trade, interdependence, and security

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1 strategic asia trade, interdependence, and security Edited by Ashley J. Tellis and Michael Wills Regional Studies The Limits of Integration in Improving South Asian Security Devesh Kapur and Kavita Iyengar restrictions on use: This PDF is provided for the use of authorized recipients only. For specific terms of use, please contact To purchase the print volume in which this chapter appears please visit < or contact 1414 NE 42nd Street, Suite 300 Seattle, Washington USA the national bureau of asian research

2 executive summary This chapter addresses economic relations in South Asia, particularly India s economic interactions with its neighbors and security implications for the region. main argument: Political conflict, poor physical connectivity, trade barriers, a lack of trade complementarity, and impediments to cross-border investment are primary factors in South Asia s weak economic integration. While having some impact, the new regional trade agreement (SAFTA) will not fundamentally create powerful new interest groups in the immediate future, especially in the critical India-Pakistan case, as long as the military remains the preeminent actor in Pakistan. Trade between India and Pakistan is too insignificant to be a mitigating factor in any India-Pakistan conflict. Investments in physical networks encompassing water and energy offer greater security payoffs in South Asia than trade. These networks range from oil and gas pipelines to electricity grids and river water schemes. However, the projects are likely to be realized only if they involve several countries and multilateral financing and guarantees. policy implications: Positive security externalities are more likely to arise if economic interactions are either part of cross-border networks of production or the result of large fixed network investments in goods and services where substitution is very difficult. Increasing intra-industry and cross-border trade in services are essential to economic growth and economic integration in South Asia. Two specific areas of potential cooperation are energy (pipelines and power grids) and river basin resource sharing and management; U.S. support for such cross-border projects could be quite helpful. While the Indo-U.S. nuclear deal potentially offers India an important mechanism to address its burgeoning energy needs, its failure to materialize would sharply increase India s incentives to secure access to Iran s sizeable gas supplies.

3 South Asia The Limits of Integration in Improving South Asian Security Devesh Kapur and Kavita Iyengar This chapter addresses the characteristics of and trends in economic relations in South Asia, focusing particularly on India s economic interactions with Pakistan and China as well as the security implications for the region. Although the region has bucked the global trend of regional trade integration, significant differences are emerging as India s trade relations with Sri Lanka and China are booming while those with Pakistan remain moribund. In addressing the trade-security nexus in the region the paper makes four key points. First, substantial trade integration between India and Pakistan is unlikely in the foreseeable future. The primary barriers are domestic politics in both countries and, in particular, the role of the Pakistani army as the preeminent actor in Pakistan. The sort of normalization that accompanies significant economic interactions would pose severe challenges for the raison d etre of the military s dominance in that country. Furthermore, trade between the two countries will continue to be hostage to periodic bouts of terrorist attacks in India. In the foreseeable future the Pakistani military will be both unable and unwilling to completely stamp out the jihadi groups, and governance weaknesses will continue to make India susceptible to such attacks, which will continue to disrupt relations with Pakistan. Business (and trade) can handle risk more easily than uncertainty, and terrorist attacks sharply increase the strategic uncertainty facing cross-border traders. If the Devesh Kapur holds the Madan Lal Sobti Professorship for the Study of Contemporary India and is Director, Center for Advanced Study of India, University of Pennsylvania. He can be reached at <dkapur@sas.upenn.edu>. Kavita S. Iyengar is Senior Consultant, Regional Cooperation, at the Asian Development Bank s India Resident Mission. She can be reached at <kiyengar@adb.org>.

4 242 Strategic Asia logic of business is hostage to chronic uncertainty, business is unlikely to thrive. Second, the paper is more sanguine about growing trade relations between China and India notwithstanding the fact that the two countries will continue to be strategic competitors. With their rapid growth the two countries have much to gain from each other s markets. Additionally, China and India do not have the sort of domestic compulsions that are a critical hindrance in India s relations with Pakistan. Much of the China-India trade will not, however, be driven by cross-border investments; this trade therefore is unlikely to create the sort of deeper integration usually arising from such investments. China will continue to keep India off-balance through its support for Pakistan (and other countries in the region that have contentious relations with India), while at the same time seeking economic gains through closer trade links with India. India is likely to redouble efforts to seek closer relations in China s near-abroad, especially with Japan and Myanmar (Burma). Third, the chapter argues that physical networks encompassing water and energy offer greater possibilities of security payoffs in South Asia than does trade. These networks range from oil and gas pipelines to electricity grids and river water schemes. Given low levels of trust and the large capital expenses, however, the projects are likely to be realized only if they involve several countries as well as multilateral financing and guarantees. Finally the paper cautions against drawing any simple conclusion from growing trade volumes to positive security externalities. In contrast to other time periods, global trade is much more competitive; this change implies that if security issues cause a disruption in supplies than substitution possibilities are much easier and therefore less expensive. This is especially true of products traded among developing countries since these rarely include hi-tech items where markets may be more oligopolistic (and therefore have higher costs of disruption). Moreover, a major share of non-commodity trade is driven by intra-industry trade arising from crossborder investments and regional production networks. Investments and production networks are critical and their absence in the region will limit the positive security spillover effects of trade. The structure of this chapter is as follows. The first section overviews recent economic and trade developments in the region and then examines the key characteristics of the region s trade. The next section analyzes the institutional arrangements that undergrid cross-border trade. The chapter subsequently examines a broader gamut of economic relations extending beyond trade to cross-border investments and physical networks especially in energy and river basins. The final part of the paper discusses the security

5 Kapur and Iyengar South Asia 243 implications of the differing patterns of cross-border economic relations in the region and draws implications for U.S. policy. Macroeconomic and International Trade Trends in South Asia Over the past quarter-century South Asia has experienced the second fastest growth in the world (after East Asia). Annual average growth in South Asia has been 5.6% compared to 7.7% in East Asia (see Table 1). As to be expected given India s dominance, the region s growth has been driven by India, although Bangladesh has also done well and Pakistan somewhat less so (see Table 2). A comparison of gross domestic product (GDP) and population growth is instructive. From 1990 to 2003 average population growth rates for Bangladesh, India, Pakistan, and China were 1.96%, 1.95%, 2.88%, and 1% respectively. Per capita growth rate differences are amplified by the much higher population growth rates of Pakistan on the one hand and much lower rates of China on the other, with Bangladesh and India in the middle. With the exception of India and to a lesser extent Bangladesh, the recent economic performance of South Asian countries has been relatively weak, especially when compared to East Asia. Bangladesh has been an unsung success story in the last few decades, given its bleak prospects when the country became independent. Yet with the exception of garment exports (which are threatened by the demise of the Multifibre Arrangement or MFA), Bangladesh has had little success in developing other modern sectors, leaving few viable drivers of future growth. In the 1980s the country best poised in the region to emulate the newly industrialized countries of East Asian was Sri Lanka. Although Sri Lanka has not done badly, the civil war has severely curtailed those ambitions. While Nepal s prospects were earlier smothered by foreign aid, more recently political conflict within the democracy movement, the monarchy, and a crippling Maoist movement have all had ruinous consequences. The recent political settlement, however, offers some hope that the worst may be behind. After a dismal decade in the 1990s, the Pakistan economy has shown surprising buoyancy since The degree to which national resources are preempted by the military, the weakness of Pakistan s human capital, and the importance of the military s self-interest as the driver of policymaking all, however, present daunting challenges to Pakistan s medium term prospects. By comparison world GDP growth over this period was 2.9%.