ALTHOUGH all economic theories advocate trade, many things have the potential to go wrong in the practical world.
Inappropriate sector development, policies aimed at harming a specific country within a trade union, incompetent and ineffective joint ventures, the inability of industries to share knowledge, and producer groups gaining enough support in a region to curb any regional trade are some examples.
The terms ‘economic union’ and ‘economic cooperation’ have gained momentum. To understand regional cooperation, it is important for a person to have knowledge about theories related to international economics and how they specifically apply to trade relations between Pakistan and India.
The theory of comparative advantage explains that two countries can trade to their mutual benefit even when one is more efficient than the other in producing everything and the producers in the less efficient economy can compete only by paying lower wages.
In this context, Pakistan is a medium-sized country (in terms of area, resources and population) vis-à-vis its neighbours: India, China and Russia.
While we are proficient in producing cement, textiles and ceramics due to our labour expertise and resource availability, it is hard for us to compete with India, for instance in the software sector and with China in the electronics sector.
Thus there is little room for fears about Indian or Chinese hegemony destroying our markets. Trade and economic cooperation with these countries is going to be beneficial if Pakistan develops the right sectors at the right time and then exports its surplus.
Regional cooperation will invariably lead to a larger market size for products and services, as it will allow free movement and lower tariff rates
Through regional economic cooperation, if China is good in producing silk and the Middle East is overflowing with petroleum products,
then it would be beneficial for both India and Pakistan to supply food and cloth to these
countries and import silk and petroleum from them in return.
According to the theory of economies of scale and economic cooperation, the more firms there are in an industry, the higher the average cost for each because the average labour input decreases as total output rises.
This advocates setting up joint ventures between firms of a group of countries that produce the same product, on a large scale, to ward-off high costs.
Similarly, considering the experience curve theory, a country that has extensive experience in an industry can lower its unit cost more than another country with little experience can. Regional alliances can also help the same industries learn from the experiences from an old industrialised country.
Regional cooperation will invariably lead to a larger market size for products and services, as it will allow free movement and lower tariff rates. An increase in the size of the market allows each firm (other things equal) to produce more and thus lower its average cost. The firms and economies of the region can benefit a lot from such alliances.
For example, the combined population of all countries in the South Asian Association for Regional Cooperation (Saarc) region is more than 1.65tr, and the demand for a product can rise by a factor of ‘n’.
If economic integration occurs among Saarc countries, the economies of scale will dictate that each country produce its specialised range of products in a specific region, i.e. the fan industry in Gujrat (Pakistan) and the automobile industry in Pune (India).
The effectiveness of such specialisation could be observed in the future, with the end result of Pakistan supplying India with better quality and lower cost fans and India exporting its locally made cars. Similarly, Pakistan can produce seats or other automobile parts for the Indian car industry at a lower cost, opening doors for intra-industry trade in specialised goods.
This is indeed the scenario of the future when more industrialisation occurs in the region. It will pave the way for external economies of scale where we would be able to locate specialised suppliers in the same region; an IT professional from Pakistan could travel to Bangalore and contribute their expertise to this developed sector over there.
The technical staff present in the area can also gain from knowledge spill over, which will occur if many firms in the same industry can be localised in a specific region.
Thus most of the trade policy measures are undertaken primarily to protect the income of the producers. In such a case, it is the duty of the politicians to go for an optimum tariff rate that should be lower than what the producers actually demand.
All regional organisations of which Pakistan is a part are trying to do the same.
Secondly, the domestic failure argument in favour of such measures is very strong. At best, economists believe that internal market failures should be corrected by domestic policies aimed at the problem sources.
And the public in the trading economies should be made aware about the true costs of the trade policy instruments.
Policy implementation is the most important and difficult part in how the government acts for the betterment of its people. Economic theories can guide regional economies towards having more free trade.
The policies emanating from these theories should be put into action keeping in view the special case of India and Pakistan and the holistic view of the management and development of economies within the local market.
The question remains whether the countries and their industrialists are jointly ready for this change or not. Another question is about the willingness of firms in these countries to form joint ventures.
At the same time, while theories support open borders and free trade, our policymakers should not overlook and forget the problems and hurdles associated with the policy and try to address them for the economic stability of the region as a whole.
Pakistan and India must continue and increase their economic activities irrespective of their border and political disputes.
The writers are assistant professors at the Department of Management Sciences, Comsats Institute of Information Technology, Islamabad.
Published in Dawn, Business & Finance weekly, September 14th, 2015