Is SAARC A Viable Economic Block PDF

Journal of Asian Economics 12 (2001) 263–290
Is SAARC a viable economic block? Evidence from

gravity model
M. Kabir Hassan*
LREC Chair Professor of Economic Development and Finance, Department of Economic and Finance,
University of New Orleans, New Orleans, LA 70148, USA
Received 1 April 2000; received in revised form 1 November 2000; 1 February 2001
Abstract
Intra-South Asian Association for Regional Cooperation (SAARC) trade appears to be very small
compared to other existing regional blocks. This might be because of normal outcome or because of
unexplored trade opportunity. If the latter is the case, then increased trade within this region might be
welfare improving. This study attempts to make a formal analysis of these issues, and estimates a
gravity model of international trade to examine whether intra-SAARC is lower or higher than what is
predicted by an economic model. This gives an idea about the structure of comparative advantage in
the SAARC countries that helps to explain why intra-SAARC trade is low and how trade among them
can be increased. It also helps us to understand the possibility of trade creation and trade diversion
effect resulting from South Asian Preferential Trading Arrangements among SAARC countries.
Whereas the gravity model has been extensively used to measure bilateral trade among countries, they
have, to the best of my knowledge, never been used to measure intra-SAARC trade. Our gravity model
results suggest that SAARC member countries are yet to achieve trade-creating benefits. Appropriate
policies need to be formulated for more regional integration. Liberalization of trade in SAARC
countries offers significant gains for all the economies in the region. Efforts should be made to
liberalize border trade and strengthen bilateral trade relations through the removal of tariff and
nontariff barriers in the general framework of South Asian Preferential Trading Arrangements.
© 2001 Elsevier Science Inc. All rights reserved.
JEL Classification: F15, F13
Keywords: SAARC; Trading blocks; Gravity model
* Corresponding author. Tel.: ⫹1-504-280-6163; fax: ⫹1-504-280-6397.

E-mail address: mhassan@uno.edu (M.K. Hassan).
1049-0078/01/$ – see front matter © 2001 Elsevier Science Inc. All rights reserved.
PII: 1 0 4 9 - 0 0 7 8 ( 0 1 ) 0 0 0 8 6 - 0
264 M.K. Hassan / Journal of Asian Economics 12 (2001) 263–290
1. Introduction
The issue of regional economic cooperation is drawing a burgeoning interest in the arena
of international economics and politics. Regional economic cooperation typically has taken
the form of free-trade areas (FTAs) and other special regional trading arrangements. South
Asian Association for Regional Cooperation (SAARC) was created in 1985 with the broad
objectives of economic, cultural and social cooperation among seven countries in South Asia.
Like most of the other regional cooperation in Asia, SAARC’s activity in economic
cooperation is still limited. This research aims at assessing the feasibility of economic
cooperation from the perspective of regional trade. Like the EC countries, the SAARC
countries share a lot of similarity in culture and socio-economic condition, but unlike EC
countries they are all poor. Another interesting feature of SAARC is that there is one large
country (India) and all others are relatively small. Hence, feasibility of economic cooperation
among SAARC countries can be a unique case study of the potential of South-South
Cooperation. This study attempts to broadly analyze the feasibility of economic cooperation
in terms of the potential for free trade among these nations.
Regional cooperation in the field of trade has been one of the major concerns of the
member countries of SAARC. Dutta (1999), Khan (1999) and Hassan (2000) give an
extensive overview of SAARC as well as regional and multilateral benefits of trade in the
world. This shared commitment to regional trade promotion has been institutionalized
following the ratification of the agreement by all the member countries of SAARC of a South
Asian Preferential Trading Agreement (SAPTA) in 1995. Obviously, economic and trade
reforms implemented by the individual SAARC member countries over the last decade have
contributed to creating a conducive environment where closer cooperation in the field of
trade and investment could be graduated from rhetorical protestations to formal agreements.
In fact, the move towards greater regional integration has now become a global phenomenon
driven by the pull of market forces, which have opened up opportunities for trade among
center-periphery. Not surprisingly, about one third of the 109 regional deals under GATT/
WTO were notified between 1990 –1994 alone when the Uruguay Round of negotiations was
in full swing. The fact that a FTA was established among the U.S., Mexico, and Canada
(NAFTA) in 1993, that the seven ASEAN members have agreed to accelerate moves towards
FTA by the year 2003 and that the Asia Pacific Economic Community (APEC) has pledged
itself to realize free trade among its members by the year 2020 testifies to a heightened
interest towards freeing the movement of factors of production within the regional space.
Intra-SAARC trade seems to be of a quite smaller order of magnitude. This might be
because of normal outcome or because of unexplored trade opportunity. If the latter is the
case, then increased trade within this region might be welfare improving. This study attempts
to make a formal analysis of these issues by estimating a gravity model of international trade
to examine whether intra-SAARC trade is lower or higher than what is predicted by the
economic model. This gives an idea about the structure of comparative advantage in the
SAARC countries that helps to explain why intra-SAARC trade is low, and how trade among
them can be increased. It also gives an impression about the possibility of trade creation (TC)
and trade diversion (TD) effect from any preferential tariff agreements among SAARC
countries.
M.K. Hassan / Journal of Asian Economics 12 (2001) 263–290 265
The gravity model has been widely used in the empirical literature to explain bilateral
trade. For example, Havrylyshyn and Pritchet (1991) estimate a gravity model of bilateral
trade between Eastern and Western Europe; Coe and Hoffmaister (1998) look into the pattern
of north-south trade; and Bayoumi and Eichengreen (1995) examine the effects on trading
patterns of the EC and EFTA; and Al-Atrash and Yousef (2000) estimate a gravity model to
address the issue of whether intra-Arab trade is too little. However, there is not such a gravity
model study of SAARC trade. To date, most authors utilized crude statistical techniques in
examining the intensity and bias of South Asian trade.
Liberalization of trade in SAARC countries offers significant gains for all the economies
in the region. A very close look at the existing structure of trade reveals that, in the context
of trade liberalization among neighboring SAARC countries, the interaction between policy-
determined barriers (e.g., tariffs, quotas, and other nontariff barriers) and natural barriers
(e.g., transport costs, linguistic and institutional differences) is important. Integrating all
these issues together will provide a comprehensive analysis of feasibility and of the prospects
for economic cooperation in terms of enhanced trade within SAARC region. The study will
have important implications for policy-making regarding economic cooperation among the
SAARC countries.
This paper is divided into five sections. Following the Introduction in Section 1, Section
2 provides an overivew of the structure and performance of foreign trade of Bangladesh.
Section 3 discusses the gravity model and its essential features. This section presents the
empirical results of the gravity model within the context of TC and TD. Section 4 gives
policy recommendation for trade expansion among the SAARC Countries. Section 5 con-
cludes the paper.
2. The structure and performance of foreign trade in Bangladesh
According to the reports of the World Bank (1999), Bangladesh has become a much more
open economy over the past decade or so, a process spurred by the trade liberalization that
occurred gradually between 1985 and 1995. Official exports plus imports rose from $4.7
billion in 1989 to $12.7 billion in 1998. This ratio is about 30% of GDP in 1998. The addition
of an estimated $1.2–2.5 billion in unofficial trade, mainly smuggling via land borders, may
expand that ratio well beyond one third of GDP.
The official commodity trade deficit was readily sustainable at little more than 5% of GDP
in 1998, when almost 70% of imports could be funded by exports. At under $2.4 billion, it
was the same proportion of GDP as it was in 1990 when exports could fund only 40% of
imports. Unofficial commodity trade is estimated to be in much greater deficit than official
trade, however, requiring a larger share of remittances to finance it (readily available in the
hundi market). Counter trade (compared with less than 10% cover in recorded transactions
with that neighbor) is covering about 25% of inward border smuggling from India. Under-
valued official imports are presumed to far outweigh such exports.
A very large proportion of official trade is concentrated in the ready-made garment and
knitwear industries; without them the deficit would be 8% of GDP. When TMG/Knit’s 1998
receipts of $3.8 billion (almost three quarters of that year’s gross export proceeds) and the
payments for directly associated imports are excluded, the 1998 official trade/GDP ratio falls
to 16% and the trade deficit rises to $3 billion.
2.1. Exports
Legal exports have grown rapidly over the past decade, averaging annual growth of almost
17% to reach almost $5.2 billion in 1997–1998. That represented 11.5% of Bangladesh’s
$42.3 billion GDP, compared with only 5% of $30 billion GDP at the beginning of the 1990s.
The growth was due almost entirely to even more rapid expansion of woven ready-made
garment assembly (cut, make, and trim) than had already occurred in the mid/late 1980s,
supplemented by a mushrooming knitwear industry. Woven RMG and Knit accounted for
55% and 18%, respectively, of total exports in 1997–1998, just over twice their share of 36%
in 1988 –1989. Their annual growth over the decade averaged 27% a year, compared with 7%
for all other exports combined. A further 1.1% of the total was provided by specialized
textiles, bringing the nonjute textile group’s share to 74.4% ($3.8 billion).
In addition to this very strong contribution to foreign exchange earnings, the RMG/Knit
development has several positive features in terms of efficient industrialization, especially
when compared with the industries (jute and tea), which used to dominate Bangladesh’s
exports. On the other hand, the very success of RMG/Knit has made Bangladesh almost as
highly dependent on a single group of export products as it was in the days of jute. And the
group is again one in which it may be difficult to retain comparative advantage—in this case,
when the umbrella of the Multi-Fiber Agreement will be lost in a few years. The export
economy is even greater concentrated than the importance of RMG/Knit would indicate. A
very small range of products accounted for almost all of the remaining 25.6% of gross export
proceeds in 1997–1998.
Bangladesh’s main traditional nonfood crop and source of export revenue, jute is ending
the decade about where it began in value terms, around $390 million. However, this now
represents less than 8% of the total compared with a still significant 29% in the late 1980s.
About one quarter of the export was (and still is) in raw form; the rest comprises jute goods.
Frozen food exports, mainly shrimp, were expected to join RMG/Knit in outpacing jute but
are not there yet. Already comprising 11% of total exports in 1988 –1989, they grew rapidly
through 1996 –1997 but then sustained a small set-back to account for less than 6% in
1997–1998 when their $294 million value was just double that of 1988/89. A similar pattern
was shown by leather and goods made from leather, including shoes. They collectively
almost doubled in value over the same period to reach $238 million in 1997–1998 (4.6% of
the total). Unlike the setback for shrimp, the latest year saw a solid increase for leather goods.
2.2. Imports
Total legal imports have grown at an average annual rate of 10% over the past decade,
much more slowly than exports’ 17%. The $7.5 billion of imports in 1997–1998 was
equivalent to almost 17% of GDP, compared with around 12% during 1989 –1994. A
significant share of Bangladesh’s total imports, amounting to over $2.4 billion in 1997–1998,
comprise the re-exportable inputs for special bonded Warehouse (sBW) units (still mainly
RMG/Knit assemblers) and export processing zone firms (EPZ) firms. These have grown at
an average rate of 22% since 1989 –1990 —fairly steadily apart from a very large surge in
1994 –1995, which was followed by a small decline the following year. If these enclave
imports are excluded, the value of all other imports in 1997–1998 was $5.1 billion. Their
average annual growth rate over the decade was 10.7%, not far below the nonenclave
exports’ 12.8% rate.
2.3. Bilateral trade balances
Bangladesh’s legal trade deficits have been fairly moderate over the past decade, aver-
aging 5.5% of GDP in US$ terms. In the latest complete year, 1997/98, the balance remained
below $2.4 million, only 5.6% of $ GDP. Thus, exports covered 69% of the cost of imports,
leaving 31%, as well as all nonmerchandise payments, to be covered in other ways—mainly
workers remittances at $1.5 billion and aid inflows at $1.3 billion. In current value terms, the
deficit was only 20% higher than in 1990, when exports were able to cover less than half of
the cost of imports. The improvement of the situation since then, and the sustainability of the
present deficit, are reflected in the declines that have occurred since 1990 in the ratio of
external debt to GDP from 40.7% to 37.6%, and in the debt service ratio, from 21% to 8%.
Bonded warehouse exports and EPZ exports (enclave export activities) yielded net exports
of $669 million in 1997–1998 after enjoying average annual growth of 21% during the
decade. Growth has been volatile, however. Annual rates close to or well above the average
occurred during 1990 –1991 through 1992–1993, in 1994 –1995, and finally in 1997–1998,
whereas very low or even negative growth rates were recorded in the other 3 years. In
contrast to the RMG/Knit SBW success, sluggish growth has beset the nonenclave economy
of Bangladesh, which has yet to be substantially liberalized. When the two enclave groups’
transactions are excluded from both sides of the trade balance, the 1997–1998 performance
for other legal trade yields a deficit of slightly over $3 billion, equal to 6.8% of $ GDP. Thus
nonenclave exports could cover only 41% of the value of nonenclave imports, similar to the
proportion for all exports and imports in 1990. A further 13% of the nonenclave import cost
is now being contributed by the net exports from enclave business, mainly the labor services
rendered through RMG/Knit assembly.
North America and the European Union are the largest legal trading partners of Bang-
ladesh on the export side, each region taking around $2 billion or 40% of all 1997–1998
exports (mainly garments of course, especially for North America). Japan and Hong Kong
follow with around $100 million or 2% each, leaving India with a paltry $65 million or 1.3%.
The latter is in sharp contrast to India’s importance as the largest source of Bangladesh’s
legal imports, now approaching $1 billion. Indeed, Bangladesh has significant imbalances
with most of its individual partners. Excluding mainly fabric imports for SBWs (but
including their garment and knit exports), significant surpluses occurred in 1997–1998 and
previous years with key export destinations being the U.S., Germany, France, and the UK.
On the other hand, large formal trade deficits were recorded with India, China, and Japan, the
countries that are Bangladesh’s main suppliers of raw materials, intermediaries, capital
goods, and finished consumer goods. Apart from these seven partners (plus Canada with
which trade was balanced), the main sources of imports are countries to which Bangladesh
Table 1
Bangladesh’s export and import performance in late 1980s and 1990s
Exports: % Share of total % Share of GDP
exports of imports
1988–89 1997–98 1988–89 1997–98
Readymade garments and knitwear 36.7 73.3 1.6 8.9
Frozen foods (mainly shrimp) 11.0 5.7 0.5 0.7
Jute goods and raw jute 29.5 7.5 1.3 0.9
Leather and leather goods 10.7 4.6 0.5 0.6
All other exports combined 12.1 8.8 0.5 1.1
Total exports 100.0 100.0 4.3 12.2
Imports: 19.6 18.2 1.7 3.2
Primary commodities 42.2 27.4 3.6 4.8
Intermediate inputs 10.8 11.3 0.9 2.0
Capital machine & arts 4.0 4.8 0.4 0.9
Final consumer goods 8.9 6.6 0.8 1.2
Enclave (B/B SBW ⫹ EPZ) estimated 14.4 31.7 1.2 5.6
Total imports 100.0 100.0 8.6 17.8
Source: National Board of Revenue and Export Promotion Bureau, 1999.
barely exports at all: Singapore (mainly entrepôt), Australia, South Korea, Malaysia, Indo-
nesia, Saudi Arabia, and Thailand, which together provided almost a quarter of nonfabric
imports in 1997–1998. (See Tables 1 and 2).
2.4. A review of trade policies of Bangladesh
Export incentives provided in Bangladesh can be broadly grouped into: a) assistance to

gross value added or returns to primary factors; b) assistance to inputs or intermediates; and
c) assistance to output. The major thrust of these incentives is directed towards: a) ensuring
that policy and administrative constraints on export activities are alleviated; b) enhancing
backward linkage and value addition; c) diversifying exports; d) promoting export-oriented
investment; and e) injection of price competitiveness in global markets. The principal policy
interventions that have influenced the incentive regime for exporters in recent years may be
identified as: 1) a general reduction in tariff levels; 2) increase in cash compensation to
nontraditional exports from 15% to 25%; 3) elimination of dual exchange rates and con-
vertibility of the Taka on current account; 4) extension of bonded warehouse (BW) facilities
to some non-RMG products such as leather; 5) provision for duty-free imports of machinery
for export-oriented units; 6) relaxation of foreign-exchange retention limits.
On the other hand, the withdrawal of cash subsidies on export credits (currently within the
lower band of 8% to 10% has negatively impacted on the incentive to export. On the whole,
the above policies have significantly reduced the anti-export bias of the trade policies, which
was very much in evidence during the 1980s.
Table 3 gives an idea of the scope and dimensions of some of the major export incentives
Table 2
Bangladesh’s trade performance: 1989/90 –1997/98
Fiscal year: 89–90 90–91 91–92 92–93 93–94 94–95 95–96 96–97 97–98
US$ million
Total exports 1523.7 1717.6 1993.5 2382.9 2533.9 3472.6 3882.8 4418.3 5161.7
Estimated SBW 641.3 830.7 993.3 1164.0 1376.4 2070.3 1908.4 2107.5 2517.4
export (25% VA)
EPZ exports 34.0 48.0 68.0 110.0 103.0 205.0 278.0 370.0 539.0
Derived non-SBW/ 848.4 838.9 932.2 1108.9 1054.5 1197.3 1696.4 1940.8 2104.7
EPZ exports
Total imports 3226.4 3686.5 3444.8 3700.4 3970.2 5762.4 6611.8 6778.6 7514.2
SBW B/B L/C fabric 481.0 623.0 745.0 873.0 1032.3 1552.7 1431.3 1580.6 1888.1
imports
EPZ imports 32.0 40.0 63.0 85.0 121.0 197.0 261.0 402.0 493.7
Non-SBW/EPZ 2713.4 3023.5 2636.8 2747.4 2816.9 4012.7 4919.5 4796.0 5132.5
imports
Total trade (X ⫹ M) 4750.1 5404.1 5438.3 6083.3 6504.1 9235.0 10494.6 11196.9 12675.4
Trade surplus of ⫺1702.7 ⫺1969.0 ⫺1451.3 ⫺1317.5 ⫺1436.3 ⫺2289.8 ⫺2729.0 ⫺2360.3 ⫺2353.1
deficit (⫺)
SBW EPZ surplus 162.3 215.7 253.3 316.0 326.1 525.6 494.1 494.9 674.7
Non-enclave deficit ⫺1865.1 ⫺2184.7 ⫺1704.6 ⫺1633.5 ⫺1762.4 ⫺2815.4 ⫺3223.1 ⫺2855.2 ⫺3027.7 average
Annual growth rate
Total exports 0.180 0.127 0.161 0.195 0.063 0.370 0.118 0.138 0.168 0.169
Estimated SBW 0.295 0.196 0.172 0.182 0.504 ⫺0.078 0.104 0.195
export (25% VA)
EPZ export 1.125 0.412 0.417 0.618 ⫺0.064 0.990 0.356 0.331 0.457 0.516
Derived non-SBW/ ⫺0.011 0.111 0.190 ⫺0.049 0.135 0.417 0.144 0.084 0.128
EPZ export
Total imports 0.440 0.143 ⫺0.066 0.074 0.073 0.451 0.147 0.025 0.109 0.155
M.K. Hassan / Journal of Asian Economics 12 (2001) 263–290
SBW B/B L/C fabric 0.295 0.196 0.172 0.182 0.504 ⫺0.078 0.104 0.195 0.196
imports
EPZ imports 1.133 0.250 0.575 0.349 0.424 0.628 0.325 0.540 0.228 0.495
(continued on next page)
269
Table 2
270
Continued
Fiscal year: 89–90 90–91 91–92 92–93 93–94 94–95 95–96 96–97 97–98
N on-SBW/EPZ 0.114 ⫺0.128 0.040 0.027 0.425 0.226 ⫺0.025 0.070 0.094
imports
Total trade (X ⫹ M) 0.345 0.138 0.006 0.119 0.069 0.420 0.136 0.067 0.132 0.159
Trade surplus or 0.793 0.156 ⫺0.263 ⫺0.092 0.090 0.594 0.192 ⫺0.135 ⫺0.003 0.148
deficit (⫺)
SBW ⫹ EPZ 0.329 0.175 0.247 0.032 0.612 ⫺0.060 0.002 0.363 0.212
surplus
Non-enclave deficit 0.171 ⫺0.220 ⫺0.042 0.079 0.597 0.145 ⫺0.114 0.060 0.085
% GDP
Total exports 0.050 0.056 0.064 0.075 0.076 0.092 0.096 0.108 0.122 0.082
Estimated SBW 0.021 0.027 0.032 0.036 0.041 0.055 0.047 0.051 0.059 0.041
export (25% VA)
EPZ exports 0.001 0.002 0.002 0.003 0.003 0.005 0.007 0.009 0.013 0.005
Derived non-SBW/ 0.028 0.027 0.030 0.035 0.031 0.032 0.042 0.047 0.050 0.036
EPZ exports
Total imports 0.107 0.120 0.111 0.116 0.118 0.153 0.164 0.165 0.178 0.137
SBW B/B L/C 0.016 0.020 0.024 0.027 0.031 0.041 0.036 0.039 0.045 0.031
fabric imports
EPZ imports 0.001 0.001 0.002 0.003 0.004 0.005 0.006 0.010 0.012 0.005
Non-SBW/EPZ 0.090 0.098 0.085 0.086 0.084 0.107 0.122 0.117 0.121 0.101
imports
Total trade (X ⫹ M) 0.157 0.176 0.175 0.190 0.194 0.246 0.260 0.273 0.299 0.219
Trade surplus on ⫺0.056 ⫺0.064 ⫺0.047 ⫺0.041 ⫺0.043 ⫺0.061 ⫺0.068 ⫺0.058 ⫺0.056 ⫺0.055
deficit (⫺)
SBW⫹EPZ surplus 0.005 0.007 0.008 0.010 0.010 0.014 0.012 0.012 0.016 0.010
Non-enclave deficit ⫺0.062 ⫺0.071 0.055 ⫺0.051 ⫺0.053 ⫺0.075 ⫺0.080 ⫺0.070 ⫺0.072 ⫺0.065
GDP in US$ million 30190 30755 31164 31933 33559 37613 40303 41036 42322
Source: The World Bank, 1999.
Table 3
Extent of coverage under major national export incentive schemes and GSP (1993–1994)
Type of incentives Sectors/areas for Coverage Related aggregate As % of related
which available (min. USD) indicator aggregate
indictor
Import under BWF RMG leather, 991.30 Total export 39.10
ceramics etc. accruals
Credit Disbursed through Non-traditional 16.40 Export financing 8.50
Export Development exports (with to non-traditional
Fund (in foreign additional incentives exports
exchange) for new non-
traditional exports)
Export Financing Previously 438.90 Total outstanding 6.10
subsidized. Currently loans
at lower interest
bands of 8–10 p.c.
Total net export 27.30
Export from EPZ All units set up in 100.30 Total exports 4.1
(additional incentives EPZ
like no advance income
tax cuts, duty free
machinery import etc.)
Duty Drawback from Non-bonded imports/ 26.80 Net exports 1.70
DEDO local producers (excluding
bonded imports)
ECG Scheme of SBC Pre. Post shipment 151.20 Total export 5.96
and Comprehensive accruals
Exports of RMG under Provided in 27 242.80 Total RMG 18.80
GSP European countries; exports
(95% exports in EC)
Source: Export Promotion Bureau and Bangladesh Bank.
currently in place in Bangladesh. Some of the current policy changes have also lessened the
difference between incentives enjoyed by direct exports and deed exports and between EPZ units
and 100% export-oriented units outside the EPZ. The impact of different incentives varies across
sectors (Rob, 1994) as well as between the stages of production. Although incentives such as the
cash compensation scheme, operated by Bangladesh Bank, are targeted at enhancing backward
linkage and the duty-free import of machinery is intended to promote export-oriented investment,
incentives in the way of the ECG, operated by Shadharan Bima Corporation, are intended to sever
marketing risks (CPD, 1996).
3. The gravity model of Bangladesh trade with the world
3.1. International trade of the SAARC countries
Presently, intraregional trade in South Asia is also very small, accounting for only 3.5%
of the region’s total trade. An encouraging feature is, however, that over the recent years
Table 4
Intra-regional trade among SAARC countries (figures are in millions of US$)
Country Year Intra- Total % of Intra- Total % of Intra Total % of
export export Total import import Total trade trade Total
export import trade
Bangladesh 1991 80 1687 4.7 251 3421 7.3 331 5108 6.5
1997 86 4076 2.1 885 6857 12.9 971 10933 8.9
India 1991 622 17873 3.0 95 19509 0.5 717 37382 1.9
1997 1398 33289 4.2 174 38911 0.4 1572 72200 2.2
Maldives 1991 10 54 18.5 23 162 14.2 33 216 15.3
1997 15 93 16.1 36 433 8.3 51 526 9.7
Nepal 1991 21 257 8.2 99 500 19.8 120 757 15.8
1997 81 394 20.6 167 624 26.8 248 1018 24.4
Pakistan 1991 218 6494 3.4 119 8431 1.4 337 14925 2.3
1997 228 8632 2.6 228 11595 2.0 456 20227 2.3
Sri Lanka 1991 61 1987 3.1 308 3061 10.1 369 5048 7.3
1997 120 4652 2.6 620 5654 11.0 740 10306 7.2
Total South 1991 1012 28352 3.6 895 35084 2.6 1907 63436 3.0
Asia
1997 1928 51136 3.8 2110 64074 3.3 4038 115210 3.5
Annual average 11.3 10.3 — 15.4 10.6 — 13.3 10.5 —
growth rate of
SAARC trade:
1997 over 1991
(%)
Source: International Monetary Fund (IMF), The Direction of Trade Statistics, 1998.
(from 1991–1997) intratrade (exports and imports together) rose faster, at the rate of 13.3%
per annum, than the overall trade of the region, which grew at the rate of 10.5% per annum
(Table 4). The relatively higher growth rate of intraregional trade compared to the region’s
total external trade has been attributed to the rise in intraimports which grew at the rate of
15.4% during this period, compared to 10.6% for overall imports. This resulted in the
increase of the share of intraimports from 2.6% in 1991 to 3.3% in 1997 of the region’s
overall imports. Whereas the region’s overall exports rose by 10.3%, its intraexports rose by
11.3%. As a result, intraregional exports, as percentage of the region’s total exports,
increased from 3.6% in 1991 to 3.8% in 1997.
This low level of intratrade is essentially because of the relatively low level of industri-
alization of the member countries. As these economies develop and industrialize, trade
among them will perhaps increase automatically. However, such a process will take a long
time. Integration of the markets of South Asian countries will provide a better basis for
industrialization and lead to a more rapid expansion of trade and other linkages among
themselves. The process of industrialization and trade expansion would perhaps be slower in
the absence of such a mechanism.
The low volume of intraregional trade can be partly explained in terms of the traditional
theory of comparative advantage based on factor proportions. This theory predicts that the
volume of trade is positively correlated to the intercountry differences in relative factor
endowments. The intuition behind this theory is that countries with different relative factor
Table 5
Percentage and annual growth rate of Intra-regional trade among the SAARC countries
Country Year Share in Annual growth Share in Annual growth
intra-export rate between intra-import between
(%) 1991–1997 (%) 1991–1997
Bangladesh 1991 7.9 28.0
1997 4.5 1.2 41.9 23.4
India 1991 61.5 10.6
1997 72.5 14.5 8.2 10.6
Maldives 1991 1.0 2.6
1997 0.8 7.0 1.7 7.7
Nepal 1991 2.1 11.1
1997 4.2 25.2 7.9 9.1
Pakistan 1991 21.5 13.3
1997 11.8 0.7 10.8 11.4
Sri Lanka 1991 6.0 34.4
1997 6.2 11.9 29.4 12.4
Region 1991 100.0 100.0
1997 100.0 11.3 100.0 15.4
Source: International Monetary Fund (IMF), The Direction of Trade Statistics, 1998.
endowments will have different autarky production trade-offs and, let alone, markets will
take advantage of these trade-offs, creating gains from specialization and exchange. In its
traditional form, Heckscher–Ohlin trade theory focuses on differences in relative factor
endowments of human capital and natural resources. However, in all its forms, the theory
assumes constant returns to scale and free access to technological knowledge.
Table 5 sheds light on the relative importance of individual SAARC countries in the
region’s intratrade. Nearly three fourths of South Asia’s intraregional exports originate in
India. In 1991, India accounted for 61% of the region’s intraregional exports. Growing at an
annual average rate of 14.5%, this share went up to 72% in 1997. Pakistan’s share in the
region’s intraregional exports in 1991 was 21.5%, but it fell to 11.8% in 1997. The share of
Bangladesh in the region’s intra-export fell from 7.9% to 4.5%, that of Nepal increased from
2.1% to 4.2%, whereas that of Sri Lanka remained unchanged at about 6%. As regards
intraregional imports, Bangladesh and Sri Lanka occupy the first and the second position,
respectively, and their imports from the region have risen at annual rates of 23.4% and
12.4%, respectively. In 1997, Bangladesh accounted for 42%, and Sri Lanka for 29% of the
region’s intra-imports. Note that the percentage share of all individual SAARC countries,
other than Bangladesh, declined during this period.
In the area of exports, for a number of commodities SAARC member countries compete
intensely with one another in the international market. Bangladesh and India compete in the
markets of U.S. and EC in exporting such goods as jute and jute goods, while all the major
SAARC countries compete with each other in the export of ready-made garments in the
markets of the developed countries. In the case of textile exports, the competition is tough
between India and Pakistan, whereas Pakistan, Bangladesh, and India compete with each
other in exports of leather and frozen fish. India and Sri Lanka are major competitors in the
Table 6
Number of products on which tariff concessions negotiated in three SAPTA trade negotiations
Country First round Second round Third round
Total no. For LDCs Total no. For LDCs Total no. For LDCs only
of products only of products only of products (agreed bilaterally)
Bangladesh 12 1 226 11 69 32
Bhutan 11 7 47 10 145 10
India 106 62 911 514 373 144
Maldives 17 00 5 3 368 00
Nepal 14 4 195 4 75 48
Pakistan 35 15 363 131 80 58
Sri Lanka 31 11 95 23 82 54
Total 226 100 1842 696 1192 246
Source: National Schedules of Concessions of SAARC Member Countries.
markets for processed gems, diamonds, and jewelry. The competition among most of the
SAARC countries for textiles and apparels markets, especially in the U.S., is expected to
increase with the phasing out of the Multifiber agreement.
The mechanism of negotiation for exchange of concessions has been to exchange
request and offer-lists of products by member states specifying products of export
interest on which concessions will be sought and offered. The first round of trade
negotiations commenced in the last quarter of 1993 and was completed in April 1995.
Concessions negotiated in the first round covered 226 products (Table 6). Offers were
exchanged on tariff preferences only, even though the member states had earlier agreed
to negotiate on exchange of concessions on para-tariff and nontariff measures as well.
The second round of negotiations began in March 1996 and was concluded in November
1997. In that round, concessions were offered on 1842 products. A welcome develop-
ment in the second round was that agreement was reached to relax nontariff barriers
(NTBs) on products for which tariff concessions were exchanged. The third round of
negotiations, which followed the same pattern as the second, was concluded in Novem-
ber 1998. Concessions were exchanged on 1192 products in that round. These included
both bilateral concessions and concessions for the region as a whole.
The three rounds of trade negotiations conducted under SAPTA so far have produced
very modest result. The reason is that a large number of products on which concessions
were exchanged are hardly traded in the region. It is also said that the offers exchanged
in the second and the third rounds on both tariffs and NTBs have not actually been
implemented.
3.2. Regional economic cooperation and its effects
The basic economic theory of preferential trade agreements (PTAs) stresses that they will
have a number of effects, such as TC and TD. TC occurs when preferential tariff cuts cause
a partner nation to start importing from its other partners rather than producing the goods
itself, due to the fall in relative price of the imported good through tariff removal, regardless
of its preferential nature. TD occurs when a partner country starts importing a good from its
other partners rather than from nonpartner countries, due to the fall in the price of the
partner-sourced import good relative to the nonpartner-sourced import good, caused by the
preferential nature of the tariff cut. Because the PTA involves some trade liberalization, there
is a potential welfare gain to the member country in the standard economic model (due to
TC), but because the PTA involves a new distortion in the market due to the preferential or
discriminatory nature of the tariff cut. There is also a potential welfare loss (due to TD). The
potential overall welfare effect is ambiguous.
The notions of TC and TD involve the use of static, partial equilibrium market models.
PTAs are also thought by economists to potentially have general equilibrium (GE) and
dynamic effects. GE effects include terms of trade, wage rate, and other factor return
changes. Dynamic effects include economies of scale, growth, and innovation. One growth
effect is the impact of PTA-induced changes in trade balances in the partner nations on their
macroeconomic equilibrium. If all partner nations were to improve their trade balances
through the combined effects of TC and TD, then this would be a macroeconomic shock that
would impact their output growth. Any change in output growth would in turn impact import
demand, not just from partner countries but also from nonpartner exporters. This might be
considered a trade growth effect distinct from TC and TD. Some economic modelers would
go further and argue that higher output growth may lead to dynamic gains through higher
investment and innovation levels. Empirical estimates of the growth effects of PTAs vary
widely, due to the varying assumptions and arguments built into the estimating models, but
effects are usually found to be positive, except where negative terms of trade effects reduce
welfare and spending in a member country.
Regional economic cooperation or integration may take one of various forms. These forms
are usually classified into four groups: i) an FTA, where member countries remove all trade
barriers among themselves but retain their individual commercial policies toward the outside
world; ii) a customs union, which is similar to a FTA except that the member counties adopt
common external commercial policies; iii) a common market that is a customs union that also
allows for free factor mobility within the market; iv) an economic union, which is a common
market that seeks to achieve a complete unification of monetary and fiscal policies. In
addition, there is a monetary union that lies in between a common market and an economic
union (Huang and Tu, 1994).
The effects of regional economic cooperation, typically taking the form of a customs
union, include the following static effects: i) TC effects, deriving from both production and
consumption gains; ii) TD effects, derived by replacing cheaper imports with those of the
member countries, as a result of tariff discrimination; iii) improved international bargaining
power due to the larger economic size; iv) decreased administrative expenditures among the
member counties; v) less smuggling among the member countries. There are also the
following dynamic effects: a) higher production efficiency brought about by enhanced
competition and thus specialization and resource relocation; b) decreased average production
costs due to economies of scale in larger markets; c) higher international investment,
resulting from an increase in investment opportunities and lower uncertainty and risks; and
d) enhanced technological change resulting from increased competition. All these factors
lead to faster economic growth.
Except for the TD effect, all the effects support the notion of regional economic coop-
eration. However, the countries may also be constrained by some other economic factors,
such as: i) a government’s reliance on tariff revenue may discourage it from joining in this
kind of arrangement; ii) a large trade deficit depresses the will of a government to risk a
possibly deteriorating trade balance, resulting from tariff reduction or abolishment; iii) the
worry that unequal tariff, or imperialistic opportunities may be further exploited by some
powerful member country discourages other members from joining; iv) the decreased trade
policy independence may concern some developing countries that would like to pursue an
independent development policy.
The economic arguments of TC and TD depend, among other things, on the assumption
that prices reflect the social cost of production. However, in the context of the LDCs there
are several reasons for this not to be true. First, wage rates may not measure the social cost
of labor on account of unemployment and urban wage rigidities. Second, the shadow price
of foreign exchange may be different from its market price on account of foreign-exchange
constraint. Under these circumstances, import substitution may be rational in the absence of
regional integration. The merit of integration, however, lies essentially in the fact that there
are economies of scale a block can realize in the production of a commodity in a certain
industry in a partner country of the block.
3.3. Methodology and data
The gravity model offers a systematic framework for measuring the normal pattern of
trade. International trade flows are determined by comparative advantage, the possibility of
intraindustry trade, transport costs, and so forth. Trade policy may revise the normal trade
flows. The gravity model of international trade estimates the trade flow as a function of
variables that directly or indirectly affect the determinants of normal trade flow. We can use
it to examine whether a lower magnitude of intra-SAARC trade is a normal outcome. The
gravity model has long been used for empirical studies of the pattern of trade. Specifically,
the volume of trade between two countries should increase with their real GDPs (the
so-called gravity variable), since large countries should trade more than small ones, and with
per capita incomes, since rich countries should trade more than poor ones. It should diminish
with geographical distance because proximity reduces transportation and information costs.
Because the dependent variable in the gravity model is bilateral trade between pairs of
countries, each variable (other than distance) is entered in product form. Researchers then
add dummy variables for participation in various preferential arrangements. If one finds a
positive coefficient on the dummy variable indicating that two countries, both of which
participate in the same preferential arrangement, trade more with one another than predicted
by their incomes and distance, then the conclusion drawn is that the arrangement is trade
creating for its members. If there is a negative coefficient on the dummy variable indicating
that only one member of the pair participates in a particular preferential arrangement, this is
taken as evidence of TD vis-a-vis the rest of the world. (Eichengreen and Irwin, 1996;
Frankel et al., 1994).
Results obtained using this approach can be questioned on several grounds. One is that the
coefficients on dummy variables for subgroups of countries will pick up all respects in
which those countries differ in their trade performance that are not controlled for in the
gravity equation. To take an example pursued by Frankel and Wei (1995), if all the
countries in a region share a common language, then including a dummy variable for that
region but not a measure of language will tend to spuriously attribute the effects of the
shared language in encouraging economic links to commercial policy measures. More
generally, dummy variables for preferential arrangements serve as a catch basin for
omitted factors.
Related to this is the difficulty of measuring economic distance independent of the trade
flows that the investigator seeks to explain. The underlying theory appeals to transaction
costs of trade, and in empirical implementation it is posited that such costs should rise with
distance. But economic and geographic distances are not the same. Insofar as economic
distance is mismeasured, its effects may be loaded into the dummy variables intended to
capture the effects of regionalism. A further problem with the gravity model is the omission
of third-country effects. It is generally assumed that bilateral trade depends only on economic
conditions in the two countries considered. In practice, however, bilateral trade will also
depend upon competitiveness relative to other countries and markets. More generally, insofar
as economic variables in third countries affect trade flows between other country pairs,
gravity equations suffer from omitted-variables bias.
A final problem arises from the practice of pooling data for industrial and developing
countries. While this maximizes degrees of freedom, the relationship between trade and
economic characteristics may vary between the two groups of countries. The income
elasticity of trade may be different at high and low levels of income or for different types
of goods, for example. Transaction costs may have very different structures in countries
with more and less articulated markets. Results based on heterogeneous cross-sections
may therefore suffer from subsample instability and heteroskedasticity.
The typical gravity model specification relates bilateral trade to income, population (or per
capita income), distance, and congruity between the trading partners:
log共TRADEijt) ⫽ a ⫹ B1 log(GDPitGDPjt) ⫹ B2 log(PCIitPCIjt)

⫹ B3 log(DISTANCEij) ⫹ B4 (BORDERij) (1)
where TRADEijt is bilateral trade between countries i and j at time t (measured in U.S.
dollars), GDP is real gross domestic product (the so-called gravity variable), PCI is per capita
income, DISTANCE is distance between two countries, and BORDER is dummy variable
that takes a value of 1 if two countries have common border and 0 otherwise. As trade is
expected to increase with the size of the domestic economy (GDP), per capita income (PCI)
and common border (BORDER), and to decrease with distance (DISTANCE). B1, B2, and
B4 should be positive, and B3 negative.
Annual data on bilateral trade flows among SAARC countries has been collected from
IMF’s Direction of Trade Statistics. The UNCTAD and the United Nations COMTRADE
database have also been used to compare import and export trade flows of SAARC countries.
3.4. Analysis of empirical results
A more systematic way of adjusting for the natural determinants of trade is by means of
the gravity model. The assumptions of the model are that trade between two countries is
proportionate to the product of their GNPs and the product of their per capita GNPs. An
increasing function of adjacency (when two countries share a common land border), and
inversely related to the distance between them. Dummy variables are added when both
countries in a given pair belong to the same regional grouping. This provides a means of
determining how much trade within each region is due to factors common to trade throughout
the world and how much remains to be explained by regional effects.
Multicollinearity is possible if the correlation between two variables is very high. Pairwise
correlation between two variables varies from ⫺0.03 to 0.60 in our sample. High multicol-
linearity increases variances of OLS estimator and lowers the significance levels of esti-
mates. This may also lead to the scenario where the sample data may be compatible with a
diverse set of hypotheses, thus increasing type II errors (the probability of accepting a false
hypothesis). However, both Gujrati (1988), and Judge et al. (1988) consider 0.8 to be the
critical threshold for serious problems with multicollinearity. In OLS results, we have found
that Durbin–Watson (DW) statistics are low (less than 2), indicating existence of autocor-
related errors in the sample. In the presence of autocorrelations, the OLS estimators are no
longer efficient (minimum variance), although they are unbiased and inconsistent. Therefore,
the autocorrelated errors must be adjusted in the estimation.
We have estimated gravity models for years 1996 and 1997 with GLS method that corrects
for both heteroskedasticity and autocorrleation. Both years provide qualitatively the same
results. For the sake of brevity, we present only the 1997 results. Tables 7–9 present results
for 1996. Tables 10 –12 present results for 1997.
Table 10 provides the descriptive statistics of all explanatory variables and regional blocks
used in this study for the year 1997. We use regional block variables in our analysis in three
ways. First, we use seven regional blocks of countries—SAARC1, SAARC2, ASEAN1,
ASEAN2, NAFTA, EEC1, and EEC2—with which Bangladesh has regular and significant
trade. SAARC1 block consists of Bangladesh, India, Nepal, and Bhutan, whereas SAARC2
block consists of all seven members (the remaining members are Pakistan, Sri Lanka, and
Maldives). ASEAN1 consists of Indonesia, Malaysia, Philippines, Thailand, Singapore, and
Laos, whereas ASEAN2 consists of ASEAN1 countries plus Korea, Japan, and China.
NAFTA block consists of U.S. and Canada. EEC1 consists of Germany, Italy, UK, Neth-
erlands, Spain, Belgium, France, and Denmark, whereas EEC2 consists of EEC1 plus Brazil.
Second, we form hypothetical trading blocks among Bangladesh and ASEAN1, ASEAN2,
NAFTA, EEC1, and EEC2 countries to examine the likely effects of such grouping if they
were to materialize. Third, we add a term for each grouping in order to capture TD effects.
These terms are indicated by a suffix “N,” standing for trade with nonmembers of the
grouping in question. Table 11 presents the correlation matrix of variables and all trade
blocks for the year 1997.
We present the regression results for the year 1997 in Table 12. To check the robustness
of our results, we perform three regression runs: first, with the existing and hypothesized
Table 7
Descriptive statistics for 1996
Series Obs Mean STD Minimum Maximum
LOGTRADE 351 6.091 3.287 0.000 12.603
LOCGDP 351 35.291 5.256 17.552 44.943
LOGPCI 351 ⫺0.677 5.898 ⫺25.677 8.885
LOGDISTANCE 351 8.081 0.946 5.037 9.360
BORDER 351 0.100 0.300 0.000 1.000
SAARC1 351 0.017 0.130 0.000 1.000
SAARC1N 351 0.262 0.440 0.000 1.000
SAARC2 351 0.051 0.221 0.000 1.000
SAARC2N 351 0.407 0.492 0.000 1.000
ASEAN1 351 0.043 0.203 0.000 1.000
ASEAN1N 351 0.359 0.480 0.000 1.000
ASEAN2 351 0.103 0.304 0.000 1.000
ASEAN2N 351 0.442 0.497 0.000 1.000
NAFTA 351 0.003 0.053 0.000 1.000
NAFTAN 351 0.142 0.350 0.000 1.000
EEC1 351 0.080 0.271 0.000 1.000
EEC1N 351 0.433 0.496 0.000 1.000
EEC2 351 0.103 0.304 0.000 1.000
EEC2N 351 0.462 0.499 0.000 1.000
BANASPAN1 351 0.060 0.238 0.000 1.000
BANASEAN1N 351 0.399 0.490 0.000 1.000
BANASEAN2 351 0.128 0.335 0.000 1.000
BANASEAN2N 351 0.467 0.500 0.000 1.000
BANNAFTA 351 0.009 0.092 0.000 1.000
BANNAFTAN 351 0.205 0.404 0.000 1.000
BANEEC1 351 0.103 0.304 0.000 1.000
BANEEC1N 351 0.462 0.499 0.000 1.000
BANEEC2 351 0.128 0.335 0.000 1.000
BANEEC2N 351 0.484 0.500 0.000 1.000
Source of Data: IMF, Direction of Trade Statistics.
trading block countries; second, with existing trading block countries; finally, with the
hypothesized trading block countries.
We have 27 countries in our data set, so that there are 351 data points [⫽(27*26)/2] for
a given year. We find all three standard gravity variables (GDP, GDP per capita and distance)
to be highly significant statistically at the 1% level of significance. Although the BORDER
variable retains its sign, it is not statistically significant. All variables except GDP PER
CAPITA have their expected signs. The unexpected negative sign for GDP per capita
variable suggests that as the GDP per capita of a country improves, it trades less with its
block member. Though this result may be plausible with the members of SAARC countries
because most of them have similar per capita income, it is not clear why it may be so with
other trading partners.
The dependent variable in all regressions is the value of trade (imports plus exports), in
log form, between pairs of countries. The estimated coefficient on the log of the product of
the two countries’ GDPs at about 0.336 indicates that trade increases with size but less than
280
Table 8
Correlation matrix for 1996
LOG LOG LOG LOG BOR SAA SAA SAA SAA ASE ASE ASE ASE NAF NAF EEC EEC EEC EEC BAN BAN BAN BAN BAN BAN BAN BAN BAN BAN
TRA GDP PCI DIST DER RC1 RC1 RC2 RC2 AN1 AN1 AN2 AN2 TA TAN 1 1N 2 2N ASE ASE ASE ASE NAF NAF EEC EEC EEC EEC
DE ANC N N N N AN1 AN1 AN2 AN2 TA TAN 1 1N 2 2N
E N N
LOGTRADE 1.00
LOGGDP 0.39 1.00
LOGPCI 0.12 0.60 1.00
LOGDISTANCE 0.01 0.20 0.16 1.00
BORDER 0.20 0.02 ⫺0.08 ⫺0.58 1.00
SAARC1 ⫺0.11 ⫺0.07 ⫺0.15 ⫺0.28 0.25 1.00
SAARC1N ⫺0.48 ⫺0.14 ⫺0.38 ⫺0.06 ⫺0.11 ⫺0.08 1.00
SAARC2 ⫺0.20 ⫺0.13 ⫺0.21 ⫺0.35 0.27 0.57 0.13 1.00
SAARC2N ⫺0.49 ⫺0.20 ⫺0.24 0.06 ⫺0.24 ⫺0.11 0.60 ⫺0.19 1.00
ASEAN1 ⫺0.01 0.02 0.08 ⫺0.32 0.26 ⫺0.03 ⫺0.13 ⫺0.05 ⫺0.18 1.00
ASEAN1N ⫺0.09 0.03 0.11 0.13 ⫺0.21 ⫺0.10 ⫺0.12 ⫺0.17 ⫺0.11 ⫺0.16 1.00
ASEAN2 0.12 0.16 0.17 ⫺0.31 0.26 ⫺0.04 ⫺0.20 ⫺0.08 ⫺0.28 0.63 0.10 1.00
ASEAN2N ⫺0.02 0.10 0.12 0.34 ⫺0.30 ⫺0.12 ⫺0.11 ⫺0.21 ⫺0.08 ⫺0.19 0.63 ⫺0.30 1.00
NAFTA 0.11 0.08 0.06 ⫺0.11 0.16 ⫺0.01 ⫺0.03 ⫺0.01 ⫺0.04 ⫺0.01 ⫺0.04 ⫺0.02 ⫺0.05 1.00
NAFTAN 0.18 0.27 0.22 0.36 ⫺0.14 ⫺0.05 ⫺0.09 ⫺0.09 ⫺0.11 ⫺0.09 ⫺0.10 ⫺0.14 ⫺0.07 ⫺0.02 1.00
EEC1 0.35 ⫺0.13 ⫺0.04 ⫺0.51 0.32 ⫺0.04 ⫺0.18 ⫺0.07 ⫺0.24 ⫺0.06 ⫺0.22 ⫺0.10 ⫺0.26 ⫺0.02 ⫺0.12 1.00
EEC1N 0.06 ⫺0.12 ⫺0.05 0.52 ⫺0.29 ⫺0.12 ⫺0.10 ⫺0.20 ⫺0.07 ⫺0.18 ⫺0.08 ⫺0.30 0.06 ⫺0.05 ⫺0.08 ⫺0.26 1.00
EEC2 0.33 ⫺0.10 ⫺0.01 ⫺0.40 0.26 ⫺0.04 ⫺0.20 ⫺0.08 ⫺0.28 ⫺0.07 ⫺0.25 ⫺0.11 ⫺0.30 ⫺0.02 ⫺0.14 0.87 ⫺0.14 1.00
EEC2N 0.02 ⫺0.07 ⫺0.03 0.58 ⫺0.31 ⫺0.12 ⫺0.08 ⫺0.22 ⫺0.03 ⫺0.20 ⫺0.05 ⫺0.31 0.11 ⫺0.05 ⫺0.07 ⫺0.27 0.85 ⫺0.31 1.00
BANASEAN1 ⫺0.06 0.02 0.07 ⫺0.34 0.20 ⫺0.03 0.01 ⫺0.06 ⫺0.06 0.84 ⫺0.04 0.51 ⫺0.08 ⫺0.01 ⫺0.10 ⫺0.07 ⫺0.22 ⫺0.09 ⫺0.23 1.00
BANASEANIN ⫺0.10 0.02 0.09 0.15 ⫺0.21 0.03 ⫺0.02 ⫺0.03 ⫺0.08 ⫺0.17 0.85 0.07 0.49 ⫺0.04 ⫺0.10 ⫺0.24 ⫺0.05 ⫺0.28 ⫺0.02 ⫺0.21 1.00
BANASEAN2 0.08 0.16 0.16 ⫺0.34 0.21 ⫺0.05 ⫺0.05 ⫺0.09 ⫺0.16 0.55 0.14 0.88 ⫺0.20 ⫺0.02 ⫺0.16 ⫺0.11 ⫺0.34 ⫺0.13 ⫺0.36 0.66 0.05 1.00
BANASEAN2N ⫺0.04 0.08 0.10 0.36 ⫺0.29 0.01 ⫺0.06 ⫺0.06 ⫺0.09 0.20 0.51 ⫺0.32 0.86 ⫺0.05 ⫺0.05 ⫺0.28 0.10 ⫺0.32 0.16 ⫺0.24 0.62 ⫺0.36 1.00
BANNAFTA 0.06 0.09 0.06 0.01 0.07 ⫺0.01 0.09 ⫺0.02 0.05 ⫺0.02 ⫺0.07 ⫺0.03 ⫺0.08 0.58 0.14 ⫺0.03 ⫺0.08 ⫺0.03 ⫺0.09 ⫺0.02 0.05 ⫺0.04 0.04 1.00
BANNAFTAN 0.07 0.20 0.16 0.21 ⫺0.15 0.10 0.13 0.07 0.01 ⫺0.11 ⫺0.12 ⫺0.17 ⫺0.08 ⫺0.03 0.76 ⫺0.15 ⫺0.09 ⫺0.17 ⫺0.07 0.05 0.02 0.00 ⫺0.01 ⫺0.05 1.00
BANEEC1 0.29 ⫺0.14 ⫺0.05 ⫺0.42 0.26 ⫺0.04 ⫺0.03 ⫺0.08 ⫺0.13 ⫺0.07 ⫺0.25 ⫺0.11 ⫺0.30 ⫺0.02 ⫺0.14 0.87 ⫺0.14 0.75 ⫺0.16 ⫺0.09 ⫺0.12 ⫺0.13 ⫺0.17 ⫺0.03 0.01 1.00
BANEEC1N 0.02 ⫺0.10 ⫺0.04 0.42 ⫺0.29 0.01 ⫺0.04 ⫺0.06 ⫺0.07 ⫺0.20 ⫺0.05 ⫺0.31 0.10 ⫺0.05 ⫺0.07 ⫺0.27 0.85 ⫺0.16 0.71 ⫺0.09 ⫺0.05 ⫺0.20 0.06 0.04 0.00 ⫺0.31 1.00
BANEEC2 0.28 ⫺0.10 ⫺0.02 ⫺0.32 0.21 ⫺0.05 ⫺0.05 ⫺0.09 ⫺0.16 ⫺0.08 ⫺0.29 ⫺0.13 ⫺0.34 ⫺0.02 ⫺0.16 0.77 ⫺0.06 0.88 ⫺0.20 ⫺0.10 ⫺0.16 ⫺0.15 ⫺0.21 ⫺0.04 0.00 0.88 ⫺0.20 1.00
BANEEC2N ⫺0.02 ⫺0.05 ⫺0.02 0.47 ⫺0.30 0.00 ⫺0.05 ⫺0.07 ⫺0.05 ⫺0.20 ⫺0.01 ⫺0.33 0.16 ⫺0.05 ⫺0.05 ⫺0.29 0.72 ⫺0.33 0.85 ⫺0.10 ⫺0.03 ⫺0.22 0.11 0.03 ⫺0.01 ⫺0.33 0.85 ⫺0.37 1.00
Table 9
Regression results for 1996 (corrected for autocorrelation and heteroskedasticity)
Variable Coefficient T-statistics Coefficient T-statistics Coefficient T-statistics
Constant ⫺4.499*** ⫺1.611 ⫺3.922 ⫺1.395 ⫺6.031** ⫺2.212
LOGGDP 0.336* 11.272 0.311* 9.820 0.229* 5.253
LOGPIC ⫺0.271* ⫺9.535 ⫺0.237* ⫺7.799 ⫺0.149* ⫺3.387
LOGDISTANCE ⫺0.201 ⫺0.719 ⫺0.184 ⫺0.654 0.149 0.515
BORDER 0.598 1.270 0.517 1.129 0.889** 1.906
SAARC1 ⫺5.008* ⫺4.242 ⫺4.391* ⫺3.619
SAARC1N ⫺3.686* ⫺8.380 ⫺2.851 ⫺6.198
SAARC2 ⫺1.850 ⫺1.289 ⫺1.822 ⫺1.290
SAARC2N ⫺1.255*** ⫺1.694 ⫺1.271*** ⫺1.700
ASEAN1 ⫺5.454 ⫺1.101 ⫺3.276* ⫺3.764
ASEAN1N ⫺3.098 ⫺1.178 ⫺1.310* ⫺3.089
ASEAN2 0.263 0.065 1.929 1.477
ASEAN2N 0.814 0.368 0.883 1.305
NAFTA 2.927 0.962 3.889*** 1.750
NAFTAN 1.106*** 1.616 1.054*** 1.563
EEC1 4.713** 1.975 4.209* 3.809
EEC1N 1.691* 3.460 1.554* 3.255
EEC2 ⫺2.658 ⫺0.931 ⫺0.938 ⫺0.629
EEC2N ⫺0.947 ⫺1.202 ⫺0.781 ⫺1.007
BANASEAN1 2.429 0.494 ⫺3.919* ⫺3.909
BANASEAN1N 1.949 0.737 ⫺1.647* ⫺2.649
BANASEAN2 1.482 0.351 3.499* 3.808
BANASEAN2N ⫺0.043 ⫺0.019 1.759* 2.694
BANNAFTA 0.916 0.458 3.587* 2.597
BANNAFTAN 0.000 0.000 0.698 1.363
BANEEC1 ⫺0.292 ⫺0.145 4.126* 3.802
BANEEC1N 0.000 0.000 1.415* 2.754
BANEEC2 1.394 0.595 0.919 0.779
BANEEC2N 0.000 0.000 ⫺0.457 ⫺0.724
R-square 0.674 0.663 0.582
DW 2.068 2.132 2.414
*, **, and *** indicate significance levels at 1%, 5%, and 10% respectively.
proportionately. This reflects the fact that small countries tend to be more dependent on trade
than larger, more diversified ones. The estimated coefficient on the product of per capita
GDPs is about ⫺0.244, indicating that poorer countries trade less with each other. The
coefficient on the log of distance is about ⫺0.546 indicating that when distance between two
nonadjacent countries is higher by 1%, trade between them falls by 0.55%. The coefficient
on adjacency, at 0.717, indicates that two countries sharing a common border trade roughly
2.048 times as much [exp(0.717) ⫽ 2.048] as two otherwise similar countries.
If there were nothing to the notion of trade blocks, these basic variables would soak up
most of the variation in bilateral trade flows, leaving little to attribute to a dummy variable
indicating whether two countries are members of the same regional grouping. Variations in
intraregional trade would be due solely to the proximity of countries and their rates of
economic growth. In fact, the dummy variables for membership in the same regional
grouping SAARC are statistically significant. The SAARC1 and SAARC2 dummy variables
are statistically significant and negative, indicating the preferential trading agreements
Table 10
Descriptive statistics for 1997
Series Obs Mean STD Minimum Maximum
LOGTRADE 351 5.580 3.830 0.000 12.681
LOGGDP 351 35.293 5.256 17.553 44.944
LOGPCI 351 ⫺0.675 5.899 ⫺25.676 8.885
LOGDISTANCE 351 8.081 0.946 5.037 9.360
BORDER 351 0.100 0.300 0.000 1.000
SAARC1 351 0.017 0.130 0.000 1.000
SAARC1N 351 0.262 0.440 0.000 1.000
SAARC2 351 0.051 0.221 0.000 1.000
SAARC2N 351 0.407 0.492 0.000 1.000
ASEAN1 351 0.043 0.203 0.000 1.000
ASEAN1N 351 0.359 0.480 0.000 1.000
ASEAN2 351 0.103 0.304 0.000 1.000
ASEAN2N 351 0.442 0.497 0.000 1.000
NAFTA 351 0.003 0.053 0.000 1.000
NAFTAN 351 0.142 0.350 0.000 1.000
EEC1 351 0.080 0.271 0.000 1.000
EEC1N 351 0.433 0.496 0.000 1.000
EEC2 351 0.103 0.304 0.000 1.000
EEC2N 351 0.462 0.499 0.000 1.000
BANASEAN1 351 0.060 0.238 0.000 1.000
BANASEAN1N 351 0.399 0.490 0.000 1.000
BANASEAN2 351 0.128 0.335 0.000 1.000
BANASEAN2N 351 0.467 0.500 0.000 1.000
BANNAFTA 351 0.009 0.092 0.000 1.000
BANNAFTAN 351 0.205 0.404 0.000 1.000
BANEEC1 351 0.103 0.304 0.000 1.000
BANEEC1N 351 0.462 0.499 0.000 1.000
BANEEC2 351 0.128 0.335 0.000 1.000
BANEEC2N 351 0.484 0.500 0.000 1.000
among these countries did reduce TC among the member states. If two countries are
SAARC1, for example, they would trade 98% less among themselves than two otherwise-
similar countries would [exp(⫺4.059) ⫽ 0.02]. Not only that the grouping among SAARC1
block (Bangladesh, India, Nepal, and Bhutan) indicate significant TD effect: members of
SAARC1 trade 82% less with nonmembers than do typical countries in our sample
[exp(⫺1.749) ⫽ 0.18]. Similar results prevail for SAARC2 countries. Therefore, SAARC
member countries not only reduce trade among themselves, but they also reduce trade with
nonmember countries. Although SAARC was formed as a regional cooperation organization,
it is yet to achieve the benefits of trade among themselves.
The estimated coefficients of ASEAN2, NAFTA, EEC1, and EEC2 dummy variables are
not statistically significant. However, both ASEAN1 and ASEAN1N are statistically signif-
icant and negative, suggesting that formation of economic blocks with these existing blocks
will neither create trade nor increase trade with nonmember countries. If two countries were
members of the ASEAN1, they would trade 99% less [exp(⫺5.243) ⫽ 0.01] in 1997, as
would two otherwise similar member countries. Members of ASEAN1 would trade 81% less
with nonmembers than would typical countries in our sample [exp(⫺1.665) ⫽ 0.19].
Table 11
Correlation matrix for 1997
LOG LOG LOG LOG BOR SAA SAA SAA SAA ASE ASE ASE ASE NAF NAF EEC EEC EEC EEC BAN BAN BAN BAN BAN BAN BAN BAN BAN BAN
TRA GDP PCI DIST DER RC1 RC1 RC2 RC2 AN1 AN1 AN2 AN2 TA TAN 1 1N 2 2N ASE ASE ASE ASE NAF NAF EEC EEC ECC EEC
DE ANC N N N N AN1 AN1 AN2 AN2 TA TAN 1 1N 2 2N
E N N
LOGTRADE 1.00
LOGGDP 0.44 1.00
LOGPCI 0.13 0.60 1.00
LOGDSTANCE 0.01 0.20 0.16 1.00
BORDER 0.19 0.02 ⫺0.08 ⫺0.58 1.00
SAARC1 ⫺0.11 ⫺0.07 0.15 0.28 0.25 1.00
SAARC1N ⫺0.42 ⫺0.14 ⫺0.38 ⫺0.06 ⫺0.11 ⫺0.08 1.00
SAARC2 ⫺0.20 ⫺0.13 ⫺0.21 ⫺0.35 0.27 0.57 0.13 1.00
SAARC2N ⫺0.53 ⫺0.20 ⫺0.24 0.06 ⫺0.24 ⫺0.11 0.60 ⫺0.19 1.00
ASEAN1 ⫺0.01 0.02 0.08 ⫺0.32 0.26 ⫺0.03 ⫺0.13 ⫺0.05 ⫺0.18 1.00
ASEAN1N ⫺0.07 0.03 0.11 0.13 ⫺0.21 ⫺0.10 ⫺0.12 ⫺0.17 ⫺0.11 ⫺0.16 1.00
ASEAN2 0.12 0.16 0.17 ⫺0.31 0.26 ⫺0.04 ⫺0.20 ⫺0.08 ⫺0.28 0.63 0.10 1.00
ASEAN2N ⫺0.01 0.10 0.12 0.34 ⫺0.30 ⫺0.12 ⫺0.11 ⫺0.21 ⫺0.08 ⫺0.19 0.63 ⫺0.30 1.00
NAFTA 0.10 0.08 0.06 ⫺0.11 0.16 ⫺0.01 ⫺0.03 ⫺0.01 ⫺0.04 ⫺0.01 ⫺0.04 ⫺0.02 ⫺0.05 1.00
NAFTAN 0.18 0.27 0.22 0.36 ⫺0.14 ⫺0.05 ⫺0.09 ⫺0.09 ⫺0.11 ⫺0.09 ⫺0.10 ⫺0.14 ⫺0.07 ⫺0.02 1.00
EEC1 0.34 ⫺0.13 ⫺0.04 ⫺0.51 0.32 ⫺0.04 ⫺0.18 ⫺0.07 ⫺0.24 ⫺0.06 ⫺0.22 ⫺0.10 ⫺0.26 ⫺0.02 ⫺0.12 1.00
EEC1N 0.08 ⫺0.12 ⫺0.05 0.52 ⫺0.29 ⫺0.12 ⫺0.10 ⫺0.20 ⫺0.07 ⫺0.18 ⫺0.08 ⫺0.30 0.06 ⫺0.05 ⫺0.08 ⫺0.26 1.00
EEC2 0.35 ⫺0.10 ⫺0.01 ⫺0.40 0.26 ⫺0.04 ⫺0.20 ⫺0.08 ⫺0.28 ⫺0.07 ⫺0.25 ⫺0.11 ⫺0.30 ⫺0.02 ⫺0.14 0.87 ⫺0.14 1.00
EEC2N 0.04 ⫺0.07 ⫺0.03 0.58 ⫺0.31 ⫺0.12 ⫺0.08 ⫺0.22 ⫺0.03 ⫺0.20 ⫺0.05 ⫺0.31 0.11 ⫺0.05 ⫺0.07 ⫺0.27 0.85 ⫺0.31 1.00
BANASEAN1 ⫺0.04 0.02 0.07 ⫺0.34 0.20 ⫺0.03 0.01 ⫺0.06 ⫺0.06 0.84 ⫺0.04 0.51 ⫺0.08 ⫺0.01 ⫺0.10 ⫺0.07 ⫺0.22 ⫺0.09 ⫺0.23 1.00
BANASEAN1N ⫺0.08 0.02 0.09 0.15 ⫺0.21 0.03 ⫺0.02 ⫺0.03 ⫺0.08 ⫺0.17 0.85 0.07 0.49 ⫺0.04 ⫺0.10 ⫺0.24 ⫺0.05 ⫺0.28 ⫺0.02 ⫺0.21 1.00
BANASEAN2 0.09 0.16 0.16 ⫺0.34 0.21 ⫺0.05 ⫺0.05 ⫺0.09 ⫺0.16 0.55 0.14 0.88 ⫺0.20 ⫺0.02 ⫺0.16 ⫺0.11 ⫺0.34 ⫺0.13 ⫺0.36 0.66 0.05 1.00
BANASEAN2N ⫺0.02 0.08 0.10 0.36 ⫺0.29 0.01 ⫺0.06 ⫺0.06 ⫺0.09 ⫺0.20 0.51 ⫺0.32 0.86 ⫺0.05 ⫺0.05 ⫺0.28 0.10 ⫺0.32 0.16 ⫺0.24 0.62 ⫺0.36 1.00
BANNAFTA 0.07 0.09 0.06 0.01 0.07 ⫺0.01 0.09 ⫺0.02 0.05 ⫺0.02 ⫺0.07 ⫺0.03 ⫺0.08 0.58 0.14 ⫺0.03 ⫺0.08 ⫺0.03 ⫺0.09 ⫺0.02 0.05 ⫺0.04 0.04 1.00
BANNAFTAN 0.10 0.20 0.16 0.21 ⫺0.15 0.10 0.13 0.07 0.01 ⫺0.11 ⫺0.12 ⫺0.17 ⫺0.08 ⫺0.03 0.76 ⫺0.15 ⫺0.09 ⫺0.17 ⫺0.07 0.05 0.02 0.00 ⫺0.01 ⫺0.05 1.00
BANECC1 0.30 ⫺0.14 ⫺0.05 ⫺0.42 0.26 ⫺0.04 ⫺0.03 ⫺0.08 ⫺0.13 ⫺0.07 ⫺0.25 ⫺0.11 ⫺0.30 ⫺0.02 ⫺0.14 0.87 ⫺0.14 0.75 ⫺0.16 ⫺0.09 ⫺0.12 ⫺0.13 ⫺0.17 ⫺0.03 0.01 1.00
BANEEC1N 0.04 ⫺0.10 ⫺0.04 0.42 ⫺0.29 0.01 ⫺0.04 ⫺0.06 ⫺0.07 ⫺0.20 ⫺0.05 ⫺0.31 0.10 ⫺0.05 ⫺0.07 ⫺0.27 0.85 ⫺0.16 0.71 ⫺0.09 ⫺0.05 ⫺0.20 0.06 0.04 0.00 ⫺0.31 1.00
BANEEC2 0.31 ⫺0.10 ⫺0.02 ⫺0.32 0.21 ⫺0.05 ⫺0.05 ⫺0.09 ⫺0.16 ⫺0.08 ⫺0.29 ⫺0.13 ⫺0.34 ⫺0.02 ⫺0.16 0.77 ⫺0.06 0.88 ⫺0.20 ⫺0.10 ⫺0.16 ⫺0.15 ⫺0.21 ⫺0.04 0.00 0.88 ⫺0.20 1.00
BANEEC2N 0.01 0.47 0.00 0.16 0.72 0.85
⫺0.05 ⫺0.02 ⫺0.30 ⫺0.05 ⫺0.07 ⫺0.05 ⫺0.20 ⫺0.01 ⫺0.33 ⫺0.05 ⫺0.05 ⫺0.29 ⫺0.33 ⫺0.10 ⫺0.03 ⫺0.22 0.11 0.03 ⫺0.01 ⫺0.33 0.85 ⫺0.37 1.00
283
The dummy variables of hypothesized blocks—BANASEAN1, BANASEAN2, BAN-

NAFTA, BANEEC1, and BANEEC2—are, however, neither trade creating nor trade divert-
ing. In summary, the 1997 cross section results point to the conclusion that the regional trade
arrangements among the SAARC countries were neither trade creating nor trade diverting.
4. Policy recommendation for trade expansion among the SAARC countries
The economies of the SAARC countries are similar in factor endowments and cost
structure. Therefore, interindustry trade based on comparative advantage is unlikely to be
significant in the SAARC countries. The modern theory of international trade suggests that
countries with similar patterns of demand are likely to trade more among themselves because
goods, which have achieved economies of scale, can more easily be sold in another country
having a similar preference pattern. Therefore, economies of scale can trigger profitable trade
flows even in the absence of comparative advantage. (Anam and Rahman, 1991).
Tariff concessions offered by member states through the three rounds of tariff negotiation
have not produced any perceptible impact on the expansion of intraregional trade. For one
thing, products of major export interest to member countries seldom appear in the national
lists of concessions to partners, whereas products in different categories on which conces-
sions have been exchanged are hardly traded among partner countries. Also, the existing
tariff rates for many of these products are already low and, therefore, the margin of tariff
preferences granted thereon is insignificant. Tariff cuts, therefore, under SAPTA have not led
to any substantial increase in trade of these products.
The stagnant level of exports to, and growing imports from, the region has resulted in a
large deficit in Bangladesh’s intraregional trade. A simple reason behind Bangladesh’s
stagnant exports to the region is that it does not produce much of the products that are
actually demanded by the regional partners. The low level of industrialization and, hence,
insufficient diversification of the country’s production base are important factors behind the
country’s low volume of exports to the region. Commercial policy barriers prevailing in the
partner countries may also have contributed to this problem. SAPTA provides an opportunity
to Bangladesh for expanding its exports to the region if its production base could be enlarged
and all commercial policy barriers to its actual and potential exports to the region were eased.
Thus, apart from the fact that regional trade liberalization will offer opportunities to obtain
supplies from the neighboring sources at lower transport cost, less restriction on imports will
generate competition and act as an incentive to increase efficiency. The increased competi-
tion faced by Bangladesh’s industries from partner country products will force them to
increase efficiency, improve quality and lower costs. Resources will be reallocated away
from the marginal and inefficient firms that are currently sheltered by high tariff walls.
Improvement in allocative efficiency, which is an important objective of trade liberalization,
will thereby be achieved.
SAPTA may also bring considerable advantage to Bangladesh in terms of enhancing its
export potential through the creation and development of industrial capacity. By being able
to import raw materials, intermediate inputs, capital machinery and technology from major
partner countries, which are presumably cheaper sources of supply, Bangladesh may develop
Table 12
Regression results for 1997 (corrected for autoregression and heteroskedastieity)
Variable Coefficient T-statistics Coefficient T-statistics Coefficient T-statistics
Constant ⫺1.532 ⫺0.496 ⫺0.028 ⫺0.009 ⫺7.133* ⫺2.501
LOGGDP 0.382* 10.722 0.336* 8.796 0.305* 6.435
LOGPCI ⫺0.293* ⫺8.306 ⫺0.244* ⫺6.404 ⫺0.209* ⫺4.336
LOGDISTANCE ⫺0.579*** ⫺1.867 ⫺0.546*** ⫺1.772 ⫺0.039 ⫺0.129
BORDER 0.702 1.473 0.717 1.566 1.193* 2.57
SAARC1 ⫺4.732* ⫺3.637 ⫺4.059* ⫺3.053
SAARC1N ⫺2.806* ⫺4.752 ⫺1.749* ⫺2.706
SAARC2 ⫺4.798* ⫺3.056 ⫺5.363* ⫺3.465
SAARC2N ⫺3.350* ⫺4.009 ⫺3.514* ⫺4.046
ASEAN1 ⫺8.097 ⫺1.449 ⫺5.243* ⫺3.179
ASEAN1N ⫺4.126 ⫺1.443 ⫺1.665* ⫺3.145
ASEAN2 0.113 0.027 1.114 0.839
ASEAN2N 1.509 0.685 0.700 0.988
NAFTA 0.355 0.106 2.371 1.085
NAFTAN 1.117 1.584 1.055 1.505
EEC1 0.221 0.091 0.906 0.799
EEC1N 0.757 1.523 0.695 1.447
EEC2 ⫺0.648 ⫺0.090 0.765 0.481
EEC2N ⫺0.189 ⫺0.229 ⫺0.219 ⫺0.273
BANASEAN1 3.578 0.646 ⫺4.996* ⫺4.819
BANASEAN1N 2.784 0.972 ⫺1.541** ⫺2.314
BANASEAN2 0.788 0.179 3.999* 4.097
BANASEAN2N ⫺0.970 ⫺0.419 1.849* 2.653
BANNAFTA 2.083 0.859 4.489* 3.172
BANNAFTAN 0.000 0.000 1.479* 2.651
BANEEC1 0.855 0.417 1.757 1.604
BANEEC1N 0.000 0.000 0.685 1.330
BANEEC2 1.391 0.529 3.159** 2.455
BANEEC2N 0.000 0.000 0.635 0.965
R-square 0.737 0.731 0.680
DW 2.232 2.326 2.544
*, **, and *** indicate significance levels at 1%, 5%, and 10%, respectively.
significant manufacturing capacity. By adding more value to its products, it would be able
to not only get back the revenues foregone from tariff concessions but also to enhance the
growth of new industries in the country.
Tariff preferences should be offered on items that have high import value, that are actually
traded, and on those that have high potential for entering into intraregional trade. All
irrelevant items that do not have domestic production may be excluded from the concession
lists. No useful purpose will be served by extending concessions on items that have hardly
any prospect of being exported by a SAARC country.
The rules of origin requirement will need to be modified to bring change in the local
content requirement for LDCs, which depend very greatly on imported inputs for their export
production. Because of extreme dependence on imported inputs, low backward linkage of
industries and, hence, low domestic value added, the range of goods on which Bangladesh
and other LDC members could obtain concessions is very limited. In fact, the present rules
of origin tip the balance of benefits in favor of the more industrialized countries such as India
and Pakistan. In order to make more LDC products eligible for SAPTA concessions, the local
content requirement for LDCs may be brought down to 25%.
Exchange of tariff preferences will hardly stimulate trade if NTBs that are more serious
impediments to trade expansion are not phased out simultaneously. There are a wide arrays
of NTBs in SAARC countries such as import quota, licensing, bans, exchange controls,
technical standards, health requirements, state trading monopolies, different customs nomen-
clature, and cumbersome customs procedure and documentation. Information should be
obtained about these NTBs in different countries and measures taken to affect a total
standstill and roll-back of these NTBs, particularly with respect to intra-SAARC trade. Note
that in the second SAPTA round the offer to withdraw NTBs was restricted to products in
which tariff reduction was agreed. An across-the-board reduction in NTBs would be needed
to stimulate intraregional trade.
Successful trade liberalization presupposes the existence of a strong and growing private
sector. A strong private sector leads to increased efficiency in production and better alloca-
tion of resources, and thus enables increased production and a bigger exportable surplus.
Governments should not, therefore, try to monopolize trade through state trading organiza-
tions, but encourage greater participation in trading activities by the private sector. Dealing
with state trading agencies is also considered a disadvantage by foreign importers and, hence,
state participation in trade should be minimized as much as possible. Recent moves in all
SAARC countries to increase the role of the private sector in national economic activities are
steps in the right direction.
The SAARC countries compete with each other for similar types of foreign investment.
The SAARC countries, with the possible exception of India, have inherited the most labor
intensive production processes while the Pacific Rim countries move on to production of
goods that require more skilled labor and capital. In earlier stages, production utilizing
relatively labor intensive technologies move to the Pacific Rim countries from the developed
countries after they switched to the second or third generation technologies. The relatively
cheap labor cost is still a major incentive for investment in the SAARC region countries. The
major impetus for the growth of foreign investment in the SAARC countries within the
region has to come from India, the dominant economic entity within the region. India’s
current state of industrial development, as well as its technical and manpower capabilities,
could serve as resources for the whole region.
The SAARC countries can increase financial cooperation among themselves via clearing
union arrangements, export credits, and payments unions. The lack of internally generated
foreign exchange in many of the SAARC countries mean that most of the funds needed to
finance imports must be obtained abroad. Often the financing is in terms of development
assistance or export credits made available by the developed countries. Although this type of
concessionary financing increases north-south trade, it does not provide any assistance in
intra-SAARC trade. Increased financial assistance among SAARC countries may be the key
to achieve this. The operational issue is then to devise financial arrangements that facilitate
greater trade and investment linkages and in the process circumvent the need for convertible
currencies. Three such arrangements are a clearing union, an export credit and a payments
union. Any financial arrangement, however, among the SAARC countries will be limited by
the nonconvertibility of the currency of the member countries and the region’s chronic
(convertible) foreign exchange shortage. The success of arrangements such as export credit
facilities, the ACU and payments union will depend on the participation of multilateral
institutions such as the ADB or the World Bank particularly in providing access to convert-
ible currencies. An alternative route could be a willingness on the part of the trade surplus
countries to accept nonconvertible currencies as payment.
The long history of political conflicts, particularly among India, Pakistan and Bangladesh
has blocked potentially profitable trade channels. In addition, financing difficulties have
compounded the problem. All South Asian countries are heavily dependent on foreign
assistance for financing their large and expanding trade deficits. The terms and conditions of
foreign aid frequently constrain the recipients to purchase from specified donor sources.
5. Summary and conclusion
The increasing complexity of international relations and consequent problems with global
economic institutions appear to be economic facts of life in the 21st century. Notwithstand-
ing the creation of the World Trade Organization and the effort to establish commercial rules
of the road at the global level, this supports the idea that regional economic arrangements,
whose negotiation involves fewer transaction costs, will be the wave of the future. The rise
of regionalism has understandably raised the specter of exclusionary blocs and concern over
the danger of trade diversion. This paper has asked whether there are grounds for drawing
such inferences from the history of regionalism in the SAARC countries.
The current low level of intratrade among the SAARC countries is essentially because of
the relatively low level of industrialization of the member countries. As these economies
develop and industrialize, trade among them will perhaps automatically increase. However,
such a process will take a long time. Integration of the markets of South Asian countries by
agreeing to institute a mechanism for expanding trade will provide a better basis for
industrialization and lead to a faster expansion of trade and other linkages among themselves.
The process of industrialization and trade expansion would perhaps be slower in the absence
of a preferential trading arrangement (SAPTA).
We have found that the formation of the SAARC FTAs will likely have a significant
impact on Southeast Asia’s trade that cannot be attributed to the participating countries’
observable economic characteristics or even to unobservable factors, such as histories of
intimate trade relations or beneficial trade structures, whose effects remained constant over
time. At the same time, some limitations of the analysis should be recognized. The analytic
framework does not take into account the potential impact of preferential trading arrange-
ments on the growth of output in member countries. Within the methodology, several
potential extensions of the underlying approach could also be considered. One is to differ-
entiate trade into different types of products, such as food or manufactured goods. Another
extension would be to expand the geographical coverage to include developing countries,
possibly while allowing these countries to have different behavioral coefficients.
Our gravity model results suggest that SAARC member countries are yet to achieve
trade-creating benefits. Our results support the hypothesis that intra-SAARC trade is too low,
and SAARC countries as a whole trade less with the outside world than would be expected.
To the extent that regional trade is limited by the absence of complementarity in production
and resource bases and financing difficulties, immediate benefits from TC within SAARC are
not likely to be significant. However, trade in the region is also inhibited by structural
rigidities created by political conflicts. Removal of such rigidities under the SAARC
agreement can open up some profitable intraregional trade channels. In addition, there is
room for mutually profitable cooperation within the SAARC in the areas of trade cooperation
in external markets and regional water management with regard to the problems of floods and
irrigation. SAARC regional integration, in a way that is compatible with multilateral
liberalization, could contribute to growth not only by increasing trade and allowing regional
producers to benefit from economies of scale, but also by encouraging foreign direct
investment and the deepening of capital markets.
Acknowledgments
The author thanks the Editor, Professor Dutta, and two anonymous referees for their
valuable suggestions and comments. The author also benefited from the suggestions and
comments made on earlier drafts of this paper by Professors M.U. Ahmed and A.R. Bhuiyan
of Dhaka University and Dr. M.R. Shelley of the Center for Development Research, Dhaka
Bangladesh. An earlier version of this paper was presented in Dhaka and New York. The
author acknowledges a research grant from the American Institute of Bangladesh Studies
(AIBS).
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Is SAARC A Viable Economic Block PDF

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Journal of Asian Economics 12 (2001) 263–290

Is SAARC a viable economic block? Evidence from

JEL Classification: F15, F13

Keywords: SAARC; Trading blocks; Gravity model

* Corresponding author. Tel.: ⫹1-504-280-6163; fax: ⫹1-504-280-6397.

2. The structure and performance of foreign trade in Bangladesh

2.3. Bilateral trade balances

2.4. A review of trade policies of Bangladesh

Export incentives provided in Bangladesh can be broadly grouped into: a) assistance to

3. The gravity model of Bangladesh trade with the world

3.1. International trade of the SAARC countries

3.2. Regional economic cooperation and its effects

3.3. Methodology and data

log共TRADEijt) ⫽ a ⫹ B1 log(GDPitGDPjt) ⫹ B2 log(PCIitPCIjt)

3.4. Analysis of empirical results

The dummy variables of hypothesized blocks—BANASEAN1, BANASEAN2, BAN-

4. Policy recommendation for trade expansion among the SAARC countries

5. Summary and conclusion

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