After a bilateral meeting during the recent SAARC summit in the Maldives, Prime Minister Manmohan Singh and Prime Minister Yousaf Raza Gillani resolved to "open a new chapter" in the relations between the two countries. Presumably catalyzing economic relations is the leading edge of this process. The commerce secretaries have also met and seemed to mean business by setting specific timelines for the first time, to initially reduce tariff barriers sharply as envisaged in the SAFTA agreement, and then addressing the issue of non-tariff barriers. Pakistan has also finally declared an intention to grant MFN status to India to reciprocate the MFN status already granted to Pakistan by India.
The declarations together signify a renewed determination by the political leadership of the two countries to pursue economic logic as a means of improving the material conditions of their respective citizens. That the pressure of the 'hawks' on both sides has been successfully resisted, manifests the maturity of the political leadership in both countries. That the forward step in economic relations is subject to reversals, indicates that progress is vulnerable to internal pressures in each country from those who seek conflict rather than cooperation. Let us identify the elements of the substantive content of this "new chapter" that may be about to open.
Available evidence over the last hundred years, shows that when two countries engage in free trade, both gain, even in the extreme case where one country is initially more efficient in producing all the tradable goods: the gains from trade for both countries flow from specialization on the basis of goods in which a country is RELATIVELY more efficient.
Furthermore recent evidence shows that when a smaller country engages in free trade with a bigger country, the smaller country gains relatively more.
Beyond this is the question of trade where one country has no particular comparative advantage on an inter-industry basis. In this case the evidence shows that intra-industry specialization can become the basis of trade gains. Thus Pakistan for example can reap the economies of specialization in particular types of apparel in the case of the textile industry; and production of spare parts and components in the case of automobile, light engineering and electrical industries.
Thus Pakistan can get substantial economic benefits from a free trade relationship with India, and indeed South Asia as a whole.
Investment is inseparable from trade. Investment not only enlarges the volume of goods traded but also plays a significant role in compensating for a possible trade imbalance through improving the capital account of the receiving country.
Trade with Investment from India can have three strategic advantages for Pakistan: (a) It could pull Pakistan out of its current recession and place Pakistan on a high growth trajectory. (b) Cheaper imports from India compared to imports from the rest of the world, could reduce inflation rates, particularly food inflation which is a major factor in currently rising poverty. (c) Lower inflation rates in goods consumed by the middle class could improve the distribution of real income in Pakistan.
The choice before Pakistan and India is clear: either remain mired in hostility and under utilized economic potential; or through economic relations build a better future for their peoples and be part of a resurgent South Asia that could lead the world.