Peak Trade and Make in India

For the past few decades, upto the financial crisis, international trade grew at a rate of around 7% a year, which was almost double the rate of growth of world GDP. Post financial crisis, the trade growth was sluggish, and for the last couple of years it has grown at around 3 percent, lesser than the pace of world GDP growth. In terms of trade to GDP share too, the world trade rose from around 40% of world GDP in the early 90s to peak at around 61% in 2011. It has now fallen to around 60%. This had lead to the theory that the world trade has peaked.

Paul Krugman doesn't agree. He says that trade outgrowing GDP is not a natural law and we should neither be amazed nor disturbed if it stops happening. Some other economists chime in saying that it might just be a cyclical phenomenon and not a structural shift. However, there is good amount of evidence that the international trade growth, as we know it, has indeed peaked. And the reasons are structural and not just cyclical. That's a cause for concern for countries like India that are thinking of giving a push to the manufacturing sector, with a significant outward focus. Krugman can afford to the dismissive as his country is the biggest market for the world. We can't.

Coming back to peak trade issue, the long term trade elasticity to income has decreased when compared to the 90s. A rise in 1 percent in global income would have lead to around 2.2 percent of increase in world trade in the 90s, but it hardly lead to a growth of 1.3 percent in the 2000s. This has fallen further after the financial crisis, indicating a deep structural shift, in the sense that the responsiveness of income growth to the growth in international trade has somehow derailed from the traditional way it behaved for decades.

There might be several reasons for this, but the most plausible one is about the global supply chains getting saturated. Especially the supply chain trade between China and the US, the main drivers of international trade, apart from EU.

During the 90s, there was a rapid expansion of global supply chains that took place. China was at the centre of it, including some east asian economies. The parts, components and such intermediates trading across borders rose significantly. There was also the WTO deal that acted as a catalyst in the process. The phenomenon continued for almost couple of decades. This has run its course and now we see that the process has peaked. China has slowly reached a stage where it's domestic contribution has increased significantly and has plateaued. In short, whatever integration had to occur, has occurred, and there is not much scope for further integration, in the existing merchandise trade area. This, is just one of the reasons.

Other reasons, that might be contributing are the compositional shift in the share of world trade that is slowly shifting towards services, such as software and information technology. Also, there are theories that countries have erected non tariff barriers and other protectionist measures after financial crisis. However, to me, the theory of global chain saturation tops the list, for the simple reason that it appears to explain the general observation better.

For those interested further on peak trade topic, this IMF paper discusses the Peak Trade issue in detail.

It is in this context that we need to strategise carefully about "Make in India" initiative. There is no doubt that we need to launch such an initiative to give a fillip to our manufacturing sector. And also to focus attention on the bottlenecks that hold back India's manufacturing potential. However, if we are thinking of making one more China out of India, it is time to think as to where all the demand for our made in India stuff would come from. The RBI governor probably had this in mind, when he spoke about an inward looking manufacturing policy.

However, all is not bleak even if we decide to force an export led manufacturing growth story. Probably, the new deals at WTO, specifically the trade facilitation agreement concluded recently and the future IT agreement might give a boost to the international trade, leading to some gains. Also, EU might recover eventually. Some more areas for trade, such as farm and services might open up further. And so on. However, to hinge the hopes on international developments is risky. And that's reason enough to focus on what can be done in the existing situation where the international trade has supposedly peaked.

I believe that Make in India campaign should focus on few things when it comes specifically to international trade, to start with. (notwithstanding other never ending suggestions on improvements in other areas such as labour productivity, capital, land, credit and so on which are general in nature). One, to see if we can integrate better with the existing global value chain setup. For example, we are non existent in electronic hardware supply chain, one of the biggest areas that we lost out due to poor policy making.  Two, our ports and supportive infrastructure are shoddy, cutting us out of world markets as ships avoid calling directly, leading to transhipments through Singapore, Dubai and even Colombo. Third, the paperwork and bureaucratic procedures related to international trade in our country is cumbersome and frustrating.
Any effort to send our manufactured products in international markets should focus on the above issues. I didn't mention quality of our products as there is an automatic market mechanism in place to punish bad quality products and Govt can hardly do much about it anyway. So the effort should focus on policies to catch low hanging fruits of global value chains like hardware manufacturing, improving infrastructure for international trade, and easing trade procedures.
This would ensure a better integration in the existing setup, and keep us ready when, and if, the world gets ready for another peak trade in future.