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Trade deficit once again falls victim of populist policies

India just decided not to join RCEP, a trade agreement with mostly small countries (most of ASEAN, Australia, New Zealand), plus two medium economies (Indonesia and Republic of Korea), and two large economies (China and Japan, besides India itself). The concern at the top appears to have been about bilateral trade deficits with RCEP countries, especially China. Trade economists are always mystified by political concerns over bilateral deficits. They do not indicate winning, losing, fairness, unfairness, or anything else. But the view that deficits are a "loss" seems as common in India - and not just among BJP members - as it is in the Trump White House.

A country's total balance of payments position is determined by fundamental economic forces, such as the balance between savings and investment. Allocation of that deficit or surplus across countries is not a particularly interesting question: implement a policy to change a bilateral balance, and it will just reappear somewhere else so that the overall balance is maintained, since there has been no change to its fundamental determinants. Whack-a-mole, if you will.

So, let's ask a harder question: does India gain from trade when it runs a persistent current account deficit with the rest of the world? As a first approximation, it imports more than it exports. The answer is certainly and definitively yes: because consumers get access to goods they value at a competitive price. And businesses get access to inputs they need to produce their own outputs, which can then be exported or sold to domestic consumers.

There are different estimates of the gains from trade, but one that I like is from Ralph Ossa at the University of Zurich in a 2015 article in the Journal of International Economics. It's a simple model, but it's rigorous, and accounts for some important relationships in the data. His analysis shows that if India were to cut off imports entirely - which would also eliminate exports by the Lerner symmetry; no more deficit - real income would fall by between 19% and 27%. Which is a lot in anyone's language.

So like RCEP or don't like it but find a better reason than the idea that any country, including India, can only gain from trade if it exports more than it imports. Perhaps consider how to better redistribute both gains and losses of trade so to properly deal with some of the justified complaints about liberalization. But walking away from RCEP is also yet another slap in the face - after the TFA hold up, cell phone tariffs, and all the rest - for those highly respected trade economists, like Bhagwati and Panagariya, who publicly supported PM Modi. Modi's economic policies are many things, but they are rarely liberal. We should all hope the current slowdown is not an indication of a reversion to the old standard growth rate, that would be a huge disappointment after all the good work that was done.

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