Trade distortions, the Doha Round, and food price volatility

Kym Anderson has an interesting piece about the relationship between trade distortions and food prices. He argues that sudden rise in global food prices are driven by major policy shifts like tariffs and subsidies, leading to a tit-for-tat behavior by countries that produce them.

Trade-related policies contribute to agricultural market volatility and the volatility around the long-run-trend terms of trade slows national economic growth, he argues. The main point of the piece: continue with agriculture liberalization. Here is a similar argument. The disagreements on agriculture liberalization has been holding up Doha for eight years now. The author says that the more barriers in this sector, the more volatility. So, seeking a Special Safeguard Mechanism (SSM) is not good to reduce volatility. [But, how can the Doha Round pass without addressing these issues?]

The price hike of 2008 was also partly a consequence of policy changes in the US and EU, namely their decision to subsidise biofuels and set mandates/targets for their use domestically in response to rising fossil fuel prices. It led other governments to impose food export restrictions to insulate somewhat their consumers from the price rise, which pushed international food prices even higher and, domino-like, drove more exporting countries to follow suit. Some food-importing countries also lowered temporarily their import tariffs, to reduce the rise in their domestic food prices.

The parallel movement of food and energy prices is consistent only after the previous half-century. The author finds that the coefficient of correlation between 1960 and 1999 is -0.18, compared with 0.84 for 2000-07. The comparison may not be quite accurate because of the timeframes between these two periods but the high and positive R-squared value for 2000-07 gives us some information about the way food and energy prices move (in tandem). Note that agriculture constitutes around 3% of global GDP, 6% of global trade, and 8% of global exports (exports of non-farm primary products is 31% and all other merchandise exports is 25%).

Governments of many developing countries harmed their farmers directly by taxing their exports and indirectly by encouraging manufactures and overvaluing their currencies. This meant that price incentives facing farmers in many developing countries were depressed by both own-country policies and the protective policies of high-income countries.

The good news is that many developing countries have reduced hugely their anti-agricultural export policies, and even some high-income countries have lowered their trade-distorting assistance to their farmers – albeit replacing part of it with more-direct assistance to farmers that are only somewhat decoupled from production.

The argument against SSM and giving some policy space to deal with contingencies in the developing countries are not consistent with the evolving consensus among experts that such measures need to incorporated in the Doha Round. Without these measures it would be hard to deal with national crisis triggered by disruptions in agriculture production and trade. For instance, what happens if there is extended drought in a country and producers chase after higher priced markets abroad-- this will lead to starvation. To check the population from starving, some contingency measures are essential. Some hooks to full agriculture trade liberalization is required for the survival of the Doha Round.

Even a recent WTO World Trade Report emphasized for inclusion of “trade contingency measures”. The report argues for “trade contingency measures” that would give some policy maneuver for countries to deal with domestic pressure to prop up domestic markets affected by the crisis. The contingency measures discussed in the report include safeguards measures, anti-dumping and countervailing measures, the re-negotiation of tariff commitments, the raising of tariffs up to their legal maximum levels, and the use of export taxes. These are needed because too little flexibility in trade agreements may render trade rules unsustainable.

Also, note that the drastic rise in food prices was not necessarily triggered by protectionist measures, which was the resulting response to the food crisis (which was especially caused by demand factors).Trade distortion is one of the many causes of the drastic rise in food prices:

• Rising incomes per head in the emerging economies
• Changing pattern of food consumption (shift from food to meat reduces food supply as it is being used to rear animals)
• Subsidised biofuels production in the West raise demand for maize
• Aggregate maize, rice, and soybeans production stagnated in 2006 and 2007 (partly due to drought)
• Increasing speculation because of declining stock

Martin Wolf dismisses the idea that liberalization is the only answer:

The political focus of the Doha round on lowering high levels of protection is largely irrelevant. The focus should, instead, be on shifting the farm sector towards the market, while cushioning the impact of high prices on the poor.

The move towards genetically modified food in developing countries is as inevitable as that of the high-income countries towards nuclear power. At least as important will be more efficient use of water, via pricing and additional investment. People will oppose some of these policies. But mass starvation is not a tolerable option.

Futile efforts to regain the lost glory of Nepalese garment industry

In my latest op-ed, I argue that exclusively chasing for duty-free access for Nepali garment and textile exports to the US markets is not a panacea for the problem associated with this dying industry. I think nothing is going to move forward even if Nepali exporters gets preferential treatment in the US market because after the end of MFA in 2005, the market is already flooded with similar exports from other countries that enjoy economies of scale in production and are more efficient and competitive (price and quality) than Nepali exporters. Last year, I wrote an op-ed (Times up for garment industry) arguing why the garment and textile industry cannot be depended upon for export-led growth.

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Futile efforts

CHANDAN SAPKOTA

During her visit to the US late September, Deputy Prime Minister and Foreign Minister Sujata Koirala touted that her delegation lobbied hard with some US Congressmen to pass a bill that would treat Nepali garment and textile sector preferably in the US market. She boasted that there were “positive and promising” responses from the US regarding duty-free access, which could, in principle, resuscitate the dying export-based garment and textile industry.

Each time a high-level delegation visits the US, they implore for preferential treatment of Nepali garment and textile industries. This fruitless effort has been continuing since the end of Multi-Fiber Agreement (MFA)—which established a system of quotas to limit the quantity of imported textiles and apparel products from specific countries to the US, Canada, and the EU — in 2005, after which the Nepali garment and textile industry has seen drastic decline in exports and market share in the West.

The value of garment exports between January-April 2009 was less than 10 percent of what was exported in the same period in 2004. This sector has already shed over 90 percent of jobs and 98 percent of firms. In the first five months of 2009, the value of readymade garment exports was US$3.4 million, a 49 percent drop from the same period last year. Recall that the garment sector was once the highest foreign currency exchange earning sector. Now, its contribution is minimal and agricultural goods like pulses have more weight on the export basket.

In a way, the political and financial resources invested so far in securing preferential access to the US market sounds reasonable. However, after more than four years of lobbying, there is hardly any progress. The policymakers are bogged down into this issue as if this is the only sector that would help stimulate export-led growth and employment generation. Exploration of other comparatively advantageous sectors have been overshadowed by the obsessive focus on securing preferential access to a market that is already flooded with similar goods from countries which enjoy huge cost and competitive advantage over Nepali exporters.

At this juncture, we need to ask two questions: What is the chance of getting preferential access to the US markets under present circumstance? If it does, will Nepali garment and textile exporters then be able to regain the lost market share?

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The illusionary notion that securing duty-free access to the US market would revive the garment and textiles sector is fundamentally flawed. Policymakers and investors should be a bit more realistic about our real manufacturing and export capacities.

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Unfortunately, there is no positive answer to these questions. A senior diplomat, who is quite familiar with these issues, from the State Department opined that it is very “unlikely” that Nepal would get preferential access to the US market under the present circumstance. Unfortunate this might be but it is not surprising. By now the Nepali lobbying troupe has a fair idea of how hard it is to secure preferential treatment from the US Congress; despite over four years of lobbying, things have not moved a bit in the positive direction. It should have been a clear indication that the entire effort might be a lost cause, not because we don’t need to prop up this sector but because we can’t do it under present labor and economic conditions in particular and the incapacity to fulfill enhanced labor, quality and environmental requirements brought about by increasing globalization in general. The senior official advised Nepali leaders and lobbyists to be a bit more realistic and not chase for something that is not attainable. Now, revert back to what DPM Koirala touted while she was in DC in September? It seems like she has not fully fathomed this issue.

Now, let us assume that Nepali garment and textile exporters get preferential access to the US market. Will this help revive the lost glory of this industry? It seems unlikely because of five reasons. First, due to persistent labor problems ranging from bitter disputes on minimum wage to hiring and firing provisions, the firms are simply unable to supply pre-ordered goods on time.

Second, investors are discouraged to invest in this sector due to unmanageable red tapes and irresolvable industrial relations. Third, the problem is further compounded by frequent bandas and transport strikes. The cumulative effect is that delivery is costly and not possible within the stipulated timeframe, leading to loss of valuable customers like WalMart and Gap Inc. This is more of supply than demand issue.

Fourth, exporters from China and India, among others, are more competitive in terms of price and quality than Nepali exporters. They enjoy economies of scale and their governments have elaborate plans to prop up production and distribution efficiently. This is clearly lacking in Nepal because of the lackluster response from government and myopic business vision of investors. Until 2005, the government and exporters basked on preferential treatment and completely disregarded the need to upgrade the old production structure into a new, consolidated one so that it can compete with more efficient exporters from abroad. Fifth, Nepal cannot jump successfully into the highly-competitive US market because exporters from other countries have already eaten up the pre-2005 market pie of Nepali exporters.

This does not mean that we need to abandon the promotion of garment and textile industry abroad. It would be fruitful to look at regional markets, which has higher potential than markets abroad because of lower transportation and transaction costs. This sector could gain more if the same amount of political and financial capital is invested in lobbying to eliminate countervailing duty (CVD) of 4 percent in the recently signed Nepal-India trade treaty.

Expediting establishment of GPZs and giving tax credits and subsidy incentives to investors would also aid the process, though, to be frank, no one knows how much this will help the dying sector regain its past glory. To satisfy the never-ending fascination with Western markets, the government and the exporters need to look into niche markets rather than the entire garment and textile market, which, as argued before, are already conquered by competitive firms from other countries. Promoting selected products that reflect Nepali tradition and heritage would be one of the potential niche markets.

The illusionary notion that securing duty-free access to the US market would revive the garment and textiles sector is fundamentally flawed. Policymakers and investors should be a bit more realistic about our real manufacturing and export capacities. A preferential treatment, which is very unlikely in the present context, will not be a panacea to the multiple, intricate problems of the garment and textiles sector.

[Published in Republica, November 10, 2009]

The promise of mobile phones

Liquidation of Hetauda Textiles Factory

Finally, the Nepalese government has decided to liquidate a dead textile factory, which the Maoist government tried to revive believing that despite its utter lack of competitiveness, it could produce and supply textiles while creating artificial demand from the security agencies. It was populist and bad idea that only added deficits.

Reversing the Maoist government´s policy, the government has decided to send Hetauda Textiles Factory (HTF) into liquidation, citing that the revival of the dead industry was not possible.

The cabinet meeting held on Wednesday took the decision to this effect.

“We had to admit to the cabinet that past attempts to revive the failed and long-closed industry only added financial loss and burden to the government,” said a senior official at Ministry of Industry, disclosing the cabinet decision to myrepublica.com.

HTF was closed eight years ago after it posted a huge financial loss due to its failure to compete with imported textiles, mainly from India. Prior to the closure, the factory used to consume 1,200 tons of cotton and was employing about 1,200 people.

This is what I wrote when I reviewed the Maoist government's budget on 23 September, 2008:

Demonstrating a socialist manifestation and big planner attitude, the finance minister has adorned the budget with varied slogans and a resolution to revive moribund and sick firms. The promise to inject money and resuscitate state-owned enterprises like Hetauda Textile Mills, Gorakhkali Rubber Industry and Agricultural Tools Factory completely compromises efficiency and productivity in favour of a populist political agenda of creating employment. He has put an upper limit on demand by arguing that government agencies and security forces would consume production from these incompetent companies.

Again, he needs to be given a reminder of how the Soviet Union failed miserably when it embarked on grand and fruitless investment in railways and the manufacturing sector. Corruption and inefficiency thrived as the state-owned companies created illusionary demand, that is, they created their own demand and supply, and rotated the goods and services among themselves, leading to waste of resources in one sector and shortage in the other.

Will Nepal gain from the new India-Nepal trade treaty-II?

Paras Kharel looks beyond simple economic theoretical benefits from the revised trade treaty (2009) between Nepal and India. The devil in the trade deal is getting clear!

What has also been overlooked by Nepal is the non-binding nature of the provision for waiver of additional duties other than that counterbalancing an excise duty. That India “shall consider” waiver at Nepal’s request does not make it mandatory for India to remove it. Our negotiators have been caught napping. And there is more to it. The possible waiver of such additional duties being applicable only to products of “medium- and large-scale” manufacturing units leaves open the room for applying them on products of small-scale units. In addition, the Protocol to Article I says that the two sides “shall undertake measures” to “reduce or eliminate” non-tariff, para-tariff and other barriers that impede promotion of bilateral trade. This weak formulation does not entail a binding commitment to categorically eliminate such barriers.

The list of primary products qualifying for duty-free and quota-free access has been expanded to include floriculture, atta, bran, husk, bristles, herbs, essential oils, stone aggregate, boulder, sand and gravel. But it was unnecessary to list some of the products as they were already eligible for preferential treatment—for example, the existing list of eligible primary products included flour (atta is one type of flour) and forest produce (herbs come under non-timber forest products). There is a need to make the list clear and precise, based on standard international classification, to remove ambiguities and arbitrariness in interpretation. As things stand now, either country can impose customs duty on products not mentioned in the list, whereas the very first point on the list reads “agriculture, horticulture and forest produce and minerals which have not undergone any processing”—which is quite all-encompassing. Besides, Nepal’s strategy should be to add value to products such as herbs and essential oils through processing rather than exporting them in raw form.

It has been agreed to calculate value addition for Nepali manufactured products to get preferential access to India on a free-on-board, rather than ex-factory price, basis. This is of little help as stringent rules of origin—30 percent value addition and change-in-tariff heading at 4-digit level—that are beyond Nepal’s current level of industrialization and supply capacity have not been relaxed. The quantitative restrictions slapped since 2002 on four Nepali products—vegetable ghee, acrylic yarn, zinc oxide and copper wire rod—remain. Indian manufactured goods, meanwhile, will continue to get preferential treatment from Nepal without having to meet any rules of origin.

See this blog post for additional information.

Lessons for developing countries from Finland’s state-led growth success

Finland is one of the examples of successful state-led development, where the state helped in capital accumulation (reflected in an "unusually" high investment rate) in manufacturing industries while at the same time committing itself to upholding the market economy. With this it was able to smoothen coordination failures and informational externalities, thus aiding the process of specialization and production. In a research paper No. 2009/35 (The Finnish Development State and its Growth Regime), authors Markus Jantti and Juhana Vartiainen argue that the state acted as a net saver, and credit was rationed to productive investment outlays. They also argue that incomes policies and welfare reforms were important in sustaining the necessary political compromise that underpinned the Finnish development state.

Note that Finland was still an agrarian economy until 1930s. As late as in the 1950s, more than half the population and 40 per cent of output were still in the primary sector. Per capita GDP was only half of that of Sweden. Yet by the late 1970s, Finland had become a mature industrial economy.

Finland is an example of a late but successful state-led industrialization that was carried out rapidly. The economic policy strategy that achieved this was a judicious mix of heavy governmental intervention and private incentives. Governmental intervention aimed at a fast build-up of industrial capital in order to ensure a solid manufacturing base. At the same time, however, it was made clear that the aim of heavy-handed state intervention was not to establish a planned economy as a permanent solution. Rather, the government and the constitution made it clear that the basic property rights of capitalism would ultimately be respected. [...]From the 1950s onwards, as trade unions became stronger, the labour movement became a more active partner in this more or less implicit social contract. Thus, in a manner similar to that of Austria, Korea and Taiwan, decision-making has been quite corporatist.

Public savings accounted for as much as 30 per cent of aggregate savings during the 1950s and 1960s. This surplus was channelled partly to support private investments in capital equipment throughout the country, and partly to start public companies in some key sectors of the economy. State companies were established in the basic metal and chemical-fertilizer industries as well as the energy sector. As late as in the 1980s, state-owned companies contributed about 18 per cent of the total industry value-added in Finland. [...]Low and rigid interest rates and administrative rationing of credit to some areas of business investment, at the expense of depositors and households.In the period 1960-84, gross fixed capital formation was 26.3 per cent of GDP, a figure exceeded in the OECD area only by Norway. [...]A pragmatic cooperation between organized private agents (bankers and business leaders), on the one hand, and government officials and civil servants, on the other, has played a key role in enhancing economic growth.[...]The programme of rapid capital accumulation also presupposed wage moderation and the acceptance of higher taxes. Upholding industrial competitiveness and profitability thus acquired high priority on the economic-political agenda. The crude instruments to accomplish these were comprehensive income policy settlements as well as repeated devaluations.[...]The implicit social contract was not limited to upholding industrial competitiveness. Social welfare reforms were gradually introduced at the same time, which can also be interpreted as an attempt to buy wage moderation with the promise of welfare services.

The question now is: are these measures applicable to other countries or can they be emulated in other less developed countries? The authors say No but policymakers can derive "indirect" lessons form Finland's success!

The specific policy package described in this paper is hardly applicable today. We know now that the crude accumulation of physical capital is not the key to rapid economic growth. Instead, today’s leading doctrines of economic development and development assistance emphasize property rights, good infrastructure as well as education, particularly that of women. Using public funds to boost expensive physical investment projects is clearly no longer a relevant policy goal. Nor would such a programme be feasible since the regulation tools of the 1950s—credit rationing, soft monetary policy, public ownership of key industries—have become obsolete.

Furthermore, Finland’s success story may have been due to rather favourable but transitory circumstances. The crucial phase of state-led economic growth and the buildup of welfare services coincided with favourable demographics, so that reforms created more winners than losers. Once the demographic structure becomes less advantageous, it is less certain that there will be such a happy congruence between the demands of the market economy and the political aspirations of voters.

Finland’s example offers a general message of hope for many countries affected by conflicts and poverty. Consider Finland’s history up to the Second World War: a small, backward country colonized by more powerful neighbours, torn by a violent civil war just as independence was within reach, and subsequently limited in its political manoeuvring room by the geopolitically challenging Cold War environment. Yet, it was possible for the Finnish decision makers—the government as well as various corporatist organizations—to forge a political compromise that was deemed politically legitimate and exploited the global economy to undertake a rapid economic transformation. This could be the positive message for any aspiring, less developed country in which initial conditions seem uninspiring.

Does aid aid growth?

This Discussion Paper No. 2009/05 from UNU-WIDER says that aid has a positive and statistically significant effect on growth over the long run.

The micro-macro paradox has been revived. Despite broadly positive evaluations at the micro and meso-levels, recent literature has turned decidedly pessimistic with respect to the ability of foreign aid to foster economic growth. Policy implications, such as the complete cessation of aid to Africa, are being drawn on the basis of fragile evidence. This paper first assesses the aid-growth literature with a focus on recent contributions. The aid-growth literature is then framed, for the first time, in terms of the Rubin Causal Model, applied at the macroeconomic level. Our results show that aid has a positive and statistically significant causal effect on growth over the long run with point estimates at levels suggested by growth theory. We conclude that aid remains an important tool for enhancing the development prospects of poor nations.