Introduction
The main conclusion reached in this essay is that the full and unconstrained resumption of trade on the basis of MFN (most favoured nation) status granted by India and Pakistan to each other, as required by the World Trade Organisation, holds great promise. It has been seen in many parts of the globe that deep animosities among nations can be overcome by trade which produces a dynamic of interdependence between people and the owners of production systems. It has often been claimed that democracies don't go to war with one another. That may be true to some extent. It can also be maintained that countries that have tied their economic systems with bilateral and regional trade agreements find it difficult to use military force to settle differences. The main line of thought to be advanced in this article is that the peace process between India and Pakistan would succeed if it is supported vigorously by trade. However, to make sure that the two countries don't use 'trade wars' as they did in the 1940s and 1950s to make political points against one another, it would be a good strategic move to fix Pakistan and India into a regional trading arrangement.

This thesis is developed in four sections in addition to the introduction and conclusion.

I. Why Regional Trade?
Economic theory is ambivalent about regionalism- an arrangement that provides the members of a regional association preferential access to each others' markets. The purists have no time for such an approach¹. They maintain that the only way to promote trade for individual countries is not to worry about how their partners reciprocate if they themselves open their borders. Borders not only in the developing countries but all across the world are blocked with all manner of barriers. They cover the entire gamut of restrictions governments place in the free flow of goods across their frontiers. These restrictions include tariffs, quantitative restrictions, and a vast variety of non-tariff barriers. The last category encompasses practices such as health, labour and environmental standards importers impose on the exporters. Sometimes importers also include the requirement that the products imported by them contain a certain amount of raw material that originates with them. How to dismantle these barriers? According to pure economic theory, unilateralism is the only way to proceed since the advantages of free trade are far greater than the damages they may cause.

However, since that is not the way the world functions, purists are prepared to make room for global trading arrangements such as the one that led to the creation of the World Trade Organisation. The WTO is the second best route towards free trade. This is about as far as pure theory is prepared to go in terms of promoting global trade. It has no patience with regional trading arrangements (RTAs).

But there are pragmatists who argue that in an imperfect world, regional trading arrangements (RTAs) play an important and productive role. But, argue the proponents, such arrangements must be open, they must not discriminate too much against those who are not included within their purview. Open regionalism of this type is useful for a number of reasons. To begin with, it locks in a government's commitment to lower tariffs and to the removal of other constraints against a relatively free movement of goods. Countries operating on their own can- and often do- change trade regulations in response to pressures by vested interests or to meet resource shortfalls. This has been sdone very frequently in Pakistan by a device called the SRO, issued from time to time by the Central Board of Revenue, usually in response to pressure from vested interests. Such unilateral actions are difficult to take when countries surrender some of their rights and a bit of their sovereignty to regional trading arrangements.

RTAs also lead to greater foreign direct investment. Foreign investors operating within RTAs have the comfort that government policies will not change suddenly. They can also access much larger markets. They can locate their investments in one place and expect to sell their goods in a wider market. Some RTAs also tie their member countries to follow certain rules in the areas of politics, human rights, governance and the like. Mercosur- an arrangement between Argentina, Brazil, Paraguay and Uruguay- makes it incumbent upon the member countries to design their political systems in line with the basic principles of liberal, representative democracies. Any sharp deviation from this type of governance can lead to expulsion from the arrangement. It was this requirement in the treaty that originally set up Mercosur that prevented a military take-over in the perpetually troubled Paraguay in the late 1990s.

When we talk about regional cooperation from Pakistan's perspective, should we talk only about South Asia or should we also look at other possibilities including regional alliances with the non-Arab countries of the Middle East, the Muslim countries of Central Asia, even bilateral trading and economic arrangements with China, Asia's largest and most dynamic economy? We should certainly look at all these possibilities. We will for the moment concentrate on the subject of regional cooperation in South Asia.

Three of South Asia's largest economies, Bangladesh, India and Pakistan, were once part of a single political entity- British India. It was, therefore, inevitable that even after partition, there would be considerable inter-country flow of goods and commodities. This happened, but only for a while. In 1948-49, the first full year after partition, 32 per cent of Pakistani imports came from India while India bought 56 per cent of Pakistan's exports. Fifty two years later, the situation was dramatically different. In 2000-01, India imported only 0.42 per cent of Pakistan's exports and provided only 0.13 per cent of the latter country's imports.

In absolute terms, Indian exports to Pakistan in 2000-01 were valued at only US$ 186 million out of a total of US$ 44 billion. In the same year India imported only US$ 65 million worth of goods and commodities from its northern neighbour while its total imports were US$ 50 billion. While politics have obviously interfered in the conduct of trade between India and Pakistan, other countries have not done well either. South Asian intra-regional trade declined from 19 per cent in 1948-49 to 12 per cent in the early 1950s to only 2-5 per cent in recent years.

These official numbers, however, underestimate the real volume of trade between the countries in the region, particularly between India and Pakistan. Estimates of illegal trade between these two countries through smuggling or through third countries (for example Singapore and Dubai) put its value at one billion dollars a year. From being major trading partners at the time of their birth, India and Pakistan now exchange very little of the goods, commodities and services they produce.

While political quarrels between India and Pakistan have caused many problems, they are not the only reason why intra-regional trade did so poorly in South Asia. There were several other causes as well, among them the autarkic economic policies followed by all countries in the region, poor communication links among the countries and lack of complementarity in the products produced by the regional economies. Let me deal with each of these three factors.

The South Asians, under the influence of Fabian socialism bought to the region by Jawaharlal Nehru, India's first prime minister, and later adopted by Prime Minister Zulfikar Ali Bhutto in Pakistan and Mujibur Rahman, Bangladesh's first president for his country, gave a large role to the South Asian state. In turn, the governments of the region pursued import substituting policies in both industry and agriculture, de-emphasising export led growth that brought economic miracles to East Asia.

The South Asians, having taken the decision to delink their economies, made no effort to improve intra-regional communications. This was an incredibly short sighted and economically self-defeating policy to adopt. The British had left a fairly well developed road and railways network that linked all parts of their large empire in India. The North Western Railway linked Karachi with Delhi and the fabled Grand Trunk Road connected Peshawar through Delhi with Calcutta. The railway and road network that was built with the NWR and the GT Road as their backbones could have been of considerable economic value had the two countries continued to develop them. That, of course, did not happen.

And in so far as the complementarities among the regional economies are concerned, these were not sufficiently pronounced for several decades to warrant the development of strong regional trading ties. It is only in recent years, with the IT sector becoming a leading player in the Indian economy, that Bangladesh, Sri Lanka and Pakistan can begin to take advantage of what India has already achieved.

Even if Pakistan and India have the political will to open their presently closed borders to inter-country trade, it would be better to do it initially in the context of a regional arrangement. Using such an arrangement will reduce the temptation for either country to use trade as a weapon of diplomacy. The time has come to build these relations on a more robust foundation.

II. Growth Strategy for Pakistan
Once Pakistani policymakers begin to factor in international trade as an important determinant of development, they could adopt an entirely new strategy of growth. This strategy, as we will suggest below, would not necessarily follow those that propelled the region of East Asia and China towards relative prosperity. It would also not seek to build the knowledge-intensive export sector to the extent India has done. Instead, it could follow a strategy of its own- a kind of hybrid based on the experiences of other Asian nations.

Pakistan could follow one of the three models that have been tried successfully by various Asian countries. The first of these is the model that produced the 'miracle economies' of East Asia. Also called 'tigers' and 'cubs,' these economies essentially tapped the large export markets available in the industrial world. This strategy essentially duplicated what Japan had done in the 1950s and 1960s. In following export led strategies, the industrial sectors in the miracle countries were guided by the state which identified areas for them to expand into. The industries that were being helped were almost always privately owned.

Nonetheless, the state not only helped industries identify markets abroad, it also got the financial sector to lend large amounts of money to the chosen industries at below market rates. In the parlance of economics this was called 'directed credit'- credit provided by banks to industries at the direction of the state. This connection between industry and finance proved remarkably successful but it also led to the financial crisis of 1997-98. What came to be called 'crony capitalism'- that is how directed credit evolved- worked for a while but had to be adjusted once the financial crisis exposed its weaknesses. This has been done successfully and the East Asians are back on the high growth trajectory- something few analysts expected at the peak of the crisis.

The other model that Pakistan could adopt was pursued by China. It focused on developing the human resource by providing all people- boys and girls, men and women, and residents in all parts of the country- with free education and health. China's human resource development occurred in an environment of authoritarian management of the economy and of the political system. Either by design or purely because of pragmatism, the Chinese, starting in the 1970s, released the enormous energies of this well educated and healthy labour by gradually loosening the political and social controls they had placed on them. First agriculture and then small scale and privately owned industries responded to these incentives. The rest, as they say, is history.

Then there is the Indian model, one aspect of which we will discuss below in some detail. What is today known as the 'Indian way' was not a well thought-out strategy initially. In fact, the explicit Indian strategy for development adopted by the country's first generation of leaders achieved a result exactly the opposite of that intended. It constrained growth rather than accelerating it. In the period between the mid 1950s and the mid 1980s, the Indian economy chugged along at what came to be called the 'Hindu rate of growth' a growth rate of some 3-3.5 per cent a year. The model being followed now is the product of a series of accidents and ad hoc decisions.

It has as its foundation Prime Minister Jawaharlal Nehru's decision taken in the 1950s to set up half a dozen institutes of technology. When these institutes began to produce thousands of engineers and science graduates, there were very few employment opportunities available within the state dominated, moribund, highly inefficient and stagnant industries. A large number of graduates of the now famous IITs had to look outside India for jobs and they found thousands of them in the telecommunications, information and communication technology (ICT) industry in the West. When, in the late 1990s and the era of dotcom explosion, the U.S. industry ran into serious skill shortages, a significant part of this was met by labour imports from India. Thus the Indian Diaspora was created which in the 1980s and 1990s not only acquired great wealth but also considerable experience and expertise. Once the non-resident Indian community had become viable in terms of size, wealth, income, and expertise, it was able to help with the development of the ICT industry back in the homeland. Consequently, India's IT sector became one of the most vibrant in the world.

What we see in India today is an economy that is being pushed forward by a growth rate which has relied very heavily on knowledge accumulation as an important contributor to growth. India's policymakers are now confident that, based on the recent transformation of the economy, they will be able to get their country to climb on to the same growth trajectory on which China is proceeding. This, in sum, is the much applauded Indian model of economic success.

Looking at the future, but also looking back at the experience of the various successful Asian countries, what strategy should Pakistan follow? Islamabad has a menu of options available. It could use private industry to aggressively enter the export sector, exploiting the abundant financial resources now available within the reformed financial sector. This would mean following the track previously travelled by the miracle economies of East Asia. But, unfortunately for Pakistan, there is not much synergy between the structure of Pakistan's industrial sector and the nature of demand in the world's large markets. Pakistan will not be able to duplicate the experience of East Asia.

Or, alternatively, Pakistan could invest massively in developing its large human resource by providing it with education, health and opportunities for skill development and knowledge accumulation. Such a strategy could work if Pakistan had the resources but more importantly the political will. When China went on that track it saved about 42 per cent of its gross national income, a proportion more than three times Pakistan's abysmally low saving rate of today. China's human resource oriented strategy produced results after two generations, or at least a generation and a half, had been sacrificed for the sake of the future. Pakistan neither has the luxury of time nor the political will on the part of its leaders to take the country through such a grind.

Finally, Pakistan could follow the Indian approach of concentrating on the accumulation of skills and knowledge by one segment of the population. A small (small relatively to the size of the population but still numbering in the millions) highly skilled workforce could enter the growth niches available in the global markets. This is the strategy adopted by the first administration of President Pervez Musharraf. It was championed with great energy by the then Minister of Science and Technology, Dr. Atta-ur-Rahman. Unfortunately, it did not produce the promised results.

I would advocate, instead, an approach that draws a bit on the Indian experience but then moves on an altogether different track. This two pronged approach would still emphasise knowledge and skill development as India has done so successfully. Based on a well equipped workforce, Pakistan could either export its abundant workforce or take part in the rapidly evolving 'outsourcing' opportunities that are changing the global production system. On the other track, Pakistan could become the hub of north-south and east-west commerce. The north-south track could link Central Asia, including Afghanistan, with India and points beyond. The east-west track could connect the western parts of China with the Arabian Sea through the ports of Karachi and Gwadar. These two tracks will cross in Pakistan and bring enormous benefits to the country.

For Pakistan to follow such a strategy, it will have to undertake large investments in improving the physical infrastructure- roads, railways, ports and airports. It will also need to develop its economy to supply this transit trade with the services it needs including insurance, finance, warehousing, processing, transhipment, etc. Modernisation of the service sector to facilitate such a strategy would mean focusing on creating appropriate levels of skills within the country in a number of diverse areas.
What I have spelt out above is a strategy for sustained growth and development suitable for a country in Pakistan's situation. Pakistan could successfully exploit its young people to work for the skill-short sectors in the western economies. It could, at the same time, use its geography as a point of transit for two routes- new versions of the old Silk Route- that would allow commerce to flow from different parts of the world. Following this two-pronged approach, Pakistan could leap frog into the future without going through the paces of development followed by other Asian countries. But a great deal of thought and planning will need to be done to develop and implement this novel strategy. And, most important of all, for this strategy to succeed Pakistan will need to draw strength from its neighbours, particularly India, and work within the frameworks of regional trading arrangements. In the section that follows, I will examine how India has fared in the last few years after analysing how Pakistan could benefit from its neighbour's experience.

III. A Resurgent India
Pakistan's rapidly improving relations with India should produce economic opportunities that could be successfully employed. One of them is in the sector of information and communications technology, or ICT, where India has begun to experience shortages of skilled workers. There are reports of reverse migrations of Indians from the United States back to their homeland. There are also reports of Indian companies entering into strategic alliances with firms in Asia in order to enter the rapidly expanding markets of the region. Could Pakistan take advantage of these developments? To answer this question, let us first look at the IT sector.

The global economy, in spite of some recent hiccups, has begun to respond to some extraordinary developments in information and communication technologies. Rapid progress in electronics, telecommunications, and satellite technologies over the last two decades permit high-capacity data transmissions at a very low cost. This has brought about a quasi-neutralisation of physical distance as a barrier to communication and as a factor in economic competitiveness. As Andrew S. Grove, founder and CEO of Intel Corporation, said at a software conference in October 2003, 'from a technical and productivity standpoint, the engineer sitting 6,000 miles away might as well be in the next cubicle and on the local area network.'

It is the enormous reduction in the cost of communicating with distant places and the ease with which enormous amount of data and information can flow instantaneously that has brought about the shrinking of physical space. For instance, in 1985 the cost of sending 45 million bits of information per second over one kilometre of optical fibre was close to one hundred dollars; in 1997 it was possible to send 45,000 million bits per second at a cost of just 0.05 cents. This has led to the redefinition of the work place. Even those working on a single project, such as the architectural design of a new building, don't have to sit together or be located in adjacent offices. They can easily communicate with one another over the internet.

All change is unsettling; rapid change such as the one brought about by the revolution in ICT has had the same effect in many different ways. Initially the fear was that this extraordinary development will produce an unbridgeable digital divide between the rich and the poor across the globe as well as within countries. This fear led the UNDP to devote the better part of its Human Development Report, published in 2001, to this subject. The authors of the report warned that unless full cognizance was taken of the adverse consequences of the spread of information technology, there was a real possibility that a couple of billion of world citizens will be condemned to live for generations within impoverished ghettos scattered all around the globe.

However, as with most technological changes, the benefits that accrued to both individuals and countries that were quick to participate in this change far outweigh the associated costs. That notwithstanding, there is now the opposite fear, expressed by many in the United States. This concerns the possible loss of jobs to places such as India, a country that has shown the ability to turn their large and young populations into economic assets rather than burdensome liabilities. There is no doubt that under the influence of the IT revolution, the global economic system is going through a fundamental transformation. One manifestation of this is the way corporate America is linking itself with the high-technology sector of India. But those who are adversely affected initially by this link see it as a 'zero-sum' development, in which India's gain comes at the cost of America's loss. There is greater likelihood that this will prove to be a 'plus-sum' game in which both sides, India and the United States, will gain.

Why is India the most prominent beneficiary in the developing world of the ICT revolution? This question has many answers; of which two provide a clue to what is happening in that country. One, India's great success in the ICT sector, particularly as an exporter, is owed in part to a decision taken half a century ago by Jawaharlal Nehru, the country's first prime minister. When Washington decided that the imperatives of the cold war required it to provide large amounts of economic and technical assistance to South Asia, Nehru asked for the establishment of institutions patterned after the MIT. This initiative led to the founding of the Indian Institutes of Technology at six different locations. The IITs now have the well-earned reputation of producing world class engineers and scientists. However, these institutions served only a small segment of the country's vast population. Last year, for instance, they accepted only 3,500 of 178,000 persons who applied for admission. Very wisely, the Indian government, drawing a lesson from the success of the IITs, replicated them within the large public sector.

While the IITs became institutions of excellence, the entire public sector geared itself to train tens of thousands of scientists and engineers. Consequently, India now produces 3.1 million college graduates a year, a number that is expected to double by 2010. The number of engineering colleges is expected to grow 50 per cent, to nearly 1,600 in four years. Not all the graduates are qualified to do world class work which is the reason why there is a movement to improve the quality of teaching by offering much higher salaries. Indians living abroad are also helping. The non-resident Indians (NRIs) in the United States have teamed with Wharton School and Northwestern University's Kellog Graduate School to found a new Indian School of Business at Hyderabad.

The second reason for India's attraction as a destination for corporate back-office work is the play on what economists call 'wage-arbitrage.' This is the difference in the cost of labor in the developed and developing countries for doing the same kind of work. To take one example: it is estimated that this year the tax returns of some 20,000 were prepared in India, a number set to increase tenfold, to 200,000 next year. An Indian accountant charges US$ 500 a month for this work which is equal to the amount paid for a single day by an American preparing the same tax return.

The Indians have been able to forge alliances with corporate America that have brought enough employment opportunities to the country to accommodate a significant number of graduates from technology institutions. By some estimates, at least one-third of new IT development work for big U.S. companies is done overseas, with India the biggest site. By 2008, forecasts McKinsey, the consulting firm, IT services and back-office work in India will increase five-fold, to a US$ 57 billion annual export industry employing four million people and accounting for 7 per cent of the country's gross domestic product.

While India has succeeded, is there place for other countries with young populations for obtaining similar benefits from the rapidly changing structure of the global economy? A large part of the increment to global output will be in the knowledge-intensive service sector. Manufacturing in developed countries accounts for just 14 per cent of output and 11 per cent of jobs. It is in this part of the economy that initial outsourcing occurred and East Asia and China were the main beneficiaries of that development. The service sector accounts for 60 per cent of the output of developed economies and more than two-thirds of employment. It is in this part of the economy that the Indians have taken a share. But the sector is large and there is space for other developing countries. Consider one developed country and one part of the knowledge-intensive service sector. The output of America's IT sector is estimated at US$ 240 billion. It is growing at a rate of more than 8 per cent a year. Indians, with exports to the U.S. of about US$ 7 billion, still have less than three per cent share in the market.

What are the lessons available to other developing countries from the Indian experience? There are at least four and the most important of these is to rapidly develop tertiary education. Second, to boost government spending on research and development, which is quite properly the province of government. Third, provide public funding for graduate science and engineering students. Fourth, develop financial markets so that new technology can be financed by institutions such as Venture Capital Firms or through instruments such as high-yield bonds and initial public offerings. These lessons would be transmitted more readily within the context of a regional trading arrangement in which the Indian IT sector becomes a major player.

IV. A South Asian Regional Arrangement
One way of promoting trade relations with India is to do it within the context of a regional arrangement. That could be one way of overcoming the enormous suspicion that exists on both sides of the border. This suspicion cannot be suddenly willed away in a season. Working with India within the regional context may be a good way to start.

South Asia has already paid a heavy price for not taking the regional route. In the late 1950s, when economic development was adopted as a major goal by all developing countries, South Asia and East Asia were at about the same stage of development. In the early years of the 21st century, the latter region has left the former behind by a very wide margin. In terms of average incomes of the citizens of the two regions, East Asia is about ten times richer than South Asia. Even if we assume that better regional cooperation would have added, on average, one percentage point of growth to the South Asian regional output, the combined GDP of South Asia today would be at least 70 per cent higher. This would have translated into an equivalent increase in per capita income and a considerable decline in the number of people living in poverty. It would not be an exaggeration to say that a significant part of the persistence of poverty in South Asia can be attributed to the lack of economic cooperation among the countries of the region.

Another way of assessing the benefits of closer economic cooperation among the countries in the area is to look at the impact of open trade between India and Pakistan, the region's two largest economies. A study prepared for the World Bank in 1993 estimated that free exchange of goods and commodities between India and Pakistan would have resulted in a nine-fold increase in the flow of trade between them over a period of five to ten years. Simply removing the import bans the two countries have placed on their exports to one another could bring enormous gain to both sides. For instance, granting each other the 'most favoured nation' status but still maintaining a 50 per cent tariff would increase the volume of trade between the two countries by a factor of three.

As a member of the World Trade Organisation, Pakistan is supposed to grant the 'most favoured nation' treatment to India. This has not been done while India has extended this benefit to Pakistan. An MFN status would help to remove some of the distortions that exist in the flow of trade between the two countries. But such a move would still be within the context of bilateral relations. To go beyond that and cast relations within a regional context, policymakers in Islamabad may begin to focus their attention on the areas in which such an arrangement could work.

There are four areas in particular in which regional economic cooperation holds considerable promise. They are information technology, energy, water, and research and development. Let us look at each of these in turn.

India, along with Israel and Ireland- the three 'Is'- are now major players in the global IT sector. As discussed in a previous section, India has already carved out a significant place for itself in the world in this sector. There are many ways smaller countries of South Asia could benefit from the enormous advances India has made. Institutions providing training in IT could get affiliated with the well-known and highly developed science and technology centre in India. Fledging IT companies in Bangladesh, Pakistan and Sri Lanka could form strategic alliances with the larger companies in India. Even though India has a very large population and thousands of IT graduates are produced by the training centres in the country, there are some labour shortages that could be met by the skilled workforces from other countries. There are many other opportunities in the IT sector that could be exploited.

There are even more opportunities available in the sector of energy. Of all the major economies on the mainland of South Asia, India is the most deficient in energy and the existing gap between demand and supply will expand as the economy continues to grow. What are the options available to India for closing the gap? Currently, oil and gas constitute 63 per cent of India's primary energy consumption. According to one estimate, oil demand will increase from 1.9 million barrels per day to 4.9 million by 2020, an annual rate of growth of 4.6 per cent a year, slightly less than the expected rate of increase in GDP. Two thirds of oil and consumption is now met from imports. This places a very heavy burden on the Indian economy which could be lessened somewhat by importing cheaper electric power and natural gas from a number of countries in the neighbourhood that have deliverable surpluses.

Pakistan is one source of energy India could tap. Both