Reducing tariffs and non-tariff barriers such as costs can boost trade between India and Latin America.
MAURICIO MESQUITA MOREIRA
Is India the next big thing for Latin America? The analysis and findings contained in India: Latin America's Next Big Thing? clearly indicate that the fundamentals exist for a strong trade relationship between the two regions.
Latin America and the Caribbean has the natural resources that India needs to grow and thrive. As was the case with China, this “natural resource pull” should be strong enough to send bilateral trade soaring. Aside from this factor, similarity in demand patterns provides another good reason to trade, particularly in manufactured goods aimed at these two economies’ vast low- and middle-income populations. The puzzle, then, is why has it not yet happened?
A simple examination of the trade costs between the two economies offers a quick solution to this puzzle. Tariffs imposed on Latin America’s exports to India are close to prohibitive, particularly on agricultural products.
Tariffs imposed on India’s exports to Latin America are not as high, but cannot be deemed harmless either. If we add to these already formidable obstacles, the hard-to-quantify-but-no-less-damaging non-tariff barriers and high costs of shipping goods between the two economies, the answer to why it has not happened yet appears obvious.
Despite frequent declarations of commitment to trade and integration, governments on both sides of the relationship have yet to effectively address the most obvious and serious obstacles to bilateral trade. True, we need to acknowledge that trade agreements have been signed between India and Latin America partners such as Mercosur and Chile. However, the limited scope of these initiatives conspires to severely reduce their effectiveness.
Unless they incorporate more Latin America countries and substantially expand the number of products covered, they are not going to solve the paradox of the “missing trade.” Moreover, they can address only part of the trade costs. An effective trade agenda must also bring transport costs down by working on a regulatory framework that promotes investment and competition in transport services between the two economies.
Without reducing trade costs it is hard to be optimistic about bilateral investments. Despite the recent boom in outward FDI from both India and Latin America, a very small proportion of these investments has gone to reinforcing the bilateral relationship. There have been a few emblematic examples in IT services, mining, and manufacturing, and these might be revealing of the relationship’s potential. However, such examples have been exceptions rather than the rule.
The bulk of Latin America’s and India’s outward FDI goes to their major trading partners in the United States, Europe, and Asia, and this is far from surprising. Trade brings economies together, making the incentives to invest clearer and the barriers, particularly the informational barrier, less relevant. Without a critical mass of trade, the prospects for bilateral investments between Latin America and India appear dim.
More trade also appears to be a key ingredient for strengthening and consolidating a growing movement towards cooperation between the two economies that were barely part of each other’s foreign policy agenda until they opened their borders to international trade. The similarity of per capita incomes and production patterns in both economies represents a wealth of possibilities for the exchange of knowledge and policy experiences, as well as for joint action on global regulatory issues. A testament to this potential is both the increasing number of cooperation agreements being signed and India-Latin America collaboration in international fora.
More trade is likely to strengthen the virtuous circle in which trade boosts incentives for cooperation while cooperation creates even more opportunities to trade. In this regard, cooperation would benefit from an institutional setting more capable of making political and economic commitments, as well as from an effort to collect and evaluate data. This emerging pattern of India-Latin America cooperation, which is based on specific interests and issues rather than open-ended commitments, seems best suited to reflect the countries’ diverse interests and to maximize the benefits from cooperation.
FACING THE CHALLENGES
As regards the competitive challenges posed by India’s emergence, two sectors stand out: Information Technology (IT) and Business, Professional and Technical (BPT) services and manufacturing. In IT and BPT services, India cannot be seen as the new kid on the block. India is already a leading player, whereas Latin America is still trying to become a significant member of the club. In IT, Latin America’s supply constraints—e.g. the limited stock of engineers—rule out large-scale exports. But these constraints are less an obstacle to the region’s ability to enter market niches in which the region can demonstrate its strengths. Nearshore advantages (e.g. cultural and physical proximity) give the region an important advantage for serving both the growing U.S. Latino market and the regional market; this fact has not gone unnoticed among the major Indian IT firms. In BPT, the gap between Latin America and India is considerably smaller, particularly in low-skill activities such as call centers and telemarketing, which are a better fit for the region’s current resources and nearshore advantages. As in IT, Indian companies are already investing to exploit these advantages and in this sense are helping rather than hindering the development of this industry in Latin America.
A number of Latin America countries already have sectoral policies in place to promote the export of IT-BPT services, which are generally well focused on reducing the tax burden and alleviating credit constraints. However, they usually lack a more general cost-benefit analysis and overlook the key binding constraint on the industry’s development: the supply of qualified engineers. In this regard, it is not only necessary to improve local skills, but also to carry out initiatives to liberalize trade in services, particularly of foreign engineers and other professionals. Whereas building local skills can produce results only in the medium to long term, foreigners can provide an immediate injection of skills and establish seeds for training and transferring know-how.
Manufacturing presents a very different set of circumstances. On the surface, India’s current share of world manufacturing exports does not pose a major challenge to Latin America’s manufacturers. But a careful look at that country’s recent export trends, factor endowments, and political economy constraints reveals a huge potential and political imperative to be a major exporter of manufacturing goods. As such, India will be a force to reckon with in the not so distant future.
India’s presence in high tech and labor-intensive goods has been increasing rapidly, both in the U.S. and world markets. There are also strong signs not yet captured by the trade data, but visible in outward FDI flows, that India is likely to play a more important role in the so-called medium technology industries, particularly in the automobile sector.
To unleash its full manufacturing potential, India will have to overcome a number of important binding constraints, including labor regulations, infrastructure, and human capital. The country, though, does not seem to have any other realistic option. Its extremely successful IT-BP services cannot provide better jobs to the more than half a billion people who still perform very low productivity tasks in agriculture. The government has already given strong signs that it is willing to move to overcome these constraints, and the results of the recent election seem to strengthen the political momentum.
All this suggests that governments in the region would be wise to acknowledge a scenario in which India joins China as a major exporter of manufactured goods. Such a scenario will only add to the predicaments Latin America already faces in competing with China. It has become abundantly clear that the manufacturing “road” to development has become highly congested and particularly hazardous for countries that cannot count on an abundant supply of skilled workers.
We argue in the report that this likely scenario exponentially increases the urgency (and the costs of inaction) of an agenda that address Latin America’s well known deficiencies in education, access to credit, S&T, and infrastructure. Addressing these deficiencies is crucial to enable the region to increase productivity, diversify away from simple, labor-intensive goods, and make better use of its natural resources and proximity to the world largest market.
The future of manufacturing in the region and its ability to expand employment well beyond limited agricultural and mining jobs depends on the political will to address these “simple” and “basic” issues head on. Some speak of a more challenging agenda of heavier government intervention to address a number of failures in product and factor markets. In a moment when the heavy hand of the state is being felt not only in China and India, but also in far less likely countries such as the United States and the U.K., this sort of agenda cannot be completely dismissed. Yet, it seems wiser, especially given the region’s poor record with this level of intervention and its scarcity of resources, to concentrate government efforts on more basic and valuable activities such as building and running infrastructure efficiently and insisting that schools and universities produce the resources needed for development and growth. After all these years, the region clearly cannot take all of this for granted
Mauricio Mesquita Moreira is Principal Economist in the Integration and Trade Sector of the Inter-American Development Bank and coordinator of India: Latin America's Next Big Thing? Republished with permission.