NEW DELHI, JUNE 18, 2010: TRADE costs for merchandise trade between India and China have declined significantly over a 20 year period, between 1980 and 2008. According to a study by the Asian Development Bank (ADB) on trade costs between India and China, although bilateral trade between the two countries increased exponentially, there is still room to lower trade costs further, particularly in India, which has tremendous potential for infrastructure investment. As Asia’s two giants continue to expand their trade, the benefits are likely to spread throughout Asia and the world, predicts the study.

The ADB study was prompted by the resurgence of economic activity in the two most populous nations in the world, considering that until recently there was little trade between Asia’s two giants. The paper examines the dynamics of trade between India and China and the role that changes in trade costs have played in the process.

For the first half of the study period, since the revolution in China, its trade was determined more by politics and the needs of central planning than by market-oriented economic forces. In the second half, trade and its associated growth and investment expanded rapidly, with the country’s accession to the World Trade Organization in 2001 marking a significant milestone. Investment in infrastructure, in particular, helped to bring down trade costs.

India’s economy opened up around the 1980s when real GDP growth continued at about six per cent. Licensing regulations were loosened, and the private sector was allowed into previously prohibited activities. Following the 1990 foreign exchange crisis, more significant liberalisation began with the reforms of 1991. Barriers to foreign trade were reduced, greater inward foreign direct investment was allowed, and supporting service sectors were liberalized.

Considering these as the turning points in each country, the ADB study calculated the decline in trade costs based on a theory-founded gravity model of international trade using observed bilateral trade flows and gross domestic product data. The analysis revealed that trade costs have declined sharply since the 1980s, accounting for an increasing portion of growth in total trade between the two countries.

Whereas the reduction of trade costs accounted for less than one third of the increase in trade between India and China during the 1980s, lower costs seemed to explain about three quarters of trade expansion during the 1990s, when bilateral trade flows were liberalised, and up to nearly 85 per cent between 2001–2008.

While China’s tariffs on imports from India fell during this period, and Indian tariffs on imports from the China dropped sharply, overall trade costs for the two countries declined and bilateral trade increased almost exponentially. The benefits are expected to have a ripple impact in all of Asia and the world.