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Bangladesh's policy paradox

Published: Thursday, Dec 03, 2015


Posted : 03 Dec, 2015 00:00:00



Tariff escalation

Bangladesh's policy paradox

Muhammad Shafiullah

Tariff escalation is a trade policy espoused by many countries of the world, especially developing countries, whereby higher duties are levied on finished goods than on relatively unprocessed goods or raw materials. This represents a structural bias against importation of processed goods intended to protect local industries and jobs. Tariff escalation presents a conundrum for policy makers in developing countries as they try to balance protection of local industries and social welfare.

Industries in developing countries often find it difficult to compete with their international counterparts since they are often unable to afford improved technologies. For a developing country, it is often necessary to protect some of its industries to prevent departure of important technologies, retain 'high value added' industries and prevent substantial job losses. In addition, protection also forms part of 'import-substituting industrialisation policy. However,  leaning toward an 'import-substitution' policy can create an "anti-export bias" in which domestic firms are loathe to exports, where profit margins are low, and focus more on selling in local markets where profitability is higher due to protection. In addition, import-substituting industries enjoying protection frequently develop into geriatric 'infant industries' which are unproductive, inefficient and heavily reliant on government subsidies and/or bailout. Industries protected for long periods have a tendency to ask for protection ad infinitum and strongly resist lowering of protection levels.

In such a situation, economists regularly argue in favour of an 'export-oriented industrialisation' strategy for developing nations. Trade openness is thought to bring about innovation, efficiency and improve productivity through competition and access to larger markets. However, import-substitution and export-orientated industrialisation are not mutually exclusive polices as developing countries may opt for opening up for certain industries, while safeguarding certain other industries. There are many developing economies, including the East Asian Tigers -Hong Kong, Singapore, South Korea and Taiwan - which successfully transitioned from a protectionist import-substituting industrialisation strategy to that of an open export-oriented one. The East Asian Tigers are also noted to have benefitted greatly from this transition as they managed to grow their economies in excess of 8 per cent per annum for substantially longer period of time.Bangladesh's policy paradox

In addition to impacting economic growth, trade protection and tariff escalation have social welfare and justice implications. Trade protection invariably leads to higher prices for consumers who, as a result, are able to afford a lower consumption bundle than their counterparts in an open economy. This represents a 'deadweight loss' of welfare to consumers. In particular, tariff escalation is intended to raise the prices of finished goods (consumed largely by end users) and increase profitability of certain industries, resulting in funds being funneled from consumers to producers. In some cases, trade protection comes at a cost to the economy as subsidies and other similar types of protection are paid by taxpayers. However, this has to be weighed against the welfare lost due to closure of industries and job losses, especially in developing countries where chronic unemployment and poverty are more common. Nevertheless, the net effect of trade protection is invariably higher prices to the average consumer. Consequently, the costs of trade protection are often borne disproportionately by consumers (or the average taxpayer), which clearly exhibits a loss in social welfare and frequently leads to economic injustice.

How does Bangladesh fare in terms of protection, especially tariff escalation? Figure 1 presents data on average input and output tariffs, and on tariff escalation (ratio of input tariff to output tariff) from Bangladesh and select developing economies and regions. As can be seen, Bangladesh leads the list in all three measures. While input tariff in Bangladesh is slightly higher than in South Korea and South Asia as a whole, output tariff of some 50.66per cent is some 2.5 times that of the next highest levels in Thailand (18.67per cent) and the South Asia region (18.25per cent). This low input tariff coupled with very high output tariff increases effective protection for consumer (finished) goods. In Bangladesh, the highest escalation occurs in the final stage of processing, from intermediate inputs to production of final goods. Given the 5 tariff slabs of 1-2per cent (capital goods), 5per cent (basic raw materials), 10per cent (intermediate goods), and 25per cent (final consumer goods), it can be seen that there is a big jump in the final stage of processing-from 10per cent to 25per cent. But the matter does not end there. The top rate of 25per cent on final consumer goods (FCG) is topped up with Regulatory Duty (4per cent) and Supplementary Duties, resulting in an average tariff of 50per cent on FCG. Therefore, it is no surprise that Bangladesh has the highest tariff escalation, with a value of 3.95, among the countries compared. Vietnam, Bangladesh's competitor in readymade garments with a promising leather and footwear sector, has the second highest tariff escalation at 3.11. In addition, the South Asian region has an average tariff escalation ratio of 1.76. Furthermore, Figure 2 shows that Bangladesh's tariff escalation growth towers over other developing countries in recent times suggesting that effective rates of protection have been rising over time driven by increased tariff escalation.

This high level of Bangladesh's tariff escalation has created an 'anti-export' bias, a phenomenon that has been widely discussed in academia. Many industries in the country remain protected where labour productivity remains stubbornly low. The benefits of tariff escalation on industry and employment are also unclear and the empirical evidence fails to reach a consensus on the matter. In addition, inefficient state-owned and protected industries, such as sugar in Bangladesh, languish and consumers continue to pay higher prices. This often becomes a burden on consumers, especially the poor. While import-substitution can lead to some industrialisation, the growth and productivity augmenting features of export-led industrialisation have been well documented in the economics literature. Consequently, Bangladesh must focus on gradually reducing its trade protection, especially that of finished goods imports. This, in turn, will help reduce inflation and stimulate innovation and competitiveness in industries currently enjoying protection.

Dr. Muhammad Shafiullah is a Senior Economist at Policy Research Institute (PRI). He can be reached at: mshafiullah@pri-bd.org.

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