Can FTAs be leveraged for FDI?

Empirical research have proven that commerce pacts and investments are enhances when the accomplice nations differ in relative endowments and are at completely different phases of growth, whereas commerce pacts and investments might be substitutes when the accomplice nations are equally endowed and competing for a similar FDI.

By Sanjay Chadha

The thrust on FTAs with massive developed markets just like the US, Canada and the European Union has been gaining momentum for a while. The Indian stakeholder-industry has proven a extra affirmative angle to bounded commerce offers with the US, Canada, the UK and the EU, albeit with an strategy that may finest be described as considered one of cautious optimism. These are massive markets and have the potential to develop into large export locations for Indian merchandise. Whereas the bigger image seems to be commerce, one can’t ignore the attendant potential profit the preferential entry to those massive markets brings—an inducement for FDI in manufacturing.

After all, conventional knowledge states that FDI in manufacturing will get drawn to protected markets, the place it’s cheaper to arrange a producing unit relatively than pay the tariffs required to serve the market by means of exports. This sort of FDI has a protracted historical past, going again to the industrialisation of the UK, Canada and Australia. A 2002 World Financial institution report cites research that affirm excessive tariff charges on imported items induced FDI inflows into the UK, Canada and Australia, at that time limit.

Whereas an MNC’s determination to undertake international funding is guided by many components equivalent to infrastructure, human capital, tax coverage consistency and such endowments within the recipient nation, the scale of the market is a considerably decisive issue within the alternative of the FDI recipient nation. Most research discover a highly-pronounced optimistic impact of the scale of the host market on FDI inflows. Due to this fact, to the extent that an FTA creates an prolonged market by together with entry to the FTA accomplice nations’ market, a optimistic relationship between FTAs and FDI would emerge. Because of tariff eliminations, the markets of the FTA accomplice nations could be served from a single unified location. This impact permits some companies to develop past what they might have been in a position to obtain within the nationwide market of a single nation.

Empirical research have proven that commerce pacts and investments are enhances when the accomplice nations differ in relative endowments and are at completely different phases of growth, whereas commerce pacts and investments might be substitutes when the accomplice nations are equally endowed and competing for a similar FDI.

This assumes a larger significance within the wake of the latest occasions which the pandemic has introduced into focus—the significance of dependable and resilient provide chains over, merely put, the bottom value provide chains. There’s a diversification transfer by MNCs looking for plurality of manufacturing and to safe uninterrupted provide chains to be able to keep away from disruptions; a transfer which has prompted investments to maneuver horizontally relatively than vertically—a extra risk-neutral mannequin. A rustic with a modest market measurement however FTA entry to massive markets is more likely to rating over a big nation with an enormous standalone market, particularly if it may possibly supply different incentives and create a extra conducive setting.

For instance, Vietnam, which in itself isn’t a really massive market, has efficiently leveraged its preferential tariff entry to many massive Western and Asian markets by means of its commerce agreements. This (making Vietnam a most well-liked vacation spot for FDI in manufacturing) has been one of many main figuring out components for MNCs diversifying below a China-plus-one technique. Many ASEAN and South Asian nations (together with India) have been competing for a similar FDI. One other instance is Bangladesh, which has duty-free entry to the EU, UK and Canada in textiles below their GSP (Common System of Preferences) for LDC nations, thereby making Bangladesh a most well-liked vacation spot for FDI in textiles and a competitor for Indian textiles that don’t have related duty-free entry to those massive markets.

Given India’s stage of growth, it will solely be prudent to hunt a parity in tariff concessions in these massive markets, by means of FTAs. Discovering FTA companions in massive Western markets would indisputably be a lift within the arm for the manufacturing {industry} within the nation and would attract many extra.

The writer is Further secretary, Division of Commerce
Views are private