector. Progress has been slow, however, primarily because labor shedding, which accompanies the streamlining of public sector enterprises, creates an additional pool of unemployed. This creates potential social tension and also requires an increase in state support. The alternative strategy that has been followed by and large is to slowly privatize viable SOEs while not expanding the remaining SOEs and letting employment shrink with retirement. The output share of SOEs has fallen and so has employment in SOEs relative to the private sector (Table 3.18). In the future, further reform of small and medium-sized SOEs would involve further privatization and restructuring. The World Bank notes that small and medium SOEs should be culled from

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Table 3.18 Industrial Output Share, by Form of Ownership, 1980, 1984, 1988, 1992, 1996, and 2002 (percentage). Form of Ownership

1980

1984

1988

1992

1996

2002

State-owned Collective Foreign

80.2 19.8 —

75.8 24.2 —

68.2 28.9 1.0

61.6 29.2 7.1

43.2 31.3 18.5

30.0 29.0 34.0

Source: Central Bureau of Statistics, PRC.

the SOE portfolio. Half of these (about 150,000) could be sold as viable businesses and the rest could be liquidated or their assets sold. Labor Markets Wage rates are either administered by the Government, in the case of SOEs, or freely determined by markets in the private sector and in SEZs. There are no trade unions and labor is free to move within the local labor market. However, migration between provinces is still controlled, although these movements have been somewhat relaxed as labor shortages have arisen in the rapidly growing coastal provinces. There is no shortage of workers willing to move from the interior to the more rapidly-growing industrial centers around Shanghai, Shenzhen, and other cities where labor-intensive manufactured goods are being produced and exported and where wages are substantially higher. Migration from rural to urban areas is a prominent feature of most models of economic development and figures prominently in the experience of East and Southeast Asia. Lewis (1954) and Fei and Ranis (1961) feature the movement of low-productivity labor from the rural sector to more productive employment in the urban sector. Such movement raises the productivity of both the rural sector, as population movements raise the productivity of the remaining workers, and the urban sector, where the new migrants earn more money than they did previously working on the farm. Such rural-to-urban migration tends to bring wages in the two sectors into equilibrium, although a disparity remains because urban workers typically have more capital to work with and are more highly skilled and educated.

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In both industrialized and developing countries the gap between rural and urban standards of living measured by per capita income differentials would be a factor of 1.5–2 times. In the PRC these differentials are substantially higher, as much as 6 times (Whalley and Zhang, 1997). In the PRC, a set of historical circumstances has created a situation where this natural flow of labor, which contributes to overall economic efficiency, has been interrupted. The household registration system, hukou, which was installed as a regulation in 1958, requires that all changes of residence have to be registered with and approved by both origin and destination governments. This policy effectively restricted rural-to-urban migration to those who were willing to risk breaking the law. As the pressure to migrate increased, particularly after the growth in agricultural output between 1978 and 1983, peasants no longer had to report for their daily work schedules to the collectives since these had been dismantled. With the rise of TVEs, rural workers were allowed to move to small towns to work. In fact, during the mid-1980s rural enterprises provided an average of 10.8 million jobs per year (Whalley and Zhang, 1997). Nevertheless, over the next two decades, from 1985 to 2005, the rate of rural-to-urban migration did not increase beyond 0.25% yearly. Failure to obtain hukou certificates prevented rural migrants from acquiring any of the perquisites available to legitimate urban residents, including children’s education, housing, and other social benefits. They were often employed in the construction industry and were provided temporary housing by their employer. Because their status was so tenuous, most migrants never established permanent residence and many came to be known as the “floating” population, moving backward and forward between rural and urban locations depending on the availability of work and other personal factors. In view of all of the hardships and uncertainties they face, many potential migrants simply elect not to migrate, despite the higher wages they could earn in the city. The barriers to migration have imposed a substantial deadweight loss on the economy and created a social situation where urban residents have higher incomes and more benefits than those living in rural areas, including more social spending for

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health and education. The disparity in living standards and income creates further divisions in the social fabric of the communist system. Social tension, crime, and protests by farmers and other rural residents have increased. Yet, despite these problems, the hukou system remains intact. Fiscal Reform The shift to more private enterprise entailed adjustments in government budgets. The PRC’s revenue share in GDP fell sharply from nearly 35% in 1978 to 18.5% in 1991 and a large fiscal deficit developed. However, inflation remained low. Savings rates also increased as farmers became self-sufficient. Furthermore, the TVEs were discouraged from borrowing from the State and encouraged to finance their investment projects themselves. Real interest rates were positive as inflation rates were generally held in check aside from two bouts of inflation in the late 1980s and mid-1990s. To cushion the movement toward more market orientation in the non-state sector, the Government was able to maintain support of traditional SOEs, which were less efficient yet still necessary components of the industrial sector makeup, supplying a variety of heavy manufactures and energy as well as providing employment to millions of workers. Financial Sector Reforms The PRC’s financial system is dominated by four state-owned commercial banks, which account for the vast majority of financial activity and bank lending. These banks were created in the 1980s as part of the economic reform program when the central bank function was separated from commercial banking. Besides the four commercial banks, the financial system consists of the central bank (People’s Bank of China), three policy banks that provide funds to the central Government and also finance grain procurement, and several small regional banks and rural credit cooperatives. The four commercial banks are wholly owned by the State, while the other banks are owned by state entities such as SOEs or local governments. Until 1998, the

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four commercial banks served as the financial arm of the SOEs. Lending to non-state firms has accounted for a small proportion of the loan portfolio of these banks. Credit plans were issued by the central bank to the commercial banks and their regional offices in cooperation with enterprises and the government planning agencies. Because most private firms were not part of the planning apparatus, they did not submit investment plans and many non-state firms were therefore excluded from access to credit from the four state banks. Interest rates were also managed to favor SOEs. Working capital loans to non-state firms carried 20% higher interest than similar loans to SOEs. In recent years, interest rates have become more flexible, although SOEs still have an advantage over private firms. This system of control and credit allocation to SOEs has created a credit crunch for domestic private firms including TVEs. The squeeze on lending tightened in the late 1980s and early 1990s. According to Park and Sehrt (2001), loans to collectives, TVEs, and private firms accounted for 18% of new loans by the four state banks and only 5% in 1995. Private firms have received little support from the rapidly growing equity market. Even in the late 1990s, after the supposed liberalization of the Shanghai and Shenzhen stock exchanges, only about 1% were non-state firms. Because of these systematic distortions in lending to favor SOEs, it is not surprising that savings from labor compensation and loans from friends and relatives were the most important source of funds, according to surveys of private firms. There was also probably substantial borrowing from the informal curb market, which charged much higher rates than the formal sector. Interest rates for large foreign currency loans have been decontrolled to some extent, and deposits and the interest rate structure have been simplified. However, other interest rates, including those for checking and savings accounts, have not yet begun to be liberalized (US Department of Commerce, Commercial Service website). It is not surprising that many loans were non-performing. The official estimate of non-performing loans (NPLs) in the four state banks for 1998 was 25%, of which about 20% was considered non-recoverable. Outside estimates put the figure even higher. Besides the fact that many loans to SOEs were not commercially viable, the size of the

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NPLs also reflects the social obligations that the SOEs were expected to fulfill, including education, housing, and health expenditures. Despite the continued strong hand of the central Government, there are signs that banks are beginning to respond to market signals. Some banks in the provinces, where the private sector is strong, are more willing to lend to larger private firms. There has been some growth as well in the financing of home mortgages. Asset management companies are also beginning to repackage NPLs and sell them to investors. As noted, the financial system is highly controlled and politicized and the stock market has been used to support SOEs. In addition, the Government has not been able to provide a transparent regulatory apparatus that deals with potential agency problems between borrowers and lenders. A key feature of this transformation of the financial system is the recognition of the legitimacy of private firms and their access to bank loans, as well as the ability of the banking system to evaluate lending options against market criteria. There is a clear consensus among most economists that financial sector reforms have seriously lagged behind reforms in the real sector. This is primarily because of the refusal of the State to relinquish control and ownership of the banking system. The reform of the financial sector goes beyond bank ownership and the relaxation of regulations that have created financial repression and resource misallocation. The PRC’s weak fiscal capacity is also a result of the inability of the Government to find a viable solution to the provision of social services formerly supplied by SOEs. By relinquishing lending to unviable SOEs and by developing an alternative system for financing these expenditures, the Government could begin to effectively deal with pressing social sector issues. South Asia Rethinking of economic policy in India began in the mid-1980s as it became clear that the policy regime was not working. This regime was based on a Soviet-type model characterized by import substitution and a dominant public sector, which placed many restrictions on the

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private sector. Policy reforms introduced in 1991 recognized a need to change the model by reducing government controls, providing incentives to invigorate the private sector, and lowering barriers to trade to promote integration with the global economy. The reforms were gradual, as required by a pluralistic democracy — perhaps more gradual than many reformers would have liked but necessary to gain a political consensus for the policy changes. The details of the reforms are discussed in the following sections and described in more detail in the attached comprehensive table (Appendix 3.1). Reforms proceeded broadly on several fronts. First, controls on the private sector were relaxed or removed. Industrial licensing controls were abolished and areas previously reserved for the public sector were opened up. Less progress was made in eliminating restrictions on entry into areas reserved for small-scale industry. This policy was originally designed to protect small producers. It now keeps large, labor-intensive firms out of sectors where they have international comparative advantage. The second step was to open the economy to foreign trade by dismantling quantitative restrictions (QRs) in the form of import licenses, reducing tariffs and customs duties, and introducing a flexible exchange rate regime that made the local industry more competitive in global markets. Tariffs were brought down, but not as much as in other competitors in the PRC and Southeast Asia. Third, foreign investment was expedited through simplified approval procedures and encouragement for the actual implementation of projects approved. Fourth, portfolio investment was encouraged by allowing the participation of foreign institutional investors in Indian equities. Fifth, price controls were abolished in several key industries and revised to more approximate market rates in others. Sixth, labor market controls were reviewed but not changed significantly. The present laws discourage entrepreneurs from investing in labor-intensive, export-oriented industries because it introduces unnecessary rigidities in hiring practices. Seventh, financial sector reforms were introduced to deregulate interest rates, increase prudential control and capital adequacy, and encourage greater competition by allowing more private and foreign banks to operate. Eighth, some progress has been made in raising the efficiency and profitability of SOEs, although public sector reforms

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have been minimal as loss-making public enterprises have not been restructured. We discuss individual sectors more closely and incorporate reforms undertaken by other South Asian countries the 1980s and the 1990s below (Appendix 3.1). Fiscal Reforms and Public Resources Management Value-added taxes (VAT) were introduced in several countries and excise taxes were revamped to resemble VAT in others as part of the reform agenda in the 1990s. In Pakistan, the only country without a VAT-type system, the coverage of sales taxes was expanded. However, it was not until 2004 when a general sales tax similar to VAT was introduced. In India, VAT was introduced in 2005. Marginal tax rates on personal income were lowered in several countries from 1990 to 1997. This also included expanding the coverage of income and sales taxes and simplifying tax codes. Octroi taxes on goods sold in other states, which amount to double taxation and create distortions in resource allocation, have slowly been eliminated in India and Nepal, where they were more widely used than in other parts of South Asia. Improvements in tax administration, including computerization, were introduced in several countries. In some instances (in Bangladesh and Sri Lanka), subsidies for power and fuels were reduced, and utility and energy prices raised. However, subsidies were granted to the power sector in India and to petroleum products in Sri Lanka. Financial Sector The financial sector in India consists of the Reserve Bank of India, 274 commercial banks (223 of which are publicly owned), and 24 foreign banks. Foreign banks account for only 7% of total commercial bank assets but 40% of foreign exchange transactions and 25% of the government securities market. The Reserve Bank exercises a good deal of control over commercial banks including interest rate controls and directed lending to key sectors. Foreign banks are not allowed to have local customers, and their ownership of local banks is restricted

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to 5%. Forty percent of loans by commercial banks (both private and publicly owned) are earmarked for priority sectors including agriculture, small businesses, and exporters. Foreign banks are also subject to earmarking, but only up to 32% of loans. Caps on rural lending and deposit rates have made the banking business unattractive in rural areas because of the high transaction costs and collateral requirements. There are also ceilings on earnings from deposits, as well as controls on interest rates charged to borrowers and non-resident Indian accounts. The reserve requirement is now close to the statutory minimum of 3%, having fallen from more than 10% a decade ago. Lowering the reserve requirement reduces the implicit tax on the banking system and promotes economic efficiency. Restrictions imposed by the Reserve Bank of India, such as the statutory liquidity ratio (SLR), cash reserve ratio (CCR), interest rate controls, and directed credit, have contributed to the financial repression of the banking system. This was an important means of financing public expenditures in India. There has been some liberalization since the early 1990s. The Government and the Reserve Bank have carried out reforms that have improved prudential regulation, efficiency of bank operations, and scrutiny of loan applications. The CCR and the SLR have been lowered, reducing the implicit tax on the banking system and improving bank efficiency. The rates of interest on government debt have therefore also been lowered — an indirect incentive to accumulate public debt. Nevertheless, commercial banks still hold a large proportion of government debt and these holdings preempt lending to the private sector. Repressive policies in the financial sector also allow the Government to finance public sector deficits at lower rates of inflation than would be possible in a financially integrated economy. The banking system does not have a large amount of bad debt. The level of net non-performing loans is estimated at less than 3% of outstanding net loans in 2004/2005 (International Monetary Fund 2005, Table 1.1) and about double that for gross loans. Nevertheless, the banking system in India is still highly risk-averse, and lending to the industrial sector has been weak. Currently, nearly 40% of the assets of the banking system are held in government bonds, far above the statutory requirement of 25%. The corporate sector also holds a large

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volume of government bonds and, together with bank holdings, this continues to restrict borrowing investment in the industrial sector. Financial repression of a similar nature also exists in the other countries of South Asia. There are capital controls in all other countries, and while the nature and extent of financial controls differs from country to country, the financial systems in Bangladesh, Nepal, Pakistan, and Sri Lanka have many features in common with those in India. Against this background we can summarize recent financial sector policy developments in South Asia. From 1990 to 1997 there was a general liberalization of the financial sector in the region. This included interest rate deregulation, increased competition through the entry of more private and foreign banks, reduction in required credit to priority sectors, and introduction of open-market operations by the central bank. Stock markets were established in some countries or opened to foreign investors, and regulations were strengthened in others. Interest rate deregulation took place in Bangladesh and India and open-market operations were introduced in Nepal and Pakistan in the early 1990s. Private banking rules were relaxed and private and foreign banks were allowed to establish and expand operations in Bangladesh, India, Nepal, Pakistan, and Sri Lanka. There was reduced lending to priority sectors in Bangladesh and India. The stock exchange in Sri Lanka was opened to foreign investors and a credit information bureau was established in the country. The security exchange board in India was strengthened. Since 1998, measures have been taken to strengthen financial systems and prudential standards, reduce insider lending, increase capital adequacy ratios, and adopt international best-practice standards for the banking system. Interest rates have also been further deregulated and targeted lending has been reduced. Measures to increase transparency and reduce NPLs were adopted in Bangladesh and India. Plans were made to implement Basel II standards in Bangladesh and India, and to generally raise regulatory standards in Pakistan and Sri Lanka. Central banks in Bangladesh and Nepal were strengthened and given greater autonomy. Administered interest rates were abolished in India.

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Trade Before liberalization, the trade regimes in South Asia were inwardoriented. Taxes on trade were high and QRs to protect domestic industries were widespread. After liberalization in the early 1990s, the following steps were taken. From 1990 to 1997, QRs and tariffs were reduced. QRs on most products were removed in Bangladesh. Tariff rates were reduced in all countries in South Asia and import licensing was liberalized in Nepal, Pakistan, and Sri Lanka through the removal of negative lists or abolished for some products. In addition, export incentive systems were strengthened in Nepal and Pakistan. From 1998 to 2005, tariffs were further reduced in Bangladesh, India, Pakistan, and Sri Lanka, and QRs on all products were removed in India. Exchange Rate Exchange rates in all South Asian economies are quasi-marketdetermined, although Nepal maintains a peg to the Indian rupee. All countries still have current account convertibility except Pakistan, which has a few restrictions. Managed float was replaced by a marketbased exchange rate in Pakistan and Sri Lanka in 2001 and in Bangladesh in 2003. India retains a managed float, which is responsive to market conditions. None of the South Asian countries have free capital account convertibility.

Agriculture Some success has been achieved in reducing or eliminating subsidies in Bangladesh and Nepal, but large subsidies still exist in India and Pakistan and to a lesser extent in Sri Lanka. Land reform has proceeded slowly in general. In Bangladesh there was some land reform in the 1980s. Little progress has been made in India, Nepal, and Sri Lanka. Poor infrastructure is generally still a problem in the region. More public investment is needed in irrigation and extension, as well as rural roads and watershed management. There has been

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some initiative to increase crop diversification in Pakistan. In India implicit subsidies to agriculture are draining resources from the state governments. More rational pricing of water and electricity would reduce these subsidies, and the resources thus freed up could be invested in agriculture and rural infrastructure. Adjustments in exchange rates also make agricultural exports more competitive and stimulate the growth of agro-processing industries. Restrictions on domestic trade in agricultural products have also been removed, and those on agricultural exports have been reduced. Industry Generally, the reform in industrial policies has been quicker in some areas than in others. Industrial licenses were abolished in most sectors in Bangladesh, India, and Nepal in the early years of the reform, from 1990 to 1997. They had been eliminated earlier in Sri Lanka. Foreign investment regulations were liberalized in all countries in South Asia — in the 1990s in some countries, and since 2000 in others. Foreign investment ownership was liberalized further in India in 2004. Privatization of state-owned enterprises has proceeded slowly in Bangladesh, India, and Nepal and more quickly in Sri Lanka. In Pakistan a privatization policy was approved in 1994 and the government privatized its interest in the petroleum industry in 2002. Power and telecoms were later deregulated and partially privatized in 2003. Independent regulatory agencies in oil and gas were also established. Some banks, electric utilities, and telecom companies were privatized recently. In Sri Lanka, the petroleum sector was liberalized in 2003. Economic zones were established in India in 2004 to promote exports. Public Administration Generally, the reform of government departments and public agencies has been slow throughout South Asia. In India there has been some retrenchment and restructuring in the public sector to improve efficiency. In Nepal, the number of ministries has been reduced

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and some civil servants have been retrenched. The devolution of public sector responsibilities to the provinces continues in Pakistan and progress has been made in separating accounting and audit functions. Sri Lanka imposed a freeze on public sector hiring in 2003. However, the new government created many new positions a year later. Computerization has proceeded slowly, and bureaucracies are still overstaffed. In India there has been some progress in judicial reform and the decentralization of the health and education sectors. Labor Markets More flexible labor laws are needed throughout South Asia, but little progress has been made in streamlining regulations and providing a framework for hiring and firing. While several countries are considering ordinances and new regulations, they have not yet passed any concrete legislation. The World Bank index of employment rigidity compiled in 2005 shows that South Asia still has relatively rigid employment markets. India’s is the most rigid (see Table 3.19), followed by the employment markets in Nepal, Pakistan, and Sri Lanka. Bangladesh has the least rigid labor market. Among

Table 3.19

Country Bangladesh Bhutan PRC India Maldives Nepal Pakistan Sri Lanka

Rigidity of Labor Markets Indices, 2005.

Difficulty-ofHiring Index

Rigidity-ofHours Index

Difficulty-ofFiring Index

Rigidity-ofEmployment Index

11 78 11 56 0 22 67 0

40 60 40 40 20 20 40 40

20 0 40 90 0 90 30 80

24 46 30 62 7 44 46 40

0 = least rigid, to 100 = most rigid. Source: World Bank and IFC (2006).

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the major economies, India has the most rigid labor market when it comes to firing, while Pakistan’s labor market is the most rigid when it comes to hiring. The PRC’s labor market is less rigid than South Asia’s except for the Bangladesh labor market. India, Nepal, and Sri Lanka also have extremely high indices of difficulty in firing employees. These indices are much higher than those in Bangladesh, Pakistan, and the PRC. Labor market rigidities are also present in the hiring index, where India and Pakistan rank highest, followed by Nepal, Bangladesh, the PRC, and Sri Lanka. Data for earlier years are not available, so it is difficult to judge whether progress has been made in reducing these rigidities, although the lack of new legislation suggests that these problems are deep-seated. An updated Doing Business study by the World Bank in 2007 focusing on South Asia echoes the need for more flexible labor market regulations. Greater flexibility can be achieved by simplifying procedures and cutting the mandated period for redundancy dismissal, as well as removing time limits on term contracts. Private Investment in Infrastructure There are pressing infrastructure needs throughout South Asia. Poor infrastructure inhibits the ability to attract FDI and build export potential. Although there have been implementation problems, India has experimented with private sector involvement in the power and telecom sectors. Ahluwalia (n.d.) argues for the need for a better policy framework before private sector investments in these and other sectors can be effectively used. Recent initiatives to use excess international reserves to fund infrastructure development have been suggested by the Prime Minister but are still in the early stages of implementation. There has been significant infrastructure spending for specific projects by rich industrialists including Mukesh and Anil Ambani (reportedly the second- and third-richest people in India) and Tusi Tanti (the eighth-richest). There has also been some inflow of borrowed funds from Japan through ICICI, the biggest Indian bank. ADB has generally argued for greater infrastructure spending in South Asia.

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Impact of Policy Reforms To evaluate the success of policy reforms, we consider the changes in some of the performance variables reviewed at the start of this chapter over the reform period. Per Capita Income and Growth in Per Capita Income How much of the acceleration in growth in per capita income can be attributed to the shift in policies that occurred in India and the PRC during the reform periods 1990–2005 (for India) and 1978–2005 (for the PRC)? While we do not know this for a fact, it is plausible that most of the acceleration came as a result of policy changes that improved economic efficiency and moved resources from less to more productive uses. One way to look at this question is to compare growth rates between comparable periods before the reforms (see Table 3.20). In the PRC the growth rate of income in the 15 years before reforms from 1963 to 1978 averaged 7.7%, compared with 9.7% from 1978 to 2005 — an average gain of 2% per year. In India, comparisons between the 1976–1990 and 1991–2005 periods show a gain of 1.1% per year, from 4.9% to 6%. Hence, growth rates in both countries accelerated after reforms. In India, growth was more rapid in the first 5 years after reform than in the next 5 years, and growth has accelerated further since 2000. It is difficult to say how much of this growth was the result of reforms and the increases in efficiency that resulted from the reforms. Certainly some of the growth was the result of higher saving and investment rates, FDI, and perhaps increases in total factor productivity, which arose from the shift of resources to export industries and away from less productive agriculture. However, these improvements were, in turn, primarily due to a more conducive and open policy environment in both the PRC and India. In the rest of South Asia, gains in GDP growth during the reform period were less impressive. Growth rates accelerated slightly in Nepal and Sri Lanka, and fell by 2% in Pakistan.

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99

Average Growth in GDP and Per Capita GDP (percentage).

Country

1963–1977

1978–2005

1976–1990

1991–2005

GDP growth Bangladesh PRC India Maldives Nepal Pakistan Sri Lanka

— 7.7 — — — — —

— 9.7 — — — — —

3.9 — 4.9 — 4.0 6.3 4.6

5.0 — 6.0 6.5 4.3 4.3 4.8

Per capita GDP growth Bangladesh PRC India Maldives Nepal Pakistan Sri Lanka

— 5.2 — — — — —

— 8.5 — — — — —

1.5 — 2.7 n.a. 1.6 3.3 3.0

2.8 — 4.2 3.7 1.9 1.7 3.8

n.a. = not available. Source: World Bank, World Development Indicators Online.

Governance The indicators of governance compiled by the World Bank over the past decade show limited improvement in governance in South Asia and the PRC (see Appendix 3.2). Despite a shift toward market liberalization, South Asia is still over-regulated. Permits and licensing fees hamper business start-ups and increase costs. The tax systems remain complex, and the collection process can cost more than the taxes collected. Export and import clearances are long and costly, particularly for perishables; time-bound delivery schedules are not met. NTBs still restrict trade and import tariffs are still higher than in East Asia. Government effectiveness is inhibited by the still highly bureaucratic nature of governments in South Asia. Ministries and government agencies are sometimes charged with similar and overlapping responsibilities. There are also shortages of

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properly trained and competent technical staff to design and implement effective policies. In the PRC, the effectiveness of reform in governance has been limited. As noted at the start of this chapter, voice and accountability is low and not improving. Government control of the media is still pervasive and has extended to the Internet. Government effectiveness has fallen for several reasons, including the lack of devolution of power to the provinces and the inability to control the actions of local governments, along with the continued inefficiency of SOEs. The rule of law needs improvement, although some progress is being made in reducing the arbitrariness of the legal process. Perhaps people are becoming more aware of the shortcomings of the judicial process, and this awareness has biased responses to these questions. Corruption indices, including those of Transparency International as well as the World Bank, have increased over time. Policy pronouncements have been strongly against corruption. There have also been highly publicized convictions of wrongdoers. All these measures, however, do not seem to have had the desired effect. Cost of Doing Business South Asia and the PRC do not differ dramatically in the cost of doing business and trading (see Table 3.21). More procedures are required to start a business in the PRC than anywhere in South Asia, but the elapsed time is shorter in the PRC than in India and Sri Lanka. Licensing is also arduous, and more so in the PRC than in South Asia, requiring more procedures and long delays. International trade is more efficient in the PRC: only a few days, and fewer documents, are required to export and import. Contracts are also quite cumbersome to enforce, although slightly less so in the PRC than in South Asia. Neither the PRC nor any of the South Asian economies is as efficient as Singapore, which can be referred to as the best-practice economy. One argument to justify the flow of FDI into the PRC (and possibly also to India) despite the proliferation of bureaucratic regulations is the vast size of the economy. If a foreign investor is finally able to clear all the hurdles and set up shop there is

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Average PRC Singapore

Time for Export (days)

Import Documents (number)

Time for Import (days)

Procedures (number)

Time (days)

Procedures (number)

Time (days)

Procedures (number)

Time (days)

Export Documents (number)

8 11 7 11 8

35 71 21 24 50

13 20 12 12 18

185 270 147 218 167

7 10 7 8 8

35 36 44 33 25

16 15 10 12 13

57 43 38 39 27

29 40 28 46 17

365 425 350 395 440

9

40

15

197

8

35

13

41

32

395

13 6

48 6

30 11

363 129

6 5

20 6

11 6

24 8

25 23

241 69

Source: World Bank and IFC (2006).

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Starting a Business

Selected Doing Business Indicators, 2005.

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101

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a vast and rapidly growing domestic market that is hungry for good products. Shift in Employment and Value Added There have been policy reforms in the PRC and South Asia designed to shift resources away from agriculture to more productive industrial and manufacturing activities. In sector value added and sector employment trends these efforts have not been successful. Employment and output have shifted mostly from agriculture to services in both South Asia and the PRC, although the available data on employment cover a shorter period than the data on value added (see Tables 3.9 and 3.22). Why this lack of response in employment and value added when other indicators show more dramatic gains in industrial output, particularly in exports of manufactured goods? There are two possible reasons. The first is that labor productivity gains in industry have increased rapidly as a result of more investment. Second, some of the gains in service employment and value added, such as in telecoms, insurance, and other related services, are associated with growth in the industrial sector. If these factors are taken into account, the rapid gain in exports in the PRC and to a lesser extent in South Asia can be reconciled with more modest shifts in employment and value added.

Table 3.22

Sectoral Share of Value Added, 1980 and 2005 (percentage). Agriculture

Industry

Services

Country

1980

2005

1980

2005

1980

2005

Bangladesh Bhutan PRC India Nepal Pakistan Sri Lanka

31.6 47.2 30.1 38.9 61.8 29.5 27.6

20.5 25.8* 13.1* 18.6 40.2 21.6 16.8

20.6 15.6 48.5 24.5 11.9 24.9 29.6

28.0 37.9* 46.2* 27.6 21.4 25.1 26.1

47.8 37.2 21.4 36.6 26.3 45.6 42.8

51.5 36.3* 40.7* 53.8 38.4 53.3 57.1

* 2004 figures. Source: World Bank, World Development Indicators Online.

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Poverty Head-Count Ratios How much of the substantial decline in poverty in the PRC and South Asia is due to new policy initiatives? Since we have little information about poverty levels in the 1960s and 1970s, it is difficult to compare the reform and non-reform periods. We do know from other research on several developing countries that growth in income is generally associated with a decrease in poverty (Dollar and Kraay, 2000; Ravallion and Chen, 2004; Bourguignon and Morrison, 2002). Financial columnists like the highly respected Martin Wolf (2004) also hold this view. We know that economic growth accelerated in the reform period both in South Asia and in the PRC. We know as well that openness can also be associated with a reduction in poverty. However, a number of other factors must be considered here. Certainly in agriculture, if the poor get greater market access and can effectively sell more than they did before liberalization, their incomes and consumption will rise, including the incomes of those in their communities who supply the goods they purchase (see Timmer, 1997, and Mellor and Gavian, 1999, for an analysis of these effects). The impact on the rural poor is likely to be large, particularly if the elasticity of labor supply is not infinite. Restrictions on market access and monopoly elements that restrict the pass-through effects on the poor will have more modest or even negative impact on the poor. There have been reforms to liberalize trade in both the PRC and South Asia, and so it is likely that poverty reduction has been aided by these changes, although the details would have to be worked out more systematically country by country. Other aspects of the reform agenda could also contribute to reductions in poverty, including reforms in labor markets that open up job opportunities to the poor, educational opportunities and higher literacy rates from increased expenditure on education, and more open financial markets, which have increased credit access for the poor. This possible policy impact remains for future analysis. A recent study on India by Hasan, Mitra, and Ural (forthcoming) shows evidence of the poverty-reducing effects of economic reforms, including trade liberalization, industrial de-licensing, and more flexible labor markets. Those states that saw greater trade liberalization also saw a faster

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reduction in poverty rates. Superficially, in South Asia none of these factors seems to have made a significant difference in the pace of poverty reduction. Financial markets have been reformed somewhat and educational indicators have improved, but progress has been slow. Labor market reforms, on the other hand, have been minimal. Finally, the dramatic reduction in poverty in Pakistan may be the result of several factors including poor agricultural harvests, which raised poverty in some periods. Poverty was also lower in the 1980s because of substantial remittances from the Middle East. Nevertheless, the dramatic reduction in poverty in the 1990s and since 2000 can be questioned, simply because growth in income, along with trade liberalization and other reform variables, has not been as significant for such remarkable progress in reducing poverty to be anticipated. Inflation Reforms in macroeconomic policy, the financial sector, and international trade have had significant impact on inflation in recent years. There has been greater price stability in the past decade across South Asia and in the PRC since the financial crisis of 1997 despite political volatility in Sri Lanka, Pakistan, and India. Governments have adjusted public finance and fiscal policy by increasing VAT or retaining sales taxes as custom duties have decreased after international trade liberalization. Greater fiscal discipline and stability has also been possible as export earnings have increased and the balance of payments has improved. Governments have likewise shown greater awareness of the need for a stable price environment in encouraging inflows of capital for investment. International Trade Reforms in international trade have had a dramatic effect on growth in exports and trade in general. The PRC has had the most dramatic experience. From 1963 and 1977, trade was 7.9% of GDP. After the reforms began, trade accelerated dramatically, averaging nearly 36% of

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A Comparative Analysis of Economic Performance and Policy Reforms Table 3.23 Country Bangladesh Bhutan PRC India Maldives Nepal Pakistan Sri Lanka

105

Average Share of Trade in GDP (percentage).

1963–1977

1978–2005

1976–1990

1991–2005

— — 7.9 — — — — —

— — 35.7 — — — — —

19.8 62.9

30.1 76.1

14.2 n.a. 30.4 33.6 68.5

24.9 163.4 50.9 34.3 78.7

n.a. = not available. Source: World Bank, World Development Indicators Online.

GDP from 1978 to 2006, and it continues to grow more rapidly than income (Tables 3.20 and 3.23). Many different reforms contributed to this performance, including lower tariffs, FDI in export activities, the development of special economic zones, and the growth of TVEs and new private companies. Trade growth in South Asia has been perceived as less dramatic and also started more than a decade later, in the early 1990s. Nevertheless, India achieved a rate of growth in trade from 1991 to 2004 similar to that achieved by the PRC in 1979–1991, although exports grew somewhat more slowly because of the PRC’s larger export surplus. However, the growth of share of trade in GDP — from 14.2% in 1976–1990 to 24.9% in 1991–2005 — was not as fast as in the PRC. The reasons for the spurt in trade in India were similar to the shift in policies in the PRC. FDI and export processing zones played a smaller role. Reduction in trade taxes and a more efficient trade processing regime were primarily responsible for the increase in trade in India. In other South Asian countries, trade also increased rapidly, particularly in Bangladesh, where reductions in trade barriers paved the way for substantial increases in labor-intensive exports of garments. Trade as a percentage of GDP in Bangladesh rose more than 10 percentage points, from 19.8% in 1976–1990 to 30.1% in 1991–2005. Trade in Nepal and Sri Lanka also increased, but at a slower rate. Sri Lanka already had an open trading regime,

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although additional reforms contributed to a further increase in trade to nearly 80% of GDP by 2005. Being landlocked, Nepal has had to depend primarily on trade with India, which has also flourished as India has become more open. Pakistan is the odd one out. Total trade has stagnated primarily because the country has relied almost exclusively on cotton and cotton products as its primary export. It has not diversified despite a more attractive trading regime resulting from trade reforms. Foreign Direct Investment As noted above, FDI inflows into South Asia and the PRC have increased from low levels in the early 1980s, although much more dramatically in the PRC than in India (Table 3.5). From minimal levels in the early 1980s, by 2004 FDI flows to the PRC had exceeded $60 billion while India had attracted a little more than $5 billion. Inflows into the rest of South Asia have increased but are still less than a $1 billion per year. There is no simple answer to explain the disparity in the ability to attract FDI. Clearly, the policy environment in PRC was more attractive. The large number of SEZs close to Shanghai and Hong Kong, China provided excellent infrastructure including transport and communications. The regulatory environment was smooth and efficient. Local authorities were geared to cater to foreign enterprises, and there were many concessions, good infrastructure, and minimal taxes on trade. SEZs in India developed more slowly, were smaller in land area, and had more problems in infrastructure and logistics, being farther away from ports and subject to power, communications, and water constraints. SEZs in India were also subject to more regulations including restrictions on hiring and firing. All of these factors raised costs and increased risks. These impediments to growth in FDI were present to a greater or lesser extent in the rest of South Asia, although there were exceptions in the IT sector, where Bangalore has become a center for a number of related service industries. IT was not encumbered by the web of regulations that have held back manufacturing industries because it did not exist when these regulations

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were being developed. Also, since it deals in services it does not rely as much on physical infrastructure outside communications as the industrial sector. Current Account Balance As noted above, the PRC and South Asia have been running current account surpluses for the past few years. In South Asia this is a turnaround from chronic balance-of-payments deficits, one of which led to the financial crisis in India in 1991. In the 1970s and 1980s deficits were often in excess of 2% in several countries. Much of this turnaround in the balance of payments is a result of stronger export growth, helped by a more favorable policy regime, which has reduced taxes on exports and provided incentives to exporters. Clearly, if these reforms had not been adopted, South Asia would have continued to be challenged by current account deficits and the need to find ways to finance these deficits, including destabilizing inflationary finance. More buoyant exports have not only addressed these chronic problems but have stabilized financial risk and contributed to a more stable macroeconomic environment. They have also provided scope for addressing some of the longer-term infrastructure problems facing these countries. Fiscal Balance Fiscal deficits have been persistent throughout South Asia (Table 3.6) and the PRC for the duration of the reform period. There seems to be no trend toward deficit reduction as a result of macroeconomic reforms. International Reserves What part do changes in the policy environment play in the rapid buildup in foreign reserves in South Asia? Certainly the Asian crisis changed the perceptions of governments regarding the level of precautionary reserves they should hold. Countries in the Asian

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region have been accumulating reserves. However, as we noted earlier, this reserve buildup seems excessive when related to import cover or the level of external debt. Reserves have also increased as a natural consequence of more buoyancy in export markets. This buoyancy is a result of reforms in the trade regime and also in industry and the financial sectors. The reserve buildup is due in part to the reluctance of the PRC to let market forces work in foreign exchange markets to raise the value of the yuan. In South Asia, similar forces may be at play, since the countries in this region continue to intervene in foreign exchange markets, ostensibly to maintain smooth conditions. Education and Health The reform agenda in the PRC and South Asia has not considered education and health explicitly. However, the reforms themselves have had an indirect impact on these social indicators. In the PRC the responsibility for education and health programs for workers in the industrial sector was traditionally the responsibility of the employer — either the SOE or the agricultural commune. As the size of the state sector has shrunk (and private markets have grown), so has the ability of these traditional providers to provide health and educational services. It has become the general responsibility of the State to provide the services, and mechanisms are being put in place to fill the gaps. Some people have no health coverage, and the educational system is still being reorganized. In South Asia the reforms have helped to reduce the financial strains that were present during periods of slower economic growth. However, it is not clear that more resources are being devoted to primary education to improve the skills of the poor as well as the richer groups in society in equal measure, or that health expenditures have increased as a direct result of having more financial resources. There have been evident gains in reducing infant mortality, raising literacy rates, and increasing life expectancy. But the link with reforms in the productive sectors and in macroeconomic policy is less obvious.

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Total Factor Productivity The pace of economic growth has increased during the reform period. The Solow model defines growth as follows: y = α h + (1 − α) k + a

(3.1)

where y is the rate of change in income, h is the rate of change in education-adjusted labor input, k is the rate of growth in capital, α is labor’s share in income, 1 − α is capital’s share in income, and a is total factor productivity (TFP). If we assume that the capital-to-output ratio is fixed in the short run, then we can substitute y for k on the right-hand side of equation 3.1 and rearrange the equation so that y = h + a /α

(3.2)

Clearly, growth in income depends on the rate of growth in the education-adjusted labor force and TFP divided by labor’s share in income. For the sake of argument, assume that α equals 0.65, as many growth theorists working with this model have assumed. Then the impact of changes in TFP will be very important. Being a residual, TFP can have a number of components that reflect changes in output beyond changes in the education-adjusted labor and the capital stock. These changes can be innovations, new products that improve efficiency, or better management techniques such as inventory management and other logistical improvements resulting from IT applications. TFP can also reflect the movement of resources from low- to higher-productivity areas, e.g., from agriculture to industry and high-tech services, or from low-productivity sectors within industry. How have the reforms in South Asia and the PRC affected TFP? There are several estimates of TFP for the PRC but fewer estimates for South Asia. If we start from what we know and work backward, perhaps we can find an estimate and see if there have been any changes in TFP over the reform period and in contrast with the previous decade or so before reforms in South Asia. We assume that

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Table 3.24

Country Bangladesh PRC India Nepal Pakistan Sri Lanka

Growth in Labor Force and Income and Total Factor Productivity. Rate of Growth of Labor’s Income Growth, Total Factor Education-Adjusted Share in (y): 1990–2005 Productivity, Labor Force (h) Income (α) Average a = (y − h) x (α) 3.0 2.1 3.0 3.5 3.5 3.0

0.65 0.65 0.65 0.65 0.65 0.65

5.0 9.7 6.0 4.3 4.3 4.8

1.3 4.9 2.0 0.3 0.5 1.2

Source: World Bank, World Development Indicators Online; and authors’ calculations.

labor’s share is 0.65. The education-adjusted rate of growth of the labor force is 3% for Bangladesh, India, and Sri Lanka, and 3.5% for Pakistan and Nepal. This is based on labor force growth figures from 1990 to 2003 compiled from the World Development Indicators, as well as educational adjustments of about 1% in Bangladesh, India, and Sri Lanka and slightly less in Pakistan and Nepal. If we know the average rate of income growth for 1990 to 2005, then we can solve for α in equation 3.2. These calculations are shown in Table 3.24. The implication from this analysis is that the PRC had a much higher rate of TFP than the other countries, followed by India. It may not be unreasonable to observe TFP contributing about half of the increase in output every year, since there were shifts in workers within industry to more productive jobs in the foreign-assisted industries in the SEZs, combined with the movement from the interior provinces to the more highly productive coastal provinces. Because these productivity gains were much less dramatic in South Asia, productivity improvements were smaller.

The Unfinished Agenda In South Asia many reforms already in place have dealt with the macroeconomic environment including fiscal, financial, trade and investment, and exchange rate reforms. Yet more remains to be done at this level.

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Tariffs have been lowered, yet they are still higher than rates in Southeast Asia and East Asia. In India, export processing zones are relatively new and small compared with those in the PRC, and they lack efficient and cheap connectivity with major ports. Regulations are still cumbersome and are a disincentive to foreign investors. In other countries in South Asia, similar reforms in trade, foreign investment, and the financial sector are needed, although the details differ from country to country (see Appendix 3.3). Additional reforms at the microeconomic level or the so-called second-generation reforms are needed to make markets work better. These comprise continued reforms of the agriculture and industrial sectors; reform of public institutions for improved governance (civil service, bureaucracy, and public administration); reform of institutions that create or maintain human capital (education and health); and, improving the environment affecting the private sector (regulatory environment, flexibility in labor markets, legal and physical infrastructure, and clearly-defined property rights). Unlike macroeconomic reforms, however, successful implementation of second-generation reforms requires a wider consensus in the countries. Industrial Sector In India, the industrial sector is handicapped by continued overregulation of the economy. Instead of being excluded from sectors reserved for small-scale industries, large-scale industries should be encouraged to go into labor-intensive manufacturing. This would provide further impetus for the development of labor-intensive exports and encourage FDI in those industries. As it is, the cumbersome procedures and prohibitions against entry into the industrial sector discourage domestic firms as well as foreign investors, who value flexibility in determining the mix of output between different production platforms. Light regulations are preferable, and best-practice regulations in Singapore and Hong Kong, China could serve as a guide. The further privatization of the remaining public sector enterprises should also proceed, along with the development of bankruptcy laws. The public sector is still inefficient and subsidized. Privatization would free resources for other uses, add revenue to the government coffers, and increase the capacity of

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the private sector. Industrial sector development in Pakistan is also hampered by the heavy presence of the public sector. Furthermore, production and exports are highly specialized in cotton and related products. Diversification is critical if the industrial sector is to remain dynamic. In Bangladesh, the growth of industrial output has been aided by the development of nongovernment organizations (NGOs). Their role has increased dramatically and this has contributed to the dynamism of the private sector and helped to promote the growth of small-scale industry. Grameen Bank has been joined by other NGOs including BRAC, which is reportedly the biggest NGO in the world. These efforts of NGOs should be encouraged and supported by government policy wherever possible. The blueprint for NGO development in Bangladesh can also be shared with other countries in the region. Nepal’s industrial sector has been heavily dependent on developments in India. By joining other countries in regional development agreements such as SASEC, the South Asian Growth Quadrangle (SAGQ), and the Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC), Nepal can widen its contacts within South Asia and with the rest of the world. Labor Markets In India, labor markets, particularly hiring and firing, are heavily controlled by government. Companies with more than 100 employees have to ask state governments for permission to fire or retrench workers, and this permission is seldom given. To get around this regulation, firms resort to hiring contract workers and keep the number of employees below 100. This is not beneficial for firms hoping to take advantage of economies of scale. Recently, the rule has been waived for the establishment of some export processing zones, but these are few in number. Meanwhile, these labor market restrictions continue to constrain the business community. There are also proposals that the labor limit be raised to 1,000 employees. There are fewer labor restrictions in the other countries in the region, although even in those countries labor standards including the use of child labor, work hours, and safety standards need to be improved.

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Human Capital Development With the exception of Sri Lanka, all countries in South Asia rank low in human development. The UNDP Human Development Index, which blends measures of material prosperity, longevity, and schooling, ranks India 126th, Pakistan 134th, Bangladesh 137th, and Nepal 138th out of 177 countries worldwide. Only African countries score lower. In Pakistan there is a particular need to raise the level of human capital, particularly women’s education and health. More resources need to be devoted to raising educational levels and to supplying social infrastructure to poor provinces that have fallen behind and that have low life expectancy and literacy rates. Private Sector Development Many of the initiatives to stimulate the private sector also relate to the implementation of industrial policies discussed above. Private sector growth likewise depends on the ability to compete domestically and internationally. This capacity can be enhanced by the development of a more efficient and supportive regulatory environment. Doing business in South Asia is not easy. The regulatory apparatus still has a stranglehold on the private sector when it comes to starting and closing a business, obtaining licenses, hiring and firing workers, protecting investors, enforcing contracts, and engaging in international trade. Moving to best practices will require streamlining the regulatory apparatus and introducing more computerized procedures. Infrastructure The lack of a modern and efficient infrastructure foundation is inhibiting the growth of industry and the private sector in South Asia. There are transportation bottlenecks in the shortage of all-weather farm-tomarket roads, feeder roads, as well as wide highways connecting major cities. Developments in India suggest that such a highway system can be extremely effective in increasing efficiency, reducing costs and time-to-market, and also facilitating the movement of temporary labor throughout the country. Recently, the Government announced

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that over the next five years the country would spend $500 billion on improving cities, ports, roads, and airports. From about 5% of GDP, infrastructure spending would almost double to 9%. The power network throughout South Asia is overloaded and subject to periodic interruptions of service. The impact on industrial productivity is severe. To supplement the national power grid, many businesses have bought generators, which are much more costly than the national grid. Because of this, South Asia has the highest power costs of any region in Asia. Water supply and sewerage is also a constraint throughout the region, and so is irrigation water in agriculture. Lack of water in the dry season restricts agricultural productivity on rainfed fields, and the reliance on deep wells creates a demand on the underground aquifers that will eventually lead to even greater water shortages in the future. More effective water pricing in rural areas is a key to more efficient water use in agriculture. In urban areas, access to clean water and proper sewerage is critical. The lack of clean water increases the incidence of disease, and this is one reason why human development indicators are low. Many lives are lost to dysentery, cholera, and other water-borne diseases. Governance and Public Administration There is growing evidence that local governments are more effective both in gauging the needs of local communities and in delivering services to these communities. The experience of Bangladesh with village NGOs, both in providing financial services and assistance and in working with small-scale industries to improve production, marketing, and distribution, is a good example of how quasi-public sector entities can aid the private sector. The devolution of control to local governments has also been instrumental in the development of rural industry and infrastructure in the PRC through the TVEs. Economic success in raising incomes and living standards far above the national average in the state of Kerala in India has much to do with the effectiveness of the state government as well as local governments. Experiments with this shift in power and responsibility should be promoted and encouraged in the rest of South Asia.

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Long-Term Capital Market Development The financial systems of all the countries in South Asia depend heavily on the banking system for financial intermediation, and government still has a central role both in the provision of banking services and in the control of commercial banks. Medium- and longer-term capital markets are weak. To reduce the reliance on the banking system and to increase competitiveness within the financial sector, South Asia must develop longer-term capital markets, including markets for equities and bonds, insurance, and more sophisticated instruments like derivatives. Such developments will increase financial stability and reduce systemic risk and vulnerability. They will also facilitate government debt management and the conduct of monetary policy, and provide more opportunities for privatizing banks and other financial intermediaries. There are many policy aspects to these developments that require continued financial sector liberalization as well as opening of the capital account. Bond markets have developed recently, including issues by financial institutions as well as by government. As a result, yield curves are more realistic than when the market was completely dominated by government issues. Equity and derivatives markets have also grown. However, the financial system still works to serve the government’s objectives of providing finance for its own projects and priorities. Reforms have to go beyond rules and regulations for ratios and portfolio risk. What is needed is further privatization of the banking system to force the government to relinquish control. It must go beyond the reduction in ownership, which is coupled with control of the boards of directors and restrictions on the voting rights of non-government members. Without such deep regulatory changes, the banking system will continue to invest in government securities that provide a good return but will not venture into the kinds of lending that energize the private sector and further accelerate the growth of forward-looking and innovative industrial establishments (Bhattacharya and Patel, 2003; Rodrik, 2002). Other Issues In Sri Lanka and Nepal the fight against insurgencies has continued to create budgetary difficulties and drain budgetary resources. It has

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had an adverse impact on tourism and FDI, and diverts resources away from development projects. A peaceful solution is critical if these countries are to raise living standards and achieve more rapid growth in the future.

Future Prospects: A Comparison of India and the PRC8 Economic Growth and Structural Change In a review of the pattern of economic growth and sectoral changes in the PRC and India, several things stand out. These are important in assessing the future prospects for these two giant economies. First is the overwhelming importance of industrial growth in the PRC. This growth has not only been spectacular; it has been concentrated for the most part in a few sectors, primarily Standard International Trade Classification (SITC) categories 5–8 (office machinery, electrical machinery and appliances, telecommunications equipment, and miscellaneous manufactured goods). Textiles and apparel were also important but have declined in relative importance in recent years. Much of the focus in manufactured goods began with steel production, which served as the basic input for most of the other products. Subsequently, the composition of manufactured production has shifted considerably (Table 3.25). Notice the shift away from metals to process goods, particularly machinery and electrical machinery. The focus of exports is even more dramatic. From 1984–1990 to 2001–2004, the focus on a few two-digit categories showed a dramatic increase. SITC codes 75, 76, and 77 (office and data processing machines, telecommunications, sound recording and reproducing equipment, and electrical machinery) went from 4.5% of exports in the earlier period to nearly 33.4% in the latter period — a remarkable increase in 15 years — even as exports increased rapidly at double-digit rates. These three closely related product categories surpassed the three traditional export leaders — textiles, apparel, and 8

This section draws on Dowling (2008).

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Table 3.25 Composition of Manufactured Output in the PRC, 1970, 1980, 1990, and 1997 (percentage of total output of manufactured goods). Category

1970

1980

1990

1997

Metals Machinery and vehicles Electrical machinery Other manufactured goods

16.8 14.2 4.7 3.0

15.6 12.8 5.3 5.2

12.8 13.7 8.3 6.3

7.6 17.5 13.2 4.5

Source: Nararaj (2005).

Table 3.26 Export Share of Selected Two-Digit Manufacturing Industries in the PRC (percentage). Category SITC 75: Office machinery and data processing machines SITC 76: Telecommunications and sound equipment SITC 77: Electrical machinery SITC 65 and 84: Apparel and textile yarn, etc. SITC 89: Miscellaneous manufactured goods

1984–1990

2001–2004

0.4

12.9

2.9

10.4

1.2 28.1

10.1 17.9

4.9

7.3

SITC = Standard International Trade Classification. Source: Panagariya (2006).

miscellaneous exports (SITC 65, 84, 89) — by the turn of the century (see Table 3.26). The shift in export focus in such a short time demonstrates the commitment of the PRC to developing a strong export performance in semi-skilled and labor-intensive manufactured products using steel as the basic input. Much of this output was funded by FDI; by 2003 the total stock of FDI was 35% of GDP. Foreignfunded enterprises contribute about half of total exports and have ownership in more than a third of industrial enterprises. The foreign sector has been the main growth driver of the economy in the past few years, contributing about two-thirds of the total annual growth of around 9%.

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Second, one is struck by the anemic performance of the industrial sector in India. The sector has not grown as fast as the rest of the economy and has therefore provided almost no impetus for the accelerated expansion of the economy. The sector share is only 26% of GDP, much less than the 40% share in the PRC. Even accounting for some estimation errors, this is still a very big difference. The acceleration in growth in the Indian economy since the mid-1990s has been led by the services sector, with a small contribution from agriculture. FDI is only one-tenth its level in the PRC, and export growth has been slow. Merchandise exports are only about 10% of GDP and are not nearly as well focused on labor-intensive industries as they are in the PRC. Table 3.27 shows the major Indian exports as a share of total exports. They range from labor-intensive products like apparel to capital-intensive products like steel and extractive industries like petroleum and petroleum products. Furthermore, there have been small shifts in the composition of the major exports; textiles and apparel still account for more than 20% and the others have a much smaller share. From a review of industrial performance, there does not appear to be any underlying strategy for industrialization as there has been in the PRC. What about the future? It looks like the PRC can easily continue to grow at rapid rates, increase its export domination in manufactured goods categories 75–77, and perhaps expand into category 78 (road Table 3.27 Export Share of Selected Two-Digit Manufacturing Industries in India (percentage). Category SITC 66: Nonmetallic minerals manufactures SITC 65 and 84: Textiles and apparel SITC 33: Petroleum products SITC 67: Iron and steel SITC 89: Miscellaneous manufactured goods

1984–1990

2001–2004

9.4

14.9

20.2

21.0

8.5 0.8 3.0

6.3 5.0 5.2

SITC = Standard International Trade Classification. Source: Panagariya (2006).

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vehicles). By 2001–2004 this sub-sector’s share of total output was already 26%, up from a negligible amount in the 1990s. Whether this continued growth in industry is in the best interest of the country, however, is another matter. A more appropriate strategy would be to put less emphasis on industry and more on services and rural development of the backward interior provinces. India has the potential to develop a vibrant, efficient, and internationally competitive industrial sector. It has the manpower and expertise. It has the organizational and management abilities. But so far it has been constrained by a policy environment that has throttled initiative, opposed the opening up of important sectors of the economy to large-scale industries, and refused to allow competitive forces to determine wage rates and employment. Much of the current emphasis in India is to leapfrog over the industrialization phase of development and focus on a wide variety of both high- and lowtechnology services, primarily in the IT and communications sectors. To sustain rapid growth, there has to be an additional push to develop labor-intensive industry as in East Asia and the PRC. Such a strategy would also benefit rural areas as growth would trickle down to the poor. This requires better infrastructure and more flexible labor and industrial policies, which allow large-scale industry to operate in labor-intensive industries. Compared with other countries, India has quite small value added per establishment. Firms are too small to take advantage of economies of scale to produce large quantities for export (Fig. 3.3). As noted above, under the Industrial Disputes Act of 1947, companies with more than 100 employees need to ask state governments for permission to fire or retrench workers. This permission is seldom granted. Firms try to get around this regulation by hiring contract workers to keep the number of employees below 100. However, firms remain small and find it difficult to take advantage of economies of scale. While the rule has been waived for the establishment of some export processing zones, these are few in number. Also under the small-scale industries reservation policy, all labor-intensive exports in the 1980s and 1990s were reserved for exclusive manufacturing by small-scale units. The development of SEZs is a component of this industrialization strategy that can facilitate and accelerate development by focusing

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10.00 9.00 8.00 7.00 6.00 5.00 4.00 3.00 2.00 1.00 0.00 Textiles

Iron and steel

Transport Food products Machinery Machinery, equipment except electric electric

Industrial chemicals

Other chemicals

Other non- All industries metallic mineral products

Fig. 3.3 Average Firm Size in India and Comparator Countries, 1990 (value added in $ million per establishment). Note: Histograms in gray refer to India; those in black refer to comparator countries. Source: Kochhar et al. (2006).

export industries and associated infrastructure on these locations. India is already beginning to address some of the infrastructure bottlenecks along with private sector participation. In response, industry is beginning to mount a successful drive to produce a wide array of labor-intensive products for export and to generate income and employment to qualify as a takeoff to sustained industrial growth. SEZs could be a critical component of such a takeoff. While SEZs in India are numerous, they are still small and exports from these zones are still limited although growing rapidly. One hundred seventy-two SEZs in 17 provinces were established after the passage of the SEZ act of 2005, following the formation of 19 SEZs before the act was passed. Most of the SEZs are less than 100 hectares. Only six are larger — 1,000–6,000 hectares. In comparison, the largest SEZs in the PRC are 32,000 hectares or more. Nevertheless, forecasts

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suggest that exports from SEZs could compose as much as 10% of total exports by 2008. While a takeoff to more rapid industrial is becoming more likely, FDI growth in manufacturing is still slow, labor markets are still constrained, and business investment in new plant and equipment is weak. For the outlook for the next decade to change, the Government will have to remove all of these bottlenecks. Then it will definitely be possible for the industrial sector to exhibit the dynamism that the IT and related service sectors have been showing in the last few years. If this materializes, India could well grow as fast as the PRC in the next two decades, particularly if it is able to raise investment rates so that they are closer to the rates achieved by the PRC. Labor productivity, labor force participation rate, and share of the working population in the total population are all higher in the PRC and give it an advantage. However, this will change rapidly over the next couple of decades as the PRC’s slow population growth rate (following the one-child policy) begins to have a greater effect on the growth of the labor force. International Trade The PRC now has an overwhelming advantage in international trade. It exports more as a percentage of GDP (44%, compared to 20% for India) and has a larger share of world merchandise exports (4%, versus India’s 0.7%). Tariff rates are lower and India depends less on trade taxes for government revenue. Are India and the PRC likely to come into greater competition with each other in the future? If India is able to liberalize its regulatory environment, it could begin to attract more FDI into labor- and skill-intensive manufacturing industries. Over the last decade, FDI in India was mostly in power and telecommunications, very little in manufacturing, and almost none in labor-intensive manufacturing such as textile and apparel (Henley, 2003). In contrast, the bulk of FDI in the PRC was in manufacturing. If India can attract more FDI into manufacturing, it would present a challenge for producers in the PRC, particularly in view of the

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growing competitiveness of domestic Indian firms. However, the PRC has already developed a wide array of manufactured exports and will continue to develop into new areas. It has such a big advantage over India that it can easily relinquish some of its markets in lowskilled, labor-intensive products in which it may be starting to lose comparative advantage as wages rise in the southern provinces and SEZs. India could thus easily become competitive in labor-intensive industries where it, along with other countries in South Asia, already has a comparative advantage: in textiles, apparel, and footwear and leather products. India, on the other hand, has a big lead in IT and other skill-intensive software. However, it will have to develop more effective SEZs and reduce the regulatory burden that has reduced efficiency and served as a disincentive to foreign investors. The PRC is only beginning to enter the services sector. It will be hampered by the lack of fluent English speakers and the market penetration already established by India, the Philippines, Sri Lanka, and other English-speaking countries. Therefore, it is likely that South Asia and India will continue to maintain an advantage in this sector in the near future. Poverty and Income Distribution Comparing the relative success in reducing poverty since 1990, India and the PRC have had different patterns of success (see Table 3.28). Between 1990 and 2000 poverty fell by 51 percent using $1-a-day cut off, 47 percent using a $2-per-day cut off and 63 percent using the national poverty line cut off. In India the comparable percentages are 25 percent, 9 percent and 33 percent, less than half the progress made in the PRC over the decade in reducing poverty. The PRC has managed to reduce poverty dramatically, primarily because of the rapid growth of income in urban areas. In recent years the thrust to reduce poverty has sputtered somewhat as the coastal provinces have continued to outpace the interior and resources have failed to flow to redress the imbalances created by these dramatic growth differentials. For poverty levels to be reduced further a strong

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commitment to the development of the interior is required, including rural industry, better education and health, infrastructure and removal of migration restrictions that prohibit more out migration from rural areas to the cities. The PRC has sufficient resources to address these problems if it can muster the political will to do it. Restlessness has been increasing as more demonstrations have been taking place in rural provinces and the distribution of income continues to deteriorate. As noted above India has had more modest success in reducing poverty and it is doubtful whether it will be able to achieve the millennium development goal of reducing poverty to half the 2000 level by 2015 (see Table 3.28). Without a dynamic and rapidly growing industrial sector to absorb new entrants into the labor force and a lack of resources to boost education and health expenditures in the poorer Table 3.28 Poverty Levels in India and the PRC (percentage of people in poverty). Year and Poverty Line

India

PRC

$1-per-day cut off 1990 1993 1996 1998 2000 2002

46.6 51.1 46.2 44.2 34.7 —

31.5 29.0 16.4 16.1 15.4 12.7

$2-per-day cut off 1990 1995 2000 2002

88.2 82.9 79.9 —

69.9 51.6 44.8 37.3

National poverty line 1990 1995 2000 2002

38.9 36.0 26.1 —

9.4 7.1 3.4 3.0

Source: Dowling 2008, Chapter 7.

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states, India has been unable to generate employment and raise incomes enough to make a significant acceleration in poverty reduction. If policies are adjusted to bring about more rapid growth in income by raising industrial sector growth poverty reduction could accelerate over the next ten to fifteen years. Otherwise, progress will continue to be slow. Poverty reduction has also been hampered by the low elasticity of poverty reduction to growth. This is consistent with the low elasticity of employment generation with respect to income growth. Much of growth in India has been the result of capital or skill intensive growth rather than unskilled and semi-skilled labor growth. As a result employment generation and poverty reduction have been limited. India also has to put an end to widespread discrimination by class and gender. This contrasts with the Chinese experience where much of the growth in manufacturing has been in labor-intensive manufacturing. As manufacturing value added accelerates, it should bring with it a more rapid reduction in poverty and further growth in income. Tax revenues will also increase, enabling the Government to devote more resources to infrastructure and human resource development, creating a virtuous cycle of growth. Both India and the PRC have been experiencing deterioration in income distribution. From a regional perspective certain states and provinces have experienced acceleration in growth while others have languished. In the PRC these regional developments are consistent with a pattern of urban and industrial growth that has favored the coastal provinces. In India certain states with limited resource endowments and large minority populations have fallen behind and need to be restored to more rapid growth by a consistent set of policies that increase education and health indicators and create more employment.

Reforms

Bangladesh

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Chronology of Policy Reforms in South Asia. Nepal

Pakistan

1990–1997

1990–1997

1990–1997

Sri Lanka

I. Macroeconomic Reforms 1990–1997 VAT introduced in 1991

1998–2005

Excise duties being simplified to resemble a VAT system Tax administration being modernized Octroi being slowly abolished 1998–2005

Octroi abolished

Provinces initiating measures to implement agriculture income tax

1998–2005 VAT introduced in Nov. 1997, but implementation was slow

1998–2005

VAT effectively implemented (2000, 2001)

Taxes lowered across the board in March 1997

VAT rate increased from 10% to 13% (Jan. 2005)

General sales tax rate raised from 12.5% to 15%; petroleum product tax rates raised; federal subsidy on wheat reduced (2000)

Full pass-through of oil prices considered for end2005

VAT introduced in 1994 1998–2005 Increases allowed in administered prices like power rates (2000, 2002) Wide-ranging changes made to simplify tax administration and widen tax base by replacing goods and services tax and national security levy with two-tiered VAT (2003)

(Continued )

125

Low tax base in services (2001)

Coverage of general sales tax expanded

Page 125

Automated customs administration introduced; tax assessment and collection procedures simplified; VAT expanded to cover 31 new items (2000)

VAT introduced in a phased manner

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Personal income tax rate reduced in 1993–1994

Maximum marginal rate of personal income taxes reduced to 40%; surcharge abolished; exemption limit raised

1990–1997

A Comparative Analysis of Economic Performance and Policy Reforms

Fiscal Reforms and Public Resource Management

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India

Pakistan

Sri Lanka

Utility tariffs and energy prices adjusted upward (1999, 2000, 2001, 2004)

Huge subsidies granted to public sector undertakings (PSUs), e.g., power, main source of fiscal deficits (2002)

Plans made to allow private participation in petroleum sector to leave Nepal Oil Corp. as wholesaler

Coverage for sales and income taxes expanded (agriculture and services); tax amnesty and tax survey implemented; implicit fuel subsidy reduced in 2000

VAT on wholesale and retail trade introduced but not implemented in 2003

VAT and income tax coverage expanded (2005)

Introduction of VAT planned for April 2002 but slipped to 2003

Performance-based incentives being planned in Large Taxpayers Office

Comprehensive debt reduction strategy initiated in 2001 for fiscal adjustment and to pay off liabilities Central Board of Revenue reforms: Large Taxpayers Unit set up, Sales Tax Automated Refund Repository facility initiated (2003)

High levels of subsidies on fuel, wheat, fertilizer add to expenditure pressures; weak tax administration and leakages; persistent weak performance of collection agencies (2005); planned to eliminate most subsidies on fuel and wheat in 2005

(Continued )

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Securitization, reconstruction of financial assets, and enforcement of Security Interest Act 2002; act provides comprehensive framework for foreclosure of assets

Steps taken to strengthen tax administration: operations of Large Taxpayers Office improved, customs administration strengthened, excise leakages plugged

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Reforms

(Continued )

126

Appendix 3.1

Reforms

Large subsidies on power (2004, 2005)

IT enhancements made to boost tax administration

Sri Lanka

Fiscal Responsibility and Debt Limitation Bill submitted in 2003 to National Assembly for approval. Bill binds gov’t to eliminate revenue deficit (i.e., no borrowing to finance current expenditures) by June 2007 and reduce debt to 60% of GDP by 2012

Tax base broadened: broadbased business tax (called Economic Service Charge) introduced; civil service income brought into tax net; excise tax base broadened to include several household appliances

Medium Taxpayers Unit set up in different cities; income taxes filed under selfassessment system in 2004

Unified VAT rate of 15% introduced (2004), supplemented with 5% rate on essential food items and 18% on luxury goods (2005)

127

(Continued )

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Personal income taxes further reduced to 30%; corporate taxes on Indian companies unified and lowered to 35%

Pakistan

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India

(Continued )

A Comparative Analysis of Economic Performance and Policy Reforms

Fiscal Reforms and Public Resource Management (cont’d)

Bangladesh

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Appendix 3.1

India

New simplified general sales tax system introduced in July 2004; GST rate structure simplified to one standard rate of 15% from multiple rates of 15%–23% in 2004

Tax base broadened by removing 20 more exemptions from income tax in 2004

Revenue Board created; second Large Taxpayers Unit established Prices of petroleum products and electricity subsidized; large fiscal costs from operations of Ceylon Petroleum Corp. and Ceylon Electricity Board (1% of GDP in 2004); slow adjustment of electricity tariffs

(Continued )

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Tax rates for banks and private limited companies reduced (~2004) in line with plan to have one corporate tax rate by 2007

Sri Lanka

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Nepal

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Reforms

(Continued )

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Appendix 3.1

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Nepal

Pakistan

Sri Lanka

Coverage of sales and income taxes expanded (Continued )

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One LTU and 5 more Medium Taxpayers Units set up; plans made to organize entire Central Board of Revenue along functional lines (collection, audit, assessment, enforcement) (2005)

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Fiscal Reforms and Public Resource Management (cont’d)

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(Continued )

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Appendix 3.1

129

1990–1997

Several new private and foreign banks allowed 1998–2005 Bankruptcy Law 1997 passed to facilitate recovery of bad loans

1990–1997

Sri Lanka 1990–1997

Interest rates gradually deregulated and credit allocated to priority sectors reduced

Open-market operations introduced

Open-market operations introduced

Several financial institutions privatized

Several new non-bank financial institutions established

Two of 5 stateowned banks privatized

Prudential accounting and capital adequacy norms introduced

Nepal Stock Exchange established

Since 1991, foreign banks allowed to set up branches outside Colombo

Private banks allowed to expand and new ones established Securities Exchange Board of India (with regulatory and prosecuting powers) established

1998–2005 2 gov’t banks recapitalized (Nepal Bank Ltd. and Rastriya Banijya Bank) Slow reform of financial sector, dominated by gov’t financial institutions (2001)

1998–2005 Capital market development program in place with ADB and WB support (1999) Insurance sector deregulated (2002)

Credit Information Bureau established Stock exchange opened to foreign investors beginning in 1990 1998–2005 Need for financial sector reform (1999); role of domestic capital market modest (2000) (Continued )

Page 130

Rupali Bank to be privatized

1990–1997

Pakistan

10:11 AM

Role of directed credit reduced and NCBs given more freedom; NCBs also recapitalized

1990–1997

Nepal

12/12/2008

Interest rates significantly deregulated

India

b670_Chapter-03.qxd

Financial Sector

Bangladesh

(Continued )

South Asia: Rising to the Challenge of Globalization

Reforms

130

Appendix 3.1

Reforms

(Continued ) Sri Lanka

Financial Loan Court Act amended to empower loan courts to enforce debt recovery (1998)

Regulatory framework for insurance liberalization being finalized

Nepal Rastra Bank Act 2002 passed, giving bank more autonomy and strengthening regulatory, supervisory functions

Directives issued on appointments of bank board members and CEOs; minimum paid-up capital requirements of banks raised from PRs500 to PRs1 billion in 2002

Fiscal Responsibility Act passed in 2002 committing gov’t to reduce deficit to 5% of GDP and public debt from 100% to 85% of GDP in 2006

SEC strengthened; automation of stock exchange achieved (1998) Bangladesh Bank granted greater autonomy and expanded authority to conduct monetary and exchange rate policy and supervise all banks (2004) Slow NCB reform continued (2004)

National Stock Exchange established 1998–2005 Prudential norms not stringent enough; banking sector characterized by inefficiencies and high intermediation costs (1999) New insurance bill opened up market to private sector (2000)

Nepal Rastra Bank downsized; more efforts under way to enhance capacity of staff NRB Act 2002: NRB made more transparent; monetary policy stance announced at start of fiscal year

An NCB, United Bank Ltd., privatized in September 2002; gov’t divests 20% share in National Bank of Pakistan

Privatization of state-owned banks (whose financial performance has improved significantly) abandoned, but restructuring continues under the supervision of the Strategic Enterprise Management Agency (Continued )

Page 131

Pakistan

10:11 AM

Nepal

12/12/2008

India

131

Bangladesh

A Comparative Analysis of Economic Performance and Policy Reforms

Financial Sector (cont’d)

b670_Chapter-03.qxd

Appendix 3.1

Sri Lanka

Reforms in 2001: bank and non-bank prudential standards raised, i.e., capital adequacy, income recognition, provisioning for non-performing assets, disclosure and transparency in accounting; gov’t securities market improved

Ordinances issued: Secured Transactions, Company, Securities, and Insolvency ordinances

About 75% of banking sector privately owned; government still has majority share of country’s largest bank, National Bank of Pakistan

Prudential norms tightened and bank supervision improved

Measures initiated to enhance transparency and disclosure, capital adequacy, risk (2004) Administered interest rates abolished

Authorities considering amendments to Banking and Financial Institutions Ordinance, possibly raising capital requirements, rules for mergers in view of increased competition expected in 2010 under WTO commitments

Regulatory standards improved; good compliance with international supervisory standards

(Continued )

Page 132

Pakistan

10:11 AM

Measures adopted to further strengthen financial system: raised capital requirements, took steps to reduce insider lending, improved prudential supervision (2006)

Nepal

12/12/2008

Commitments secured by gov’t from NCBs to restrict new lending, reduce NPLs, rationalize branch networks (2005)

India

b670_Chapter-03.qxd

Financial Sector (cont’d)

Bangladesh

South Asia: Rising to the Challenge of Globalization

Reforms

(Continued )

132

Appendix 3.1

Reforms

India

Pension reform initiated; passage of Pension Bill would help provide a secure source of retirement income and aid in development of capital markets

Rupali Bank successfully divested; preferred bidder announced in August; sales and purchase agreement expected to be finalized later in the year; plans made to use Rupali Bank as a model for divestment of other banks (2006)

Regulatory standards improved; plan to implement Basel II in 2007

Sri Lanka

Legal framework for loan recovery improved: blacklisting directives, Debt Recovery Tribunal, Appellate Tribunal established; progress in restructuring of commercial and development banks: mgmt teams for Nepal Bank Ltd and Rastriya Banijya Bank (2 largest banks, which account for 50% of deposits) eliminated losses; profits made in 03/04 and 04/05 through retirement schemes, reduction in deposit rates

133

(Continued )

Page 133

Financial position of NCBs weakened by fuel subsidies (2006)

Insurance sector liberalized

Pakistan

10:11 AM

Licensing of domestic and foreign private sector banks liberalized

Nepal

12/12/2008

National Steering Committee formed, led by Bangladesh Bank to proceed with implementation of Basel II standards (2006)

(Continued )

A Comparative Analysis of Economic Performance and Policy Reforms

Financial Sector (cont’d)

Bangladesh

b670_Chapter-03.qxd

Appendix 3.1

Nepal

Pakistan

Sri Lanka

Slow loan recovery from large, willful defaulters; some gaps remain in the regulatory and legal framework (2006) (Continued )

Page 134

Slow restructuring of Nepal Industrial Dev Corp. (assets at 1% of GDP, perennial loss maker); these are the 2 largest dev banks

10:11 AM

Bank restructuring program slow: reform of other NCBs remains an area of concern (2006)

India

12/12/2008

Financial Sector (cont’d)

Bangladesh

South Asia: Rising to the Challenge of Globalization

Reforms

(Continued )

b670_Chapter-03.qxd

134

Appendix 3.1

(Continued )

India

Nepal

Pakistan

Trade

1990–1997

1990–1997

1990–1997

1990–1997

Tariffs reduced in stages: ranges from 5% to 100% and 8 subrates

Tariffs reduced from 225% in 1988 to 70% in 1994

1998–2005 Maximum tariff rate reduced from 355% in 1990 to 45% in 1997, 40% in 1999, 35% in 2000 (38.5% with 10% surcharge)

Import licensing system abolished for most raw materials and imported inputs Export incentives being developed 75% of forex earnings can be sold at market rate

Import licensing liberalized by removal of negative list Export incentives strengthened: concessional tariff treatment of imported inputs and freight subsidy

1991–1997 tariff structure reduced to 4 bands and rates reduced Export taxes removed Import surcharge abolished in 1991 Import licensing system liberalized: only 11 items require license

1998–2005

1998–2005

Tariff rates lowered across the board in March 1997

1998 budget included duty exemptions for imports of advanced technology machinery and equipment

Maximum tariff reduced from 35% to 30% (2001) to 25% in 2002

135

(Continued )

Page 135

Export incentives deepened by introducing bonded warehouses, duty drawback schemes, and back-to-back letters of credit

Maximum tariffs reduced from 400% in 1990/91 to 65% in 1994, 50% in 1995; average duty from 50% to 27% during the same period

1990–1997

10:11 AM

Level and structure of tariff rates improved: only cigarettes and alcohol have tariffs above 100%; maximum rate on others 60%

QRs replaced by tariffs

Sri Lanka

12/12/2008

Bangladesh

A Comparative Analysis of Economic Performance and Policy Reforms

Reforms

QRs on imports liberalized from 192 to 112 items in 1993 and about 30 in 1997

b670_Chapter-03.qxd

Appendix 3.1

Trade (cont’d)

Tax exemption on import of capital machinery to 100% exporters

Slow: India’s tariff rates still among highest in the developing world (2001)

1998–2005

Regulatory duties imposed on non-essential imports (2002)

Tariff rates for industrial goods reduced from a weighted average of 80% in 1992 to around 20% in 2004–05; planned convergence to ASEAN levels (9%) by 2009 (considered slow)

Sri Lanka

Regulatory orders on tariff exemptions reduced; procedures on imports simplified; exports and imports of wheat, petroleum, and imports of textiles, mobile phones, gold, silver completely liberalized in 2002

Custom duty rates reduced to 5 bands

Average tariff rate reduced to 14.9%; import of used machinery liberalized to encourage relocation of plants from abroad (2005) (Continued )

Page 136

Lack of export diversification strategy (2001)

QRs on imports removed in stages beginning 1992, finally abolished in 2001

Pakistan

10:11 AM

Average tariffs lowered from 89% in 1991 to 23% in 1997; number of items under QRs reduced from 315 in 1990 to 23 in 1997

QRs removed in 2001

Nepal

12/12/2008

India

b670_Chapter-03.qxd

Bangladesh

South Asia: Rising to the Challenge of Globalization

Reforms

(Continued )

136

Appendix 3.1

Remaining quantitative restrictions on imports removed, except those on grounds of religion, health, security, and environment; administrative procedures on imports and exports simplified

Nepal

Pakistan

Sri Lanka

Reduced number of tariff categories to four (5%, 10%, 20%, 25%)

Levels and dispersion of duty rates reduced; 3-tier duty structure introduced; top duty rate lowered from 30% to 25%

(Continued )

137

Restrictions on FDI in the garment sector outside the EPZs abolished

Page 137

Weak governance, corruption, hinder trade performance

10:11 AM

Trade (cont’d)

India

12/12/2008

Bangladesh

(Continued )

A Comparative Analysis of Economic Performance and Policy Reforms

Reforms

b670_Chapter-03.qxd

Appendix 3.1

(Continued ) Pakistan

Exchange Rate

1990–1997

1990–1997

1990–1997

1990–1997

1990–1997

Market-determined exchange rate; peg with Indian rupee still maintained; current account convertibility

Market-determined exchange rate; current account convertibility

Market-determined exchange rate; current account convertibility (since 1994)

Market-determined exchange rate; current account convertibility

1998–2005

Sri Lanka rupee floated in Jan. 2001

Dual exchange rate system abolished in 1992; taka freely convertible for current account transactions 1998–2005 Taka floated May 2003 by removing official band with dollar (fixed in Jan. 2002) Bangladesh Bank given greater autonomy to conduct monetary and exchange rate policy (2004)

1998–2005 Foreign exchange market liberalized (2003) Managed float responsive to market conditions

1998–2005 Exchange rate pegged to Indian rupee

Exchange rate liberalized in July 2000, replaced managed float with market-based system in 2001

Sri Lanka

1998–2005

Full autonomy of SBP in conduct of monetary, credit, and exchange rate policy granted in Sept. 2002 (Continued )

Page 138

Nepal

10:11 AM

India

12/12/2008

Bangladesh

South Asia: Rising to the Challenge of Globalization

Reforms

b670_Chapter-03.qxd

138

Appendix 3.1

b670_Chapter-03.qxd

Nepal

Pakistan

Sri Lanka

SBP ended practice of purchasing foreign exchange from the curb market in July 2002; government allowed foreign exchange companies in 2002 Some current account restrictions: advance payment for certain imports limited to 50% (Continued )

Page 139

Market-determined exchange rate; interventions confined to countering disorderly conditions

India

10:11 AM

Exchange Rate (cont’d)

Bangladesh

12/12/2008

Reforms

(Continued )

A Comparative Analysis of Economic Performance and Policy Reforms

Appendix 3.1

139

Pakistan

1990–1997

1990–1997

Sri Lanka

II. Microeconomic or Second-Generation Reforms Agriculture Sector and Land Issues

1990–1997

Subsidies eliminated

1998–2005 Slow: public investments in irrigation (2004) Archaic land laws (2004) Slow: reverse decline in public investment and institute reforms in rural infrastructure including irrigation, rural roads, and watershed management

Distribution of agricultural inputs liberalized 1998–2005 Under Agricultural Perspective Plan: monopoly of stateowned Agricultural Inputs Corporation (in import and distribution of fertilizer) eliminated (2000) Removal of fertilizer subsidies completed mid2000

Slow: Awami Tractor Scheme introduced Farm development package introduced to encourage crop diversification 1998–2005 Investments made in irrigation infrastructure in past few years (2004); surge in public expenditures in rural development in last 3 years (2004)

Management of tea plantations privatized 1998–2005 Slow: policy support, promotion of research and extension services, development of active land market for intensive land use and improved productivity (1999) Slow: addressing land issues, restrictive land regulations (2002, 2004, 2005) (Continued )

Page 140

Some steps toward land reform in the 1980s

Slow: massive subsidies for water, electricity, fertilizer

1990–1997

10:11 AM

Significant deregulation of inputs

1990–1997

12/12/2008

Nepal

b670_Chapter-03.qxd

India

(Continued )

South Asia: Rising to the Challenge of Globalization

Bangladesh

140

Appendix 3.1

Bangladesh

Land reform across 5 decades with mixed results: some progress in reducing inequality, but lack of complementary inputs

Sri Lanka Subsidies given to agriculture mainly fertilizer Weak performance of agriculture: lack of agricultural research, weak development and extension services, inconsistent tariff policy, land-use restrictions, lack of infrastructure, fragmentation of landholdings

141

(Continued )

Page 141

Agricultural Perspective Plan (1995) sets out 20-year agenda in agriculture, including addressing complementary inputs

Pakistan

10:11 AM

Slow: strategy toward diversification of agriculture from food grains to higher-value horticultural crops — implies development of post-harvest technology, cold chains, refrigerated transport, grading, and modern marketing

Nepal

12/12/2008

Lack of improvements in delivery of rural credit and crop insurance

(Continued )

A Comparative Analysis of Economic Performance and Policy Reforms

Agriculture Sector and Land Issues (cont’d)

India

b670_Chapter-03.qxd

Appendix 3.1

Pakistan

1990–1997

1990–1997

1990–1997

1990–1997

1990–1997

Industrial licenses abolished except for 14 industries in the areas of defense, health, safety, environment; liberal stance even in these 14 industries

Industrial licenses abolished except in defense, health, environment

Board of Investment established to reduce number of institutions involved in investment decisions

New liberal guidelines for foreign investment announced in 1991

Industrial licenses abolished Foreign investment regulations significantly liberalized Incentive scheme upgraded

1998–2005 Slow reform of nonfinancial SOEs continues (2001, 2002, 2004); SOEs continue to be subsidized

Significantly liberalized foreign investment regulations: automatic approvals for up to 51% foreign equity participation (Jan. 1993)

Privatization Act in place and several industries including airlines privatized Slow: restructuring policies

Significantly liberalized foreign investment for power generation New privatization policy approved in 1994 Slow: restructuring policies

3rd investment promotion zone approved in 1991 Over 30 SOEs privatized 1998–2005 Sri Lanka Telecom and National Development Bank privatized in 1997

1998–2005 New power generation policy in October 2002, to encourage private sector investments (Continued )

Page 142

Slow restructuring, privatization, institutional reforms

Restrictions on expansion of large business houses abolished

Significantly liberalized foreign investment regulations: 100% ownership permitted in medium and largescale industries, and “one window” licensing established

Sri Lanka

10:11 AM

Nepal

12/12/2008

India

b670_Chapter-03.qxd

Bangladesh

South Asia: Rising to the Challenge of Globalization

Industrial Policy and Public Enterprise

(Continued )

142

Appendix 3.1

(Continued ) Nepal

Pakistan

Sri Lanka

Slow reform of SOEs in the energy sector — large quasi-fiscal losses from oil subsidies (0.8% of GDP in 2005)

5-year tax holiday for private investors in power generation, port, airlines, telecom, infrastructure

1998–2005

Gov’t privatized its working interests in 9 petroleum concessions (~2002)

Slow: diversification of industrial production (2000); promotion of more commercial orientation in remaining SOEs (2002)

1998–2005 Slow: privatization, divestment (1999, 2000, 2001, 2002) All items placed under automatic approval route except for a small negative list in Feb. 2000

Butwal Power Co. privatized; privatization of 9 other SOEs initiated (2004); Bhaktapur Brick Factory privatized in 2004 Slow: reform or liquidation of public enterprises; 3 privatized or liquidated, 5 earmarked for early 2005 Lumbini Sugar Factory privatized (~2005)

Oil and Gas Regulatory Authority set up in 2002 to encourage competition and growth in the sector 5% of shares of Oil and Gas Development Corp. sold in 2003; sale of 51% of equity in Habib Bank Ltd. finalized in Dec. 2003

Sri Lanka Insurance Corp. privatized in 2003 Petroleum sector liberalized in 2003 Slow: progress in privatization (2004); new gov’t ruled out privatization, prefers restructuring (2005)

143

(Continued )

Page 143

Slow institutional reforms, privatization, restructuring of public enterprises

Slow SOE reform (2003)

10:11 AM

India

12/12/2008

Bangladesh

A Comparative Analysis of Economic Performance and Policy Reforms

Industrial Policy and Public Enterprise (cont’d)

b670_Chapter-03.qxd

Appendix 3.1

Sri Lanka

Slow removal of small-scale industry reservations (2002)

Review of Nepal Oil Corp in progress to assess its financial position and operating efficiency

Telecom deregulation policy announced in 2003, followed by cellular phone policy in 2004; Pakistan Telecommunication Authority issued 12 licenses to local and foreign firms and 73 fixed-line local loop licenses in 14 regions of the country

Slow: reform of power sector; started in 1996 with goal to unbundle Ceylon Electricity Board but has not been seen through (2005)

Slow: reform of state electricity boards, road transport corporations, other public enterprises (2003) Electricity Act 2003 enacted, provides liberalized captive power policy, open access to transmission and distribution, transparency in subsidy management, etc.

20% of shares of Kot Addu Power Co. divested through stock market in 2005

Slow: tariff adjustments and restructuring of Ceylon Petroleum Corp. and Ceylon Electricity Board; slow reform of CEB (deadlines for reform postponed repeatedly)

(Continued )

Page 144

Pakistan

10:11 AM

Nepal

12/12/2008

India

b670_Chapter-03.qxd

Industrial Policy and Public Enterprise (cont’d)

(Continued )

South Asia: Rising to the Challenge of Globalization

Bangladesh

144

Appendix 3.1

Pakistan

Sri Lanka

Independent regulatory agencies established for electricity and oil and gas sector (Continued )

Page 145

Some progress in privatization: Habib Bank Ltd., Pakistan Telecommunication Company, Karachi Electric Supply Company privatized. Sale of other companies under way including Pakistan Steel and Pakistan Petroleum (2006)

10:11 AM

Electricity tariff reform and privatization of power generation. Electricity Act 2003: establishes State Electricity Regulatory Commission to fix tariffs, phase out cross-subsidies, unbundle generation, transmission, and distribution, and allow access to bulk consumers

Nepal

12/12/2008

Industrial Policy and Public Enterprise (cont’d)

India

(Continued ) A Comparative Analysis of Economic Performance and Policy Reforms

Bangladesh

b670_Chapter-03.qxd

Appendix 3.1

145

Pakistan

Sri Lanka

Slow: disinvestment in public enterprises (2005) Public sector reservations reduced from 18 major industries to 3 (defense, atomic energy, rail transport) (Continued )

Page 146

Large number of economic zones established (2004)

10:11 AM

Water Resources and Power Development Authority unbundled; regional tariff and subsidy policy established

12/12/2008

Substantially liberalized FDI ownership limitations, extended to hydrocarbon and banks; but regulatory procedures cumbersome and nontransparent (2004)

Nepal

b670_Chapter-03.qxd

Industrial Policy and Public Enterprise (cont’d)

India

South Asia: Rising to the Challenge of Globalization

Bangladesh

(Continued )

146

Appendix 3.1

Bangladesh

(Continued ) Nepal

Pakistan

Sri Lanka

Slow reform of reservation of certain areas for small-scale sector

147

(Continued )

Page 147

FDI up to 100% allowed under the automatic route in most industries; simplified approval process; FDI allowed in more sectors

10:11 AM

Monopolies and Restrictive Trade Practices Act replaced by a new competition law

12/12/2008

Industrial licensing abolished in all but a few environmentally sensitive industries

A Comparative Analysis of Economic Performance and Policy Reforms

Industrial Policy and Public Enterprise (cont’d)

India

b670_Chapter-03.qxd

Appendix 3.1

India

Nepal

Pakistan

1990–1997

1990–1997

1990–1997

1990–1997

1998–2005

1998–2005 Inefficient and oversized bureaucracy (2000)

1998–2005 Number of ministries reduced (2001) Slow civil service reform (1999, 2000, 2002) Computerized civil service info system installed (2003) Decentralization implementation plan approved (2003)

Slow 1998–2005 Public resources management reform: separation of gov’t audit and accounting functions (2002) Political devolution needs to be followed up by administrative and financial devolution to allow local governments to acquire the means to carry out their increased responsibilities

Serious efforts being made to reduce size of bureaucracy 1998–2005 Slow: public ad reform (1999, 2000) Public sector hiring freeze, some public sector enterprises offered voluntary retirement packages (2003) Slow: reform of overstaffed bureaucracy and inefficient public services (2004, 2005) (Continued )

Page 148

Some retrenchment in public sector (2002); some public sector restructuring (2003)

Slow: several thousand civil servants retrenched

10:11 AM

Weak governance: need to make AntiCorruption Commission (est. 2004) fully operational, with appropriate organizational structure, incentives, and staffing

Slow

1990–1997

12/12/2008

Slow: studies and reports prepared but little action

Sri Lanka

b670_Chapter-03.qxd

Bangladesh

South Asia: Rising to the Challenge of Globalization

Public Administration

(Continued )

148

Appendix 3.1

Bangladesh

(Continued ) Nepal

Sri Lanka New gov’t created about 70,000 new positions in 2004–05

Decentralization progressing in health and education sectors

(Continued )

149

Progress in judicial reforms slower

Page 149

Promulgation of Governance Ordinance under way (clarifies responsibilities between executive and civil service)

10:11 AM

Civil Service Ordinance promulgated (July 2005)

12/12/2008

Approved reservation of 45% of vacant civil service posts for disadvantaged groups (women, dalits, janjatis)

Pakistan

A Comparative Analysis of Economic Performance and Policy Reforms

Public Administration (cont’d)

India

b670_Chapter-03.qxd

Appendix 3.1

India

Nepal

Pakistan

1990–1997

1990–1997

1990–1997

1990–1997

Labor Market

Slow: Industrial Disputes Act and Companies Act being revised

1998–2005

Need to expand contract employment, streamline labor regulations, and create greater flexibility to accommodate rapidly expanding labor force

1998–2005

4 ordinances promulgated in 2005 to improve regulatory environment: Secured Transactions, Company, Securities, and Insolvency. Competition Ordinance being drafted for more flexible contractual hiring

New labor policy approved in September 2002: reconcile national laws on industrial relations with international laws, consolidating 30 existing laws into 6

Slow 1998–2005 Slow labor market reform (2002, 2004, 2005) Need for more flexible labor laws

Restrictive labor laws; need to rationalize industrial and commercial labor laws

(Continued )

Page 150

Archaic labor laws hinder producers from retrenching workers and restructuring their businesses (2002, 2004, 2005)

Slow

1998–2005

10:11 AM

National Renewal Fund for training and redeploying workers established

Slow

1990–1997

12/12/2008

Slow

Sri Lanka South Asia: Rising to the Challenge of Globalization

Bangladesh

b670_Chapter-03.qxd

(Continued )

150

Appendix 3.1

Infrastructure

(Continued )

In 1997 Parliament ratified Mahakali Integrated Development Treaty between Nepal and India, a joint hydroelectric, irrigation, and flood control project

Private sector involvement in infrastructure development allowed (1995)

Serious infrastructure deficiencies (1998, 1999); commercialization of infrastructure faces several constraints including absence of an appropriate long-term framework and policy incentive mechanism for private investment; long-term debt markets not well developed (1998, 1999)

Butwal Power Company privatized (2004) Weak infrastructure, transport and transaction delays, high power costs, and an unpredictable regulatory framework burden economic performance (2006)

Social Action Program (SAP) launched in 1993 to improve social services including rural water supply and sanitation Telecom deregulation policy announced in July 2003 followed by the cellular phone policy in January 2004 Weak infrastructure, especially in the wake of the 2005 earthquake (2006) Substantial public sector investments in irrigation in the last few years (2006)

Underdeveloped and outdated infrastructure in agriculture (1993) Government eliminated load shedding of power in 2002; groundwork laid for utilities to be regulated by independent commission; plans to unbundle vertically integrated state-owned electricity company to encourage competition and efficiency (2003)

(Continued )

Page 151

Industry sector reforms in 1994 included reduction of entry restrictions for both domestic and foreign firms in telecoms, power projects, and other infrastructure (1995)

Sri Lanka

10:11 AM

Power shortages; public spending on physical infrastructure including energy, transport, and communications, is low and spread too thinly (1994)

Pakistan

12/12/2008

Nepal

151

India

A Comparative Analysis of Economic Performance and Policy Reforms

Bangladesh

Some progress in opening up infrastructure and energy sectors to private investment; serious infrastructure weaknesses in port and power facilities remain (1999)

b670_Chapter-03.qxd

Appendix 3.1

Infrastructure bottlenecks in irrigation and rural electrification (2002, 2004) 2003 Electricity Act enacted to promote competition, efficiency, and financial viability

High energy costs and weak infrastructure seriously impede competitiveness; some progress in unbundling power sector; insufficient supply of hydropower (2004) Continuing losses of Ceylon Electricity Board, including payment arrears (2006) No large infrastructure improvements in the last 20 years, resulting in bottlenecks in economic performance (2006)

(Continued )

Page 152

Power sector suffers from high system losses, poor quality of supply, weak financial management, and significant payment arrears (2006)

Infrastructure overstrained and suffers from underinvestment in postreform period (2000)

Sri Lanka

10:11 AM

Investments in power, road, and transport sectors have failed to keep pace with developments in the overall economy (1999)

Pakistan

12/12/2008

Large public investments in infrastructure needed, but are limited by very low government revenue base, weak project implementation capacity, and significant fiscal obligations such as recapitalization of NCBs (2004)

Nepal

b670_Chapter-03.qxd

India

South Asia: Rising to the Challenge of Globalization

Infrastructure (cont’d)

Bangladesh

(Continued )

152

Appendix 3.1

Sri Lanka

Unreliable and inadequate power supply a major impediment to industrial recovery and growth (2004). (Continued )

Page 153

Tenth five-year plan 2002–07 finalized in 2002; emphasizes improving existing infrastructure over new projects; plan recognizes need for reforms in power sector to improve cost recovery and financial viability (2003)

Pakistan

10:11 AM

Country behind most comparator countries in physical infrastructure for power, gas, ports, and telecommunications (2006)

Nepal

12/12/2008

India

(Continued )

A Comparative Analysis of Economic Performance and Policy Reforms

Infrastructure (cont’d)

Bangladesh

b670_Chapter-03.qxd

Appendix 3.1

153

Nepal

Pakistan

Sri Lanka

(Continued )

Page 154

Poor agricultural performance linked partly to problems with irrigation and surface water management (2006)

10:11 AM

Phased liberalization of communications sector

12/12/2008

Infrastructure investment of 3.5% of GDP in FY2005 way below target of 8.0% of GDP mainly because of large consolidated deficit position of federal and state governments (2005)

b670_Chapter-03.qxd

Infrastructure (cont’d)

India

South Asia: Rising to the Challenge of Globalization

Bangladesh

(Continued )

154

Appendix 3.1

b670_Chapter-03.qxd

Infrastructure (cont’d)

India

Nepal

Pakistan

Sri Lanka

Note: Year in parentheses refers to the publication date of source; this usually refers to reforms of the previous year. Sources: ADB, Asian Development Outlook, various years; IMF, Article IV Consultation reports.

Page 155

India Infrastructure Finance Company Ltd. established in January 2006 to help finance projects with insufficient longterm debt

10:11 AM

Continuing shortage of power generation capacity and financial problems at many state electricity boards (2006)

A Comparative Analysis of Economic Performance and Policy Reforms

Bangladesh

(Continued )

12/12/2008

Appendix 3.1

155

b670_Chapter-03.qxd

156

12/12/2008

10:11 AM

Page 156

South Asia: Rising to the Challenge of Globalization Appendix 3.2

Governance Indicators.

Voice and Accountability (percentile rank, 0–100) Country

1996

1998

2000

2002

2003

2004

2005

South Asia Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka Average

38.5 7.2 56.7 19.7 52.9 20.2 40.9 33.7

41.5 7.2 52.7 15.0 46.9 30.4 37.2 33.0

35.3 4.8 57.0 18.4 43.5 6.8 35.7 28.8

30.0 13.5 58.0 25.6 30.9 17.4 45.9 31.6

32.4 13.5 52.7 20.8 27.5 14.0 42.5 29.1

29.5 14.5 55.6 19.3 21.7 11.6 41.1 27.6

31.4 21.7 55.6 20.3 14.5 12.6 39.6 28.0

East Asia Brunei Cambodia PRC Hong Kong, China Indonesia Japan Korea, Rep. of Laos Malaysia Myanmar Philippines Singapore Taiwan Thailand Viet Nam Average

20.7 25.5 11.1 63.5

13.5 22.7 4.3 38.6

15.9 33.3 6.3 30.9

22.2 29.5 9.7 54.1

19.8 26.1 7.7 58.5

17.9 24.2 8.2 52.2

22.2 23.7 6.3 52.2

14.9 79.8 67.3 15.9 48.1 1.4 53.8 59.1 63.9 49.5 10.6 39.0

10.6 79.2 66.7 12.1 42.0 1.0 58.9 42.5 68.1 49.8 3.4 34.2

30.4 72.5 67.6 8.7 38.2 0.0 54.6 41.5 70.0 53.6 5.8 35.3

32.4 79.2 68.6 3.4 42.0 1.4 52.2 63.8 75.4 53.6 10.6 39.9

35.7 79.7 66.2 2.4 36.7 0.5 50.2 43.0 70.0 53.1 8.2 37.2

36.2 78.3 70.0 7.2 39.1 0.0 48.3 44.4 76.8 53.1 8.7 37.6

40.6 74.9 68.1 8.2 34.3 0.0 47.8 38.2 69.1 49.3 7.7 36.2

Latin America

50.3

52.7

54.5

52.3

53.2

53.7

52.3

World Average

50.0

50.0

50.0

50.0

50.0

50.0

50.0

Note: Voice and accountability refer to the extent to which a country’s citizens are able to participate in selecting their government, as well as freedom of expression, freedom of association, and free media. Source: Kaufmann, Kraay, and Mastruzzi (2006).

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(Continued)

Political Stability (percentile rank, 0–100) Country

1996

1998

2000

2002

2003

2004

2005

South Asia Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka Average

18.4 74.1 15.1 48.6 28.8 9 5.2 28.5

26.9 62.7 20.8 n.a. 19.8 11.8 6.1 24.7

23.1 62.7 27.8 n.a. 10.4 19.3 3.8 24.5

25 69.3 19.3 90.1 5.7 11.3 17.5 34.0

20.3 68.9 14.6 84.9 4.7 8 18.9 31.5

15.1 79.2 15.6 62.7 3.8 5.7 14.2 28.0

6.6 83 22.2 70.8 1.9 5.7 10.8 28.7

East Asia Brunei Cambodia PRC Hong Kong, China Indonesia Japan Korea, Rep. of Laos Malaysia Myanmar Philippines Singapore Taiwan Thailand Viet Nam Average

91.5 10.4 40.1 46.7

91.0 9.9 40.6 68.4

87.7 18.4 43.9 83.5

82.1 31.1 40.6 80.2

87.3 30.2 39.6 82.1

90.6 35.4 41.0 89.6

87.7 31.1 39.2 89.6

23.1 76.4 40.6 82.1 73.1 11.8 34.0 93.9 75.5 42.0 49.5 52.7

7.5 83.0 43.4 58.0 51.9 10.4 39.2 85.8 77.4 50.9 56.1 51.6

2.8 85.4 51.9 41.5 50.0 7.1 29.2 94.3 60.4 45.8 53.3 50.3

9.4 87.3 54.7 35.4 51.9 12.7 24.1 89.2 67.9 54.2 55.7 51.8

4.2 91.0 51.9 24.1 56.1 13.7 14.2 76.9 67.5 48.1 56.6 49.6

7.1 79.7 61.8 24.1 56.1 17.9 12.3 88.7 62.3 33.0 55.2 50.3

9.0 80.2 60.8 37.3 62.3 19.8 17.5 84.0 64.2 29.2 59.0 51.4

Latin America

33.0

38.1

41.5

39.1

39.0

37.0

35.8

World Average

50.0

50.0

50.0

50.0

50.0

50.0

50.0

Note: Political stability and absence of violence refer to perceptions of the likelihood that the government will be destabilized or overthrown by unconstitutional or violent means, including political violence and terrorism. Source: Kaufmann, Kraay, and Mastruzzi (2006).

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(Continued)

Government Effectiveness (percentile rank, 0–100) Country

1996

1998

2000

2002

2003

2004

2005

South Asia Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka Average

21 67.6 38.1 60 40.5 40 47.1 44.9

38.3 63.6 52.2 71.3 11 22 39.7 42.6

36.4 73.7 55 60.3 29.2 33.5 43.5 47.4

28.7 74.2 55.5 74.6 38.3 33 59.8 52.0

31.1 70.3 57.9 67 30.6 34.9 54.5 49.5

28.7 61.2 56.9 63.6 20.1 37.3 44 44.5

21.1 64.6 51.7 59.8 15.3 34 40.7 41.0

East Asia Brunei Cambodia PRC Hong Kong, China Indonesia Japan Korea, Rep. of Laos Malaysia Myanmar Philippines Singapore Taiwan Thailand Viet Nam Average

84.3 27.1 64.3 92.4

59.3 7.2 61.7 89.0

74.6 35.4 63.6 84.7

76.6 31.6 62.2 89.5

73.2 34.4 59.8 90.0

60.3 18.2 57.9 91.9

70.3 18.7 52.2 92.8

61.9 88.1 77.6 57.1 79.5 6.2 66.7 97.6 86.7 75.2 51.0 67.7

30.1 83.3 70.8 42.1 78.0 2.9 63.2 100.0 90.0 60.8 48.8 59.1

39.2 85.6 76.1 22.0 73.2 6.2 61.2 100.0 87.6 61.7 41.1 60.8

34.0 85.2 81.3 29.7 80.9 6.7 56.0 100.0 84.7 64.6 46.9 62.0

34.0 85.2 79.9 14.8 78.9 5.3 53.6 100.0 84.2 64.6 46.4 60.3

39.7 87.1 78.5 12.9 79.4 2.4 50.2 98.6 88.0 66.5 42.6 58.3

37.3 84.7 78.9 12.0 80.4 2.4 55.5 99.5 83.7 66.0 45.0 58.6

Latin America

44.9

50.2

46.4

41.7

42.7

43.8

43.4

World Average

50.0

50.0

50.0

50.0

50.0

50.0

50.0

Note: Government effectiveness refers to the quality of public services, the quality of the civil service and the degree of its independence from political pressures, the quality of policy formulation and implementation, and the credibility of the government’s commitment to such policies. Source: Kaufmann, Kraay, and Mastruzzi (2006).

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(Continued)

Regulatory Quality (percentile rank, 0–100) Country

1996

1998

2000

2002

2003

2004

2005

South Asia Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka Average

14.9 50.5 41.1 66.3 28.7 27.7 50 39.9

11.3 22.2 35.5 57.6 26.6 18.7 56.7 32.7

16.7 55.7 36.9 67 35.5 20.7 56.7 41.3

14.3 39.9 41.9 71.9 32.5 21.2 59.6 40.2

37.4 51.7 34.5 48.3 28.6 18.7 56.2 39.3

39.4 35.5 38.9 49.3 32 37.4 69.5 43.1

28.9 50 41.7 56.9 34.3 25.5 64.7 43.1

100.0 32.4 40.7 99.0

40.9 35.0 41.4 98.0

52.2 40.4 46.8 98.5

80.8 36.0 36.5 89.7

78.3 36.0 40.4 98.0

84.2 30.0 39.4 99.0

76.7 27.2 44.6 100.0

57.4 77.5 72.1 10.3 80.4 11.8 64.2 99.5 85.3 65.2 27.9 61.6

44.3 64.0 53.7 11.3 65.0 9.9 68.5 99.5 84.2 51.7 23.6 52.7

31.5 78.8 67.5 9.9 59.1 6.9 58.6 100.0 84.2 74.9 21.2 55.4

23.6 78.8 74.9 8.9 67.5 2.5 53.7 99.0 79.8 62.1 24.1 54.5

23.6 79.3 70.9 6.9 69.0 2.0 53.2 99.0 80.3 63.5 33.0 55.6

36.9 82.8 73.4 10.3 69.5 0.5 47.3 99.5 81.8 58.6 27.1 56.0

36.6 85.6 71.8 10.9 66.8 1.5 52.0 99.5 79.7 63.9 25.7 56.2

Latin America

64.4

68.7

62.2

51.3

50.7

50.5

47.3

World Average

50.0

50.0

50.0

50.0

50.0

50.0

50.0

East Asia Brunei Cambodia PRC Hong Kong, China Indonesia Japan Korea, Rep. of Laos Malaysia Myanmar Philippines Singapore Taiwan Thailand Viet Nam Average

Note: Regulatory quality refers to the ability of the government to formulate and implement sound policies and regulations that permit and promote private sector development. Source: Kaufmann, Kraay, and Mastruzzi (2006).

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Rule of Law (percentile rank, 0–100) Country

1996

1998

2000

2002

2003

2004

2005

South Asia Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka Average

27.3 9.1 54.5 n.a. 40.7 35.9 62.7 38.4

26.4 52.4 60.6 27.4 47.6 25 51 41.5

29.8 41.3 58.2 28.8 43.8 26.4 49 39.6

25.5 57.2 52.9 58.2 39.9 27.4 56.3 45.3

26.4 63.5 54.3 61.5 29.8 28.8 55.8 45.7

19.7 61.5 52.4 57.7 27.9 21.6 54.3 42.2

19.8 64.7 56 60.4 25.1 24.2 54.1 43.5

East Asia Brunei Cambodia PRC Hong Kong, China Indonesia Japan Korea, Rep. of Laos Malaysia Myanmar Philippines Singapore Taiwan Thailand Viet Nam Average

71.3 15.8 35.4 92.3

75.0 23.6 46.6 91.3

75.5 23.1 44.7 89.4

65.9 19.7 47.6 85.1

66.8 15.9 42.3 89.4

64.4 13.5 41.3 90.4

62.8 11.1 40.6 91.3

41.1 90.4 78.0 4.3 78.5 4.8 53.6 99.5 82.3 66.5 33.5 56.5

13.5 91.8 71.6 8.7 67.3 9.1 55.3 98.6 82.2 62.5 17.3 54.3

12.0 91.8 67.8 11.1 65.4 6.3 38.9 97.6 72.6 63.0 25.0 52.3

18.3 88.5 75.0 15.9 64.4 2.9 31.7 92.8 76.0 56.7 38.9 52.0

21.6 89.9 67.8 11.5 64.4 0.5 30.8 95.7 77.9 54.8 38.9 51.2

23.1 89.4 69.2 14.9 65.9 3.4 32.7 95.7 76.9 53.8 36.1 51.4

20.3 89.4 72.5 11.6 66.2 2.9 38.6 95.7 78.7 56.5 42.0 52.0

Latin America

44.0

43.0

40.8

37.1

39.6

38.4

37.4

World Average

50.0

50.0

50.0

50.0

50.0

50.0

50.0

Note: Rule of law is the extent to which agents have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, the police, and the courts, as well as the likelihood of crime and violence. Source: Kaufmann, Kraay, and Mastruzzi (2006).

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(Continued)

Control of Corruption (percentile rank, 0–100) Country

1996

1998

2000

2002

2003

2004

2005

South Asia Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka Average

35.1 n.a. 44.9 n.a. 48.8 12.2 50.2 38.2

40.2 70.6 54.4 31.4 28.4 18.6 52.5 42.3

31.4 69.6 46.6 37.3 33.8 16.2 53.4 41.2

13.7 71.6 41.7 52.9 40.2 23.5 51.5 42.2

7.4 80.9 46.1 55.9 39.2 27.5 52.9 44.3

5.9 77 44.6 52 30.4 11.3 51.5 39.0

7.9 78.8 46.8 48.8 29.1 15.8 47.3 39.2

East Asia Brunei Cambodia PRC Hong Kong, China Indonesia Japan Korea, Rep. of Laos Malaysia Myanmar Philippines Singapore Taiwan Thailand Viet Nam Average

67.8 14.6 60.0 91.2

62.3 2.9 56.4 91.2

52.5 24.5 44.1 90.7

65.7 18.6 42.6 90.7

62.7 18.1 38.7 91.2

68.6 14.2 33.3 92.2

63.1 8.9 30.5 92.1

34.1 88.8 76.6 14.6 75.6 4.9 36.6 98.0 80.5 44.4 26.8 54.3

9.3 84.3 64.2 22.5 77.0 2.5 50.5 97.1 80.4 52.0 27.0 52.0

10.8 85.8 67.2 19.6 64.2 3.4 36.8 99.5 74.0 45.1 25.0 49.5

6.9 85.8 67.2 18.1 66.7 1.5 34.8 99.5 75.0 46.6 31.4 50.1

13.2 84.8 64.2 12.7 68.1 2.0 42.2 99.0 73.5 47.1 31.4 49.9

15.2 86.8 59.3 12.3 64.7 1.0 34.8 99.5 74.0 48.0 23.0 48.5

21.2 85.2 69.0 9.4 64.5 1.5 37.4 99.0 70.9 51.2 26.6 48.7

Latin America

42.7

41.7

42.7

40.9

44.0

43.5

41.2

World Average

50.0

50.0

50.0

50.0

50.0

50.0

50.0

Note: Corruption is the extent to which public power is exercised for private gain, including both petty and grand forms of corruption, as well as “capture” of the state by elites and private interests. Source: Kaufmann, Kraay, and Mastruzzi (2006).

Sri Lanka

Need to implement 2004 subsidy reform for improved targeting of subsidies

Considerable scope for improvements in tax administration, especially customs, excises, and LTO operations to raise collections. Low levels of dev spending dampen growth. Need to raise external assistance and dev spending

Need to further broaden tax base by expanding taxation more into agricultural and service sectors and reducing remaining exemptions

Prices of petroleum products and electricity subsidized; large fiscal costs from operations of Ceylon Petroleum Corp and Ceylon Electricity Board (1% of GDP in 2004); need to allow full passthrough of higher oil prices; slow adjustment of electricity tariffs

I. Macroeconomic Reforms Fiscal Reforms and Public Resource Management

Energy sector SOEs a source of fiscal risk, need to allow full pass-through of higher oil prices

Need to allow full pass-through of higher oil prices to limit quasi-fiscal losses

Need to allow full pass-through of higher oil prices, lessen subsidies

Need to ensure implementation of Fiscal Responsibility Act 2002 (Continued )

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Bangladesh

162

Appendix 3.3

Nepal

Pakistan

Sri Lanka

(Continued )

Page 163

Need to ensure implementation of plan to have one corporate tax rate by 2007

10:11 AM

Need to ensure implementation of Fiscal Responsibility and Debt Limitation Bill to eliminate revenue deficit (i.e., no borrowing to finance current expenditures) by June 2007 and reduce debt to 60% of GDP by 2012

A Comparative Analysis of Economic Performance and Policy Reforms

Fiscal Reforms and Public Resource Management (cont’d)

India

(Continued )

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Bangladesh

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163

Need to develop capital markets; high reliance on banks

Need to improve loan recovery, staff performance, raise audit and accounting standards

Need to strengthen pension and insurance systems; divest remaining public ownership of commercial banks; broaden access to finance to underserved segment of population

Need to strengthen legal and regulatory framework; NRB needs to strengthen its supervisory capacity; NPLs of two state banks continue to be problematic

Sri Lanka Privatization of state-owned banks (whose financial performance has improved significantly) abandoned, but restructuring continues under the supervision of the Strategic Enterprise Management Agency

(Continued )

Page 164

Bank restructuring program slow; need to speed up divestment of Rupali Bank; reform of other NCBs

Need to ensure proper implementation of Basel II in 2007

Pakistan

10:11 AM

Need to ensure proper implementation of Basel II standards

Nepal

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Financial Sector

India

South Asia: Rising to the Challenge of Globalization

Bangladesh

(Continued )

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Appendix 3.3

Trade

Sri Lanka Need to improve reliability of power supply and road transport in MFA post-quota era

ER level broadly appropriate, but needs to be monitored in view of uncertainties facing Pakistan Need to lift exchange restriction on payments for current international transactions

165

(Continued )

Page 165

Tariff rates for industrial goods reduced from a weighted average of 80% in 1992 to around 20% in 2004–2005; planned convergence to ASEAN levels (9%) by 2009 (considered slow)

Pakistan

10:11 AM

Weak governance, corruption hinder trade performance

Nepal

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India

(Continued )

A Comparative Analysis of Economic Performance and Policy Reforms

Exchange Rate

Bangladesh

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Appendix 3.3

Problems in land reform: inability of land recipients to assert rights (lack of knowledge or illiteracy), low quality of land redistributed, lack of complementary inputs

Need to develop infrastructure especially irrigation systems

Weak performance of agriculture: lack of agricultural research, weak development and extension services, inconsistent tariff policy, land-use restrictions, lack of infrastructure, fragmentation of landholdings

II. Microeconomic or Second-Generation Reforms Agriculture Sector and Land Issues

Need to reverse decline in public investment and institute reforms in rural infrastructure including irrigation, rural roads, and watershed management Need for improvements in delivery of rural credit and crop insurance

Need for complementary inputs: rural finance for irrigation, farm machinery, fertilizers, rural infrastructure Need for effective implementation of Agricultural Perspective Plan

(Continued )

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Bangladesh

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166

Appendix 3.3

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Pakistan

Sri Lanka

(Continued )

Page 167

Need for strategy toward diversification of agriculture from food grains to higher-value horticultural crops — implies development of post-harvest technology, cold chains, refrigerated transport, grading, and modern marketing

10:11 AM

Agriculture Sector and Land Issues (cont’d)

India

12/12/2008

Bangladesh

(Continued )

A Comparative Analysis of Economic Performance and Policy Reforms

Appendix 3.3

167

Need for exit policies, bankruptcy law

Need to expedite restructuring policies Some progress in privatization: Habib Bank Ltd., Pakistan Telecommunication Company, Karachi Electric Supply Company privatized. Sale of other companies under way including Pakistan Steel and Pakistan Petroleum

Need for tariff adjustments and restructuring of Ceylon Petroleum Corp. and Ceylon Electricity Board; slow reform of CEB (deadlines for reform postponed repeatedly)

Need to strengthen governance and accountability including privatization (setting economically sound tariffs and reducing costs) in power sector (Continued )

Page 168

Slow reform of SOEs in the energy sector — large quasi-fiscal losses from oil subsidies (0.8% of GDP in 2005)

Need for structural reform or liquidation of lossmaking public enterprises

Sri Lanka

10:11 AM

Need to expedite institutional reforms, privatization, restructuring of public enterprises

Pakistan

12/12/2008

Need to expedite industrial restructuring, privatization, institutional reforms

Nepal

South Asia: Rising to the Challenge of Globalization

Industrial Policy and Public Enterprise

India

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(Continued )

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Appendix 3.3

Bangladesh Slow

Pakistan

Need for more flexible labor markets; need to accommodate labor concerns about unemployment insurance and dueprocess provisions in draft of Competition Ordinance

Restrictive labor laws; need to rationalize industrial and commercial labor laws

Political devolution needs to be followed by administrative and financial devolution to allow local governments to acquire the means to carry out their increased responsibilities Need for more flexible labor laws

(Continued )

Page 169

Slow

169

Need for governance reforms

Sri Lanka

10:11 AM

Need to expand contract employment, streamline labor regulations, and create greater flexibility to accommodate rapidly expanding labor force

Nepal

12/12/2008

Labor Market

Weak governance hinders investment climate: need to make AntiCorruption Commission (est. 2004) fully operational, with appropriate organizational structure, incentives, and staffing

(Continued )

A Comparative Analysis of Economic Performance and Policy Reforms

Public Administration

India

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Appendix 3.3

India

Nepal

Pakistan

Sri Lanka

Need for more and better basic physical infrastructure, including power supplies, roads, ports, and railways

Need for more basic infrastructure to raise productivity in agriculture

Need to upgrade and restore basic infrastructure, especially in the aftermath of the 2005 earthquake

Need to rebuild infrastructure, especially roads and power supply in MFA post-quota era

Need for more public-private partnerships in infrastructure financing and an improved legal and regulatory framework (Continued )

Page 170

Supply and reliability of power need to be improved, including further corporatizing sector entities, fully operationalizing the Bangladesh Energy Regulatory Commission, and adopting a pricing policy to recover operational costs

10:11 AM

Infrastructure

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Need to improve regulatory framework to international standards

South Asia: Rising to the Challenge of Globalization

Bangladesh

(Continued )

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Nepal

Pakistan

Sri Lanka

(Continued )

Page 171

More reforms needed in Chittagong port to improve vessel turnaround time and container idle time

10:11 AM

Gas sector needs to be reorganized to de-link regulation from operation, create a conducive environment to encourage private sector involvement in transmission and distribution, and link domestic prices to international levels

12/12/2008

Infrastructure (cont’d)

India

(Continued ) A Comparative Analysis of Economic Performance and Policy Reforms

Bangladesh

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171

Nepal

Sources: ADB (2006) and 2006 update; IMF, Article IV Consultation reports.

Page 172

Bangladesh Railway must adopt a more commercial focus to take advantage of increased domestic and cross-border demand for railway services

Sri Lanka

10:11 AM

More reform initiatives in roads needed to improve governance, create an autonomous user-financed road maintenance fund, and approve a multimodal transport policy

Pakistan

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Infrastructure (cont’d)

India

South Asia: Rising to the Challenge of Globalization

Bangladesh

(Continued )

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References Ahluwalia, MS (2002). Economic Reforms in India since 1991: Has Gradualism Worked? Journal of Economic Perspectives, 16(3): 67–88. ———. n.d. India’s Economic Reforms and Appraisal. Speech, Planning Commission, Government of India. Anderson, K (2003). Agriculture and Agricultural Incentives in China and India Post-Uruguay Round. Paper presented at the conference Agricultural Policy Reforms and the WTO: Where Are We Heading?, Capri, Italy. Asian Development Bank (2006). Asian Development Outlook 2006. Bhattacharya, S and UR Patel (2003). Reform Strategies in the Indian Financial Sector. Paper presented at the conference A Tale of Two Giants: India’s and China’s Experience with Reform and Growth, New Delhi, India. Bourguignon, F and C Morrison (2002). Inequality among World Citizens: 1820–1992. American Economic Review, 92(4): 727–744. DeLong, B (2003). India since Independence: An Analytic Growth Narrative. In Search of Prosperity: Analytic Narratives on Economic Growth, edited by Dani Rodrik, Princeton University Press. Dollar, D and A Kraay (2000). Growth Is Good for the Poor. World Bank Development Research Group. Mimeo. Dowling, JM (2008). Future Perspectives on the Economic Development of Asia, Advanced Research in Asian Economic Studies, Volume 5 . World Scientific, New Jersey and Singapore. Economist (2006). Who Wants To Be a Trillionaire? The Economist, 28 October, 91. Eslake, S (2005). China and India in the world economy and Implications for Australia ABERU Discussion Paper No. 20. Monash University, Melbourne, Australia. Fei, JCH and G Ranis (1961). A Theory of Economic Development. American Economic Review, 51(4): 533–565. Hasan, R, D Mitra, and B Ural (forthcoming). Trade Liberalization, Labor Market Institutions and Poverty Reduction: Evidence from Indian States. India Policy Forum. Henley, JS (2003). Chasing the Dragon: Accounting for the Under-Performance of India by Comparison with China in Attracting Foreign Direct Investment. Paper presented at the Annual Conference 2003: Globalisation and Development, Development Studies Association. International Monetary Fund (2005). Bhutan: Joint Staff Advisory Note of the Poverty Reduction Strategy Paper, Country Report 05/85. ———. (2006). World Economic Outlook Database Online. Kochhar, K, U Kumar, RG Rajan, A Subramanian and I Trokatlidis (2006). India’s Pattern of Development: What Happened, What Follows? IMF Working Paper 22.

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Lewis, WA (1954). Economic Development with Unlimited Supplies of Labour. The Manchester School, 22(2): 139–191. Mellor, JW and Sarah Gavian (1999). The Determinants of Employment Growth in Egypt: The Dominant Role of Agriculture and the Rural Small Scale Sector. Impact Assessment Report No. 7. Abt Associates, Inc. Nararaj, R (2005). Industrial Growth in China and India: A Preliminary Comparison. Economic and Political Weekly, 2163–2171. Panagariya, A (2006). India and China: Trade and Foreign Investment. Paper presented at Pan Asia Conference, Stanford University. Park, A and K Sehrt (2001). Tests of Financial Intermediation and Banking Reform in China. Journal of Comparative Economics, 29(4): 608–644. Ravallion, M and S Chen (2004). How Have the World’s Poorest Fared since the Early 1980s? World Bank Policy Research Working Paper 3341. Rodrik, D (2002). After Neo-liberalism What? Harvard University. Mimeo. Timmer, PC (1997). How Well Do the Poor Connect to the Growth Process? CAER Discussion Paper 17, Harvard Institute of International Development. UNCTAD FDI Database. United States Department of Commerce, Commercial Service website http://www. buyusa.gov/china/en/bank.html Whalley, J and S Zhang (2004). Inequality Change in China and (Hukou) Labour Mobility Restrictions. NBER Working Paper Series No. 10683. Wolf, M (2004). There’s A Proven Way to Rid the World of Poverty. Straits Times Singapore, 6 May. World Bank. World Development Indicators Online. World Bank and International Bank for Reconstruction and Development (IBRD) (2007). Doing Business in South Asia 2007. World Bank and International Finance Corporation (IFC) (2006). Doing Business in 2006: Creating Jobs.

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Chapter 4

Economic Integration Between South Asia and East Asia: The Second Phase of Pan-Asian Integration?

Introduction Recently, there has been growing interest in the evolving economic relationships between South Asia and East Asia. There are at least three reasons for this. First, two of the most dynamic countries in the world, namely, China and India, are in the region and the evolution of these giant economies together with growing economic interrelations between the two could have important implications for other countries in the region and the global economy. Second, with the surge in regionalism in post-crisis East Asia, a question that is frequently being asked is, will growing economic relations between South Asia and East Asia be the second phase and eventually lead to an integrated Pan-Asia similar to the integration achieved in Europe, sometime in the future? Third, during the pre-colonial period, Asia not only dominated the global economy but was one of the most integrated regions of the world — will this happen once again? South Asia has a long history of economic ties and cultural and religious exchange with East Asia which date back to the pre-Christian era. The first millennium of the Christian era was a period of rapid growth for India and China. Trade ties between these two countries also increased and the expansion of trade links between these countries widened localized networks into regional ones.9 Exports from 9

For a more comprehensive discussion, see Vineeta Shankar (2004). 175

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India comprised mainly rice, sugar and textiles, while imports were more varied and included Indonesian spices, various kinds of woods, Chinese silk, gold and non-precious metals such as tin, copper and vermillion. India and China were in contact with each other through a network of land and sea routes. Land routes started off as localized networks and were gradually linked into long distant trading channel known as the Silk Road. There were two major maritime ports in the east coast of India, namely, the port of Coromandel (near present-day Chennai) and Bengal. There is evidence of extensive trade with Burma and Thailand. The opening of the Straits of Malacca in the fifth century enabled direct contact with the northwestern edge of the Java Sea region where intra-regional trade was strong and which led to the establishment of the Srivijaya Empire (present-day Indonesia). This, together with the emergence of the Chola Empire in South India and the Sung Dynasty in China in the tenth and the eleventh centuries as large, unified, and prosperous regional powers, provided an additional fillip to regional economic trade and exchange. Strategically located on the route of the great maritime route connecting China and the West, Southeast Asia also provided a staging ground for merchants from the East and the West. Various strategic alliances were also made. Rajendra I of the Chola dynasty conducted a naval expedition to Srivijaya to protect trade with China. Rajendrachola Deva I named the island of Singapore (Singapura) in the 10th century AD. Hence, during the pre-colonial period, in addition to being the dominant region of the world, Asia was one of the most integrated regions of the world. The latter fact is relatively less known. Together with land and sea-borne commerce, trader, missionaries, priests, adventurers, and fortune seekers moved from South Asia to Southeast Asia. The Sanskrit language, Hinduism, and Buddhism were like old wine lacing East Asia’s culture. Names from the Sanskrit language and various Hindu-Buddhist cults were adopted in East Asia. The common people too were influenced by the stories of the Ramayana, and various deities became popular. During the colonial period (the 19th and early 20th centuries), Europeans (the Portuguese, the Spanish, the Dutch, the British, and

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the French) and the Americans were able to take control of the international trade of Asia, thereby diverting the profits from this trade to Europe. This distorted center-periphery relations made Europe stronger while the Asian empires and kingdoms became weaker. Economic links between South Asia and East Asia also weakened as South Asian soldiers were used to quash rebellions in other parts of Asia such as China (the Opium War) and Malaya. It is only after the end of the colonial period that South Asia has once again started to re-engage with East Asia. This will be discussed later. While there is growing interest on South Asia–East Asia economic relations, most studies on regionalism in Asia focus on either South Asia or East Asia separately. Studies on the implications of economic cooperation between the two regions are few — the only exceptions are a number of studies on BIMSTEC (e.g., ADB, 2005) — and these focus mainly on India’s economic relations with the PRC, ASEAN, or ASEAN+3 (Asher and Sen, 2005; Kumar, Sen, and Asher, 2006). An exception in Chandra and Kumar (2008). It is true, no doubt, that India accounts for about 80% of South Asia’s gross national product (GNP) and has been the most active in pursuing enhanced economic relations with East Asia under its so-called “Look East” policy. However, other countries in South Asia such as Pakistan and Sri Lanka are also now initiating FTA discussions with various East Asian countries, and Bangladesh, Bhutan, Nepal and Sri Lanka are members of BIMSTEC. The objectives of this chapter are threefold: to review trends in economic integration between South Asia and East Asia, highlight the potential for increased integration in the future, and recommend policies to further enhance integration between the two regions. After this introductory section, the next section provides various quantitative measures of economic integration between South Asia and East Asia. It is followed by a section that assesses the economic complementarities between the two regions by analyzing the composition of the top 10 exports of the two regions to each other, by calculating revealed comparative advantage indices, and by calculating the trade complementarity index. This section also attempts to explain why the level of integration between the two regions was low

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until 2000 and why it has started to surge since then. The section after that reviews ongoing policy efforts to promote integration between the two regions including the proliferation of FTAs between them. The final section recommends a set of policies that could be considered for enhancing integration between South Asia and East Asia.

Quantitative Measures of Integration Trade Integration South Asia’s total merchandise trade with East Asia (ASEAN+3) has grown significantly in absolute terms. It increased nearly eightfold in 1990–2006, from $12.4 billion to $96.8 billion, for an average annual growth rate of 14.6% (Fig. 4.1). The annual growth rate was relatively moderate until 2000, but it surged after that and averaged 26.2% in 2001–2006, with the largest increase being in 2006

Fig. 4.1

Total Trade between South Asia and East Asia, 1990–2006 ($ billion).

Source: IMF (2007).

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(48.6%).10 Trade with the PRC on average in 1990–2006 increased the fastest (at 28.7%), albeit from a low base, followed by trade with ASEAN (at 15.5%). Total trade with Japan grew at a relatively slower pace of 5.2% in the same period (Appendix 4.1).11 A large part of the increase in South Asia–East Asia trade is accounted for by the bilateral trade between the two giant economies of India and the PRC, which has also increased rapidly in recent years. From $48.8 million in 1990, total trade between the two countries grew to $25.6 billion in 2006 (or about 26% of total trade between South Asia and East Asia). In 2001–2006, total trade between the two countries posted an average growth of about 51%, with growth reaching 57.1% in 2005–2006. Although in 2006 South Asia–East Asia trade was higher than the volume of intra-South Asia trade ($16.2 billion), intra-Central Asia trade ($4.3 billion), and South Asia–Central Asia trade ($2.3 billion), it was much lower than the level of intra-East Asia trade, which stood at $2 trillion (Fig. 4.2). In spite of this, South Asia–East Asia trade is the second-largest component of Pan-Asian trade. Also relative to the volume of total trade, South Asia’s trade with East Asia has not changed very much (Fig. 4.3). East Asia accounted for 18.9% of South Asia’s trade in 1990 and about 21% in 1994, before it fell back to about 18% in 2000. Since then, however, East Asia’s share has been increasing, reaching about 24% in 2006. South Asia’s trade with the ASEAN countries increased steadily from about 7% in 1990 to about 10% in 2006. The same trend holds in the case of South Asia’s trade with the PRC, which has had more pronounced increases since 2000. In fact, in 2006, South Asia’s total trade with the PRC stood at about 9%, only slightly lower than its trade with ASEAN. On the other hand, South Asia’s total trade with Japan declined sharply in 1990–2006, while South Asia’s trade with 10

Except in 2002, when South Asia’s exports to the Republic of Korea and Japan softened somewhat. Trade with other partners, however, surged. 11 If East Asia were defined to also include Taiwan and Hong Kong, China, then the level of trade would increase from $14.8 billion in 1990 to $110.6 billion in 2006.

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$96.8 billion a b (23.8% /1.9% )

$2.3 billion (2.4%/0.9%) South Asia $16.2 billion (4.0%)

Central Asia $4.3 billion (4.5%)

East Asia $2,003.1 billion (39.1%)

$18.1 billion (18.9%/0.7%)

Fig. 4.2

Pan-Asian Intra-regional and Inter-regional Trade, 2006.

a

As a share of South Asia’s trade. b As a share of East Asia’s trade. Note: For inter-regional trade, the percentage figure on the left side refers to interregional trade as a share of the left-side region’s total trade; the figure on the right refers to inter-regional trade as a share of the right-side region’s total trade. Source: Appendix 4.2.

Fig. 4.3 Inter-regional Trade between South Asia and East Asia (as a percentage of South Asia’s Total Trade with the World), 1990–2006. Source: IMF (2007).

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Fig. 4.4 Inter-regional Trade between South Asia and East Asia (as a percentage of East Asia’s Total Trade with the World), 1990–2006. Source: IMF (2007).

the Republic of Korea, after a sluggish trend until 2001, started to decline slightly. South Asia accounted for a mere 1.3% of East Asia’s trade in 1990 and a slightly higher 1.9% in 2006 (Fig. 4.4). Hence, East Asia is a more important trading partner for South Asia than vice versa. Trade Intensity Index Trade shares are not sufficient to assess the extent to which countries prefer to trade with each other than with their other trading partners in the rest of the world. Therefore, we also computed trade intensity indices to measure whether trade between two regions is greater relative to their importance in world trade.12 The total Trade Intensity Index (TII) was computed as TIIij = (tij /Tit)/(twj /Twt), where tij and twj are the values of country (or region) i ’s total trade and of world trade with country (or region) j, and Tit and Twt are country i ’s total trade and total world trade, respectively.

12

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Fig. 4.5

Total Trade Intensity Index between South Asia and East Asia, 1990–2006.

Source: IMF (2007).

Figure 4.5 shows that trade intensity between South Asia and East Asia declined in 1990–2000 but has increased since then, from 0.9 to 1.1 in 2006. This reflects mainly the increasing trade intensity between South Asia and ASEAN and the PRC. South Asia’s trade intensity with Japan declined continuously during the period.

Investment Integration Data in Table 4.1 show that FDI inflows into the PRC have grown rapidly, from $3.5 billion in 1990 to more than $72.4 billion in 2005. The PRC is the second-largest recipient of FDI in the world (after the USA) and the largest FDI recipient in Asia. Singapore, with $15 billion in 2005, is the second-largest recipient of FDI in Asia, followed by Thailand and Indonesia recently ($8.9 billion and $8.3 billion, respectively), and the Republic of Korea with about $7 billion. Since the start of economic reforms in India in the early 1990s, FDI inflows have also started to grow, from a mere $237 million in

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Table 4.1 World Foreign Direct Investment Inflows into South Asia and East Asia, 1990, 1995, 2000, and 2005 ($ million). Country South Asia Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka East Asia Japan Brunei Darussalam Cambodia Indonesia Korea, Republic of Lao PDR Malaysia Myanmar Philippines PRC Singapore Thailand Viet Nam

1990

1995

2000

546.4 3.2 1.6 236.7 5.6 5.9 250.0 43.4

2,952.2 1.9 0.1 2,151.0 7.2 8.0 719.0 65.0

3,092.8 280.4 (0.1) 2,319.0 13.0 (0.5) 308.0 173.0

9,861.9 692.0 9.0 6,676.0 9.5 2.4 2,201.0 272.0

18,820.0 1,753.0 7.0

67,013.2 41.5 582.8 150.7 4,346.0 1,250.0 88.4 5,815.0 317.6 1,459.0 37,520.5 11,591.3 2,070.0 1,780.4

80,274.3 8,322.7 549.2 148.5 (4,550.0) 8,591.0 34.0 3,787.6 208.0 1,345.0 40,714.8 16,484.5 3,350.0 1,289.0

123,298.6 2,775.4 288.5 381.2 8,337.0 7,049.5 27.7 3,964.8 235.8 1,854.0 72,406.0 15,003.7 8,954.0 2,021.0

1,092.0 759.0 6.0 2,611.0 225.1 550.0 3,487.1 5,574.7 2,575.0 180.0

2005

Source: UNCTAD, FDI Indicators Online.

1990 to $6.7 billion in 2005. However, even now the level of FDI inflows into India is less than one-tenth of that in the PRC. This gap is expected to lessen further in the future as it is now well accepted in India that FDI inflows have a critical role to play in today’s global economy by providing resources and by facilitating technology transfer and improvements in managerial systems. Policies to attract FDI have been put in place as a result. The absence of comparable data on FDI, by source, limits an analysis of investment relationships between South Asia and East Asia.

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2003-04

Japan

2004-05

2005-06

Singapore

2006-07

Korea

Figure 4.6a Foreign Direct Investment Flows from Selected East Asian Countries to India, 2002/03–2006/07 ($ million). Source: Ministry of Commerce and Industry of India. 50 45 40 35 30 25 20 15 10 5 0 1999-00

2000-01

2001-02

Japan Singapore Korea

2002-03

2003-04

2004-05

2005-06

Hong Kong, China PRC

Figure 4.6b Foreign Direct Investment Flows from Selected East Asian Countries to Pakistan, 1999/00–2005/06 ($ million). Source: State Bank of Pakistan.

The data that are available from national sources and the ASEAN Secretariat show that investment relationships between the two regions, although starting to increase in recent years, is still limited.

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06 20

20 05

20 04

02 20 03

01

20

20

20 00

19 99

97 19 98

96

19

19

19

95

0 -100 -200 -300 -400 -500

India

Pakistan

Figure 4.7a Foreign Direct Investment Flows from Selected South Asian Countries to ASEAN, 1995–2006 ($ million). Source: ASEAN Secretariat FDI Database 2005.

60 50 40 30 20 10

India

06 20

05 20

03

04 20

20

02 20

01 20

00 20

98

99 19

19

97 19

96 19

95 19

19

94

0

Nepal

Figure 4.7b Foreign Direct Investment Flows from Selected South Asian Countries to the PRC, 1994–2006 ($ million). Source: Chinese Statistical Yearbook, various years.

185

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Figure 4.6a shows an increasing trend for FDI inflows into India from Japan, the Republic of Korea, and Singapore. An interesting finding is that since fiscal year 2004/2005, Singapore has overtaken Japan as the largest Asian source of FDI in India. This reflects the investments made in India by Singapore-based multi-national corporations and Singapore’s government-linked companies such as Singapore Telecom, Port of Singapore Authority, and Singapore Technologies. Singapore private sector companies have also made small-scale investments in health care, real estate, large townships, and tourism in India. Figure 4.6b shows FDI inflows into Pakistan to be rising from Japan, Singapore, and Hong Kong, China but small (relative to total FDI in Pakistan) Similarly, data from the PRC’s Ministry of Commerce show that the PRC’s outward FDI to South Asia has been increasing in recent years, although the levels are still low. Non-finance outward FDI of the PRC was $11.4 million in 2003 and rose to $17.1 million in 2005 (albeit from a decline to $4.5 million in 2004). It is interesting to note that, of these total figures, $0.14 million went to India in 2003, $0.35 million in 2004, and $11.2 million in 2005 (65% of the PRC’s FDI flows to South Asia that year). These figures, however, represent a tiny portion of inward FDI to South Asia as well as outward FDI of the PRC. Figure 4.7a and 4.7b present data on FDI outflows from selected South Asian countries to East Asia. These show some diversion of India’s FDI away from ASEAN to the PRC. In other words, while India’s investments in the ASEAN countries have softened somewhat, they have increased in the case of the PRC.13 Once again, in relative terms the magnitude of this shift is not very large. According to the data provider Dealogic, in the first 9 months of 2006 Indian companies announced a record 112 foreign acquisitions with a combined deal value of $7.2 billion. Deals in 2005 totaled $4.5 billion, which itself was thrice the figure for 2004. A noticeable feature of India’s overseas expansion is that it focuses on Europe and the USA and less on East Asia. That feature of its expansion is expected to continue into the future. An important constraint is that, although 13

The largest recipient of Indian FDI in ASEAN is Singapore (about $80 million in 2003), but the trend is not encouraging.

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the Government has relaxed limits on the use of foreign exchange by Indian companies for overseas acquisitions, companies are still not permitted to undertake overseas acquisitions equivalent to more than two times their net worth.

Economic Complementarities Commodity Composition of Merchandise Trade Tables 4.2 and 4.3 show the top 10 exports of South Asia and East Asia to each other at the two-digit SITC (Revision 3) level in 1990 Table 4.2

Top 10 Exports of South Asia to East Asia, 1990 and 2004.

Rank

SITC Code

Commodity

1990 1 2 3 4 5 6 7 8 9 10

S3–66 S3–65 S3–28 S3–03 S3–26 S3–84 S3–61 S3–33 S3–93 S3–27

Non-metallic mineral manufactures Textile yarn, fabric, etc. Metalliferous ore, scrap Fish, crustaceans, molluscs Textile fibers Clothing and accessories Leather, leather goods Petroleum, petroleum products Special transactions not classified elsewhere Crude fertilizer, minerals

2004 1 2 3 4 5 6 7 8 9 10

S3–28 S3–33 S3–66 S3–67 S3–65 S3–51 S3–03 S3–57 S3–68 S3–08

Metalliferous ore, scrap Petroleum, petroleum products Non-metallic mineral manufactures Iron and steel Textile yarn, fabric, etc. Organic chemicals Fish, crustaceans, molluscs Plastics in primary form Non-ferrous metals Animal feedstuff

Amount ($ million)

769.0 755.0 514.0 376.0 327.0 117.0 113.0 92.4 83.3 80.9 3,470.0 2,400.0 1,420.0 1,270.0 1,220.0 1,050.0 667.0 562.0 510.0 481.0

SITC = Standard International Trade Classification. Source: Computed from UN COMTRADE Online using Stata Package 9.0.

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Top 10 Exports of East Asia to South Asia, 1990 and 2004. Amount ($ million)

Rank

SITC Code

Commodity

1990 1 2 3 4 5 6 7 8 9 10

S3–33 S3–78 S3–65 S3–67 S3–77 S3–72 S3–74 S3–42 S3–71 S3–76

Petroleum, petroleum products Road vehicles Textile yarn, fabric, etc. Iron and steel Electrical machinery, apparatus, parts, NES Specialized industrial machinery General industrial machineries Fixed vegetable fats and oils Power-generating machines Telecommunications, sound equipment, etc.

753.0 621.0 604.0 578.0 462.0 453.0 431.0 363.0 266.0 216.0

2004 1 2 3 4 5 6 7 8 9 10

S3–65 S3–76 S3–42 S3–77 S3–75 S3–78 S3–72 S3–51 S3–33 S3–74

Textile yarn, fabric, etc. Telecommunications, sound equipment, etc. Fixed vegetable fats and oils Electrical machinery, apparatus, parts, NES Office machines, ADP machines Road vehicles Specialized industrial machinery Organic chemicals Petroleum, petroleum products General industrial machineries

3,600.0 3,120.0 2,490.0 2,370.0 2,090.0 2,080.0 1,800.0 1,790.0 1,720.0 1,660.0

ADP = automatic data-processing; NES = not elsewhere specified; SITC = Standard International Trade Classification. Source: Computed from UN COMTRADE Online using Stata Package 9.0.

and 2004. The data suggest that, in the case of South Asia, several unskilled labor-intensive goods dropped out of the top-10 list in 2004 as compared with 1990 (such as textile fibers, and clothing and accessories), while several capital-intensive goods (such as iron and steel, organic chemicals, and non-ferrous metals) were added to the list. In the case of East Asia, power-generating machines and iron and steel dropped out of the top-10 list, while several capital- and knowledgeintensive goods (such as office machines and inorganic chemicals) were added to the list.

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The data in the tables suggest that in 2004 there was a certain amount of complementarity between the two regions. South Asia’s exports to East Asia comprise mainly agricultural, primary, and laborintensive manufactured goods. A limited amount of petroleum products (such as kerosene, aviation turbine fuel, high-speed diesel oil, and light diesel oil) is also exported from India to East Asian countries such as Singapore. East Asia’s exports to South Asia, on the other hand, comprise mainly items in the SITC 7 product group, which are more capital- and knowledge-intensive, such as telecommunications and sound recording equipment, electrical machinery, road vehicles, and industrial machines.

Revealed Comparative Advantage Indices for Merchandise Trade Table 4.4 presents the revealed comparative advantage (RCA) indices for South Asia, calculated at the two-digit SITC level.14 The data presented are only for those commodities whose indices are equal to or above unity in 2004, signifying comparative advantage; these indices are compared with their corresponding values in 1993. The table shows that the products for which South Asia had comparative advantage in 2004 were mainly primary goods and labor-intensive manufactures.15 Textiles, yarn and fabrics, and clothing and accessories showed the highest RCA indices in 2004 (and in 1993), and this may have been the 14

RCA indices can be used to assess a country’s (or region’s) export potential. It is measured by a product’s share in the country’s exports in relation to its share in world trade. The RCA index of country i for product j is computed as: RCAij = (xij/Xit)/ (xwj /Xwt), where xij and xwj are the values of country (region) i’s exports of product j and world exports of product j, and where Xit and Xwt refer to the country’s (region’s) total exports and world total exports, respectively. An index that exceeds unity means the country (region) has a revealed comparative advantage in the product; a value less than unity implies a comparative disadvantage. Countries (regions) with similar RCA profiles are unlikely to have high bilateral trade intensities unless intra-industry trade is involved. Data limitations exclude Bhutan, Maldives, and Nepal from the computations. 15 India also has comparative advantage in iron and steel, which is capital-intensive.

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Table 4.4 2004.

Revealed Comparative Advantage Indices for South Asia, 1993 and

RCA Indices SITC Code S3–65 S3–84 S3–66 S3–61 S3–07 S3–28 S3–04 S3–27 S3–03 S3–83 S3–08 S3–43 S3–26 S3–29 S3–89 S3–85 S3–67 S3–12 S3–51 S3–22 S3–05 S3–33 S3–53 S3–69 S3–62

Rank

Description

1993

2004

1993

2004

Textile yarn, fabric, etc. Clothing and accessories Non-metallic mineral manufactures Leather, leather goods Coffee, tea, cocoa, spices Metalliferous ore, scrap Cereals, cereal preparations Crude fertilizer, mineral Fish, crustaceans, molluscs Travel goods, handbags, etc. Animal feedstuff Animal, vegetable fats, oils, NES Textile fibers Crude animal, vegetable materials Misc. manufactured goods, NES Footwear Iron and steel Tobacco, tobacco manufactures Organic chemicals Oilseed, oleaginous fruit Vegetables and fruit Petroleum, petroleum products Dyes, coloring materials Metal manufactures, NES Rubber manufactures, NES

6.6 6.5 5.7 6.2 6.4 2.1 1.6 2.0 3.7 3.1 4.1 0.4 3.6 2.0 0.8 1.8 0.8 1.1 0.5 1.0 1.3 0.3 1.4 0.7 1.0

6.0 5.8 5.7 4.5 3.9 3.4 3.2 2.8 2.6 2.3 1.9 1.8 1.8 1.7 1.6 1.5 1.5 1.3 1.2 1.2 1.1 1.1 1.1 1.0 1.0

1 2 5 4 3 10 14 11 7 9 6 31 8 12 25 13 24 18 30 20 16 37 15 26 19

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

NES = not elsewhere specified; RCA = revealed comparative advantage; SITC = Standard International Trade Classification. Source: Computed from UN COMTRADE Online using Stata Package 9.0.

result of the Multi-Fiber Agreement, which granted privileged access to garment exporters. Table 4.5 shows the merchandise goods in which individual South Asian countries had comparative advantage in 2004. The RCA indices for East Asia, on the other hand, show that this region has comparative advantage across a much wider range of goods

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Table 4.5 Commodities in Which Various South Asian Countries Have Comparative Advantage, 2004.* Country Bangladesh

India

Pakistan

Sri Lanka

Commodity Clothing and accessories, leather and leather goods, fish, textile fibers, textile yarn, fabric, tobacco and tobacco manufacturing (increase in RCA of clothing and accessories, tobacco and tobacco manufacturing; decline in RCA of leather and leather goods, textile fibers, textile yarn and fabrics) Non-metal mineral manufacturing, textile yarn, fabric, cereals, coffee, tea, animal feedstuff, iron and steel, footwear, organic chemicals, dyes, petroleum products, oilseed, tobacco and tobacco manufacturing, vegetables and fruits, animal and vegetable fats and oils, plastics in primary form, rubber manufactures (some decline in RCA of level 0 and 6 products except cereals, and iron and steel, which increased; increase in RCA of petroleum and petroleum products) Textile yarn, fabric, leather and leather goods, clothing and accessories, cereals, animal and vegetable fats and oils, sugar, fish, furniture, beddings, footwear, other transport equipment, vegetables and fruits (some increase in RCA of level 8 products) Coffee, tea, clothing and accessories, textile fibers, yarn, fabric, crude rubber, rubber manufactures, tobacco and tobacco manufacturing, animal and vegetable fats and oils, fish, travel goods, handbags, vegetables and fruits, non-ferrous metals, crude animal or vegetable material, other transport equipment (increase in RCA of coffee, tea and spices, clothing and accessories, rubber manufacturing, non-ferrous metals, other transport equipment; relatively no change for other products)

RCA = revealed comparative advantage. *Changes since 1993 are in parentheses. Source: Appendix 4.3.

(Table 4.6). These include primary goods such as crude rubber and fish; labor-intensive manufactured goods such as textiles, travel goods, and footwear; and more capital- and knowledge-intensive items such as office machines and telecommunications equipment. Table 4.7 shows commodities in which individual East Asian countries have comparative advantage.

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Table 4.6

Revealed Comparative Advantage Indices for East Asia, 1993 and 2004. RCA Indices

SITC Code S3–23 S3–75 S3–76 S3–83 S3–77 S3–43 S3–88 S3–42 S3–85 S3–84 S3–65 S3–73 S3–32 S3–03 S3–89 S3–62 S3–87

Rank

Description

1993

2004

1993

2004

Crude rubber Office machines, ADP machines Telecom, sound equipment, etc. Travel goods, handbags, etc. Elect. mach., apparatus, parts, NES Animal, vegetable fats, oils, NES Photog. apparatus, NES; clocks Fixed vegetable fats and oils Footwear Clothing and accessories Textile yarn, fabric, etc. Metalworking machinery Coal, coke, briquettes Fish, crustaceans, molluscs Misc. manufactured goods, NES Rubber manufactures, NES Scientific equipment, NES

2.5 1.8 2.3 2.1 1.6 1.6 1.7 1.6 1.6 1.5 1.4 1.1 0.5 1.3 1.0 1.1 0.8

2.4 2.1 2.0 1.8 1.8 1.6 1.6 1.6 1.5 1.5 1.4 1.2 1.2 1.1 1.0 1.0 1.0

1 4 2 3 8 7 6 10 9 11 12 15 44 13 18 16 26

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

ADP = automatic data-processing; NES = not elsewhere specified; RCA = revealed comparative advantage; SITC = Standard International Trade Classification. Source: Computed from UN COMTRADE Online using Stata Package 9.0.

Tables 4.4 and 4.6 suggest that RCAs for South Asian and East Asian countries changed somewhat in 1993 and 2004. A more formal test for this is to calculate the Spearman rank correlation coefficients between the 1993 and 2004 values (Table 4.8). The data in Table 4.8 show that in East Asia, the PRC has the lowest coefficient (0.667), and this suggests that the country has experienced the largest change in its comparative advantage compared with other countries in the East Asian region. Appendix 4.3 shows that the PRC’s RCA indices for most primary goods have been declining; this is the case for crude fertilizer, fish, and inorganic chemicals. Although not shown, our RCA calculations for the PRC also revealed that many primary goods, including live animals, fruits

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Table 4.7 Commodities in Which Various East Asian Countries Have Comparative Advantage, 2004.* PRC

Travel goods, handbags, footwear, clothing and accessories, office machines, coal, coke, textile yarn, fabric, telecom and sound equipment, prefabricated buildings and fittings, furniture, bedding, metals manufacturing, fish, inorganic chemicals, leather and leather goods, cork, wood manufacturing, electrical machinery and apparatus, crude fertilizer, photographic apparatus (increase in RCA of level 7 products; decline in RCA of most level 8 products and several level 0 products) Indonesia Fixed vegetable fats and oils, crude rubber, coal, coke, cork and wood manufactures, coffee, tea, metalliferous ore, scrap, fish, pulp and wastepaper, footwear, natural and manufactured gas, furniture, bedding, clothing and accessories, paper and paperboard, textile yarn, fabric, textile fibers, petroleum products, tobacco and tobacco manufacturing, non-ferrous metals, cork and wood, rubber manufacturing (increase in RCA of level 2, 4 products; decrease in RCA of petroleum and petroleum products) Japan Photo apparatus, metalworking machinery, special industrial machinery, road vehicles, electrical machinery and apparatus, rubber manufacturing, power-generating machines, general industrial machineries, iron and steel, telecom and sound equipment, plastic in non-primary form, chemical materials, organic chemicals, other transport equipment (increase in RCA of level 5 products and some level 7 products; decline in RCA of telecom and sound equipment) Korea, Gold, telecom, sound equipment, other transport equipment, plastics Republic in primary form, textile yarn, fabric, textile fibers, office machines, of electrical machinery and apparatus, iron and steel, leather and leather goods, organic chemicals, road vehicles, crude rubber, rubber manufacturing (increase in RCA of level 5 and 7 products; decline in RCA of level 6 products) Malaysia Animal and vegetable fats and oils, coffee, tea, furniture, bedding, crude rubber, natural and manufactured gas, petroleum products, office machines, telecom and sound equipment, furniture, bedding (increase in RCA of animal and vegetable fats/oils, and office machines; decline in RCA of fixed vegetable fats/oils, crude rubber, cork and wood manufactures, telecom and sound equipment) (Continued)

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Philippines

Singapore

Thailand

(Continued)

Fixed vegetable fats and oils, electrical machinery and apparatus, vegetables and fruits, fish, sugar and sugar preparations, tobacco and tobacco manufacturing, clothing and accessories, special transactions not classified elsewhere (increase in RCA of level 7 products; decline in RCA of level 0 products) Electrical machinery, office machines, petroleum products, organic chemicals, photographic apparatus, plastics in primary form, telecom and sound equipment, special transactions not classified elsewhere (increase in RCA of electrical machinery and apparatus, plastics in primary form, and organic chemicals; decline in RCA of office machines, petroleum products, telecom and sound equipment) Crude rubber, sugar and sugar preparations, cereals, plastics in primary form, rubber manufacturing, office machines, electrical machinery and apparatus, textile fibers, vegetables and fruits, leather and leather goods, footwear, furniture, crude fertilizer, clothing and accessories, textile yarn, fabric, photographic apparatus, animal feedstuff, animal and vegetable fats and oils, furniture, bedding, footwear, telecom and sound equipment (increase in RCA of crude rubber, plastics in primary form, textile fibers, photographic apparatus and clocks, and animal and vegetable fats/oils; decline in RCA of several level 0 and level 8 products)

RCA = revealed comparative advantage. *Changes since 1993 are in parentheses. Source: Appendix 4.3.

and vegetables, and cereals, changed from comparative advantage to disadvantage from 1993 and 2004. On the other hand, there has been an increase in the PRC’s RCA indices for most manufactured goods, such as telecommunications and sound equipment, metal manufactures, prefabricated fittings, electrical machinery parts, and office machines. In South Asia, Bangladesh has the lowest coefficient (0.552), suggesting a relatively higher change in RCA compared with the other South Asian countries. Bangladesh’s RCA in clothing

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Table 4.8 Spearman Rank Correlation Coefficients for Revealed Comparative Advantage Indices, 1993 and 2004. Country

Spearman’s Rho

No. of Observations

South Asia Bangladesh India Pakistan Sri Lanka

0.859* 0.552* 0.869* 0.736* 0.709*

65 51 65 58 61

East Asia Indonesia Japan Korea, Republic of Malaysia Philippines PRC Singapore Thailand

0.860* 0.849* 0.948* 0.803* 0.775* 0.714* 0.667* 0.797* 0.825*

66 64 65 63 65 63 64 65 65

Note: South Asia and East Asia here consist of only those countries listed above. *Significant at 1%. Source: Computed from UN COMTRADE Online using Stata Package 9.0.

and textiles decreased, while that in leather and leather goods increased. For all the countries in both regions, however, the correlation coefficients are quite high (close to unity) and statistically significant at the 1% level, indicating no significant change in RCA.

Trade Complementarity Indices One possible explanation for the increasing integration between South Asia and East Asia is that the regions’ export and import demand profiles have become more “complementary” over time. That is, goods exported by South Asia are becoming increasingly similar to the goods imported by East Asia, and vice versa. We calculated the so-called “trade complementarity index” for pairs of South and East Asian countries using SITC two-digit data in 1993

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and 2004. The results are presented in Table 4.9.16 The first set of data refers to the similarity of South Asia’s exports with East Asia’s imports, and the second to the similarity of East Asia’s exports with South Asia’s imports. The data show that while the complementarity of India’s and Pakistan’s trade with various East Asian countries has increased, the results are more mixed in the case of Sri Lanka. The complementarity of Bangladesh’s trade with East Asia has, however, declined. The overall index for South Asia as a group suggests that South Asia has been increasingly exporting the commodities that East Asia is importing (the complementarity index increased from 40 to 48), while the complementarity of East Asia’s exports with South Asia’s imports has not changed very much (the index has remained at around 49).

Trade in Commercial Services With the rapid changes in technology and globalization, trade in commercial services is becoming increasingly more important in both the South and East Asian countries. However, unlike in merchandise trade, bilateral data on the trade in services are unavailable. Hence, analysis is restricted to service exports from those countries and their breakdown into various sectors that are available in the IMF’s balance-of-payments statistics. Table 4.10 shows that the service exports of both South Asia and East Asia quadrupled in 1990–2004 to about $30 billion in South Asia and about $344 billion in East Asia. India is the largest exporter of services in South Asia, while the PRC, the Republic of Korea, and Singapore are the largest exporters in East Asia aside from Japan. Data in Table 4.11 show that information 16

The Trade Complementarity Index (TCI) between countries (or regions) k and j were computed as: TCI = 100 − sum(|mik − xij |/2), where xij is the share of good i in global exports of country j, and mik is the share of good i in total imports of country k. The index shows how well the structures of a country’s (or region’s) imports and exports match. The index is 0 when no goods are exported by one country or imported by the other, and 100 when the export and import shares exactly match.

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Table 4.9 Trade Complementarity Indices between South Asia and East Asia, 1993 and 2004. Similarity of South Asia’s Exports to East Asia’s Imports Trading Partners

1993

2004

Similarity of South Asia’s Imports to East Asia’s Exports 1993

2004

South Asia

East Asia

39.5

47.9

49.1

48.3

Bangladesh

Indonesia Japan Korea, Rep. of Malaysia Philippines PRC Singapore Thailand

16.8 26.1 17.9 12.6 13.5 20.0 12.3 14.5

9.6 17.7 12.1 7.2 7.9 9.5 6.4 10.1

38.1 39.2 47.6 38.4 26.8 47.9 43.4 37.6

46.0 37.6 43.8 37.2 24.1 38.0 34.0 44.4

India

Indonesia Japan Korea, Rep. of Malaysia Philippines PRC Singapore Thailand

37.9 49.0 36.2 34.8 38.2 37.9 33.5 37.4

51.5 54.6 49.3 41.2 41.5 47.7 38.5 52.5

40.4 36.1 37.6 32.4 31.0 33.4 43.2 28.5

49.6 39.4 43.7 42.2 24.9 37.0 43.0 38.9

Pakistan

Indonesia Japan Korea, Rep. of Malaysia Philippines PRC Singapore Thailand

18.6 27.5 19.5 14.8 15.7 20.4 15.7 15.1

21.2 26.6 20.8 18.8 17.0 18.8 18.8 19.9

40.2 46.4 41.1 38.0 24.9 33.7 44.3 29.0

46.9 45.4 48.6 38.7 23.9 34.9 42.9 43.1

Sri Lanka

Indonesia Japan Korea, Rep. of Malaysia Philippines PRC Singapore Thailand

15.0 30.1 18.4 18.5 17.5 16.6 20.8 20.1

18.7 28.3 21.1 20.2 16.5 19.5 18.2 22.6

38.8 43.1 52.8 38.0 28.5 50.9 43.6 42.2

50.1 40.5 49.0 39.1 27.1 42.7 39.9 52.2

Source: Computed from UN COMTRADE Online using Stata Package 9.0.

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Table 4.10

Exports of Commercial Services, 1990, 1995, 2000, and 2005 ($ million).

Country South Asia Bangladesh India Maldives Nepal Pakistan Sri Lanka East Asia Cambodia Indonesia Japan Korea, Republic of Lao PDR Malaysia Myanmar Philippines PRC Singapore Thailand Viet Nam

1990

1995

2000

2005*

7,190.8 391.6 4,624.9 101.1 204.4 1,429.3 439.6

11,061.2 698.2 6,774.7 232.8 679.0 1,857.3 819.2

20,671.9 815.1 16,683.7 348.5 505.9 1,380.0 938.7

30,556.7 1,245.4 23,396.6 317.2 380.4 3,677.0 1,540.1

44,472.2 n.a. 2,488.0 41.4 9,636.9 23.7 3,859.0 94.4 3,244.0 5,855.0 12,810.8 6,419.0 n.a.

111,694.1 114.0 5,469.0 65.3 22,827.3 96.8 11,601.6 364.6 9,348.0 19,130.3 27,832.1 14,845.2 n.a.

131,382.0 428.4 5,214.1 69.2 30,533.6 175.7 13,940.5 477.9 3,972.0 30,430.5 29,569.9 13,868.2 2,702.0

344,610.4 1,106.5 12,925.5 110,210.0 45,374.6 166.1 19,575.7 254.7 4,462.0 74,404.1 51,307.9 20,647.3 4,176.0

* Latest figures are 2001 for Lao PDR, 2003 for India, and 2004 for Myanmar. Source: IMF (2007a).

and communication technology (ICT) (which comprises communication services and computer and information services) accounts for the bulk of the increase in the service exports of India. In 2003, ICT accounted for about 53% of India’s service exports. In the case of the PRC, however, travel (business and tourism) is the most significant portion of service exports, accounting for about 40% of the total in 2004. India has become the leading destination for the outsourcing of ICT services, call-center support, and other back-end business operations (like data entry and handling, payroll management, accounting and bookkeeping, and ticketing). However, in spite of rapid growth, India’s share of the global software market is still small. Also, while

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Table 4.11 Commercial Service Exports for India and the PRC by Sector, 1990, 1995, 2000, 2003, and 2004 ($ million). Country/Service Sector

1990

India Transportation 959.4 Travel 1,558.4 Communication services n.a. Construction services n.a. Insurance services 123.3 Financial services n.a. Computer and information n.a. services Royalties and license fees 1.3 Other business services 1,967.1 Government services 15.4 Total Services 4,624.9

1995

2000

1,890.4 2,581.5 n.a. n.a. 170.2 n.a. n.a.

1,978.7 3,459.9 598.8 501.9 257.0 276.0 4,727.4

2003

2004

3,061.6 3,887.1 1,065.9 284.1 408.9 392.1 11,365.7

1.4 82.6 25.2 2,119.7 4,147.8 2,601.0 11.5 653.7 305.1 6,774.7 16,683.7 23,396.6

PRC Transportation 2,706.0 3,352.1 3,671.0 7,906.4 12,067.5 Travel 1,738.0 8,730.0 16,231.0 17,406.0 25,739.0 Communication services 159.0 755.7 1,345.5 638.4 440.5 Construction services n.a. n.a. 602.3 1,289.7 1,467.5 Insurance services 227.0 1,852.1 107.8 312.8 380.8 Financial services n.a. n.a. 77.8 152.0 94.0 Computer and information n.a. n.a. 356.0 1,102.2 1,637.2 services Royalties and license fees n.a. n.a. 80.4 107.0 236.4 Other business services 918.0 3,740.0 7,663.0 17,427.0 19,951.9 Personal, cultural, and n.a. n.a. 11.3 33.4 41.0 recreational services Government services 107.0 700.3 284.5 358.8 378.5 Total Services 5,855.0 19,130.3 30,430.5 46,733.6 62,434.1 n.a. = not available. Source: IMF (2007a).

the software industry in India is diversifying into new areas with strong growth potential, the hardware industry is only now beginning to receive the requisite attention of policy makers and industry. Cooperation with East Asian countries that have developed such

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Revealed Comparative Advantage in Services, 2004.

Country South Asia Bangladesh India Maldives Nepal Pakistan Sri Lanka East Asia Cambodia Indonesia Japan Korea, Rep. of Malaysia Philippines PRC Singapore Thailand

Service Sector

Communications Computer and information, communications Travel Communications, travel Communications, transportation Transportation, insurance communications, computer and information, construction, travel Travel, communications Communications, business, construction Royalties and licenses, construction, transportation Business, royalties, and licenses Personal, cultural, and recreational; travel; construction Communications, travel, transportation, construction Travel, construction Business, transportation, financial, insurance Travel

Source: Computed from IMF (2006), using Stata Package 9.0.

capabilities could create synergies for mutual benefits in this area (Sen, Asher, and Rajan, 2004). RCA indices for various commercial service trade sectors in 200417 presented in Table 4.12 suggest a certain degree of complementarity between South Asia and East Asia. South Asia has complementarity in ICT, defined as communication and computer and information services (India and Sri Lanka), and travel (business and tourism) (Maldives, Nepal, and Sri Lanka), and East Asia in royalties on licenses for the authorized use of proprietary rights (Japan and Republic of Korea), financial services and insurance (Singapore), construction services (PRC, Indonesia, Japan, Malaysia, and the Philippines), and travel (business and tourism) (Cambodia, PRC, Malaysia, the Philippines, and Thailand). 17

2003 for India and Malaysia.

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Reasons for Low Integration It is well known that levels of South-South trade and investment tend to be low because of the relative absence of complementarities. However, South Asia–East Asia trade and investment has some element of North-South trade because of the inclusion of Japan and several middle-income countries including Singapore and the Republic of Korea, which are members of the OECD. Despite that, the level of trade and investment integration has been low and has started to surge only recently (since 2001). Why is that? First, because of its cultural and colonial past, until recently South Asia looked toward Europe and the USA for markets. East Asia also looked toward its traditional markets in the USA and, to some extent, Europe. It is only recently that South Asia has started to look east for economic opportunities and East Asia to look west (see next section). Second, ever since its rout by the PRC in a brief but bloody war in 1962, India has viewed its relationship with the PRC with a sense of injustice, humiliation, and suspicion. Although labeled a “border dispute,” it is more than that. India claims an area of the PRC-controlled territory in Ladakh, Kashmir. Similarly, the PRC claims some part of what is now the Indian state of Arunachal Pradesh. Since 1988, working groups have been meeting to discuss the dispute. A settlement seems remote, but it is no longer inconceivable. Among others, India and the PRC have started to cooperate to secure strategic natural resources. For example, India announced in January 2006 that it had acquired a 20% share in the development of Iran’s biggest onshore oilfield, which is operated and 50% owned by Sinopec, the PRC’s state-owned oil company.

Ongoing Policy Efforts It is only after the end of the colonial era that South Asia once again started to re-engage with East Asia. The Asian Relations Conference held in New Delhi in 1947 under the leadership of Jawaharlal Nehru served as one of the earliest attempts to form a Pan-Asian identity. Forming a common cause with other Asian leaders on decolonization,

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Western imperialism, equality and developing-world solidarity, Nehru helped to forge the “Bandung Spirit” of 1955 which led to the nonaligned movement. This phase of India’s engagement with East Asia, however, ended with India’s border war with China in 1962, and preoccupation with Pakistan. India turned inward and adopted the Soviet model of development. India started to enhance its links with East Asia only in 1992 when it launched its “Look East” policy in the aftermath of the Cold War and the start of its economic liberalization policies. Under the Congress Government of Manmohan Singh, the “Look East” policy has been re-energized with renewed focus on India’s place in the global economy. Other South Asian countries have also followed suit. “Look East” policies in South Asia have sought to establish trade and investment links with the dynamic ASEAN and now the East Asian countries. India’s engagement with ASEAN began as a sectoral dialogue partnership in 1992, which was upgraded into a full dialogue partnership in 1995 and membership in the ASEAN Regional Forum in 1996. The first summit-level interaction began in November 2002. A Long-Term Vision 2020 paper for the ASEAN-India partnership has been prepared and is under implementation. Since 1995, India has also participated in various East Asia Summit that brings together the heads of states and governments of ASEAN +3 plus Australia, New Zealand, and India. At the Summit in Singapore last year, it was decided to revive the 3000-year old Nalanda University in India as a Pan-Asian center of excellence. The recent observer status given to the PRC and Japan in the SAARC also portends well for South Asia–East Asia economic relations. Observer status to Korea and ASEAN is also being considered. At the 2006 Asia-Europe Finance Ministers’ meeting, a decision was made to expand membership to include India, Pakistan, Mongolia, and the ASEAN Secretariat from the Asian side, and Romania and Bulgaria from the European side. More recently, as in other parts of the world, there has been a proliferation of FTAs between South Asia and East Asia. The most significant of these so far is the signing of the India-Singapore Comprehensive Economic Cooperation Agreement (CECA) on June 2005. The CECA, which took effect in August 2005, covers trade not

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only in goods but also in services, investments, and cooperation in technology, education, air services, and human resources. Various South Asian countries are also members of the Asia-Pacific Trade Agreement under the UN Economic and Social Commission for Asia and the Pacific (ESCAP). In addition, eight FTA framework agreements have been signed between South and East Asian countries (Appendix 4.4). These are the ASEAN-India, India-Thailand, BIMSTEC, PRC-Pakistan, India–Republic of Korea, Malaysia-Pakistan, Pakistan-Singapore, and Pakistan-Indonesia FTAs. Another six FTAs have been proposed — between the PRC and India, Japan and India, Malaysia and India, Pakistan and the Philippines, Pakistan and Thailand, and Singapore and Sri Lanka. Several infrastructure projects also serve to tie South Asia closer to East Asia. South Asian countries are participating in UN ESCAP’s Asian Highway Network (Figure 4.8c) and the Trans-Asian Railway Network (Figure 4.8d). Discussions are also proceeding on re-opening the World War II era Stillwell Road linking the Assam state with China’s Yunnan Province through Myanmar. This follows the reopening of a direct overland trade route along the Nathu La pass on the border between Sikkim and Tibet in July 2006 after 44 years. As the economic dynamism of the South Asian and East Asian regions continues, economic relations between South Asia and East Asia are bound to increase further. What distinguishes the present engagement with East Asia from the previous one during the precolonial period is that it is operating on multiple fronts: South Asia’s historical, cultural, and idealogical links are being complemented by growing economic interdependence including movement of capital and human resources and a growing number of free trade agreements and security relationships.

Conclusions and Policy Recommendations The major findings of this chapter are: • The level of economic integration between South Asia and East Asia, although increasing since 1990, started to surge after 2000,

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albeit from a low base, mainly because of growing interdependence between India and the PRC. • Despite the acceleration, the level of integration between the two regions is low in relative terms. • Given the complementarities between the two regions and ongoing policy efforts, economic integration is bound to increase much more in the future. Which policy actions could be taken to increase the level of South Asia–East Asia integration? First, although tariffs and NTBs are already low in many East Asian countries and South Asia has made encouraging progress in the same direction since the 1990s, there appears to be room for further reductions in tariffs and NTBs in both regions (especially NTBs in East Asia). Table 4.13, which is based on the recently released Trade Restrictiveness Index of the World Bank, suggests that the average ad valorem tariff is 25.9% in the South Asian region and 18.2% in East Asia. In South Asia, the ad valorem tariff is Table 4.13 Country

Trade Restrictiveness Indices (percentage).

Tariffs Only

Tariffs and NTBs

% Change due to NTBs

South Asia Bangladesh Bhutan India Nepal Pakistan Sri Lanka

25.9 23.6 20.5 33.6 38.9 22.9 15.8

32.7 30.7 28.2 50.8 39.0 31.3 16.0

26.2 30.1 37.6 51.2 0.3 36.7 1.3

East Asia PRC Indonesia Malaysia Philippines Thailand Viet Nam

18.2 19.4 10.6 26.2 7.3 19.5 25.9

36.7 31.4 23.4 47.6 41.0 25.9 50.9

102.2 61.9 120.8 81.7 461.6 32.8 96.5

NTBs = non-tariff barriers. Source: Hiau, Nicita, and Olarreaga (2006).

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38.9% in Nepal; 33.6% in India; about 20%–23% in Bangladesh, Bhutan, and Pakistan; and 16% in Sri Lanka. NTBs are important instruments of protection in four of the six South Asian countries (except Sri Lanka and Pakistan). In East Asia, ad valorem tariff levels are highest in Malaysia and Viet Nam (about 26%), followed by the PRC and Thailand (about 19%). But NTBs are high in all the countries, especially in Indonesia, the Philippines, and Viet Nam. South Asian countries need to reduce tariffs and NTBs further so that they can participate more effectively in the global production networks centered in East Asia while developing regional production networks of their own. Second, besides reducing tariffs and NTBs, South Asian countries and several East Asian countries also need to make progress in implementing reforms at the microeconomic level or the so-called second-generation reforms to increase transparency, good governance, and human capital. These reforms include, among others, reform of the civil service and the delivery of public goods, creation of an environment that is conducive to private sector opportunities (greater competition, better regulations, and stronger property rights), and reform of institutions that create human capital (e.g., health and education). India is on the cusp of something big. Economic growth since the early 1990s (6% and 8% in the last 4 years) is expected not only to continue but to accelerate further because, among other things, one-half of the population is below the age of 25 and a demographic dividend can be expected. But this growth will happen only if India makes progress with the second-generation reforms, particularly in education and health. Recently, public debt has been too high and this discourages investment in much-needed infrastructure development. The banking and insurance sectors have also not been opened up to encourage long-term financing for infrastructure development. The public sector is large and inefficient with much red tape. Severe labor laws cover only 10% of workers, but, once hired, laborers cannot be fired. By and large, this argument holds for other South Asian countries as well. The World Bank’s comprehensive index measuring ease of doing business (World Bank, 2006), which ranks 155 countries on 10 topics (starting a business, dealing with licenses, hiring and firing workers,

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Ranking

Singapore Hong Kong, China Japan Thailand Malaysia Korea, Republic of Taiwan Nepal Pakistan Bangladesh Sri Lanka PRC Viet Nam Bhutan Philippines Indonesia India Afghanistan Cambodia

2 7 10 20 21 27 35 55 60 65 75 91 99 104 113 115 116 122 133

Source: World Bank and IFC (2006).

registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts, and closing a business), finds that most East Asian countries and four South Asian countries (Bangladesh, Nepal, Pakistan, and Sri Lanka) rank above average. However, Cambodia, the PRC, Indonesia, the Philippines, and Viet Nam in East Asia, and Afghanistan, Bhutan, and India in South Asia rank below average. Table 4.14 shows the rankings for various Asian countries. Third, South and East Asian countries need to consolidate their FTAs. There are positive and negative economic aspects to the spread of FTAs in Asia. On the positive side, against a backdrop of slow progress in global trade talks, FTAs can promote continuing liberalization, induce structural reforms in the countries concerned, and widen

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market access across the region. Trade arrangements with dynamic, internationally competitive partners can also encourage the spread of efficient production practices. On the negative side, however, the formation of a large number of bilateral FTAs can lead to the “spaghetti bowl effect.”18 FTAs can lead to trade diversion, with bilateral FTAs being the most trade-diverting. There can be harmful effects caused by multiple rules of origin (e.g., value-added rules or changes in customs classification) arising from overlapping agreements among members of different FTAs. Complex rules increase administrative and business costs, particularly for small and medium enterprises, which have limited capacity to deal with them. Such rules can also deter FDI and trade. Furthermore, the demands of negotiating multiple trade agreements place increasing strains on the scarce trade negotiation resources of many Asian countries, particularly the least-developed countries, which have limited trade policy capacity. To make the proliferation of FTAs between South Asia and East Asia stepping-stones rather than stumbling blocks to multilateralism, policy makers in the region may wish to adopt the concept of “open regionalism” and broaden (create as large and as wide a market as possible) and deepen FTAs (extend coverage beyond trade in goods into services, investment, technology, etc.), to reduce the spaghetti-bowl effects mentioned above. Quantitative estimates using the computable general equilibrium (CGE) model and the Global Trade Analysis Project (GTAP) database suggest that a broader regional approach will have large beneficial impact. The estimated impact on national income of an ASEAN+3 and South Asia FTA is much higher than that of an ASEAN+3 and India FTA, which in turn is higher than that of an ASEAN FTA. While India benefits from an ASEAN+3 and India FTA, other South Asian countries lose. However, a broader ASEAN+3 and South Asian FTA is a win-win for all. This suggests that other South Asian countries should also join India in its “Look East” policy (Francois, Rana, Wignaraja, forthcoming). The fourth measure that could significantly affect the level of trade between South Asia and East Asia is the reduction of trading 18

For a concise restatement, see Bhagwati (2002).

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costs. This could be brought about through investment in traderelated infrastructure and streamlining of cross-border procedures (including customs procedures and logistic costs). In the case of manufactured goods, trading costs could be the single highest cost of trading in developing countries — even higher than the costs of tariffs imposed by importers on their imports. A detailed analysis of these issues is beyond the scope of this chapter, but several observations can be made. • First, most cargo between South Asia and East Asia moves by water and air, as no land transport services are operating at present. The international shipping lines serving the South Asia–East Asia region operate on the equatorial route connecting East Asia and the Persian Gulf and Mediterranean. They call at the major trans-shipment hubs of Singapore and Colombo and use feeder vessels to collect cargo from, or distribute it to, the other ports in the region. Some ships call at the secondary hubs, e.g., Port Kelang, Nhava Sheva, but these are relatively few. There are also regional shipping services, but most use the same hubs to construct back-to-back feeder services, one serving the Bay of Bengal and the other the Gulf of Thailand (Fig. 4.8a). There is a need to develop regional shipping lines so that ships call at various regional ports. • Second, unlike the other corridors, the air corridor does not have fixed routes but is made up of a series of point-to-point connections. However, the airlines have generally adopted a hub-andspoke arrangement for both passenger and freight operations. The international freight hubs are used for trans-shipment of cargoes moving between Europe, the Middle East, Southeast Asia, and East Asia. From there, there are routes connecting the hubs to the major airports and then to the local airports. Most of the transshipment hubs have developed because of the strength of the national carriers as well as demands of the local market. Thus Paris acts as a hub because of Air France’s freight operation, Frankfurt because of Lufthansa’s operations, Dubai because of Emirates, Singapore because of Singapore Airlines, and Seoul for Korean

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Figure 4.8a

209

Infrastructure: Southern Corridor: Shipping.

Airlines. The major exception is Bangkok, which has developed despite the fact that Thai Airways does not have a freighter operation. South Asia has yet to develop a regional trans-shipment hub, in part because of the lack of a national carrier with a strong freight operation and in part because of the lack of suitable airport facilities (Fig. 4.8b). • Third, land transit through the Northeast Indian states and Myanmar is not yet possible and movements through Bangladesh are difficult because of restrictions on cross-border movements as well as the condition of the road network (Fig. 4.8c). This will, however, eventually change as the volume of South Asia–East Asia trade increases. Additional corridors will have to be developed between India and the PRC through Bhutan and Nepal. Recently, the Nathu La pass between the PRC and India, which had been closed since 1962, was opened. This pass is 460 kilometers from Lhasa in Tibet and 550 kilometers from Calcutta, India’s secondlargest city. Land access to ports is also important in the case of landlocked countries.

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Figure 4.8b

Infrastructure: Central Corridor: Air Freight Hubs.

Figure 4.8c

Infrastructure: Northern Corridor: Asian Highway.

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Figure 4.8d

211

Infrastructure: Northern Corridor: Trans-Asian Railways.

• Fourth, the Trans-Asian Railways, although being built, is less developed than the Asian highway (Fig. 4.8d). The Qinghai– Tibet railway has been completed. There are plans to extend this line to Shigaste and to Yadong, a border town near India. A railway from Shigaste to Nilamu, a land port entry to Nepal is also to be built. Unlike roads, which are built to different standards but can all accommodate the same trucks, the railroad requires a common gauge. By 2015, it should be possible to travel by rail from Singapore to Kunming in the PRC. However, between East Asia and South Asia, not only are there missing sections connecting India/Bangladesh with Myanmar and then through to Thailand, but there are also different rail gauges. While India is standardizing its broad-gauge system, Southeast Asia remains meter-gauge and the PRC, standard-gauge. • Fifth, in the area of trade facilitation, countries should also make efforts to streamline cross-border procedures. These include delays in customs inspection, cargo handling and logistics, and the

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processing of documents. Customs procedures could be modernized by aligning the customs code to international standards, simplifying and harmonizing procedures, making tariff structures consistent with the international harmonized tariff classification, and adopting and implementing the WTO Customs Valuation Agreement. The World Bank and the International Finance Corporation (IFC) (2006) estimate that the time now needed to complete the processing of import documents at the pre-shipment and arrival stage averages 47 days in South Asia and 28 days in East Asia. In the OECD, it is only 14 days. As Singapore’s experience shows, electronic document filing could reduce logistic costs greatly. Within 2 years of the introduction of Singapore’s TradeNet system, the time for cargo clearance was cut from 4 days to 30 minutes. • Finally, trade promotion efforts through skillful economic diplomacy, regular exchange of business delegations, and civil society could be encouraged much more. People-to-people contacts can go a long way toward enhancing the level of trade and investment across countries.

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Appendix 4.1

Total Trade of South Asia with East Asia: Levels and Growth Rates. Total Trade of South Asia with East Asia ($ million)

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

12,400.6 12,151.8 13,824.9 14,737.1 16,930.6 21,249.4 22,226.9 22,638.0 22,518.0 24,088.6 25,106.5 30,049.4 29,427.6 38,055.3 48,872.1 65,165.8 96,825.2 4,578.6 4,119.7 5,284.5 5,258.0 6,408.0 8,517.3 8,991.2 9,631.9 9,974.4 10,996.2 11,600.4 14,287.5 13,852.7 17,796.4 21,858.3 27,111.8 40,218.8 5,885.5 5,722.1 5,888.9 6,254.5 6,504.4 7,621.0 7,688.8 6,766.8 6,478.8 6,684.3 6,493.0 6,212.5 5,693.2 6,479.2 7,448.2 8,851.9 12,045.6 1,169.6 1,511.3 1,593.1 1,797.1 2,190.4 2,549.3 2,726.7 2,873.8 3,010.0 3,084.9 2,873.6 3,964.0 3,308.2 4,523.0 5,364.7 7,336.7 8,599.8

798.8

1,058.4

1,427.6

1,827.8

2,561.8

2,820.1

3,365.5

3,054.8

3,323.3

4,139.6

5,585.5

6,573.6

9,256.7 14,200.9 21,865.4 35,961.0

Source: IMF (2007b).

Region/ Country 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 East Asia ASEAN Japan Korea, Rep. of PRC

−2.0 13.8 −10.0 28.3 −2.8 2.9 29.2 5.4

6.6 −0.5 6.2 12.8

14.9 21.9 4.0 21.9

25.5 32.9 17.2 16.4

4.2 32.5

34.9

28.0

40.2

7.0 10.2 3.2 2.5

4.2 5.5 −2.9 −6.8

19.7 −2.1 23.2 −3.0 −4.3 −8.4 37.9 −16.5

19.3 −9.2

8.8

24.6

34.9

10.1

29.3 28.5 13.8 36.7

28.4 22.8 15.0 18.6

33.3 24.0 18.8 36.8

48.6 48.3 36.1 17.2

17.7 40.8

53.4

54.0

64.5

213

Source: IMF (2007b).

4.6 1.8 −0.5 5.6 7.1 3.6 0.9 −12.0 −4.3 7.0 5.4 4.7

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Total Trade of South Asia with East Asia, Growth Rates (percentage).

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East Asia ASEAN Japan Korea, Rep. of PRC

1990

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Region/ Country

Pan-Asian Intra-regional and Interregional Trade.

Memo Items NAFTA EU

1990

1995

2000

2006

140,453.7 1,106.4 n.a.

168,535.8 1,114.5 n.a.

311,702.9 1,618.7 n.a.

746,324.4 4,265.4 2,700.6

920,914.9 5,311.0 2,034.0

2,003,110.5 16,193.8 4,330.8

6,182.1

7,527.6

12,400.6

21,249.4

25,106.5

96,825.2

142.3 107.3

68.3 242.0

89.9 365.8

152.6 1,741.6

397.1 2,629.6

2,279.6 18,103.5

215,029.1 948,499.0

302,657.3 862,502.0

457,519.0 2,010,134.0

790,475.0 2,679,330.0

1,362,714.0 3,141,640.0

1,771,058.7 6,021,300.0

EU = European Union, n.a. = not available, NAFTA = North American Free Trade Agreement. Notes: 1. For interregional trade, the reporting regions are mentioned first. 2. Regions are defined as consisting of the following countries: East Asia: ASEAN+3; South Asia: Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka; Central Asia: Afghanistan, Azerbaijan, Kazakhstan, Kyrgyz Republic, Mongolia, Tajikistan, and Uzbekistan. Source: IMF (2007b).

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Interregional Trade South Asia– East Asia Central Asia–South Asia Central Asia–East Asia

1985

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Intra-regional Trade East Asia South Asia Central Asia

1980

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Region

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Intra-regional and Interregional Trade ($ million)

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Appendix 4.2

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Intra-regional and Interregional Trade (as a percentage of the region’s total trade) 1990

1995

2000

2006

Intra-regional Trade East Asia South Asia Central Asia

29.0 2.9 n.a.

29.2 2.8 n.a.

28.6 2.5 n.a.

37.0 4.1 13.6

37.4 3.8 7.7

39.1 4.0 4.5

16.4a/1.4b 12.2/0.3 9.2/0.03

18.6/1.6 8.9/0.2 31.7/0.03

18.9/1.3 10.6/0.1 43.3/0.02

20.5/1.3 0.8/0.2 8.8/0.10

17.7/1.3 1.5/0.3 9.9/0.13

23.8/1.9 2.4/0.5 18.9/0.3

33.2 57.3

38.3 58.4

37.2 65.4

42.0 65.1

46.8 64.6

42.1 65.4

Interregional Trade South Asia–East Asia Central Asia–South Asia Central Asia–East Asia Memo Items NAFTA EU

EU = European Union, n.a. = not available, NAFTA = North American Free Trade Agreement. a Total interregional trade as a percentage of South Asia’s total trade. b As a percentage of East Asia’s total trade. Source: IMF (2007b).

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1980

Economic Integration Between South Asia and East Asia

Region

215

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Appendix 4.3 Revealed Comparative Advantage Indices in South Asia and East Asia, by Country. A. South Asia Bangladesh RCA Indices SITC Code S3–84 S3–61 S3–03 S3–26 S3–65 S3–12

Rank

Commodity

1993

2004

1993

2004

Clothing and accessories Leather, leather goods Fish, crustaceans, molluscs Textile fibers Textile yarn, fabric, etc. Tobacco, tobacco manufacturing

15.568 17.321 9.623 6.969 4.581 0.133

25.437 12.711 9.476 5.873 2.920 1.610

2 1 4 5 6 15

1 2 3 4 5 6

India RCA Indices SITC Code S3–66 S3–28 S3–65 S3–27 S3–04 S3–61 S3–84 S3–07 S3–08 S3–03 S3–83 S3–29 S3–67 S3–89 S3–85 S3–51

Rank

Commodity

1993

2004

1993

2004

Non-metallic mineral manufactures Metalliferous ore, scrap Textile yarn, fabric, etc. Crude fertilizer, mineral Cereals, cereal preparations Leather, leather goods Clothing and accessories Coffee, tea, cocoa, spices Animal feedstuff Fish, crustaceans, molluscs Travel goods, handbags, etc. Crude animal, vegetable materials Iron and steel Misc. manufactured goods NES Footwear Organic chemicals

8.290

7.300

1

1

3.245 4.057 2.939 1.550 4.194 3.583 5.721 6.559 3.724 2.967 2.325

4.564 3.830 3.589 3.156 3.028 2.757 2.699 2.498 2.418 2.291 2.013

8 5 10 16 4 7 3 2 6 9 11

2 3 4 5 6 7 8 9 10 11 12

1.255 0.767 2.129 0.791

2.009 1.734 1.584 1.533

21 26 14 25

13 14 15 16

(Continued)

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217

(Continued)

India (Continued) RCA Indices SITC Code

S3–53 S3–33 S3–22 S3–69 S3–12 S3–05 S3–43 S3–57 S3–42 S3–62

Rank

Commodity

1993

2004

1993

2004

Dyes, coloring materials Petroleum, petroleum products Oilseed, oleaginous fruit Metal manufactures, NES Tobacco, tobacco manufacturing Vegetables and fruit Animal, vegetable fats,oils, NES Plastics in primary form Fixed vegetable fats and oils Rubber manufactures, NES

2.164 0.331 1.360 1.058 1.201 1.689 0.657 0.052 1.323 1.371

1.423 1.418 1.364 1.289 1.277 1.240 1.172 1.050 1.041 1.017

13 37 19 23 22 15 29 55 20 18

17 18 19 20 21 22 23 24 25 26

Pakistan RCA Indices SITC Code S3–65 S3–61 S3–84 S3–04 S3–43 S3–26 S3–06 S3–03 S3–82 S3–29 S3–85 S3–79 S3–05

Rank

Commodity

1993

2004

1993

2004

Textile yarn, fabric, etc. Leather, leather goods Clothing and accessories Cereals, cereal preparations Animal, vegetable fats, oils, NES Textile fibers Sugar, sugar preparations, honey Fish, crustaceans, molluscs Furniture, bedding, etc. Crude animal, vegetable materials Footwear Other transport equipment Vegetables and fruit

15.771 9.779 6.079 3.202 8.062 3.160 3.011 0.011 1.799

19.970 7.945 7.507 6.729 6.305 4.832 3.467 1.503 1.309 1.254

1 2 4 5 60+ 3 6 7 41 8

1 2 3 4 5 6 7 8 9 10

0.523 0.024 0.618

1.173 1.121 1.008

12 36 11

11 12 13

(Continued)

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(Continued)

Sri Lanka RCA Indices SITC Code S3–07 S3–84 S3–23 S3–62 S3–12 S3–43 S3–66 S3–03 S3–26 S3–83 S3–05 S3–68 S3–65 S3–29 S3–79

Commodity

1993

Coffee, tea, cocoa, spices 31.233 Clothing and accessories 12.669 Crude rubber 10.156 Rubber manufactures, NES 1.776 Tobacco, tobacco manufactures 2.563 Animal, vegetable fats, oils, NES 0.014 Non-metallic mineral 4.056 manufactures Fish, crustaceans, molluscs 1.581 Textile fibers 1.234 Travel goods, handbags, etc. 1.886 Vegetables and fruit 1.617 Non-ferrous metals 0.008 Textile yarn, fabric, etc. 1.121 Crude animal, vegetable materials 1.354 Other transport equipment 0.020

Rank

2004

1993

2004

36.478 16.799 4.679 4.640 3.791 2.993 2.614

1 2 3 7 5 50 4

1 2 3 4 5 6 7

2.452 2.369 1.508 1.467 1.292 1.187 1.068 1.001

9 11 6 8 54 12 10 46

8 9 10 11 12 13 14 15

NES = not elsewhere specified; RCA = revealed comparative advantage; SITC = Standard International Trade Classification. Source: Computed from UN COMTRADE Online using Stata Package 9.0.

B. East Asia People’s Republic of China RCA Indices SITC Code S3–83 S3–85 S3–84 S3–75

Rank

Commodity

1993

2004

1993

2004

Travel goods, handbags, etc. Footwear Clothing and accessories Office machines, ADP machines

6.251 5.473 5.393 0.396

4.279 3.813 3.460 2.896

1 2 3 43

1 2 3 4

(Continued)

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219

(Continued)

People’s Republic of China (Continued) RCA Indices SITC Code S3–32 S3–65 S3–76 S3–81 S3–82 S3–89 S3–69 S3–03 S3–52 S3–61 S3–63 S3–77 S3–27 S3–88

Rank

Commodity

1993

2004

1993

2004

Coal, coke, briquettes Textile yarn, fabric, etc. Telecom, sound equipment, etc. Prefab buildings, fittings, etc. Furniture, bedding, etc. Misc. manufactured goods, NES Metal manufactures, NES Fish, crustaceans, molluscs Inorganic chemicals Leather, leather goods Cork, wood manufactures Elect. mach., appar., parts, NES Crude fertilizer, minerals Photog. apparatus, NES; clocks

2.085 2.933 1.320 1.690 1.313 2.226 1.373 1.724 1.936 0.718 0.967 0.588 2.197 1.644

2.786 2.458 2.379 2.164 2.018 1.742 1.625 1.581 1.469 1.341 1.254 1.146 1.052 0.991

8 4 20 15 21 6 19 13 12 27 25 33 7 16

5 6 7 8 9 10 11 12 13 14 15 16 17 18

Indonesia RCA Indices SITC Code S3–42 S3–23 S3–32 S3–63 S3–43 S3–07 S3–28 S3–03 S3–25 S3–85 S3–34 S3–82

Rank

Commodity

1993

2004

1993

2004

Fixed vegetable fats and oils Crude rubber Coal, coke, briquettes Cork, wood manufactures Animal, vegetable fats, oils, NES Coffee, tea, cocoa, spices Metalliferous ore, scrap Fish, crustaceans, molluscs Pulp and wastepaper Footwear Gas, natural, manufactured Furniture, bedding, etc.

6.301 12.070 3.832 22.308 4.841 4.531 3.025 3.946 0.341 4.291 14.071 2.047

19.886 17.143 9.092 7.373 6.476 4.342 4.037 3.732 3.116 3.047 2.661 2.456

4 3 9 1 5 6 10 8 35 7 2 14

1 2 3 4 5 6 7 8 9 10 11 12

(Continued)

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(Continued)

Indonesia (Continued) RCA Indices SITC Code S3–84 S3–64 S3–65 S3–33 S3–12 S3–68 S3–24 S3–62 S3–09 S3–26

Rank

Commodity

1993

2004

1993

2004

Clothing and accessories Paper, paperboard, etc. Textile yarn, fabric, etc. Petroleum, petroleum products Tobacco, tobacco manufacturing Non-ferrous metals Cork and wood Rubber manufactures, NES Misc. edible products, etc. Textile fibers

2.552 0.760 2.215 2.853 0.871 0.491 1.328 0.362 0.246 0.221

2.293 2.239 2.132 1.683 1.483 1.431 1.379 1.339 1.133 1.039

12 20 13 11 19 27 16 33 38 41

13 14 15 16 17 18 19 20 21 22

Japan RCA Indices SITC Code S3–88 S3–73 S3–72 S3–78 S3–77 S3–87 S3–93 S3–62 S3–71 S3–74 S3–67 S3–76 S3–58 S3–59 S3–51 S3–79

Rank

Commodity

1993

2004

1993

2004

Photog. apparatus, NES; clocks Metalworking machinery Specialized industrial machinery Road vehicles Elect. mach., appar., parts, NES Scientific equipment, NES Special transactions not classified elsewhere Rubber manufactures, NES Power-generating machines General industrial machines Iron and steel Telecom, sound equipment, etc. Plastic, non-primary form Chemical materials, NES Organic chemicals Other transport equipment

2.086 1.931 1.460 2.298 1.775 1.229 0.697

3.011 2.943 2.151 2.085 1.643 1.634 1.593

3 5 9 1 6 12 20

1 2 3 4 5 6 7

1.394 1.514 1.485 1.454 2.190 0.764 0.630 0.909 1.009

1.510 1.410 1.409 1.383 1.308 1.205 1.183 1.095 1.095

11 7 8 10 2 15 21 14 13

8 9 10 11 12 13 14 15 16

(Continued)

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221

(Continued)

Republic of Korea RCA Indices SITC Code S3–97 S3–76 S3–79 S3–57 S3–65 S3–75 S3–77 S3–67 S3–61 S3–26 S3–51 S3–78 S3–23 S3–62

Commodity Gold, non-monetary, excluding ores Telecom, sound equipment, etc. Other transport equipment Plastics in primary form Textile yarn, fabric, etc. Office machines, ADP machines Elect. mach., apparatus, parts, NES Iron and steel Leather, leather goods Textile fibers Organic chemicals Road vehicles Crude rubber Rubber manufactures, NES

Rank

1993

2004

1993

2004

0.633

3.010

22

1

2.311

2.972

5

2

1.759 1.570 3.368 0.932

2.744 2.097 1.863 1.674

10 13 2 17

3 4 5 6

2.038

1.651

7

7

2.170 3.464 1.520 0.859 0.722 0.580 1.955

1.538 1.391 1.384 1.322 1.280 1.208 1.194

6 1 14 20 21 24 9

8 9 10 11 12 13 14

Malaysia RCA Indices SITC Code S3–43 S3–42 S3–23 S3–34 S3–75 S3–63 S3–77 S3–24

Rank

Commodity

1993

2004

1993

2004

Animal, vegetable fats, oils, NES Fixed vegetable fats and oils Crude rubber Gas, natural, manufactured Office machines, ADP machines Cork, wood manufactures Elect. mach., appar., parts, NES Cork and wood

15.127 15.770 8.026 3.186 1.552 5.303 2.669 8.197

19.568 12.871 5.555 3.237 3.148 3.048 2.791 2.228

2 1 4 7 10 5 8 3

1 2 3 4 5 6 7 8

(Continued)

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(Continued)

Malaysia (Continued ) RCA Indices SITC Code S3–76 S3–82 S3–33 S3–07 S3–09

Rank

Commodity

1993

2004

1993

2004

Telecom, sound equipment, etc. Furniture, bedding, etc. Petroleum, petroleum products Coffee, tea, cocoa, spices Misc. edible products, etc.

4.044 1.335 1.438 1.235 0.849

2.034 1.427 1.230 1.114 1.076

6 12 11 13 15

9 10 11 12 13

Philippines RCA Indices SITC Code S3–93 S3–42 S3–75 S3–77 S3–05 S3–03 S3–12 S3–43 S3–84 S3–06

Rank

Commodity

1993

2004

1993

2004

Special transactions not classified elsewhere Fixed vegetable fats and oils Office machines, ADP machines Elect. mach., appar., parts, NES Vegetables and fruit Fish, crustaceans, molluscs Tobacco, tobacco manufacturing Animal, vegetable fats, oils, NES Clothing and accessories Sugar, sugar preparations, honey

14.604

13.446

1

1

10.332 0.417 1.491 3.633 4.298 0.556 1.210 1.968 3.469

4.456 3.165 2.283 1.731 1.465 1.126 1.111 1.096 1.082

2 29 14 4 3 25 15 10 5

2 3 4 5 6 7 8 9 10

Singapore RCA Indices SITC Code S3–77 S3–75 S3–51 S3–33

Rank

Commodity

1993

2004

1993

2004

Elect. mach., appar., parts, NES Office machines, ADP machines Organic chemicals Petroleum, petroleum products

1.927 4.921 0.961 2.228

3.589 3.063 2.433 1.582

7 1 13 6

1 2 3 4

(Continued)

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223

(Continued)

Singapore (Continued) RCA Indices SITC Code S3–57 S3–76 S3–93 S3–88

Rank

Commodity

1993

2004

1993

2004

Plastics in primary form Telecom, sound equipment, etc. Special transactions not classified elsewhere Photog. apparatus, NES; clocks

0.928 3.223 0.657

1.365 1.345 1.241

14 3 23

5 6 7

1.091

1.186

9

8

Thailand RCA Indices SITC Code S3–23 S3–03 S3–06 S3–04 S3–57 S3–62 S3–75 S3–09 S3–77 S3–26 S3–05 S3–61 S3–27 S3–84 S3–88 S3–08 S3–76 S3–43

Rank

Commodity

1993

2004

1993

2004

Crude rubber Fish, crustaceans, molluscs Sugar, sugar preparations, honey Cereals, cereal preparations Plastics in primary form Rubber manufactures, NES Office machines, ADP machines Misc. edible products, etc. Elect. mach., appar., parts, NES Textile fibers Vegetables and fruit Leather, leather goods Crude fertilizer, minerals Clothing and accessories Photog. apparatus, NES; clocks Animal feedstuff Telecom, sound equipment, etc. Animal, vegetable fats, oils, NES

14.083 9.392 4.382

18.516 5.906 4.362

1 2 3

1 2 3

3.187 0.288 1.019 1.675 1.291 1.314 0.729 2.907 2.117 1.063 3.017 0.906 1.064 1.433

3.902 1.972 1.883 1.866 1.762 1.688 1.600 1.600 1.488 1.400 1.374 1.342 1.280 1.239

4 37 21 13 16 15 26 7 9 20 6 23 19 14

4 5 6 7 8 9 10 11 12 13 14 15 16 17

0.142

1.214

50

18

(Continued)

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(Continued)

Thailand (Continued ) RCA Indices SITC Code S3–82 S3–85 S3–65 S3–66 S3–89

Rank

Commodity

1993

2004

1993

2004

Furniture, bedding, etc. Footwear Textile yarn, fabric, etc. Non-metallic mineral manufactures Misc. manufactured goods, NES

1.779 2.824 1.140 1.822

1.187 1.175 1.162 1.137

12 8 17 11

19 20 21 22

1.842

1.057

10

23

ADP = automatic data-processing processing; NES = not elsewhere specified; RCA = revealed comparative advantage; SITC = Standard International Trade Classification. Source: Computed from UN COMTRADE Online using Stata Package 9.0. Appendix 4.4 Annotated List of Free Trade Agreements (FTAs) between South Asia and East Asia. FTA Signed and Under Implementation • India–Singapore Comprehensive Economic Cooperation Agreement (CECA)






Under CECA (signed June 2005 and effective August 2005), India will remove duties on 506 products from Singapore immediately, on 2,202 items by April 2009, and cut duties on another 2,407 products to 50% by the same date Singapore will scrap tariffs on goods made in India starting 1 August 2005 The pact also covers services, investments, and cooperation in technology, education, air services, and human resources

• Asia-Pacific Trade Agreement (APTA, formerly Bangkok Agreement)


FTA under implementation since 1976

Framework Agreement Signed and FTA Under Negotiation • ASEAN–India Regional Trade and Investment Area




Agreement signed October 2003 and became effective July 2004 Reduction or elimination of tariffs will start January 2006 India and ASEAN-6, excluding the Philippines, have until 2011 to reduce or eliminate tariffs (Continued)

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225

(Continued)

Between India and the Philippines, the schedule runs to 2016 For India and new ASEAN members, India will reduce or eliminate tariffs before January 2011, while new ASEAN members will reduce or eliminate tariffs before 2016 Criteria for rules of origin remain to be resolved

• India–Thailand Free Trade Area








The Framework Agreement for the India–Thailand FTA (signed October 2003 and effective September 2004) reduces tariffs on 82 “early harvest” items by 50% in the first year, by 75% in the second year, and 100% thereafter The second phase hopes to have a comprehensive FTA covering all items by 2010 Agreement provides for emergency measures to protect domestic producers in case of sudden surges in imports

• BIMSTEC Free Trade Area







The Framework Agreement on the BIMSTEC FTA (signed in February 2004 and effective June 2004) involves a reduction and elimination of tariffs starting July 2006 up to 2010 for India, Sri Lanka, and Thailand and up to 2017 for Bhutan, Myanmar, and Nepal Negotiations began in September 2004 FTA will have two phases (for fast-track and normal-track products) Members were scheduled to provide their sensitive lists to the trade negotiating committee meeting in June 2005

• PRC–Pakistan Free Trade Agreement









In December 2004, a Joint Study Group was formed to study the feasibility of the Pakistan–PRC FTA A Memorandum of Understanding on FTA and Other Trade Issues was signed in April 2005 announcing the conclusion of the Joint Feasibility Study on Pakistan–PRC FTA and launching of negotiations on the FTA The Agreement on Early Harvest Program (EHP) was also signed EHP includes a common list of items whose tariffs will be removed and a separate list for each country whose duties will also be scrapped

• India–Republic of Korea Comprehensive Economic Partnership Agreement (CEPA)


A Joint Study Group was set up on 6 October 2004 and its concluding report was signed on January 2006. It recommended that a comprehensive economic partnership agreement (CEPA) exploit the existing bilateral economic relations between the two countries and provide significant benefits for both (Continued)

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(Continued)

Following the recommendations of the Joint Study Group, a Joint Task Force composed of government officials of both countries was constituted for the development of the CEPA FTA negotiation launched in March 2006

• Malaysia–Pakistan Free Trade Agreement



FTA negotiation launched February 2005 Early Harvest Program (EHP) signed October 2005 for implementation January 2006

• Pakistan–Singapore Free Trade Agreement


FTA negotiation launched August 2005

• Pakistan–Indonesia Free Trade Agreement





On November 2005, Pakistan and Indonesia signed the Framework Agreement on Comprehensive Economic Partnership and expressed willingness to conclude an FTA Both parties decided to negotiate a preferential trade agreement and move toward the goal of an FTA.

FTAs Proposed • PRC–India Regional Trading Arrangement





In June 2003, India and the PRC agreed to set up a Joint Study Group (JSG). The JSG was tasked to present a report and recommendation on comprehensive trade and economic cooperation In March 2005, the report of the JSG was finalized. It recommended a PRC–India Regional Trading Arrangement, which shall cover trade in goods and services, and investments

• Japan–India Economic Partnership Agreement








On 29 November 2004, Japan and India agreed to establish a Japan–India Joint Study Group (JSG) for a Comprehensive Study to serve as a framework for reviewing their economic relationship On 29 April 2005, both parties directed the JSG to submit a report within a year, focusing on requirements for a comprehensive expansion of trade in goods and services, investment flows, and other areas of economic cooperation FTA proposed August 2005

• Malaysia–India Comprehensive Economic Cooperation Agreement


FTA proposed January 2005 (Continued)

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(Continued)

• Pakistan–Philippines Free Trade Agreement


FTA proposed 2004

• Pakistan–Thailand Free Trade Agreement


FTA proposed April 2004

• Singapore–Sri Lanka Comprehensive Economic Partnership Agreement


FTA proposed October 2003

Sources: Asia Regional Integration Center website, http://www.aric.adb.org.

References Asher, MG and R Sen (2005). India-East Asia Integration: A Win-Win for Asia. Research and Information System for the Non-Aligned and Other Developing Countries (RIS), Discussion Paper No. 91/2005. Asian Development Bank (2005). A Study on Economic Cooperation between East Asia and South Asia. Technical Assistance Project No. 39592. Bhagwati J (2002). Free Trade Today. Princeton University Press. Chandra, R and R Kumar (2008). South Asian Integration Prospects and Lessons from East Asia. Indian Council for Research in International Economic Relations. Francois, J, PB Rana and G Wignaraja (eds.) (forthcoming). Pan-Asian Integration: Linking East and South Asia, Chapter 1. Palgrave Macmillan. Hiau LK, A Nicita and M Olarreaga (2006). Estimating Trade Restrictiveness Indices. World Bank Working Paper No. 3840. Washington, DC. International Monetary Fund (IMF) (2006). Balance of Payments Statistics. CDROM, April. ——— (2007). Balance of Payments Statistics. CD-ROM, July. ——— (2007). Direction of Trade Statistics. CD-ROM, June. Kumar, N, R Sen and MG Asher (eds.) (2006). India-ASEAN Economic Relations: Meeting the Challenges of Globalization. ISEAS and RIS. Shankar V (2004). “Towards an Asian Economic Community: Exploring the Past” in Nagesh Kumar (ed), Towards and Asian Economic Community: Vision of a New Asia, RIS and ISEAS, 2004. Sen R, M Asher and R Rajan (2004). ASEAN-India Economic Relations: Current Status and Future Prospects. RIS, Discussion Paper No. 73/2004. World Bank and International Finance Corporation (IFC) (2006). Doing Business in 2006: Creating Jobs. World Bank and IFC.

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Chapter 5

Economic Integration in South Asia19

Introduction Before World War II, South Asia was a relatively well integrated region of the British Empire. Then, in 1947, Pakistan and India became independent. At that time more than half of Pakistan’s imports and nearly two-thirds of its exports were with India. Total trade volumes among the countries of the region before the partition were estimated at around 20% of total trade (World Bank, 2004). They fell to about 4% by the end of the 1950s and 2% by 1967. The share of intra-regional trade began to increase only in the 1990s, after the countries in the region abandoned import-substitution policies and began to adopt trade liberalization measures. It has reached the 1950 level of around 4% of total trade — still quite small compared with trade in other developing regions in Asia and the rest of the world. There were many reasons for the dramatic fall in trade within South Asia. The most obvious was the hostility between India and Pakistan that emerged after the British partitioned colonial India in 1947. The hostility arose from a series of disagreements resulting from the partition. The first was the apportionment of water from the Indus River. There were also conflicts over Kashmir, which still persist. Trade was stopped after partition as differences between the two countries were exacerbated by disagreements over exchange rates. Trade between Pakistan and India never returned to pre-partition levels, despite the previous successful trade relationships and the 19

This chapter draws on Rana and Dowling (forthcoming). 228

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extensive infrastructure built by the British to connect these two parts of colonial India. In addition to the political and economic differences between India and Pakistan, South Asia generally embarked on a development model that drew widely on the Soviet experience, stressing import substitution and self-sufficiency rather than export promotion and openness. Soviet-style heavy industry development was also stressed along with the importation of capital goods from the Soviet Union. In the 1980s and 1990s, the region began to undergo fundamental change. First Sri Lanka (in the 1980s) and then the other countries began to open their economies to international trade and dismantle industrial regulations. International trade volumes began to increase, particularly following the Indian financial crisis of 1991 and the set of reforms that followed. Trade as a share of GDP generally rose in the 1990s and into the 21st century especially for the larger economies. Intra-regional trade (exports plus imports) of South Asia has increased more moderately, from 2.9% of total trade in 1980 to 4% in 2006 (Table 5.1). The shares have increased the most for the smaller countries. A simple gravity model suggests that trade should be much greater. Contiguous countries in the rest of the world have considerable trade with each other. Canada and Mexico, for instance, are the biggest trading partners of the USA. All countries in Europe

Table 5.1 Share of South Asian Intra-regional Trade in World Trade, 1980, 1985, 1990, 1995, 2000, and 2006 (percentage). Country Bangladesh India Maldives Nepal Pakistan Sri Lanka South Asia

1980

1985

1990

1995

2000

2006

4.8 1.9 n.a. n.a. 3.6 6.7 2.9

4.7 1.6 12.5 34.3 2.8 5.5 2.8

6.0 1.4 12.7 11.9 2.7 5.6 2.5

12.8 2.7 14.3 14.8 2.2 7.8 4.1

7.9 2.4 22.2 22.3 2.7 7.4 3.8

8.5 2.4 15.7 50.9 3.3 16.3 4.0

n.a. = not available. Source: IMF (2007b).

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trade with each other, and 65% of European Union trade is intraregional. In South Asia the share of intra-regional trade in world trade has not increased much since the start of reforms in 1991. It is not an understatement to say that there is wide scope for greater regional cooperation within South Asia. Trade within South Asia is also lopsided and dominated by Indian exports to the rest of the region. The World Bank estimates that 85% of exports to the region are from India. In the next section we review the various efforts made by South Asian countries to promote integration among themselves and the impact that these efforts have had. In the last section we derive lessons for South Asia from East Asia.

Economic Integration in South Asia There is scope for greater economic integration in three general areas. These are cross-border infrastructure, international trade and investment (including services), and financial sector cooperation. Potential also exists for cooperation in various sectors such as water and energy resources.

Cross-Border Infrastructure Major cross-border initiatives are being undertaken through the SASEC program. This program was initiated by the four members of the SAARC (Bangladesh, Bhutan, India, and Nepal) that formed the South Asian Growth Quadrangle (SAGQ) in 1996. The SASEC program was launched in 2001 with support from the Asian Development Bank and its aim was to accelerate economic cooperation within the four countries. Six priority sectors were identified: transport; energy and power; tourism; environment; trade, investment, and private sector cooperation; and ICT. Working groups were set up in each of the sectors. There has been some progress in identifying projects in each sector. In transport a framework involving several corridors was developed for regional connectivity. Six of these corridors are being explored. In trade and investment the focus was on removing NTBs

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and promoting private sector cooperation. Business facilitation has been promoted through the recently established South Asia Business Forum and commissioned studies on private sector cooperation to lower trade barriers, boost human resources, and increase connectivity in ICT. In tourism the plan is to focus on eco-tourism and visits to Buddhist sites in the region. Cooperation with the transport group is recommended to close the gap between tourist sites and main roads where necessary. ICT initiatives have been identified in enhancing high-bandwidth connectivity, establishing community information centers, strengthening ICT regulations, developing common software tools and information sharing, and developing human resources. Projects for the rural electrification of Assam based on the Bangladeshi model and the distribution of natural gas in Bangladesh with Indian assistance were started but little progress has been reported. In the environment, problems of overlapping jurisdictions, lack of interest, and the complexity of cross-border environmental issues have hampered project formulation and implementation. Of the many projects proposed, only regional air quality management was implemented. The implementation of SASEC initiatives has been modest.

Trade and Investment SAARC and Its Trade Initiatives SAARC, with its trade initiatives SAPTA and SAFTA, is the major institutional entity charged with promoting free trade in South Asia. SAARC is an association of eight countries of South Asia: Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka. SAARC encourages cooperation in agriculture, rural development, science and technology, culture, health, population control, narcotics control, and anti-terrorism. In 1993, SAARC-countries signed an agreement to generally lower tariffs within the region through SAPTA. Three rounds of preferential tariff reductions were introduced for individual products. In 2004, the SAARC countries framed the SAFTA, which sought to establish a free trade zone in South Asia. SAFTA set out

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a series of objectives in discussions that started in 1995 and continued into the next decade. The objectives were the following: eliminate all tariffs and import restrictions; harmonize customs procedures; facilitate intra-regional banking, and port and land transport facilities; develop a program to facilitate trade-related services; establish a review and monitoring mechanism; ensure equitable benefits to all member countries; and remove structural impediments to regional trade. Representatives from the members of SAARC meet yearly to discuss progress and ensure that the benefits from trade expansion resulting from the implementation of the agreement are distributed equitably. An effective and vibrant SAFTA and SAARC will likewise enhance the region’s ability to bargain in multilateral negotiations if and when they resume. Moreover, the implementation of this trade agreement will open the door for negotiations in trade facilitation dealing with so-called behind-the-border bottlenecks that go beyond harmonizing customs procedures. Some weaknesses in the agreement could, however, undermine its effectiveness unless they are remedied in further negotiations. Only customs duties are addressed. A number of other protective arrangements (NTBs) serve to reduce trade and increase costs. While NTBs that are not compatible with the GATT are to be removed, there is no effective mechanism in the agreement for removing other NTBs. Any reduction in agricultural tariffs is likely to be contentious. The successful implementation of the agreement faces other bottlenecks, such as the escape clause of sensitive lists, negotiation of rules of origin, and possible suspension of concessions for members with balance-of-payments difficulties. Given the mixed experience of SAPTA in achieving much in the past, these potential bottlenecks could well scuttle the agreement. The hope is that all countries will be more committed to free trade than they have been in the past and will be willing to make mutual concessions to make the agreement work. If the agreement is implemented, all countries in the region could benefit from scale economies and greater competition; this would also pave the way for greater trade with the rest of the world. How successful have SAARC and its related trade initiatives been in raising the share of intra-regional trade in total trade? Since we do

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not know what would have happened without them, a definitive answer is difficult. Gravity models have been used to estimate how much SAARC and its trade initiatives have contributed to the growth in trade. The gravity model suggests that trade between two countries will depend on the geographic distance between them and the relative size of their economies. Research using such a model suggests that SAPTA has had a positive effect on intra-bloc trade. Bandara and Yu (2003) use the Global Trade Analysis Project (GTAP) computable equilibrium model to analyze the impact of SAFTA on the countries in South Asia. They find that India gains more than the other countries but that the rest of the region also benefits. Increased intra-regional trade possibilities will be created but will be small relative to gains from unilateral liberalization by all SAFTA countries. Hirantha (2004) shows strong evidence of trade creation in the region under SAPTA and Srinivasan (1994) uses a gravity model to show that complete removal of tariffs would result in a 3% increase in India’s GNP. Using an expanded gravity model, Batra (2004) finds positive trade potential in SAARC, mainly from increased trade between India and Pakistan. The estimates of Frankel, Stein, and Wei (1995) indicate that trade between India and Pakistan is 70% lower than that between two other economies that are otherwise identical. Bilateral and Plurilateral FTAs Two bilateral FTAs involve South Asian countries: those between Sri Lanka and India and between Nepal and India. The Sri Lanka–India FTA took effect in March 2000. The agreement provides for dutyfree status as well as duty-preference access for goods manufactured in the two countries. Both countries have prepared a list of products that will be duty-free and have agreed to phase out tariffs on a number of other items. India and Nepal have had a trade treaty for many years. The current treaty was renegotiated in 2002 from a treaty signed in 1996. The treaty has a number of components. The major features are an emphasis on trade facilitation and the reciprocal grant of unconditional MFN status. A unique feature not found in other trade agreements is

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a provision for refunds to Nepal for excise and other duties collected by India on goods produced in India and exported to Nepal. Nepalese primary products have full access to the Indian market, free of duties and quantitative restrictions. Indian exports to Nepal are similarly unencumbered. There is a clause where India agrees to promote industrial development in Nepal through the favorable treatment of industrial goods produced in Nepal. Nath (2004) has analyzed the treaty and argues that it is not consistent with WTO rules. BIMSTEC started as BISTEC in June 1997 at a meeting of the trade ministers of Bangladesh, India, Sri Lanka, and Thailand. In December 1997 Myanmar was added as a fifth member. Each member country has been assigned a lead role in different sectors — trade and investment, technology transfer, transportation and communication, energy, tourism, and fisheries. Ministerial meetings are held periodically, and, at a meeting in November 2003, additional subsectors for cooperation were identified: textiles and clothing, drugs and pharmaceuticals, gems and jewelry, horticulture, processed foods, automotive parts, coconuts, spices, rubber, and tea and coffee. Thailand was the most active member and had the idea of using BIMSTEC to establish a foothold in South Asia. The emphasis on gems and jewelry and automotive parts reflects the commercial interests of Thailand (Bhattacharya and Bhattacharyay, 2006; Inoue, Murayama, and Rahmatullah, 2004). An FTA between India and the other members of BIMSTEC is being discussed. A framework agreement FTA was signed in February 2004; it stipulates preferential treatment and a time frame for tariff reductions. Subsequent meetings focused on ironing out details on rules of origin, sensitive lists, and NTBs so that an agreement could be concluded before the BIMSTEC summit in February 2007. Originally the agreement was to be concluded in July 2006. The India–BIMSTEC FTA differs from SAFTA in that it has provisions for agreement in services and investment. These were not part of the package to be discussed at the BIMSTEC summit but will be negotiated later on. Talks between India and BIMSTEC are mired in disagreement over the number of products on the sensitive lists and rules of origin. India wants a short preferential list of items, but its

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BIMSTEC partners want to accommodate a large number of items. Other areas of discussion include the negative list of items to be excluded from tariff reduction commitments under the FTA and the removal of NTBs. To summarize, remember that trade before partition was about 20% of total trade in the region. Since then, trade barriers have resulted in changes in comparative advantage, particularly in Pakistan, where the most obvious result is the development of an industrial base to counter the cessation of trade with India. How much trade would occur if all trade barriers were removed is thus debatable. The World Bank (2004) argues that even with free trade the amount of trade within South Asia would be relatively small (although certainly bigger than current flows) because of limited complementarities. All countries in the region have comparative advantage in labor-intensive manufactured products, and the benefits of trading these products among the countries themselves are limited. RCA analysis based on more disaggregated data on international trade in goods and services, however, suggests that there may be scope for a greater volume of trade within South Asia (see Table 4.5). India has comparative advantage in capital-intensive products like iron and steel, organic chemicals, and petroleum products, as well as some agricultural products. Bangladesh, Pakistan, and Sri Lanka have comparative advantage in clothing and accessories, leather goods, and textile yarn and fabric, along with rubber in the case of Sri Lanka. In the services sector (see Table 4.12) all the countries in the region have comparative advantage in communications services, so the scope for trade may be limited. Intra-South Asian trade is, therefore, expected to increase in the future, especially if the political will to implement the various agreements can be sustained, but perhaps not to the pre-partition level. Therefore, while seeking to enhance regional trade, it is also important for South Asia to find economies of scale in the rest of the world. Chandra and Kumar (2008) recommend a twin track policy for South Asia — integration within itself and better integration with the rest of the world. As they argue, integration within South Asia is more likely to succeed if undertaken as part of a broader Pan-Asian cooperation.

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The region’s “Look East” policies seem to reflect added emphasis on increasing trade with Southeast Asia and East Asia. BIMSTEC reflects this look-east orientation. South Asia can pursue such a strategy by lowering tariffs and other forms of protection on an MFN basis and by pursuing FTAs with East Asia. This would open their economies further and allow them to release comparative advantage. South Asia could also enhance links with Central Asia.

Money and Finance Several institutional developments in the past decade were designed to promote greater monetary and financial integration in South Asia. In 1998, SAARC heads of state agreed in principle to establish a network of central bank governors and finance secretaries of the SAARC region. Dubbed SAARCFINANCE, the network has the basic objective of discussing macroeconomic policy issues and establishing closer links among the members. This is achieved through semi-annual meetings of central bank governors and finance secretaries, staff visits and regular exchange of information, and harmonization of banking legislations and practices. In addition, the network seeks to forge closer cooperation on macroeconomic policies, promote research on economic and financial issues, and train staff of the central banks, ministries of finance, and other financial institutions of SAARC members. The secretariat of the network rotates among the member countries and its chair moves with the SAARC chair. Each central bank has established a cell in its research department to coordinate the activities of SAARCFINANCE (Dasgupta and Maskay, 2003). In addition to SAARCFINANCE, at the Dhaka summit of November 2005, it was formally decided to initiate regular meetings of the South Asian finance ministers (SAFMs) within the first quarter after the annual SAARC summits. The Dhaka summit also required the SAFMs to meet on the sidelines of ADB and World Bank annual meetings to take stock of the macroeconomic developments and outlook for South Asia; the achievement of SAARC development goals as correlated with the Millennium Development Goals; and the investment climate, foreign capital flows, financial sector

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reforms, and other areas of cooperation. While this effort is very useful in initiating regional policy dialogue in South Asia, a system of multitiered meetings based on the East Asian experience could also be considered. The meetings of SAFMs could be preceded by meetings of finance secretaries and central bank deputy governors, and by working-level meetings of mid-level officials. Issues could thus be reviewed and discussed at various levels before they are brought before the SAFMs for decision. At the Dhaka summit, it was also decided to establish a SAARC development fund to be an umbrella funding mechanism for all SAARC projects. Accordingly, in 1996 the South Asia Development Fund was set up under the SAARC to identify regional projects in industry, energy, agriculture, and services, as well as projects in infrastructure and social development. For further financial and monetary integration beyond these steps to take place within South Asia, additional work has to be done to assess whether a common currency is feasible and whether there is enough macroeconomic convergence and political will to entertain the idea of a common market. With this in mind, financial integration within South Asia can be studied from several points of view. Concerning the background conditions required for a monetary union similar to the European Union, there are good prima facie reasons for moving forward with plans to pursue a monetary union. The region has begun to exhibit greater convergence for a number of macroeconomic indicators like the inflation rate, interest rates and exchange rates, public debt, and fiscal deficits (Saxena and Baig, 2003; Jayasuriya et al., 2003). The patterns of shocks experienced tend to be similar. Agricultural volatilities tend to be correlated since the monsoon patterns are similar across the region. The countries also have a similar production mix, and a similar variety of agricultural products (including sugar, wheat, and rice) and labor-intensive manufacturing (including textiles, cotton fabrics, and garments). India is the exception. Its economy is more diverse and it produces a variety of manufactured goods. Because of its small share of international trade, the region has not been subject to strong external shocks like Southeast Asia and East Asia. Exchange rates have

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tended to move together and the major currencies are closely aligned with the US dollar in a managed float while the small countries are tied to the Indian rupee. Pursuing a basis for a common currency could strengthen fiscal and monetary policy coordination and create more incentives for greater intra-regional trade and the establishment of a single market. Labor mobility would be encouraged and fiscal transfers could provide insurance by diversifying risk among several countries. Two further points can be considered. First, while a currency union may not have a strong basis at the start, its establishment would increase harmony. Second, a currency union is definitely good for the economies that join. Rose and Engel (2002) find that members of a currency union trade more and have less volatile exchange rates. Frankel and Rose (2000) show that trade triples for each member of a currency union. They also find that every 1% increase in trade relative to GDP raises income per capita by 0.33% over a 20-year period. Furthermore, Glick and Rose (2001) show that bilateral trade doubles when a pair of countries forms a currency union. The stumbling blocks to further monetary cooperation lie with the lack of political will, which is manifested in hostility between Pakistan and India, and the continued low level of internal trade in the region. Ironically, Saxena (2002) and Maskay (2003) both find, on the basis of the above criteria, that India and Pakistan are the most suitable candidates for a single currency. Until more trade occurs, either spontaneously or through regional agreements like SAARC, BIMSTEC, SAPTA, and SAFTA, a monetary union is unlikely. However, mutual cooperation toward more realistic opportunities such as currency swap arrangements and the use of surplus foreign exchange reserves to fund infrastructure development in the region can be effectively considered.

Lessons from East Asia and Recommendations East Asia20 has grown dramatically in the past four decades and in the 1990s was known as the Asian economic miracle. Much of this 20

East Asia is defined as ASEAN + 3.

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3,500

3,000

2,500 total world exports 2,000

1,500

1,000 intra-regional exports

500

Fig. 5.1

06 20

04 20

00

02 20

20

98 19

96 19

94 19

92 19

90 19

88 19

86 19

84 19

82 19

19

80

0

Total World and Intra-regional Exports of East Asia, 1980–2006 ($ billion).

Source: IMF (2007b).

dynamism has been the result of openness to international trade and the pursuit of multilateralism within the GATT/WTO framework. Intra-regional trade also grew in tandem with global trade with the rest of the world (Fig. 5.1). Since the Asian financial crisis of 1997, there has been a re-orientation of development thinking in East Asia regarding the role of regionalism. The contagion effects of the Asian financial crisis were strong and unexpected and some of the initial policies under the IMF package were not fully appropriate, requiring a re-assessment of the role of regional factors in growth and international trade. Slow progress in the Doha round of multilateral trade negotiations was also partly responsible for renewed interest in regional trade arrangements. What can South Asia learn from the experiences of East Asia? The most significant lesson is that regionalism can help maximize the benefits of globalization while minimizing its costs. South Asia should strengthen its efforts to enhance cooperation within the region and

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with East Asia — the latter subject is discussed in Chapter 4). At the November 2005 SAARC summit, the leaders approved, among others, observer status for Japan and the PRC. Observer status for the Republic of Korea and ASEAN is also being considered. The presence of ASEAN, the PRC, Japan, and the Republic of Korea, which have a rich experience in promoting regional cooperation in East Asia, should provide a catalyst for SAARC integration. The level of integration within ASEAN+3, which includes these three countries, has been increasing rapidly. Granting observer status to the East Asian countries should also have a positive impact on economic integration between South Asia and East Asia for Asia-wide integration. Trade and Investment As mentioned above, although SAFTA has put more teeth into the trade agreement than previously agreed on as part of SAARC, the sensitive-list loophole still exists. Speedy implementation of SAFTA would certainly help. NTBs should be reduced. Trade in services and movement of labor could also be included in SAFTA. As noted in Chapter 4, following the global trend, FTAs between South Asia and East Asia have recently proliferated. While there is a risk that the proliferation of FTAs could raise administrative costs and divert trade, there seems to be no stopping the spread of these agreements, particularly after the stalling of the Doha round of multilateral trade negotiations in the middle of 2006. Deepening the scope of FTAs beyond tariffs to include services and other facets of international exchange, as well as broadening membership, is one way of increasing the efficiency of these kinds of trade arrangements. Money and Finance As mentioned above, the recently established regular meetings of the South Asian finance ministers at the apex level could be supplemented by meetings of deputies comprising finance secretaries and central bank deputy governors to set the agenda for the ministerial meetings.

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Efforts could be made to develop consensus on topics of regional interest and to monitor short-term capital flows as part of an “early warning system” to detect potential currency and banking crises. East Asia has made good progress in establishing regional financing arrangements under the Chiang Mai Initiative. To date, 16 bilateral swaps amounting to $83 billion have been signed. Encouraging progress is being made to “multilateralize” these bilateral swaps and to form a centralized reserve pool. South Asian countries may consider participating in these efforts for liquidity support in emergencies, in addition to funds from the IMF. East Asia has also come up with initiatives to develop regional bond markets. These include the ASEAN+3 Asian Bond Market Initiative and the Asian Bond Funds I and II of the Executives’ Meeting of East Asia-Pacific Central Banks (EMEAP). These efforts can serve as a template for local currency bond markets in South Asia. South Asia could also participate in the on-going East Asian efforts. The recent signing of a bilateral swap agreement between India and Japan is a step in the right direction. Infrastructure The SASEC initiative in South Asia can benefit from interaction with the Greater Mekong Sub-region Initiative begun in 1992 and involving Cambodia, the Lao People’s Democratic Republic, Myanmar, Thailand, Viet Nam, and two southern provinces in the PRC. This program is well established and has overcome many of the handicaps that SASEC may encounter as it begins its programs of regional cooperation in infrastructure. Chapter 4 highlighted the significant constraints posed by high transport and logistic costs on increased trade relations between South Asia and East Asia. Land transit through Myanmar is not possible at present, but this situation will eventually change over time. Additional corridors between India and the PRC through Bhutan and Nepal will have to be developed. Logistic constraints will also have to be addressed to facilitate the movement of goods between the two regions.

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Capital Account Liberalization and International Financial Integration One of the characteristics of the Asian financial crisis that most surprised economists and government officials was the power of capital movements to disrupt activity and cause large movements in exchange rates. There were many reasons for the large amount of speculation at that time, including the size of international liquidity and the large amounts of short-term external debt held by Thailand and other countries whose currencies were under attack. Premature capital account convertibility certainly played a critical role as well. Where capital accounts were closed in South Asia and in the PRC, speculators could not mount an attack. This does not mean that the countries of South Asia should eschew capital account convertibility. To fully integrate into the global economy and to attract foreign investors into local stock and bond markets, capital account convertibility is a must. However, South Asia should study the crisis carefully, particularly the bank and financial practices that sowed the seeds of the crisis. Capital account liberalization should be sequenced properly. When South Asia feels it is ready and its financial sectors are strong, viable, and sufficiently well regulated, it can begin to loosen the controls on capital movement, but not earlier.

References Bandara, JS and W Yu (2003). How Desirable Is the South Asian Free Trade Area? A Quantitative Economic Assessment. World Economy, 26(9): 1293–1323. Batra, A (2004). India’s Global Trade Potential: The Gravity Model Approach. Indian Council for Research on International Economic Relations. Working Paper No. 151. Bhattacharya, SK and BN Bhattacharyay (2006). Prospects and Challenges of Cooperation and Integration in Trade, Investment and Finance in Asia: An Empirical Analysis on BIMSTEC Countries and Japan. CESifo Working Paper No. 1725. Chandra, R and R Kumar (2008). South Asian Integration Prospects and Lessons from East Asia. Indian Council for International Economic Relations. Dasgupta, A and NM Maskay (2003). Financial Policy Cooperation in SAARC: A First Step toward Greater Monetary Integration in South Asia. South Asian Economic Journal, 4(1): 133–143.

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Frankel, JA, and AK Rose (2000). Estimating the Effects of Currency Unions on Trade and Output. NBER Working Paper No. 7857. Frankel, JA, E Stein and S Wei (1995). Trading Blocs and the Americas: The Natural, the Unnatural and the Super Natural. Journal of Development Economics, 47(1): 61–95. Glick, R and AK Rose (2001). Does a Currency Union Affect Trade? The Time Series Evidence. NBER Working Paper No. 8396. Hirantha, SW (2004). From SAPTA to SAFTA: Gravity Analysis of South Asia Free Trade. Department of Commerce, Faculty of Management Studies and Commerce, University of Jayewardenpura, Sri Lanka. Mimeo. Inoue, K, M Murayama and M Rahmatullah (2004). Sub-regional Relations in the Eastern South Asia: With Special Focus on Bangladesh and Bhutan. IDE-JETRO Joint Research Program Series No. 132, Institute of Developing Economies, Japan. International Monetary Fund (IMF) (2007). Balance of Payments Statistics. CDROM. July. ——— (2007). Direction of Trade Statistics. CD-ROM. June. Jayasuriya, S, N Maskay, D Weerakoon, YR Khatiwada and S Kurukulasuriya (2003). Monetary Cooperation in South Asia. South Asia Network of Economic Research Institutes SANEI, Kathmandu, Nepal. Working draft. Nath, V (2004). Nepal-India Trade Treaty and WTO Compatibility. In Implications of the WTO Membership on Nepalese Agriculture, edited by RP Sharma, MK Karkee and LK Gautam. Food and Agriculture Organization, United Nations Development Programme, and Ministry of Agriculture and Cooperatives, Nepal. Rana, PB and JM Dowling. Forthcoming. Economic Integration in South Asia and Lessons from East Asia. In Pan-Asian Integration: Linking East and South Asia, edited by J Francois, PB Rana and G Wignaraja. Palgrave Macmillan. Rose, AK and C Engel (2002). Currency Unions and International Integration. Journal of Money, Credit and Banking, 34(4): 1067–1089. Saxena, SC (2002). Is the Euro Area a Role Model for Asia? University of Pittsburgh. Mimeo. Saxena, SC and MA Baig (2003). Monetary Cooperation in South Asia: Potential and Prospects, RIS (New Delhi)/SACEPS (Dhaka) Workshop on Monetary Cooperation in South Asia: Potential and Prospects, 23 December 2003, RIS, New Delhi. World Bank (2004). Trade Policies in South Asia: An Overview. Report No. 29929, Washington, DC. ———. World Development Indicators Online.

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Fei, JCH 173 Francois, J 15, 18, 227 Frankel, JA 55, 233, 238, 243

Abella, M 54, 55 Ahluwalia, MS 63, 173 Alesina, A 19, 55 Anderson, K 173 Asher, MG 177, 200, 227

Gavian 103 Glick, R 238, 243 Grilli, V 19, 55

Baig, MA 237, 243 Bandara, JS 233, 242 Batra, A 233, 242 Bhagwati J 227 Bhattacharya, SK 115, 173, 234 Bhattacharyay, BN 234, 242 Bourguignon, F 103, 173

Hasan, R 32, 55, 103, 173 Henley, JS 173 Heshmati, A 21, 29, 55 Hiau, LK 227 Hirantha, SW 233, 243

Chandra, A 19, 55 Chandra, R 16, 18, 177, 227, 242 Chen, S 103, 174 Cowen, D 55

Inoue, K

234, 243

Dasgupta, A 236, 242 Datt, G 32 Deardorff, AV 39, 55 DeLong, B 58, 173 Deng Xiaoping, 75 Devarajan, S 4, 18 Dollar, D 19, 32, 55, 103, 173 Dowling, JM 69, 173, 243 Dreher, A 6, 18, 20, 21, 55

Kearney, Inc. 29 Khadria, B 45 Khatiwada, YR 243 Kochhar, K 173 Kraay, A 32, 55, 103, 173 Kumar, N 16, 177, 227 Kumar, R 18, 227, 242 Kumar, U 173 Kurukulasuriya, S 243

Engel, C Eslake, S

Lewis, WA 174 Li, 20, 21

Jadhav, N 51, 56 Jayasuriya, S 237, 243

238, 243 173 244

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Author Index Littellvin, E 39 Lonnroth, K 54, 55 Maddison, A 18 Martin, W 103 Maskay, NM 238, 242, 243 Mellor, JW 103, 174 Milesi-Ferretti, GM 19, 55 Mitra, D 103, 173 Morrison, C 103, 173 Murayama, M 234, 243 Nabi, I 4, 18 Nararaj, R 174 Nath, V 243 Ng, MCM 20, 21 Nicita, A 227 Olarreaga, M

27

Panagariya, A 174 Pang, IAJ 20, 21 Park, A 88, 174 Patel, UR 115, 173 Poddar, T 1, 18 Purushothaman, R 18 Quibria, MG

32, 55

Rahmatullah, M 234, 243 Rajan, RG 173 Rajan, R 200, 227 Rana, PB 15, 18, 227, 243 Ranis, G 173

Ravallion, M 32, 103, 174 Rodrik, D 19, 115, 174 Romer, D 55 Rose, AK 238, 243 Salgado, R 55 Sarah, G 174 Saxena, SC 237, 238, 243 Sehrt, K 88, 174 Sen, R 177, 200, 227 Shankar, V 175, 227 Shaw, H 55 Srinivasan, T 233 Stein, E 233, 243 Stern, RM 39, 55 Teo, L 55 Timmer, PC Ural, B

103, 174

103, 173

Weerakoon, D 45, 243 Wei, S 233, 243 Whalley, J 86, 174 Wignaraja, G 15, 18, 227 Wilson, D 18 Wolf, M 174 Yi, E 1, 18 Yu, W 233, 242 Zanello, A 55 Zhang, S 86, 174

245

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Subject Index

Asian Development Bank 46, 81, 230 Asian economic miracle 238 Asian financial crisis 5, 6, 50, 51, 84, 239, 242 Asian highway network 7, 48, 203 Asian Relations Conference 201 Asia-Pacific Trade Agreement 203, 224 Asia-wide FTA 14 Asset management companies 89 Australia 8, 37, 39, 46, 54, 202 automotive parts 234

ad valorem tariff 204, 205 administered interest rates 93, 132 Afghanistan 1, 38, 73, 206, 214, 231 agricultural collectives 81 air corridor 208 Anil Ambani 97 Arakan road 49 ASEAN 3, 13, 14, 48, 50, 52, 136, 165, 177–179, 182, 185, 186, 202, 203, 207, 213, 214, 224, 225, 238, 240, 241 ASEAN+3 3, 52, 177, 178, 202, 207, 214, 238, 240, 241 ASEAN+3 and India FTA 207 ASEAN+3 and South Asia FTA 207 ASEAN+3 Asian Bond Market Initiative 241 ASEAN+3 finance ministers 3 ASEAN FTA 207 ASEAN Regional Forum 202 ASEAN Secretariat 184, 185, 202 Asia 1, 3–10, 12–17, 20–24, 27–32, 36, 38–40, 42–54, 57–59, 61–63, 65–67, 69–80, 84, 85, 89–91, 93–100, 102–115, 122, 125, 156–161, 175–183, 185–190, 192, 194–198, 200–209, 211–216, 218, 224, 227–231, 233–242 Asia-Europe Finance Ministers’ meeting 202 Asian Bond Funds I and II 241

back-to-back feeder services 208 Bandung Spirit 202 Bangalore 106 Bangladesh 1, 4, 22, 24, 26–30, 32–40, 44–46, 49, 58–74, 77–79, 91, 93–97, 99, 101, 102, 105, 110, 112–114, 125–172, 177, 183, 191, 194–198, 200, 204–206, 209, 211, 214, 216, 229–231, 234, 235 Basel II standards 93, 133, 164 Bay of Bengal 36, 112, 208 Bay of Bengal Initiative for MultiSectoral Technical and Economic Cooperation (BIMSTEC) 36, 112, 177, 203, 225, 234–236, 238 Bengal 36, 112, 176, 208 246

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Subject Index Bhutan 1, 4, 24, 36, 49, 58, 59, 62–65, 67, 69–71, 73, 74, 77, 78, 96, 102, 105, 156–161, 177, 183, 189, 204–206, 209, 214, 225, 230, 231, 241 Bilateral and Plurilateral FTAs 233 BIMSTEC summit 234 BISTEC 234 border dispute 201 British 4, 15, 176, 228, 229 British Empire 15, 228 broad-gauge system 211 Buddhism 176 Buddhist sites 231 Burma 176 Calcutta 209 capital account convertibility 7, 8, 46, 50, 94, 242 capital account deregulation 5 capital account liberalization 3, 19, 36, 50, 51, 242 capital- and knowledge-intensive items 191 capital flow 6, 19, 23, 236, 241 capital market development 115, 130 capital outflows 51 cargo handling and logistics 211 cargo handling and transfer 15 Central Asia 16, 179, 214, 215, 236 central bank 17, 39, 87, 88, 93, 236, 237, 240, 241 Central Intelligence Agency 71 central planning 80 Chennai 176 Chiang Mai Initiative 3, 17, 241 China 1, 52, 53, 74, 87, 106, 111, 156–161, 175–177, 179, 186, 202, 203, 206, 218, 219 China’s Yunnan Province 203 Chinese silk 176 Chola dynasty 176

247

Chola empire 176 clearing and payments system 53 Cold War 202 Colombo 130, 208 colonial era 201 colonial period 176, 177 commercial banks 66, 87, 88, 91, 92, 115, 164 Common Market of Eastern and Southern Africa 47, 48 comparative advantage 13, 16, 90, 122, 177, 189–195, 200, 216, 218, 224, 235, 236 Comparison of India and the PRC 116 competitiveness 2, 4, 6, 7, 36, 40–43, 45, 47–49, 83, 115, 122, 152 competitiveness index 42, 49 competitiveness indicators 7, 41 complementarities 13, 177, 187, 201, 204, 235 connectivity 2, 10, 21, 29, 111, 230, 231 construction services 199, 200 contagion 3, 5, 239 contagion effects 3, 239 control of corruption 29, 72, 161 cooperation in agriculture 231 Coromandel 176 corporate governance 5, 53 Corporate Governance Ratings 53 corruption 4, 21, 29, 31, 72, 74, 100, 137, 148, 161, 165, 169 corruption perception index 29 cost of doing business 100 credit plans 88 crop diversification 95, 140 cross-border infrastructure 15, 230 cross-border procedures 15, 208, 211

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customs inspection 15, 211 customs procedures 15, 47, 208, 212, 232 Dealogic 186 debt service 51 decolonization 201 deepening of financial markets 2 demographic dividend 205 design and sequencing of reforms 9 development strategy 3, 4 direct foreign investment 19 doing business study 97 double mismatch 5 double taxation 7, 50, 91 drugs and pharmaceuticals 234 Dutch 176 Ease of Doing Business Index 206 East Asia 3, 5, 6, 8, 10, 12–17, 30–32, 36, 39, 42, 46, 49, 52, 53, 73, 74, 80, 99, 111, 156–161, 175–183, 185–190, 192, 195–198, 200–209, 211–216, 218, 224, 230, 236–241 East Asia Summit 14, 202 economic complementarities 13, 177, 187 Economic Cooperation Organization 37, 38 economic efficiency 2, 47, 86, 92, 98 economic growth 4, 6, 11, 19, 20, 31, 44, 45, 65, 76, 103, 108, 109, 116, 205 economic integration 13, 21, 27, 175, 177, 203, 204, 228, 230, 240 economic reforms 5, 10, 14, 51, 80, 81, 103, 107, 111, 125, 162, 182 education and health 10, 29, 70, 108, 111, 113, 123, 124, 205 effectiveness of government 21

effectiveness of the regulatory apparatus 31 energy and power 16, 230 environment 2, 9, 10, 14, 16, 17, 29, 43, 57, 75, 80, 98, 104, 106, 107, 110, 111, 113, 119, 121, 137, 142, 147, 150, 171, 205, 230, 231 Europe 1, 8, 13, 43, 54, 82, 175, 177, 186, 201, 202, 208, 229 European Central Bank 39 European finance ministers 14 European Union 37, 39, 50, 214, 215, 230, 237 European Union Council 39 exchange rate policies 50 excise taxes 91 Executives’ Meeting of East AsiaPacific Central Banks (EMEAP) 241 export diversification 3, 136 export processing zones 10, 105, 111, 112, 119 feeder vessels 208 financial crisis of 1997 and 1998 3 financial infrastructure 8, 52 financial integration 3, 6, 7, 17, 36, 46, 52, 236, 237, 242 financial intermediation 2, 115 financial liberalization 66 financial markets 2, 3, 8, 52, 103, 104 financial repression 89, 92, 93 financial sector reforms 87, 89, 90 financial services and insurance 200 fiscal balance 64, 107 fiscal consolidation 51 fisheries 234 five interested parties [FIPS] 40 flexible labor markets 103, 169

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foreign direct investment (FDI) 2, 6–9, 11, 12, 19–21, 23–25, 31, 33–35, 45, 49–51, 63, 64, 82–84, 97, 98, 100, 105, 106, 111, 116–118, 121, 137, 146, 147, 182–186, 207 foreign exchange reserve 25, 51, 52, 69, 238 foreign investment regulations 95, 142 fostering regional cooperation 15 free trade agreements (FTAs) 3, 6, 14, 16, 36–38, 50, 178, 202, 203, 206, 207, 224, 226, 233, 236, 240 free trade area 16, 37, 48, 225 FTA framework agreements 203

government effectiveness 29, 31, 73, 74, 99, 100, 158 Grameen Bank 112 gravity model 229, 233 Greater Mekong Sub-region Initiative 241 Greater Mekong Subregion program 17 gross national product (GNP) 177, 233 Group of Eight 36–38 Group of Eight Developing Countries 36–38 Group of Four (G4) 40 growth in per capita income 9, 20, 59, 98 Gulf of Thailand 208

G20 39, 40 gems and jewelry 234 General Agreement on Tariffs and Trade (GATT) 40, 232, 239 giant economies 11–13, 116, 175, 179 global competitiveness 4, 43 global competitiveness survey 43 global economy 1, 3, 6, 12, 13, 21, 23, 40, 45, 90, 175, 183, 202, 242 global integration 3, 19 Global Trade Analysis Project (GTAP) 207, 233 globalization 1–3, 5, 6, 16, 17, 19–21, 23, 26–31, 35, 36, 43, 45–47, 49, 196, 239 globalization indicators 6, 21 globalization indices 27, 49 Goldman Sachs 1, 12 good governance 2, 10, 14, 72, 205 governance 2, 5, 11, 14, 20, 51, 53, 72, 74, 99, 100, 111, 114, 137, 148, 149, 156, 165, 168, 169, 172, 205

harmonization of financial regulations 8, 52 harmonize customs procedures 232 health and education 6, 12, 14, 21, 30, 31, 87, 96, 108, 149, 205 high-bandwidth connectivity 231 Hinduism 176 horticulture 234 household registration system 86 hub-and-spoke arrangement 208 hukou certificates 86 human development indicators 9, 75, 114 human development report 72 human resource indicators 9 ICT services 198 IMF and World Bank 40 IMF’s balance-of-payments statistics 196 impact of policy reforms 58, 80, 98 import-substituting policies 4 incidence of poverty 9 index of labor market integration 43

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India 1, 4, 7, 9–17, 22–45, 47–53, 57–80, 89, 91–107, 110–114, 116, 118–172, 175–177, 179, 182–184, 186, 189, 191, 195–207, 209, 211, 214, 216, 217, 224–226, 228–231, 233–235, 237, 238, 241 India’s border war with China 202 India–BIMSTEC FTA 234 India-Singapore Comprehensive Economic Cooperation Agreement (CECA) 202, 224 indicators of governance 74, 99 indices of corruption 31 indices of globalization 21, 43 indigenous factors 21, 28, 31 Indonesia 26, 28, 30, 31, 38, 39, 41, 42, 46, 51–53, 156–161, 176, 182, 183, 193, 195, 197, 198, 200, 203–206, 219, 220, 226 Indonesian spices 176 Indus River 228 industrial de-licensing 103 Industrial Disputes Act of 1947 119 industrial licenses 95, 142 industrial licensing 90, 147 industrial policy 10, 142–147, 168 industry 7–9, 11, 12, 17, 48, 54, 67, 68, 80, 81, 86, 90, 95, 102, 108–110, 112–114, 119, 120, 123, 144, 151, 184, 189, 199, 229, 237 infant mortality 71, 77, 108 inflation 9, 35, 51, 60, 61, 65, 87, 92, 104, 107, 237 information and communication technology (ICT) 16, 198, 200, 230, 231 information technology (IT) 4, 8, 12, 44, 54, 106, 109, 119, 121, 122, 127 infrastructure 7, 8, 10–12, 15–17, 41–43, 48, 52, 54, 83, 94, 95, 97, 106, 107, 111, 113, 114, 119, 120,

123, 124, 140, 141, 143, 151–155, 166, 170–172, 203, 205, 208–211, 229, 230, 237, 238, 241 infrastructure bottlenecks 43, 120, 152 infrastructure reforms 10 initial conditions 9, 58, 75 innovation 2, 23, 109 insider lending 93, 132 Institute of International Finance 23, 25 institutions 9, 10, 14, 51, 58, 83, 111, 115, 130, 132, 142, 205, 236 International Bank for Reconstruction and Development (IBRD) 174 international best-practice standards for the banking system 93 international competitiveness 2, 7, 36, 40, 43, 45, 47 International Finance Corporation (IFC) 96, 101, 206, 212 international flows of labor 43 international freight hubs 208 international harmonized tariff classification 212 International Labour Organization (ILO) 70, 78 international migration policy 6 International Monetary and Financial Committee 40 International Monetary Fund 22, 40, 52, 73, 92 international reserves 9, 25, 69, 97, 107 international shipping lines 208 international trade 2, 6, 7, 11, 15, 19, 20, 23, 35, 36, 38, 39, 45, 46, 61–63, 82, 83, 100, 104, 113, 116–118, 121, 177, 187, 188, 190, 192, 218, 224, 229, 230, 235, 237, 239 Internet 21, 100

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Subject Index intra-regional trade 15, 16, 47, 176, 214, 215, 228–230, 232, 233, 238, 239 Intra-South Asian trade 235 investment 2, 5, 6, 8, 10, 12, 14–16, 19, 20, 23–25, 33, 35, 47, 49–53, 63, 64, 73, 77, 83, 87, 88, 90, 93–95, 97, 98, 102, 104, 106, 110, 111, 121, 140, 142, 146, 151, 152, 154, 166, 169, 182–186, 201–203, 205, 207, 208, 212, 224, 226, 230, 231, 234, 236, 240 investment in trade-related infrastructure 15, 208 investment integration 35, 182, 201 IT 4, 8, 12, 44, 54, 106, 109, 119, 121, 122, 127 Jamuna bridge in Bangladesh 49 Japan 1, 3, 17, 39, 40, 52, 61, 74, 97, 156–161, 179, 182, 183, 186, 193, 195–198, 200–203, 206, 213, 220, 226, 240, 241 Java Sea 176 Jawaharlal Nehru 201 Kashmir 73, 201, 228 Kearney Inc 56 Kearney, A. T. Inc. and the Carnegie Endowment for International Peace 18 Kearney’s Index 21, 25, 27 Kunming 211 labor force participation 70, 78, 121 labor market 2, 8, 10–12, 43, 54, 85, 90, 96, 97, 103, 104, 111, 112, 121, 150, 169 labor market integration 43 labor market reforms 104 labor market restrictions 112 labor migrants 43

251

labor reforms 51 labor-intensive industry 11, 12, 79, 119 labor-intensive manufactured goods 13, 85, 191 Ladakh, Kashmir 201 Latin America 32, 156–161 leapfrog 12, 119 Lhasa 209 license raj 4 licensing 4, 39, 90, 94, 99, 100, 133, 135, 142, 147 life expectancy 70, 71, 77, 108, 113 living standards 2, 8, 9, 57, 58, 75, 87, 114, 116 local currency bond markets 17, 241 local governments 87, 100, 114, 148, 169 logistic costs 15, 208, 212, 241 Long-Term Vision 2020 paper 202 Look East policy 177, 202, 207 macroeconomic convergence 17, 237 macroeconomic reforms 10, 80, 81, 107, 111, 125, 162 Maharashtra 41, 42 Malaysia 26, 27, 30, 38, 39, 41, 42, 52, 53, 156–161, 183, 193, 195, 197, 198, 200, 203–206, 221, 222, 226 Maldives 1, 4, 22, 24, 59, 62–74, 77, 78, 96, 99, 105, 156–161, 183, 189, 198, 200, 214, 229, 231 Manmohan Singh 202 Mao rebels in Nepal 73 market flexibility 11 Mediterranean 208 Mercosur 36, 37, 48, 50 meter-gauge 211 microeconomic reforms 10, 51, 80 Middle East 43, 44, 55, 104, 208

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migration 2, 6, 8, 35, 36, 43, 45, 47, 54, 85, 86, 123 migration from rural to urban areas 85 migration policies 36, 45 millennium development goal 123, 236 monetary stabilization 3 most-favored-nation (MFN) approach 36 Multi-Fiber Agreement 190 multilateral negotiations 232 multilateralism 14, 207, 239 Myanmar 36, 49, 156–161, 183, 198, 203, 209, 211, 225, 234, 241 Nalanda University 202 Nathu La pass 203, 209 natural disaster relief 17 natural gas in Bangladesh 231 Nepal 1, 4, 5, 9, 10, 16, 22, 24, 32–36, 39, 44, 46, 49, 58, 59, 61–64, 66–75, 77–79, 91, 93–99, 101, 102, 105, 106, 110, 112, 113, 115, 125–172, 177, 183, 189, 198, 200, 204, 205, 206, 209, 211, 214, 225, 229–231, 233, 234, 241 Nhava Sheva 208 Nilamu 211 non-farm rural enterprises 82 non-performing loans (NPLs) 51, 88, 89, 92, 93, 132, 164 non-resident Indians (NRIs) 51 nontariff barriers 7, 17, 38 North America 1, 8, 46, 52, 54, 214, 215 North American Free Trade Agreement (NAFTA) 46, 50, 52, 214, 215 Northeast Indian states 209 Northern Corridor 210, 211

North-South trade 201 number of physicians per thousand households 29 Octroi taxes 91 open regionalism 14, 207 openness 1, 2, 19, 20, 28, 29, 31, 35, 40, 62, 103, 229, 239 Openness Factor Indicators 28 openness to trade 19 Opium War 177 Organisation for Economic Cooperation and Development (OECD) 71, 84, 201, 212 outsourcing 4, 8, 54, 198 Pakistan 1, 4, 10, 15, 22–28, 30–40, 44–46, 50, 52, 58, 59, 61–74, 77–79, 91, 93–99, 101, 102, 104–106, 110, 112, 113, 125–172, 177, 183, 184, 186, 191, 195–198, 200, 202–206, 214, 217, 225–229, 231, 233, 235, 238 Pan-Asia 13, 175 Pan-Asian center of excellence 202 Pan-Asian cooperation 16, 235 Pan-Asian identity 201 Pan-Asian Integration 13, 175 partition 228, 235 Pearl River Delta 83 People’s Republic of China (PRC) 1, 3, 6–13, 17, 20, 26–31, 39, 40, 42, 43, 45, 47, 48, 52, 53, 57–87, 89, 90, 96–111, 114, 116–118, 120–124, 156–161, 177, 179, 182, 183, 185, 186, 192–206, 209, 211, 213, 218, 219, 225, 226, 240–242 per capita GDP 9, 33–35, 58, 60, 99 Persian Gulf 208 personal contact 21, 26 pharmaceuticals 4, 234

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Subject Index Philippines 28, 30, 39, 46, 52, 53, 122, 156–161, 183, 194, 195, 197, 198, 200, 203–206, 222, 224, 225, 227 plurilateral FTA approach 36 policy reforms 2, 8, 9, 57, 58, 80, 90, 98, 102, 125 Policy Reforms in South Asia 57, 125 political engagement 21, 27 political stability 29, 73, 74, 157 political stability and violence 73 Port Kelang 208 Port of Singapore Authority 186 portfolio investment 23, 25, 51–53, 90 Portuguese 176 Poverty Head-Count Ratio 34, 59, 61, 103 poverty ratios 32, 59 poverty reduction 6, 9, 20, 31, 58, 75, 103, 104, 124 pre-Christian era 175 pre-colonial period 13, 175, 176 preferential tariff reductions 231 preferential trade agreements 36 premature capital account convertibility 242 pre-partition 16, 228, 235 primary school enrollment 29 primary school pupil-teacher ratios 29 principal component analysis 21 principal components 29 private investment in infrastructure 97 private sector cooperation 16, 230, 231 private sector development 113, 159 privatization policy 95, 142 processed foods 234 processing of documents 15, 212

253

productivity 2, 11, 44, 49, 81, 85, 98, 102, 109, 110, 114,.121, 140, 170 proliferation of FTAs 14, 178, 202, 207, 240 property rights 10, 14, 29, 111, 205 property rights protection 29 public administration 10, 95, 111, 114, 148, 149, 169 public enterprise 10, 84, 91, 142–147, 168 public spending on education 29 Pudong New Zone in Shanghai 83 Purchasing Power Parity 4, 34, 61, 72, 73 Qinghai–Tibet railway 211 quality of the labor force 20, 21, 29 quantitative restrictions (QRs) 90, 94, 135, 136, 234 race to the bottom 7, 49 Rajendra I 176 Rajendrachola Deva I 176 Ramayana 176 rating agency 53 reduction of trading costs 15, 207 reform of institutions 10, 14, 111, 205 reforms in agriculture and industry 9, 80 reforms in labor markets 103 regional connectivity 230 regional integration 15, 38, 227 regional policy dialogues 3 regional shipping lines 208 regional trade agreements 36 regional trans-shipment hub 209 regulatory quality 29, 74, 159 regulatory scores 29 remittance flows 43, 44, 54 remittance income 43

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remittances 8, 21, 26, 30, 43, 44, 45, 104 renminbi 84 repatriation of profits 8, 50 Republic of Korea 3, 27, 39, 42, 52, 179, 181, 182, 186, 196, 200, 201, 203, 221, 225, 240 Reserve Bank of India 91, 92 resource allocation 2, 91 revealed comparative advantage indices 177, 189, 190, 192, 195, 216 rule of law 29, 31, 72, 74, 100, 160 rules of origin 14, 207, 225, 232, 234 rural credit cooperatives 87 rural electrification 152, 231 rural-to-urban migration 85, 86 SAARC 1, 16, 17, 36, 45, 47, 48, 50, 202, 230–233, 236–238, 240 SAARC development goals 236 SAARC finance ministers 17 SAARC Preferential Trading Arrangement (SAPTA) 16, 231–233, 238 SAARC summits 236 SAARCFINANCE 236 SAFTA 16, 17, 47, 231–234, 238, 240 Sanskrit language 176 SAPTA 16, 231–233, 238 SASEC program 230 second phase of Pan-Asian integration 13, 175 second-generation reforms 10, 14, 111, 140, 166, 205 semi-skilled and labor-intensive manufactured products 117 services 7, 9, 11, 12, 14, 15, 17, 35, 36, 40, 45, 47, 62, 68, 79, 89, 102, 107–109, 114, 115, 118, 119, 122, 125–128, 140, 141, 148, 151, 158,

166, 172, 196, 198–200, 203, 207, 208, 224, 226, 230, 232, 234, 235, 237, 240 Shigaste 211 short-term external debt 51, 242 Sikkim 203 Silk Road 176 Singapore 26, 30, 41, 42, 46, 52, 53, 74, 100, 101, 111, 156–161, 176, 182, 183, 186, 189, 194–198, 200–203, 206, 208, 211, 212, 222–224, 226, 227 Singapore Technologies 186 Singapore Telecom 186 Singapore’s TradeNet system 212 Sinopec 201 size of the state sector 76, 108 software industry in India 199 South Asia 1, 3, 5–10, 12–17, 20–24, 27–32, 36, 38–40, 42–54, 57–59, 61–63, 65–67, 69–80, 84, 89, 91, 93, 94–100, 102–115, 122, 125, 156–161, 175–183, 186–190, 194–198, 200–204, 206–209, 211–216, 224, 228–231, 233–237, 239–242 South Asia and East Asia 3, 12–15, 30, 36, 175, 177–183, 187, 195–197, 199, 200, 202, 203, 207, 208, 216, 224, 240, 241 South Asia Association for Regional Cooperation (SAARC) 1, 16, 17, 36, 45, 47, 48, 50, 202, 230–233, 236, 237, 238, 240 South Asia Business Forum 231 South Asia Development Fund 237 South Asia Free Trade Agreement (SAFTA) 16, 17, 47, 231–234, 238, 240 South Asia Subregional Economic Cooperation (SASEC) 16, 17, 112, 230, 231, 241

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Subject Index South Asia’s external economic relations 21 South Asia–East Asia economic relations 13, 179, 202 South Asia–East Asia trade 13, 179, 201, 209 South Asian Development Fund (SADF) 17 South Asian economic performance 21 South Asian finance ministers (SAFMs) 236, 237, 240 South Asian Growth Quadrangle (SAGQ) 112, 230 South India 176 Southeast Asia 10, 46, 63, 85, 90, 111, 176, 208, 211, 236, 237 Southern Corridor 209 South-South trade 201 Soviet-style heavy industry development 229 Soviet-style system 80 spaghetti bowl effect 207 Spanish 176 Spearman rank correlation coefficients 192, 195 special economic zones (SEZs) 82–85, 105, 106, 110, 119–122 Sri Lanka 1, 4, 9, 16, 22, 24, 26–36, 38, 39, 44, 46, 50, 52, 58–75, 77–79, 91, 93–102, 104, 105, 110, 113, 115, 122, 125–172, 177, 183, 191, 195–198, 200, 203–206, 214, 218, 225, 227, 229, 231, 233–235 Srivijaya 176 Srivijaya Empire 176 Standard International Trade Classification (SITC) 11, 116–118, 187–190, 192, 195, 216–224 standard-gauge 211 state-owned commercial banks 87

255

state-owned enterprises (SOEs) 82, 84, 85, 87–90, 95, 100, 142, 143, 162, 168 Stillwell Road 203 stock market 6, 20, 47, 89, 93, 144 Straits of Malacca 176 streamlining of cross-border procedures 15, 208, 211 structural reforms 3, 206 sub-Saharan Africa 32 Sung Dynasty 176 supply responses 9, 80 supply-side constraints 12 sustainable development 80 Taiwan 26, 30, 31, 41, 42, 74, 156–161, 179, 206 tariff and nontariff barriers in South Asia 38 tariff reduction 16, 36, 38, 47, 231, 234, 235 tariffs 4, 7, 10, 14, 16, 39, 40, 46, 82, 83, 90, 94, 99, 105, 111, 126, 128, 135, 136, 145, 162, 168, 204, 205, 208, 224, 225, 231–233, 236, 240 tax administration 10, 91, 125–127, 162 taxes on international trade 62, 63 technological connectivity 21 technology 2, 4, 12, 14, 16, 29, 83, 119, 135, 141, 167, 183, 196, 198, 203, 207, 224, 231, 234 technology transfer 183, 234 telecommunications 4, 8, 11, 14, 54, 116, 117, 121, 153, 188, 189, 191, 194 textiles and apparel 116, 118 Thai Airways 209 Thailand 26, 30, 31, 36, 39, 41, 42, 52, 53, 156–161, 176, 182, 183, 194, 195, 197, 198, 200, 203–206,

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208, 211, 223–225, 227, 234, 241, 242 Tibet 203, 209, 211 timing and sequencing of policy reforms 58 total factor productivity (TFP) 98, 109, 110 total health expenditure 29 tourism 16, 21, 116, 186, 198, 200, 230, 231, 234 township and village enterprises (TVEs) 81, 82, 86–88, 105, 114 trade complementarity index 177, 195, 196 trade creation 233 trade facilitation 47, 211, 232, 233 trade in commercial services 196 trade intensity indices 13, 181 trade liberalization efforts 14 trade liberalization measures 228 trade promotion 15, 212 Trade Restrictiveness Index 204 trade treaty 233 trade-related infrastructure 15 Trans-Asian Railway Network 203 trans-Asian railway system 7, 48 Trans-Asian Railways 211 transparency 2, 14, 51, 53, 93, 100, 132, 144, 205 Transport 16, 83, 106, 141, 144, 146, 151, 152, 165, 167, 172, 191, 193, 208, 217, 218, 220, 221, 230–232, 241 transportation and communication 234 trans-shipment hubs 208 travel 21, 190–193, 198–200, 211, 216, 218 twin track policy for South Asia 235 twin-track approach 16

UN COMTRADE Online 187, 188, 190, 192, 195, 197, 218, 224 UN Economic and Social Commission for Asia and the Pacific (ESCAP) 203 UN ESCAP’s Asian Highway Network 203 UN International Covenant on Economic, Social, and Cultural Rights 54 UN Security Council 40 UNCTAD FDI Database 24, 35, 64 UNDP Human Development Index 113 unfinished agenda 10, 110, 162 United Kingdom 39, 52, 71 United Nations 7, 21, 40, 72 United Nations Conference on Trade and Development (UNCTAD) 7, 24, 33, 35, 64, 183 United Nations Development Program (UNDP) 72, 113 United States 1, 15, 38, 39 Value-added taxes (VAT) 91, 104, 125–128 vested interests 4 Viet Nam 46, 52, 156–161, 183, 198, 204–206, 241 voice and accountability 29, 73, 74, 100, 156 voice and accountability scores 73 Western imperialism 202 Workers’ Remittances 21, 44 World Bank 15, 16, 32–34, 40, 44, 59–73, 77–79, 84, 96, 97, 99–102, 105, 110, 204–206, 212, 228, 230, 235, 236 World Bank index of employment rigidity 96 World Competitiveness Index 42

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Subject Index World Competitiveness Yearbook 40, 41 World Development Indicators Database 34, 64 World Development Indicators Online 32–35, 44, 59–63, 65–72, 77–79, 99, 102, 105, 110 World Trade Organization 39

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World War II 15, 79, 203, 228 WTO Customs Valuation Agreement 212 Yadong 211 Yangtze River Delta Zhejiang

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