Two cheers for the Australia-India Trade Agreement
By Doctor John Humphreys, Australian Taxpayers’ Alliance Chief Economist
From diversity of trade to competition-fueled innovation: Free trade is a powerful force for economic growth. Historically, countries that pursue less restrictive international trade succeed, while those that look inwards tend to fall behind. A shift toward freer international trade during Australia’s productivity reforms in the 1980s led to a golden period of economic prosperity that we continue to benefit from 30 years on.
Naturally, you might expect economists to always applaud new trade agreements, such as the recently signed Australia-India deal. Not quite. Trade deals and free trade are two very different ball games. In short, trade deals involve special treatment for certain countries over others, which can create price distortions. The economics of trade deals can get painfully complex, but essentially trade deals result in two things:
“trade creation” (which is good) and
“trade diversion” (which is bad)
Ultimately, the full impact of a trade deal depends on many factors but, as a rule, any economic benefit is minor compared to what real free trade can achieve. Their tendency to divert trade from countries with higher competitive advantages and lower opportunity costs is why free trade economists are generally lukewarm when it comes to trade deals, and some are openly hostile to the idea.
Even so, the Australia-India trade deal deserves to be applauded. As with most trade deals, the direct benefits from the Australia-India trade deal are small, as confirmed by the feasibility study done by the Centre for International Economics back in 2010. The study showed that the direct benefits to Australia of free bilateral trade with India is worth about 0.2% of GDP. This is small compared to the benefits of broader free trade, but the sad reality is that other approaches to trade reform have run into roadblocks. Trade deals may represent slow progress, but slow progress is better than no progress.
Additionally, the Australia-India trade deal offers the dynamic benefits that come from greater competition. Politicians and media too often criticise imports, ignoring their benefit to consumers, and their propensity to drive innovation and growth in a market economy. Trade deals also often come with associated reforms that can make it easier to move or invest in the other country. In the case of the Australia-India deal, recognition of professional qualifications will be streamlined and Indian students with a first-class honours in STEM fields will be able to work in Australia for an extra year.
The deal offers another benefit - one that goes beyond typical economic analysis: It diversifies Australia’s trade relationships, shifting away from our country’s heavy reliance on China. Australia benefits significantly from our economic relationship with China and that is likely to continue well into the future but, from a geopolitical perspective, it is dangerous to rely on any one foreign country. That’s not to say Australia should shun China; any sudden shift in that direction would create massive economic pain for the most vulnerable people in the country. Rather than decrease our economic links with one country, Australia should embrace a variety of trade partners.
The Australia-India trade deal is being hailed as a significant step forward in trade and that isn’t really true. But it is a small step forward in trade and a geopolitical shuffle towards closer relations with the world’s largest democracy. And that deserves two cheers.