Indiaís Minister of Commerce was in town last
week. He had the usual few words to say about the benefits that
are supposed to have accrued to pretty much everybody since the
entry into force of the free trade agreement with Sri Lanka in
2000. Trade between the two countries has increased at least
four-fold, and it is now worth well over $2 billion. India had
cut its tariffs on Sri Lankan goods by 2003, and Sri Lanka is
due to do away with all remaining taxes on Indian imports during
2008. Free trade has triumphed, apparently.
Unfortunately, the story isnít so simple. Taking
a closer look at what has happened in practice would prompt even
the most ardent believer to question the undoubtedly beguiling
theory of free trade.
Sri Lankaís major export under the free trade
agreement is hydrogenated vegetable oil. It has become big
business here. About a dozen factories have been set up, and
they employ some thousands of Sri Lankans. Production has
increased several times since 2000. In 2002, 80,000 MT of
hydrogenated vegetable oil was shipped to India, and this had
more than doubled to some 165,000 MT by 2005. Sri Lankaís
trade deficit with its rather more powerful neighbour was cut
from a ratio of 1:10 to around 1:3 over the same period.
Free trade is supposed to be about each country
focusing on the goods that it can produce most efficiently, and
then selling them to others and using the proceeds to buy
whatever else it needs on a level playing field. However, this
is clearly not the reality. Sri Lanka has been importing crude
palm oil from Malaysia, putting it through a rather simple
chemical process, and then exporting the end result as
hydrogenated vegetable oil to India. Indian products have
been undercut only because the Sri Lankan government has been
imposing very little duty on crude palm oil, while India has
been taxing such imports heavily.
The industry was bound to run into trouble.
Indian manufacturers were understandably upset at what they
considered to be unfair competition, because many of their
established plants were operating well below capacity or were
being forced to close up altogether, and they began pressing the
Indian government to protect them. Sri Lanka exported more than
100,000 MT of hydrogenated vegetable oil to India in the first
six months of 2006, and it proved to be the beginning of the end
for Sri Lankaís industry. India decided to forget the free
trade agreement and simply put a stop to Sri Lankan imports.
Factories stood idle for months while negotiations were underway
to find a compromise solution, and everybody was relieved when
the Indian government agreed to restart the trade with a fixed
ceiling on Sri Lankan products of 250,000 MT per year.
In fact, the dispute didnít end there. The
Indian government faced further demands from its industrialists,
and it finally decided to reduce its import tariff on crude palm
oil at the end of 2007. Sri Lankan products rather abruptly
became no cheaper than those made in India.
Hydrogenated vegetable oil will end up as just
another small enterprise in Sri Lanka. Exports canít endure for
long, and the industry wonít prosper unless people in this
country can be convinced to eat an awful lot more fatty foods.
Sri Lanka benefited from the situation for a while, but there
was never any real reason to manufacture large amounts of
hydrogenated vegetable oil here, so this is far from an advert
for free trade. Sri Lankan workers are hardly going to celebrate
having temporarily stolen a few jobs from their probably no
better off Indian counterparts. Sri Lankan leaders will have to
start worrying about the trade deficit again.
Meanwhile, it turns out that most of the local
producers are actually Indians. They only came over here to
exploit the loophole in the free trade agreement. Sri Lanka was
essentially incidental to this tale.
Pepper is the other important product in the
free trade agreement. Again, Sri Lanka has been exporting
increasingly large quantities, and this has resulted in India
imposing a cap on Sri Lankan pepper of some 2,500 MT per year.
Sri Lankan producers do have an advantage in
this case. Indian yields are now amongst the lowest in the
world, and wages are probably the highest, so the principles of
free trade would suggest that they ought to give it up. However,
this is easier said than done. Pepper farmers have to make major
investments in their cultivation, because vines take several
years to yield after planting, and it is a brave farmer who rips
them up to make way for another crop.
Desperate farmers donít have a choice. Kerala
produced almost all of Indiaís pepper in 2000, and it is one of
the longest living, healthiest and most literate states outside
the West, yet it also has one of Indiaís highest rates of farmer
suicide, and literally thousands of Kerala farmers had taken
their own lives by 2006. Drought didnít help, but
plummeting prices were the major cause of distress, because most
farmers depended exclusively on cash crops for their survival.
In 2000, pepper fetched well over INR 200 per kilo, but this had
dropped to under INR 70 per kilo by 2003, and prices only
recovered to around INR 80 per kilo in 2006. Keralaís government
judged that its pepper farmers could have no hope of even
recouping their costs after 2000, because one hectare produced
less than 300 kilos of pepper and required inputs of around INR
33,000. Farmers were in deep trouble.
The free trade agreement canít be blamed for all
of this. Prices in the global market were adversely affected
during this period by the massively increasing supply from new
entrants to the pepper business like Vietnam. However, it
certainly made the situation worse. Indian imports went up by a
multiple of five from only 3,000 MT in 2000, while Indian
exports dropped by more than half to some 20,000 MT in 2003. In
2005, Sri Lanka shipped some 7,500 MT of pepper, while total
imports to India amounted to around 15,000 MT. Sri Lankan
producers often complain about Indian protectionism. Free trade
would allow them to further increase their market share and earn
more foreign exchange for the country, but this doesnít seem
like such a great idea when one farmer commits suicide every 30
minutes in India. Sri Lankan industry representatives
announced earlier this year that there would be no further
pepper exports under the free trade agreement until India
removed the 2,500 MT cap, but they are still sending some 4,000
MT under a separate duty-free scheme to feed the essential oil
factories of Indiaís export processing zones. Pepper is
going to survive as an important industry in Sri Lanka.
Meanwhile, Sri Lankan farmers may not even be
profiting from the problems of their Indian comrades. It
has been suggested that pepper from other countries is being
diverted this way to take advantage of the free trade agreement.
Sri Lanka should be ashamed if this is so.
Indiaís Minister of Commerce looked forward to
signing a Comprehensive Economic Partnership Agreement with Sri
Lanka later in 2008. It will go beyond the abolition of
duty on trade in goods to consider other barriers to free trade,
and it will encompass trade in services as well. Both countries
are also expected to reduce the number of products excluded from
the free trade agreement. Trade is bound to receive another
impressive boost in value, and bilateral investment may well
increase too. Sri Lanka might gain, but past experiences need to
be reviewed in a rather more circumspect manner than has been
the tendency to date, because the modest successes of the free
trade agreement have at the same time been glaring failures.
Free trade has a cost. Hydrogenated vegetable oil
manufacturers on both sides of the strait know it by now, but
nobody understands this better than the pepper farmers of Kerala.
Itís about time somebody told Indiaís Minister of Commerce.