Post-pandemic Recovery calls for Trade Policy Overhaul

The year 2020 will be recorded in economic history as the year when the world population lived dangerously – under the onslaught of an unknown killer virus that did not discriminate between rich or poor, developed or developing countries. The health pandemic was compounded by the consequential economic aftermath that left global output, employment, and trade in disarray. The health-cum-economic crisis is being compared more with the Great Depression of the 1930s than with the Great Recession of 2008-09. The former was triggered by the stock market collapse in the United States which started in 1929 while the latter had its trigger in the over-leveraged mortgage-backed US securities. Covid-19 is the trigger for the present crisis.

There is still so much uncertainty around that projections of negative output and trade shocks by leading international agencies like the World Bank, IMF, and WTO, keep changing by the month. Gleaning from the various projections, global GDP is likely to dip at least 5% in 2020 while global trade could face a deeper shock of 12-32%, says WTO. The second quarter 2020 GDP of Bangladesh’s leading export destination – the USA — dipped a record 33%, projecting annualized GDP for 2020 to fall about 9%. Then there is too much uncertainty about the global recovery phase. Bangladesh economy will not be spared. Our exports that were already losing steam over the past five years are already down 15% in FY2020. Merchandise trade (export and import of goods) is down 17% after reaching the milestone of $100 billion in FY2019. Expected recovery in FY2021 is laced with too much uncertainty. In a way, it would be what we make it out to be. It is the time – and opportunity – to undertake serious reforms. To be sure, a revamped trade policy would be critical to engineer a robust and sustained economic recovery.

Trade is the means through which our economy integrates with the rest of the world. In light of the global shock in output and trade, the big question is, can our trade and exports recover without a big shake up in our trade policy. To answer that question, we need to first get a good handle on what constitutes our trade policy and what needs to be done.

It is my humble belief that trade policy is the least understood of the various components of macroeconomic policy. The media is never behind in reporting the rise or fall in exports or imports, trends in our balance of trade, the current account balance, and so on. But it is trade policy and its orientation that ultimately determines how these various trade indicators play out. Most recently, top trade news seems to focus on one particular aspect, export diversification; that is, product diversification in our concentrated export basket, though diversification of our exports could mean much more than just diversification of products. Trade policy is at the center of the debate about what works and what does not in our quest for the elusive goal of export diversification.

Perhaps it would be appropriate to start with laying the contours of what constitutes trade policy in the Bangladesh context. It is a general presumption that the two tri-annual MOC Notifications (Import Policy Order and Export Policy) guide Bangladesh’s trade policy orientation and direction. However, a closer examination suggests otherwise. The IPO comprises a set of legally binding WTO-compliant regulations and processes governing import of goods. Though the Export Policy (not as binding as the IPO) also lays down some regulatory and restrictive instructions governing exports, it is more a promotional notification that elaborates the Government’s aspirational goal of stimulating export-led growth. In pursuit of that primary objective, the EP lays out various incentive schemes, including subsidies for specific exports, as well as other support measures aimed at diversifying our export basket. Because neither the IPO nor EP deals with tariffs and their implications for export and import incentives, they miss out a critical component of Bangladesh trade policy.

Trade policy illustrated

Producers have a binary choice between selling in two markets – export market or the domestic market, except for RMG producers who are mandated to export only. Fundamentally, the prevalent regime of trade-related taxes, subsidies, and other support policies that create incentives or disincentives to produce for the export market versus the domestic market constitute trade policy. To illustrate, export subsidies or other support mechanism (e.g. concessional loans for export) create incentives for production geared to the export market. On the other hand, policies that tax or restrict imports create incentives for production of import substitutes for domestic sale. When the balance of incentives favor exports the policy can be termed export-oriented. When import taxes (that raise prices of imports as well as import substitutes) and import restrictions (to reduce import competition) make sale in the domestic market more profitable than exports, the incentive regime is biased in favor of import substitution. There is also the theoretical possibility of formulating a balance of equal incentives between exports and domestic sales, in which case trade policy would be neutral between exports and import substitute production. The bottom line: to export, the price received from export must be higher than what the producer were to receive from selling that product in the domestic market. Fundamentally, in the Bangladesh context, policies that create the balance of incentives between production for exports versus domestic sales constitute trade policy (e.g. protective tariffs, export subsidies). On the external front, trade policy involves efforts to open up market access for exports through Bangladesh’s membership in multilateral institutions (WTO), bilateral or regional trade agreements, and seeking preferential access out of international support measures (ISMs) accorded to LDCs.

Fundamentally, the prevalent regime of trade-related taxes, subsidies, and other support policies that create incentives or disincentives to produce for the export market versus the domestic market constitute trade policy.

Based on the preceding articulation of trade policy, PRI research confirms that despite the widespread presumption that export is highly incentivized by all sorts of cash subsidies and other support measures, high tariff protection given to import substitute production raises profitability of domestic sales that far outweighs incentives given to exports. The price an exporter receives for his product is much less than what the domestic market has to offer. That indeed is the crux of the trade policy dilemma in Bangladesh. To many this finding would be a surprise, but painstaking research over a long period confirms this is the case.

By trade policy, therefore, I am not referring to the regulations and processes that govern import and export trade; I am referring to the package of policies that actually impinge on and determine relative incentives for cross-border exchange of goods, services, and consequential payments in international currencies.

Quite expectedly, Covid-19 pandemic has exacerbated the trade part of the economic shock. Is trade policy up and ready to cope with the trade-related developments and also provide the impetus to fuel rapid economic recovery once we have got a handle on controlling the virus and returning life to some semblance of normalcy. It is fair to say that trade policy, as inherently a package of incentives that impinge on firm-level choice between producing for exports or domestic sales, is not that well understood and even less reported or discussed in the media. Yet, how best we cope with the current health-cum-economic crisis and how we engender a rapid post-pandemic economic recovery of production, consumption, imports, exports, and jobs, depends in large measure on our trade policy orientation, now and for the upcoming post-pandemic economy. Suffice it to say that trade and trade policy matters if we are to expect a superior overall economic performance in these challenging times.

..how best we cope with the current health-cum-economic crisis and how we engender a rapid post-pandemic economic recovery of production, consumption, imports, exports, and jobs, depends in large measure on our trade policy orientation, now and for the upcoming post-pandemic economy.

Bangladesh trade policy must gear up to address two phases of the Covid-19 health-cum-economic shock. First, it must ensure a trade facilitating stance for import-export of Covid-19 mitigation products. Trade openness policy will have to be pursued to cope with the trade shock while complementing the Government’s stimulus package. Next and finally, trade policy will have to be re-oriented to engender a robust post-pandemic economic recovery under challenging global developments.

Covid-19 trade facilitating policy

Covid-19 pandemic is a global phenomenon; that makes national trade policies as essential instruments in the management of the crisis. Bangladesh could play a positive role in the global initiative by adopting – even if for a short period – trade facilitating provisions in the conduct of its own trade in Covid-19 related products. Bangladesh acted swiftly to adopt facilitating measures, such as tariff reductions or waivers, and removing unnecessary regulations or restrictions, for a large list of medical products and equipment. Any ban on exports of Covid-19 related medical equipment, if taken as an ad hoc emergency measure, must now be withdrawn as Bangladesh’s expectation is that other economies specializing in the cost-competitive supply of Covid-19 related medical equipment should keep their exports flowing even under travel and transportation constraints. Trade in goods and services backed by facilitating trade policy will play a key role in overcoming the pandemic and limiting its impact in Bangladesh by providing access to essential medical products, ensuring access to food staples to meet any supply deficit, getting inputs like seeds, fertilizers, and pesticides to farmers, and, most importantly, supporting jobs and economic activity in the face of deepening global recession-

• reducing the cost and improving the availability of COVID-19 goods and services,
• reducing tax and administrative burdens on importers and exporters,
• reducing the cost of food and other products heavily consumed by the poor,
• contributing to the fiscal and monetary stimulus packages launched to limit the negative economic and social impact of the Covid-19 related downturn, and Trade openness remains the key. While it is true that Bangladesh’s increasing trade integration with the global marketplace could accentuate and even perpetuate the economic fallout from what is a health pandemic, this is the wrong time for severing our international trade linkages. If anything, this is the time to play a positive role in enhancing the rules-based global trading system by facilitating rather than impeding cross-border trade flows. On balance, Bangladesh’s gains from the multilateral system – of which there has been plenty — will eventually far outweigh any losses that might accrue from the hitherto globalized regime.

A revamped trade policy will be essential for supporting the eventual economic recovery and building resilience to future crises.

Overhauling trade policy to stimulate economic recovery

While the preceding analysis and proposed measures will help address and cope with the health pandemic induced economic crisis, what can be stated with confidence is that business-as-usual trade policy will not be enough to fuel a robust post-Covid-19 sustained economic recovery that includes resumption of high GDP growth trajectory, healthy export performance, and strong job creation at home. These are ambitious goals laid down in the FY2021 Budget and likely to be stipulated in the forthcoming 8th Five-Year Plan, FY2021-25. Achieving these goals will need inter alia a major overhaul of our trade policy.

..that business-as-usual trade policy will not be enough to fuel a robust post-Covid-19 sustained economic recovery that includes resumption of high GDP growth trajectory, healthy export performance, and strong job creation at home.

To articulate the overhauled trade policy, it would be important to begin with some perspectives – positive and negative — on potential global developments within which post-Covid-19 Bangladesh exports-imports will take place.

On the negative side, of course a global downturn is certainly not going to be helpful to our exports, even with all the caveats mentioned above. If the health pandemic persists, and there is resurgence of Covid19 around the world, global economic recovery would be sluggish, as WB-IMF projections suggest, except that projections for trade growth during recovery seem more optimistic than output growth. The projected global slowdown (which is beyond our control) will dampen import demand for Bangladesh exports in major markets, with significant impacts on RMG exports due to the fact that RMG has a significant 6.5% share of global export market. Another negative comes from some dark clouds on the political economy horizon which must be taken note of. The world economic order was rattled even in the pre-pandemic period due to tendencies in some developed country destination markets in favor of economic nationalism, unilateralism, and deglobalization, trends that have been shaking the very foundations of the post-war regime of rules-based trade that gave impetus to trade and income growth for much of the post-war period. 

True, a global health pandemic that precipitates an economic crisis presents enormous challenges on the path to recovery. But all is not lost in a global economy that is constantly evolving. First, though one expects a global downturn to depress demand for apparel exports, our experience from the global financial crisis (GFC of 2008) alerts us to the possibility of a saving grace coming from the famous “Walmart effect” which help sustain demand for basic garments, which make up 78% of our RMG exports. Second, US-China trade tensions will inevitably result in “switching” US (and Japanese) import demand from China to other sources. Bangladesh will be high on that list potentially giving a substantial boost to RMG exports if we can get our act together. Third, for non-RMG exports of Bangladesh, where export market shares are infinitesimal (except for jute and jute goods) and demand is not a constraint, in principle, slowdown in global demand is unlikely to be the problem. Ensuring export incentives and competitiveness domestically will be the challenge. Fourth, recently there was encouraging news from China which opened up market access for Bangladeshi exports with DFQF facility for 97% of tariff lines. Similar facilities exist in Japan, Australia and New Zealand. Overall, East Asia and Pacific, together, now constitutes a market size that is larger than EU or USA, with regional GDP in excess of USD 22 trillion.

In this backdrop, a revamped trade policy for stimulating post-pandemic economic recovery should take the following route, beginning with the recognition that we have essentially two trade policy tracks, one for RMG exports and another for the rest. RMG operates in a ‘free trade’ enclave (zero tariffs inputs under Special Bonded Warehouse (SBW)), nearly immune to the high tariff and protection regime that creates significant anti-export bias for Non-RMG exports. That is the crux of the problem. This trade policy dualism has got to change. Unless trade policy for non-RMG exports is brought at par with RMG, export diversification has no chance. Until such time as we can unify the two tracks of trade policy, our only option is to revamp the twin tracks of trade policy for post-pandemic recovery, along the following lines:

First, the biggest challenge to export diversification comes from the high protection regime in the domestic economy. Of the 1300 HS-6 non-RMG products that were exported in FY2019, there are plenty with strong competitive advantage and export prospects are vast because they have an infinitesimal share of the global market with perfectly elastic demand as long as our exporters can supply them competitively. These are the products with promise of export diversification. Demand constraint will not be a problem for these export products in the post-pandemic global market. The list of these products is long. The problem with non-RMG exports (firms are not 100% exporters), like footwear, plastic, agro-processing products, light engineering, is that domestic tariff-induced protection is so high, making domestic sales so profitable, that exporting is not an attractive option. To get any traction on export diversification, this perverse incentive system must be turned around. The over-arching challenge in future trade policy lies in making exporting activity more attractive than selling in the domestic market.

To get any traction on export diversification, this perverse incentive system must be turned around. The over-arching challenge in future trade policy lies in making exporting activity more attractive than selling in the domestic market.

Second, to counter the external demand shock emanating from Bangladesh’s main global markets – USA and EU (including UK) – prepare a vigorous plan for geographical diversification to break into new markets in East Asia and the Pacific (e.g. China, Japan, S. Korea, Australia, New Zealand) whose regional market size has reached USD 22+ trillion, exceeding that of EU and USA. Trade policy should fully exploit DFQF facilities still on offer in this region, both for RMG and non-RMG exports.

Third, all out measures will have to be undertaken to enhance export competitiveness, ideally based on comparative-advantage-following (CAF) strategies. Top on the list are measures to improve trade infrastructure (e.g. digital economy, ports, transport, storage), access to finance, ease of doing business, skill development, FDI for improved technology, management, and market access. Let us recognize that Bangladesh’s comparative advantage is not limited to labour-intensive RMG only. PRI research confirms that 40% of the 290 non-RMG exports of over USD 1 million in FY2019 displayed competitive advantage against 60 plus countries that exported to the same destination markets. Until such time as the two trade policy tracks are brought at par with each other, all non-RMG exporters will have to be given SBW facilities to get zero-tariff imported inputs.

Fourth, a sliver of hope has emerged from the fact that RMG backward linkage industries, primary textiles sector (PTS), have becomes globally competitive supplanting some 60% of RMG import requirement of yarn and fabrics, amounting to USD 21.5 billion in FY2019, when RMG exports were USD 34 billion. Termed as “deemed exports”, they represent embedded exports in RMG, and could be regarded as a kind of export diversification. Over 73% of PTS output now supports exports with barely 27% going to the domestic market. PTS now deserves as much support measures as RMG in the post-pandemic recovery phase. 

Fifth, while recognizing that RMG export prospects globally are not fully exhausted, efforts should continue for expanding market access to old and new markets on the one hand, and improving competitiveness by adopting all measures to raise quality, efficiency, productivity, and compliance in the RMG sector and its backward linkage industries. .

Sixth, jute and jute goods exports have reached the USD 1 billion milestone with bright prospects as eco-friendly products in the global market. Heavy R&D spending (public + private) on this product group is urgently needed to innovate new products and capture the vast and growing global market for eco-friendly consumer products. Lockdowns in this pandemic has closed BJMC mills which were undercutting export prices of jute yarn and twine, hurting private BJMA and BJSA mills. This is an opportunity to close them for good by retrenching labour with golden handshakes. That will lead to significant boost to export of jute goods.

Seventh, the march of globalization in the past quarter century has created opportunities for vertical integration of production processes across borders prompting the growth of global value chains (GVCs) leading to the phenomenal rise in trade of intermediate goods (parts and components of final products). FDI has been the driving force behind such cross-border trade integration. As part of the export diversification strategy, Bangladesh should be advised to diversify into intermediate goods production for exports (e.g. auto parts, parts and components of electronic goods) by vigorously seeking FDI. In this regard, Vietnam’s experience is a learning opportunity.

Finally, historical and cross-country evidence shows that robust export performance requires two common traits for the exchange rate: (a) flexibility, and (b) under-valuation, or strict avoidance of over-valuation. With a weak record on both these features Bangladesh exports have been sluggish during much of the 7th Five Year Plan period (FY16-20). Recognizing that it would be well-nigh impossible for the economy to export and grow its way out of the Covid19 slump with an already proven over-valued exchange rate, the crisis presents a timely opportunity for “compensated” depreciation of the exchange rate (i.e. associated with complementary measures to neutralize inflationary or other negative effects) to give a boost to post-pandemic export performance and its diversification.

In epilogue, one cannot but emphasize the critical importance of being prepared to take full advantage of demand pick up during the recovery stage, as the impact of the pandemic fades out globally, as well as in the Bangladesh economy. A crisis, said Nobel Laureate economist Paul Romer, is a terrible thing to waste. Following the political-economic crisis in 1990, Bangladesh launched the deepest trade policy reforms in its history, indeed completely changing direction from an inward-looking restrictive trade policy to an outward-looking export-oriented one, that paid huge dividends in terms of trade and export expansion, growth acceleration, and poverty reduction. The current health-cum-economic crisis presents yet another opportunity for changing course and revamping trade policy to bring parity in incentives geared towards expansion of RMG and non-RMG exports alike, thereby infusing traction in export diversification, and promoting comparative-advantage-following (CAF) import substitution.