“No nation was ever ruined by trade, even seemingly the most disadvantageous,” said Benjamin Franklin, one of the founding fathers of the United States of America in 1774 (1). In the past week, India certainly paid no heed to that as it continued to stay away from the RCEP, originally negotiated between 16 countries – ASEAN members (10 countries) and their FTA partners (Australia, China, Korea, Japan, New Zealand and India). Touted as the largest regional trading agreement to date (member countries account for a third of global GDP and 40% of global trade), the stated purpose of RCEP was to make it easier for products and services of one country to be available across others.
India had decided to exit the discussions in November 2019 over ‘significant outstanding issues’ which it has ‘consistently’ raised during negotiations. The Minister for External Affairs commented that India’s stance was based on ‘clear eyed calculation’ and that no pact was better than a ‘bad agreement’ (2). While India ships 20% of its total exports to RCEP nations, imports from them account for 34%. Combined, these countries accounted for USD105bn (of USD184bn or 57%) of India’s trade deficit in 2019.
In our opinion, the economics of the transaction did not work for India. It harbours the ambition of expanding manufacturing (through Make in India); initial focus being on import substitution, but eventual aim is to export to the rest of the world. RCEP entailed inadequate provisions to check surge in imports and was, therefore, unpalatable to India. But to certain observers, (2) the ongoing clash with China made India wary (hence, its refusal to join the BRI as well) of entering any agreement. Afterall, India’s decision to stay away might have considerations beyond just the economics of the transaction.
23 things: On the economics of free trade, however, Ha-Joon Chang, a South Korean economist (currently at University of Cambridge, England) has fabulous views, aptly covered in his book 23 Things They Don’t Tell You About Capitalism. In a theoretically profound book, Chang, while not hitting out at capitalism per se, has gone on to bust several myths which have become sort of ‘given’ in the world of developmental economics.
Chang contrasts two countries. Country A, until two decades ago was highly protectionist, with average industrial tariff of 30% plus. It restricts cross-border flow of capital, has a highly regulated banking sector and numerous restrictions on foreign ownership of assets. Foreign firms are discriminated against through differential taxation. ‘A’ conducts no elections, is riddled with corruption and has opaque property (incl. IP) rights. It has a large number of state-owned entities that make huge losses.
Country B’s trade policy has literally been the most protectionist in the world in the past few decades, with average industrial tariff of 40-55%. Majority of the population cannot vote, corruption is rampant and political parties sell government jobs to their financial backers. It has not recruited a single civil servant through the competitive process. Record of government loan defaults worries foreign investors. Especially in banking, foreigners cannot become directors, its IP rights record is patchy, at best.
It might not be a huge surprise that country A is China around the year 2000; but, not many would have guessed that country B is US around 1880s. Despite all ‘supposed’ anti-developmental policies, China was the world’s fastest growing economy for three decades until 2010, and so was the United States in the 1880s.
Unlike Ben Franklin (USD100 bill carries his face), the thoughts of other US leaders on protectionism are interesting. Alexander Hamilton, the then Treasury Secretary (USD10 bill carries his face) submitted a report to the Congress in 1790s arguing that industries in their infancy need to be protected and nurtured by the government before they can stand on their feet. On the USD5 bill appears Ab Lincoln, who in defiance of British pressure on the Unites States to adopt free trade, had opined that “within 200 years, when America has gotten out of protection all that it can offer, it too will adopt free trade.” Funnily enough, Britain itself adopted free trade only towards 1860s when its industrial dominance was absolute. Before that, Robert Walpole (who ran the country between 1721 and 1742) was the original architect of the infant industry argument that Alex Hamilton followed.
Chang concludes by stating that free-trade and free-market policies have rarely worked. Most rich countries did not use such policies when they were developing countries, while these policies have slowed down growth and increased income inequality in developing countries.
Beyond just the price: Now, foreign policy and macro data in general are fun to track and one might get it right once in a while too. But, in our experience, consistently mining macro data as an investment edge does not work. For us, bottom-up earnings cycle analysis combined with a top-down sectoral allocation view seems to generate best results.
A topic that seldom comes across in conversation with seasoned investors is the feedback mechanism. For example, we were once asked how different investment returns would look had we not exited an investment. Although the question has merits, we admittedly chose not to track it.
In our July 2018 memo (link here, pg. 8-9), we had argued that markets are notoriously bad at giving feedback and as investment managers we need not be unemotional, but rather inversely emotional (worried when others are not). Consequently, on several occasions, we have taken the decision to sell an investment because our investment thesis did not play out (despite markets still being positive on the name, we were long: link here). There have often been occasions where we decided to sell an investment just because our investments in a business exceeded our comfort zone of either its trading liquidity on the bourses or regarding the weight of the investment in the fund.
In the end, just as Chang professes, India’s decision to not join the RCEP may have been based on considerations ‘beyond just the economics’. Similarly, for us, there are often times when the decision to sell an investment has considerations which are ‘beyond just the price’. It allows us to stay inversely emotional, which, to us, is far more valuable.