Academic journal article Indian Journal of Economics and Business

Income Convergence of the SAARC-5 Countries

Academic journal article Indian Journal of Economics and Business

Income Convergence of the SAARC-5 Countries

Article excerpt

Abstract

This paper proposes that multilateralism and regionalism are complementary, and that regional income convergence is likely when a culturally similar mindset and committed regionalism exists. Historical policy interventions of SAARC are: the formation of SAARC in 1985, the introduction of the SAARC Preferential Trading Agreement in 1995, the formation of the South Asian Free Trade Area in 2006, more bilateral agreements since 1990, and multilateral liberalization by most member countries in the 1990s. The paper uses LP approach and also explores the cointegration and causal relationships between international trade, income per capita, and income convergence and concludes that multilateral liberalisation have had a positive impact on increasing trade.

Keywords: SAARC-5, trade liberalization, income convergence, structural breaks, causality

JEL Codes: F15, I38, C22

I. INTRODUCTION

The complementary nature of regional trade agreements (discriminatory RTAs) and multilateralism (non-discriminatory RTAs) is widely discussed in the literature (Ethier, 1998; Koopmann, 2003; Ornelas, 2005). The argument assumes that RTAs and multilateralism are interdependent, and that both encourage growth and trade creation (both world and intra-regional). When a particular region successfully forms trade agreements, the region gains the confidence to promote multilateralism and vice versa, assuming that tariffs and non-tariff barriers are still higher than zero. Globally oriented policies (multilateralism) are likely to trigger regional economic activities and factor mobility by creating links between regional firms and industries by utilizing advantages such as relatively lower transportation and transaction costs (Ariff, 1994). Jayanthakumaran and Sanidas (2007) show the complementary nature of RTAs and multilateralism using the example of founder members of Association of South East Asian Nations (ASEAN-5), and conclude that intra-ASEAN-5 exports and national gross domestic product (GDP) increased with the implementation of both RTAs and multilateralism at different stages of integration. This result is consistent with Plummer (1997: 211), who argues that AFTA (ASEAN free trade area) and associated accords are being used as complementary initiative to improve the region's economic environment in the increasingly competitive global economy.

The next logical step in this process is to test the hypothesis that multilateralism and RTAs are complementary, and that regional income convergence is likely to occur with culturally similar mindset and committed RTAs, which often have links geographically and culturally. Trade and investment reforms (regardless of RTAs or multilateralism) tend to allocate resources within the region, due to the comparative advantages gained through the removal of quotas and tariffs in traditionally protected sectors, and these allow income to flow from a rich to a poor nation. The catching-up that occurs is due to the involvement in new emerging manufacturing sectors under this comparative advantage, and the converging capital--labour ratio across countries in the region (Slaughter, 1997). The expectation is that income will eventually trickle down to respective booming sectors and then to sub-sectors in the economy. Regional members are likely to integrate more due to their ethnic and cultural links and lower transport and transaction costs. The existing literature on the trade--growth nexus (Lewer and Van den Berg, 2003) and trade--income convergence/divergence nexus (Ben-David, 1996) provide a strong for this hypothesis.

Most of the member countries of SAARC intensified globally oriented tariff reforms in the 1990s in their own time. Regarding RTAs, India, Pakistan, and Sri Lanka agreed to bring down their customs duties to the 0-5 per cent range in eight years by around 2016 for products from wealthy member countries, to allow differential treatment for the least developed members (World Bank, 2004: 138). …

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