Growth of value chains will be hurt by trade war: Chief Economist Aaditya Mattoo

Aaditya Mattoo is the co-author of a World Bank Development Report (WDR) 2020 on global value chains (GVCs) and its role in powering a surge of international trade after 1990. In India on a short visit, Mattoo, the World Bank's Chief Economist for East Asia and Pacific region, spoke of the impact of the US-China trade war on GVCs, the lessons India could learn from countries like Bangladesh and Vietnam and why automation and artificial intelligence need not necessarily lead to job losses. Edited excerpts from an interview.

What is the impact of the US-China trade war on GVCs?

There is no doubt that a trade war especially because not so much of the increase in protection but the increase in uncertainty, is hurting trade. Global value chains often require investments in relationships and your willingness to make those investments is diluted by uncertainty. So that's a problem. So the growth of value chains will be hurt by a trade war.

There is a second dimension to a trade war which is supposing two countries have a trade war, will it benefit me because some of the trade will come to me. To a limited extent yes, it is conceivable that a trade war between the US and China will divert trade to Vietnam or India. But I think that is fundamentally myopic because there is long term uncertainty that is created by a trade conflict. But let me say that these are the downsides.

The positive is that the slowing down of the global value chains is not something that is a given from the outside. A large country like India has the capacity to change the face of international trade. But it's not just India that is out of it. Africa is out of it, South America is out of it, the Middle East is out of it. So if you had a concerted effort to revive multilateralism which increased connectivity and reduced barriers you could see a revival of global trade.

Last point, when you think of a trade conflict today, a country like India can change the nature of trade cooperation. Because there are legitimate concerns that the US has about China, because of subsidies and state-owned enterprises (SOEs) that are distorting trade. So supposing India were to not be a reluctant participant in trade negotiations but a leader to redefine and capture the narrative, then who knows, it could change the whole international dynamic of cooperation and address the sources of the trade war which is a kind of insecurity that a country like the US feels when other countries catch up.

India has just chosen to sit out of the Regional Comprehensive Economic Partnership. How does this impact India's chances of wanting to be part of GVCs?

I think the biggest impediments to India's participation in GVCs are its domestic impediments -- distortions of its land, labour, capital markets, the weakness of its logistics chain and also its relatively restrictive trade policy in goods, and to a certain extent, in services. These are the big impediments.

A trade agreement is a way of accelerating reforms. It is not necessary – a lot of these reforms can be implemented unilaterally. What a trade agreement does is trade-off or spur reforms in return for improved access to markets.

Now the markets that it could get – there are estimates that India could see an increase in exports by 7 %, it could see an increase in its GDP by 1% if it joined RCEP. This has to be compared with the cost of being left out. But its hard for me to judge whether that would have provided the greatest spur.

What I can say unquestionably is that India's own reforms would have provided a big boost too GVC participation and also those reforms are necessary to benefit from any agreements whether its regional or multilateral.

So what are these steps that India should take?

So India has already taken steps – important steps to improve its logistics services, improving the hard infrastructure and a lot of regulatory reforms. In the labour market you are aware of the rigidities which make it hard for firms to grow, its striking that while in most countries, large firms dominate exports and trade, in the case of India, there is a phenomenon of stunting, there aren't firms growing.

In the case of India there are very few firms that employ more than 500 people – only about 10% in the case of India and almost three times as much in the case of China. So I think those reforms really matter. Land reforms are crucial, they also have distortionary effects on capital markets. Land as collateral is important for them.

I also feel that the trade policies that India has in one sense its going in reverse, its quite striking if you look in terms of from 2012 India's share trade in exports in goods and services in GDP has declined from some 25% to some 20%.

And there I think services reform is also crucial. Because services reform will enhance India's participation in both goods value chains and services value chains. And here the past reforms – in telecom, finance, transport – has delivered benefits but it's incomplete. There are crucial services like retail that are very important for development. Retailers often invest in logistics value chains. Those sectors are still restricted. Business services like accounting and legal services – those increase transactions costs a lot. Those reforms are a priority.

The World Bank has produced an "Ease of doing business (EODB)" list in which India has jumped many places. How do you square that jump in the ranks with what you have just said – that India still needs lots of reforms?

There are also indicators that look at the explicit policy. Foreigners cannot won more than a certain percentage in sectors like retail or insurance.

Those are explicit policies. Ease of doing business says how many days it takes for me to get a license, how many days does it take for me to do A,B or C. But between the ease of doing business procedural story and between the policy explicit story falls the shadow of regulatory discretion where a regulator decides whether to award a license, whether to award a particular right to entry – that is an area which is very hard to shine the light on.

But my sense is that that is an area where there are big imperfections that need to be addressed.

So for businesses what does it mean when it is said that India has moved up many notches in the EODB rankings?

As I said, the improvements are unquestionably there – a lot of procedures that were time-consuming have been streamlined. And that must be recognised and must be valued. But finally the proof of the pudding is in the eating – whether people are investing, who when the value chains are moving away from China, whether they are coming to India.

And I think that's where the fundamentals that I keep emphasising. A lot influences your comparative advantages – location, whether it is easy for me to employ people, pay them an efficient and fair wage and be productive and profitable.

And when I produce, is it easy for me to move products, whether it is to bring inputs in without having to haggle with customs or to export out to destinations which give me relatively liberal access. Those are the kind of things, if you break it up, if you look at that value chain of importing to export, which is why I am saying a lot of this is a domestic reform agenda.

What are the lessons that India can learn from countries like Bangladesh and Vietnam because the report highlights these countries as successes?

Bangladesh shows that it is sometimes a blessing not to be able to do everything.

The fact that they did not have a domestic textile industry that did not need to be protected meant that they were easily able to allow the cloth to be imported and focus on doing what they were really good at – cutting and stitching.

In India's case the need to protect the domestic textile industry has become a handicap for the domestic apparel industry.

Bangladesh has 7% of the world's apparel industry. It has reduced poverty from than 44% to less than 10%. It might be embarrassing that we have a lot to learn from Bangladesh. But Bangladesh is also a sad story because it is stagnant. It has been doing the same thing for the past 30 years.

And this is where Vietnam is interesting. Vietnam has seen a progression. There is one very interesting aspect of Vietnam that people don't notice – Vietnam has seen a progression up the value chain. It has moved from apparel to electronics to progressively more and more sophisticated participation that is what Vietnam has to teach us. That you can endogenously improve your skills and mould your comparative advantage in a way that is consistent with your state of development.

You have said that Artificial Intelligence/ automation need not be feared, it will not necessarily mean constricting employment rather it can lead to employment creation. Can you explain this?

The industries that have seen the greatest robotification are those that have been the fastest growth in demand for imports from developing countries.

In general, historically, it has always been true that human ingenuity does not just find ways to make human beings redundant. It also finds new tasks for human beings to do.

But I don't think that's a reason to be complacent. I like to this of this as a race between two prices – one of the price of real wages in China, the other is the price of a robot. If real wage increases faster, then the price of robot falls, then a company in China will when it faces rising wages in China, move its production out to Vietnam, Bangladesh and hopefully India.

But if the price of the robot falls faster, the real wage rises, that same company will not move, it will buy a robot. There is no doubt that the price of robots is falling and there is no doubt that the real wages are rising. There is a narrow window in between. It's not a window of complacency, it's a window of urgency and you need to find a way in which you implement reforms and take advantage of this.