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The state of trade liberalisation in Bangladesh


Published: Tuesday, Oct 25, 2016


Posted : 25 Oct, 2016 00:00:00



The state of trade liberalisation in Bangladesh

Muhammad Mahmood

Bangladesh at its independence followed a state interventionist economic policy with a highly protectionist trade regime with an extensive list of import restrictions. Since the 1980s a large number of developing countries liberalised their trade regime. Bangladesh was one of them.

The reason for trade liberalisation among developing countries differs from country to country. In the case of Bangladesh, the trade liberalisation process which started in the 1980s, deepened in the 1990s and thereafter, egged on by the Bretton Woods institutions, World Bank and the International Monetary Fund (IMF).

By the very early 1980s the economic situation was dire. Continued poor performance of the economy as reflected in sluggish gross domestic product (GDP) growth and deteriorating current account balances forced some rethinking of economic policies. The situation was further exacerbated by reduced flows of foreign aid.

The government came increasingly under pressure particularly from the World Bank (WB) and the IMF and other foreign aid donors to institute economic reforms to lift economic performance which was extremely unsatisfactory by all criteria of macroeconomic performance evaluation. A more fundamental issue surrounding the trade liberalisation process was the issue of poverty reduction.

In most cases the reason for trade liberalisation is to expand production and export base, in particular for manufactures which accounted for 66 pent of world trade in merchandise. A liberal trade regime, it was hypothesised, would expand the production and export base by reducing the distortions in relative prices which will enable the country to direct its scarce resources to most productive sectors of the economy thereby stimulating economic growth which in turn will also create an enabling environment to reduce poverty.

In this context, manufacturing is of great importance to policy makers because a sound manufacturing base provides the country with more flexibility in trade as manufactures face far less barriers in trade than primary goods. However, to create a competitive manufacturing base behind a protection wall will put the industry at a competitive disadvantage as protection increases profitability of import substitutes relative to exports and/or raises input costs. This is described as an absolute bias against exports. Thus, only a liberal trade regime can help a country to achieve international competitiveness.   

Trade policy reform with a view to liberalising the trade regime in Bangladesh is possibly the most significant economic reform measure that has so far been undertaken in the country since its independence. A liberal trade regime is not necessarily a free trade regime. There is no general  consensus on what really constitutes trade liberalisation unlike free trade where there exists a body of theoretical frameworks that define free trade.

Therefore, trade liberalisation can be viewed in a number of ways. These include (i) reductions in anti-export bias by moving towards equalising incentives between the exporting and import competing sectors (i.e. tariffs can be reduced or offset by subsidies); (ii) reducing the level of government intervention in all forms. This may include removal or reduction in import restrictions, tariff and non-tariff barriers; subsidies etc. and (III) replacing one more distorting instrument of intervention by a less distorting one where quotas are replaced by tariffs.

Any of these measures can lead to a more open trade regime relative to a previous one with high levels of state intervention in trade.  More importantly a liberal trade regime tends to be neutral between production for exports and  the domestic market. Export prices should reflect the combined impact of world prices and scarcity of domestic inputs.

The trade policy reform measures in Bangladesh included reduction and rationalisation of tariff and import taxes, simplification and streamlining of administrative procedures, gradual elimination of import prohibitions and other quantitative restrictions but with a local touch. This local touch is  visibly demonstrated  through removal  of certain regulations and taxes   quite often replaced   by the introduction of a new set of regulations and taxes under different names and different contexts.  The end result quite often could be just maintaining status quo.

Average protective tariffs have been reduced from 73 per cent in fiscal year (FY) 1991-92 to 25.6 per cent in FY 2014-15. This fall in average tariff could have led to reductions in effective rates of tariffs, but it did not. Resistance to dismantling of protection regime grew too strong by the mid-1990s such that input tariffs started falling faster than output tariffs.

Differential rates of tariff still exist not only on the basis of broad classifications but also for a wide range of products within those broad classifications, ranging from zero tariff for food grains to 85 per cent for several protected consumer goods (e.g. textiles, footwear, ceramics, agro-processed products).

Bangladesh also uses tariff escalation based on the degree of processing. This involves higher the level of processing, higher the level of tariffs. This means final consumer goods attract the highest levels of tariff. This situation is further compounded by the imposition of a number of other taxes and duties on imports which can be broadly described as para tariffs (e.g. supplementary duties). For FY2016-17, average protective tariffs, according to Policy Research Institute (PRI) research, are as follows:  45.2% for final consumer goods, 15.4% for intermediate goods, 13.4% for basic raw materials and 9.2% for capital goods.

With protective import quotas gone, import tariff remains the principal instrument of trade policy in Bangladesh, thus becoming the major impediment to competition with the consequent distorted resource allocation. In certain cases government approvals are needed to import specific goods and this is tantamount to import licensing which was abolished quite some time ago.  Also all importers are required to register with appropriate authority. This causes transaction costs to rise given the lengthy bureaucratic process involved.  

Further distortion in resource allocation has been introduced with export incentives given to selected manufacturing industries. But the export incentive program implementation process is complex and non-transparent thus compromising the whole process. Overall, the result is the erosion of competitiveness through increased transaction costs.

Any country that followed tariff escalation as a policy option has failed to develop either a competitive manufacturing industry or to solve current account deficits. The ultimate price for such protection is always borne by domestic consumers and export-oriented industries. There are a variety of channels through which tariffs can act as a tax on exports. For example, one important channel through which import tariffs negatively impact on exports is by altering the prices of primary factor inputs -- wages and cost of capital. Such distortions clearly affects a country's ability to export.

In many instances goods that attract such tariffs have no domestic import competitors. Therefore, one can presume that this is primarily a revenue-raising exercise adding another layer of consumption tax which remains the principal source of government revenue in Bangladesh. Where such tariffs are directed to protect domestic manufacturing, it can lead to internal terms of trade between manufacturing and agriculture to turn against agriculture causing resources to flow out of agriculture into manufacturing.  Such a resource transfer violates move towards a neutral trade regime as such can be considered as reversal of trade liberalisation.

Overall the trade liberalisation process in Bangladesh appears to exemplify a situation where a driver is simultaneously using the accelerator and the brake to drive a car with devastating consequences for the vehicle.

Implicit in the World Trade Organisation (WTO) principles is that trade should take place on the basis of comparative advantage; but government interventions limit the extent to which trade can take place within the framework of comparative advantage. It is true that Bangladesh has made strides in liberalising trade to enable the country to find its competitive niche in the global market.

However, there still remains significant regulatory controls, a wide range of import duties and taxes, administrative discretions which further add to complexity and uncertainty.  When regulatory enforcement and administrative discretions are exercised by inefficient and corrupt bureaucracy, that can only lead to hinder exports.

Macroeconomic policies to maintain low inflation and a competitive exchange rate regime will allow Bangladesh to trade on its comparative advantage. Comparative advantage does not remain anchored over time; rather, it evolves overtime with changes in resource endowment and technological advances.  That evolution can only take place if the country embraces open economic engagement with the rest of the world. Therefore, trade and exchange rate liberalisation are important steps towards creating a competitive economy to achieve faster and durable economic growth.

Almost all economists agree that when countries trade, the real incomes are generally raised. That does not imply that everyone will win from trade, but only that net gain will be positive for trading nations.   So it is important that winners or the government compensatethe losers, in which case all will come out ahead. This can be done through minimum wage legislations, transfer payments and public investment in reskilling and skilling the workforce which will enable the country to achieve increased productivity and sustained economic growth.

To conclude, the agenda of trade liberalisation in Bangladesh is far from complete and continues to undermine the country's ability to trade on its comparative advantage in labour-intensive manufactures. Consequently, the economy's full potential for further export expansion and export diversification remains under-utilised.

Dr. Mahmood is a Senior Fellow of the Policy Research Institute of Bangladesh. He can be reached at Muhammad.mahmood47@gmail.com