Dr. Zaidi Sattar, Chairman, Policy Research Institute, Bangladesh

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EXPANDING THE EXPORT BASKET

*Dr. Zaidi Sattar on Trade Policy Reform & Export Diversification

At the recent National Export Trophies distribution event, the PM urged local entrepreneurs to take advantage of the SEZ and Export Development Fund to diversify our export basket. However, there are concerns regarding the sorry state of infrastructure that plague these SEZ. In your opinion, what factors can encourage local businesses to diversify exports?
Everybody is aware that we only have one major export item: Ready Made Garments (RMG). Everybody also knows that we need to diversify our export basket, but are there policies in place, which will help with the transformation? Export diversification has many dimensions. For the moment, let’s focus on product diversification, which essentially means increasing the share of non-RMG products in our export basket. That is what the Honorable Prime Minister was referring to.

In my view, an effective and appropriate trade policy is critical for a superior export performance as well as its diversification. But first, it is important to get a good grip on what trade policy really is. The popular perception is that trade policy is about promoting exports while discouraging imports to generate or save foreign exchange, improve our balance of payments, and create jobs at home. A trade economist has to look at it differently. Trade policy can be broken into two parts: external and domestic. The external part of trade policy is easy to understand. It has to do with what is popularly known as ‘export promotion’ which is about seeking market access, preferential or otherwise, in countries and regions around the world. The domestic part of trade policy fundamentally refers to the package of policies and incentives that affect the price of exports, relative to those of domestic import substitutes. If the policy favors the relative price of exports, then producers will export and allocate more resources to export production. If the policy favors relative price of import substitute for domestic sales, then producers will shun exports and prefer to sell in the local market.

We have RMG, which is a 100% export industry while we also have more than 1300-1400 distinct tradable products that we export in smaller quantities every year. However, 75% of these exports are under $1 million. In FY2018, we exported $32 billion worth of garments and barely $5 billion worth of non-garments. In order for export diversification to take place, we need to reduce the share of RMG’s contribution to export while increasing the share of non-RMG products. However, that isn’t happening because RMG exports have been growing much faster than non-RMG for the past two decades. Consequently, the share of garments in total export has grown to 83% and is still increasing.

So where lies the problem? I argue that it has to do with our trade policy which is skewed against exports, and more so against non-garment exports. Let me try to explain:

Firstly, the current incentive system heavily favors import substitute production with the help of high protective tariffs. We now use tariffs and Para-tariffs as principal instruments for protection. On most domestically produced products protective nominal tariffs range from 50% to 100%, and even more. These protective tariffs are like subsidies that help raise the price of import substitutes making domestic sales more profitable. Compare this with export subsidies, which range from 5% to 20% on a few selected exports. Hence, our trade policy subsidizes import substitutes more than it incentivizes export, particularly non-RMG products. Note that exports face cutthroat competition in the world market and there is no protection support for them. In a recent study, we found that ordinary consumers (who bear the main burden of the protection tax) are paying for most consumer goods prices that were on average 70% above international prices, which translates into $17 billion extra or 5-6% of FY2017 GDP.

The question is what has this got to do with export diversification. The answer is simple. RMG exporters, being 100% export oriented, are not faced with the perverse incentive as they are fully geared to exports. It is non-RMG exporters – who have to choose between exports and domestic sales – that find domestic sales far more profitable than exports. Additionally, most of the 4000 small non-RMG exporters do not get the facility of duty-free import of input that is given to RMG exporters. In that case, how can non-RMG exports grow faster than RMG exports to make our export basket more diversified? All exports also face the additional challenge of weak trade infrastructure such as customs, problematic ports, roads and rail networks which hurt all industries. And there is the perennial problem of the ease of doing business in Bangladesh that also discourages foreign direct investment (FDI), which is most needed by the non-garment sector to flourish. Finally, the exchange rate is another instrument of trade policy that affects the price of exports relative to import substitutes. Research evidence around the world has shown that an undervalued exchange rate stimulates exports. In our case, we have let the real effective exchange rate appreciate for the past five years making our exports less competitive, hurting non-RMG exports clearly more than RMG.

The external part of trade policy deals with opening access to markets using all the trade preferences that Bangladesh enjoys as an LDC. We should seek out non-traditional markets such as East Asia, China, Japan and other emerging markets. We do this with the help of export promotion measures, preferential trade agreement or regional agreement. The primary trade policy is the incentive policy; what is the relative incentive of export versus domestic production and in this part of trade policy we have not been performing well. The newly elected government will need to address this inherent contradiction in trade policy on a priority basis in order to advance the national agenda of export diversification.

I would urge the new government to take lessons from the RMG sector. In the 1980s local entrepreneurs urged the government to allow them to import items such as yarn, accessories, export quality fabric, duty-free, in order to ensure world-priced input and a level playing field in world markets. And using our labor cost advantage, the basis of our comparative advantage; they set up a highly profitable industry. The same facilities need to be made available to non-RMG sectors.

In order to diversify, the government needs to ensure a balance of incentives between export and import substitutes, through a reform of trade policy.

What policies would you request of the newly elected government to further the development and trade goals of the nation?
Bangladesh has long term plans of becoming an Upper middle-income country by 2031 and a high-income country by 2041. In order to get there, we need growth rates in double digits, which can only be achieved through greater exports. Although our economy has grown to $275 billion it simply isn’t big enough to get high growth rates on the back of domestic demand. The world economy is a vast market of $75 trillion. In short, we need to strive harder to export more and become an export-oriented country.

The Chinese economy has grown to $10 trillion in size simply through a strong focus on export. We need a very strong political stance on this matter in order to dispel the nationalist ideas of producing everything at home. Well, India tried it for 50 years without success. And of course, the vested groups will discourage the lowering of tariffs but the government needs to take a firm stance. Take the example of Vietnam, which has an export GDP ratio of nearly 100% and exports of $225 billion with an extremely diverse export basket.
Bangladesh is a trading nation, which greatly benefitted by opening up its economy in the 1990s. It has to continue on this road of openness.

In your opinion, which sector will be the next RMG sector for Bangladesh and why?
The next RMG sector should be the footwear sector. The sector has two parts; leather and non-leather. Footwear export went up to $750 million in the last fiscal year, however; it has been underperforming this year.

The biggest names in footwear for non-leather shoes such as Nike, Adidas, Reebok, and so on, contract production in countries such as China, Vietnam, India, and Indonesia. The international production structure of footwear is almost like garments. Large brand name companies do not have their own factories but contract out supplies to where they find low-cost and efficient firms. However, we have been unable to capture a good chunk of that market. Much of this is due to lack of foreign direct investment into Bangladesh.

I would also say jute has a tremendous amount of potential in becoming a big export earner. Bangladesh is the largest exporter of the finest quality of jute but we have fallen behind in terms of innovation in jute products. The government needs to invest heavily in R&D on jute products. State-owned jute mills, running perennially at huge losses, are a problem in this sector. Indeed, they are hurting the growth of profitable private jute industries. Next, I would say toys and electronics also have great possibilities going forward. However, all this needs foreign investment but we have still been unable to attract much of it.

The agriculture sector’s contribution to GDP has fallen over the years but the sector is still a big employer of unskilled workers. What do you think the newly elected government’s policies regarding the agriculture sector should be?
The agriculture sector’s contribution to GDP has continued to fall steadily and it still employs about 40% of the labor force. But the sector is becoming mechanized which means fewer people are working on a piece of land. This frees labor to move into more profitable sectors. And this is exactly the point of structural change in development; moving from agriculture to industrialization and modern services.

The new government simply has to focus more on raising productivity in agriculture. In most developed countries agriculture contributes only 5% to the GDP. Given the goals of Bangladesh to move up to upper-middle-income and higher-income levels, we need to draw some lessons from the model of the developed countries.

What are your thoughts on the trade war between China and USA? How do you see it impacting Bangladesh?
I would rather call it a trade friction and a spat between the two countries, and currently, the two countries are at the table to negotiate better terms. It is pointless to think that any country will emerge as a winner if they do engage in a trade war. Other countries also stand to lose. In the short run, if there is a trade spat between the two countries, it means Chinese exports to the USA will slow down. Secondly, American importers will then be on the lookout for alternative sources and Bangladesh is one such prospect. If Bangladesh is even able to capture 1% of the Chinese export business, that will be a major push for our exports, garments and non-garments alike.

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