The Political-Economy of the South Asian Economic Union

In a preceding article on the subject, I analyzed the merits and demerits of South Asian Free Trade Agreement (SAFTA) from an economics standpoint. I concluded that if economic theory and the experience of existing trading arrangements was any sign of things to come, SAFTA does not seem to make much economic sense, at least not in the short run, and without adequate the necessary safeguards and sharing or transfer of costs and benefits among participant countries--mechanisms that they have, thus far, largely hesitated to put in place or have ignored outright. The political-economic ambitions of the region’s politicians, however, do not stop here. The 2002 Katmandu Declaration on Economic Integration, in addition to calling for creation of a South Asian Free Trading Area by 2006, calls for the creation of a South Asian Customs Union (SACU) by 2015, and a South Asian Economic Union (SAEU) by 2020.


In this article, I would go beyond the case for SAFTA and examine whether, in the longer-run, a South Asian Economic Union along the lines of European Union, for example, makes any more or less sense than the former. In doing so, I would look at the issue from two lenses. Firstly, what additional effort and political-economic capital would the SAARC countries have to spend to realize a full-blown economic union, under what circumstances does that make sense, and what bottlenecks might be expected along the way. Secondly, and more importantly, whether or not a political rationale for moving forward with an economic union change our decision calculus, and if so, what are the implications of that for how the countries must approach the current (and on-going) efforts to bring about SAFTA in the lead on to an SAEU.



To answer the first question, it is important to first understand what various types of trading and economic integration arrangements mean and what are their inter-relationships with each other. These agreements can be broadly characterized under two classes, namely, free trading arrangements-blocks and economic integration schemes. The former-type includes a natural trading block, a preferential trading agreement, a free trade area, and a customs union while the latter type includes a common market, a monetary union, and an economic union.

What is interesting about this taxonomy is the pre-requisites and conditionalities as well as the relationships between the various kinds of arrangements. Establishing a customs union, for example, requires a lot of give-and-take on the part of the participants as they have to come up with a mutually agreeable and uniform external tariff structure that all members could live in. While a free trade area, on the other hand, allows some degree of relaxation as members can have their own external tariffs for non-members countries that allows them, to an extent, to protect their import competing sectors.


Setting up each successive layer of integration also requires expending increasing levels of additional economic and political capital on the initiative. While the conditions for free trade areas and customs unions are relatively technical, setting up a common market requires considerably more commitment through factor mobility that might in turn require certain social commonalities like language, ethnicity, race and non-discrimination in certain elements of public policy. Going a step further, for example, in setting up an economic union calls for an even greater commitment and coordination between its members as it requires, in its strictest form, the alignment of monetary, fiscal and even social policy – all of which are generally considered as sovereign rights of a nation state.


C. Westerate, in a 1948 paper titled "The Economic and Political Implications of a Customs Union", talks at length about how the establishment of each successive layer of integration requires a full and complete implementation of the preceding layer. Westrate highlights how lack of harmonization in policies of member countries would lead to capital and labor flight towards the country of favorable policy position and thus undermine the political feasibility of such a union. Simply speaking, if SAARC countries are to form a South Asian Economic Union one day, they must be prepared to relinquish sovereignty over a whole list of policy areas not only within the trade sphere but also within the broader socio-economic sphere as well.


Westerate’s analysis, taken on its face value, has considerable logic behind it. It also imposes a very strict set of conditions on any such proposed venture. Setting up a customs union, a common market, or an economic union is certainly no child’s play. It is very serious business that raises a whole Pandora’s Box of interesting issues and challenges for the participating countries. Are the countries involved committed enough to the idea of an economic union that they would make the hefty economic, social, and political sacrifices needed to realize such an arrangement? Are the imperatives of setting up an economic union strong enough that the participants are willing to give up their sovereignty of economic and social policy? Are the countries involved willing to share--through mechanisms of fiscal transfers--the burdens that might, time and again, accrue to them due to the loss of autonomous policy-making ability? Until these and other tough questions are adequate addressed by the politicians and people of the respective countries, the claims of setting up common markets and economic unions are just that--merely claims.


What is, then, the future of the South Asian Economic Union? The answer to that question comes from the political rather than economic realm. South Asian Economic Union, like the European Union, is hypothesized to bring peace to this volatile region. After the end of the second world war, for example, it was inconceivable that Germany and France would ever enter into an economic arrangement--much less a union--of the kind that they find themselves in today. Some have argued that the biggest benefit of the EFTA and EU is that it has diminished the prospect of another war between these traditional European rivals to a virtual impossibility. Similar factors were at play when ASEAN was founded in the 1960s as the smaller countries in South East Asia region vowed to cooperate amongst each other to guard against possible invasion by larger players in the region ( e.g. China, Korea, and Japan). That seemed to have worked thus far as well.



The proponents of SAEU are clearly looking at the larger political gains that are to be achieved from this scheme. Whether SAFTA and SAEU would be able to tie these seven South Asian countries, often at odds with each other, together in bonds of friendship and tolerance is an open question. Would forging ahead with SAFTA/SAEU change the foreign policy dynamic between these two very important members of the group, namely, India and Pakistan, or would it become another classic case of throwing good money after bad? If the past and current behavior is a credible sign of things to come, the chances of realizing its political objectives of the SAFTA/SAEU are somewhat questionable.

In the case of both EU and NAFTA, successful and sustainable economic integration arrangement has required a large country to act as an anchor for the arrangement. The question is: Can Indians make the kind of sacrifices (made by larger EU members e.g. Germany and France) needed to make this arrangement a reality? Can India really prove themselves worthy of leading a group of skeptical countries without actually making them feel that they are being led? Can India show the kind of magnanimity befitting of an emerging super-power that has no insecurities about its new-found status--and hence no need to assert it--that would be required of an anchor country to make SAFTA/SAEU a success?


If the unsuccessful SAARC is to transition into a successful SAFTA (and SAEU), the countries of this region would have to have a clean break from the past and build a different kind of relationship in the future. The onus for doing so clearly lies with India. Without that, SAFTA is likely to be still-born or, at the very least, lead to suboptimal results. The other countries of the SAARC region are justified in looking towards India’s current actions, policies, and postures for signs of things to come. If, for legitimate or not-so-legitimate reasons, such degree of commitment is not to be expected of the SAARC countries, especially India and Pakistan, going forward with SAFTA, SACU, and SAEU is going to be a costly experiment whose failure can be easily foretold.