1. Export Competitiveness: The Incentive Framework Paul Brenton International Trade Department World Bank April 2008

2. Outline Why the incentive framework matters Tariffs and resource allocation Tariffs and revenues Tariffs, employment and adjustment Looking at overseas markets Tax and labour policies Tools and Data

3. Incentive framework: key issues Do tariff, tax and labor laws –Encourage investment to serve the domestic market over exports? –Favour large firms over small firms? –Support old firms/sectors over new activities? –Encourage investment in capital over investment in people? –Discourage foreign investment relative to domestic investment (or vice versa)? Incentives - introduction

4. The Real Exchange Rate Concerns with unstable and over-valued ER –But how to identify over-valuation - different methodologies RER depends on many factors Capital inflows for investment, remittances, aid flows etc Productivity growth in response to reforms Tradables –> appreciation Non-traded -> depreciation Policies that are good for the economy will tend to reinforce real depreciation –Improve productivity in key non-traded sectors (transport, telecoms, energy) –Further trade liberalization –Gradually shift in reliance for macro management to fiscal policy Incentives - introduction

5. The pros and cons of keeping substantial trade protection The case for trade protection –In many low income countries tariffs are a major source of revenue –Protected sectors provide an important source of income for the poor –Particular industries need time to adjust to globalisation –Resources in these sensitive sectors face particularly high costs of adjustment with potentially important impacts on poverty Costs of maintaining protection –Anti-export bias, raises cost of intermediates –resources stuck in low productivity activities – could be earning higher returns in expanding export and efficient import competing sectors –Limits investments by firms and workers to become more productive –Impact on customs resources and reform – delays dealing with NTBs –Impact on poverty – protected products may form a high share of the consumption bundle of the poor –Risk of trade diversion – most countries are party to regional and/or bilateral preferential trade agreements Incentives - introduction

6. Tariffs and protection Issues –Does the structure and level of tariffs entail a bias against exports? –Is the tariff schedule complex and difficult for customs to apply? Indicators –Average tariff relative to countries with strong growth Weighted/unweighted, MFN, Statutory, applied –Dispersion and complexity of tariffs Escalation, Effective protection, Non-ad valorem duties –OTRI Tariffs and resource allocation

7. Example: Kenya has reduced its tariffs …but its average tariff is still above the fast-growing economies Source: Bank staff calculations, based on UNCTAD TRAINS 12 of 16 Fast growing economies; does not include India, Botswana, Burkina Faso and Cambodia due to data limitations Fast growing economies Simple average tariff [%] Kenya Tariffs and resource allocation

8. Example:Tanzania still has a relatively large number of tariff peaks Tariffs and resource allocation

9. Example: Effective rates of protection vary significantly across sectors in Morocco Tariffs and resource allocation

10. Need to look at revenues from trade: exemptions, VAT and excises matter - an example from Mauritius Tariffs and revenues

11. Sources of Tariff and Customs Data Tariff schedules –Government –WITS Summary information and indicators –WTI –ITC MacMap –World Tariff Profiles –WTO Trade Policy Reviews –IMF reports (aggregate customs collections) Customs/Revenue Authority

12. Tariffs, employment and adjustment How much employment are tariffs protecting? –The cost per job protected The adjustment implications of tariff reform –Will adjustment be concentrated in particular sectors, particular groups of workers…? Measures to ease adjustment –Support for enterprise restructuring and skill upgrading within sectors –Training and social safety for workers moving to new sectors and occupations Tariffs, employment and adjustment

13. Example: Mauritius - Tariffs and employment Employment 199 0? 9509 3361 1093 3123 98 1040 47443 2543 286 2133 0? 0? 0? 0? 217 8024 Tariff rate Of 57 manufacturing sectors, only 17 sectors have protection of an average tariff of greater than 10 per cent. The average tariff for 24 sectors is less than 1 percent. For 8 sectors the average tariff lies between 1 and 5 per cent. Tariffs, employment and adjustment

14. In some sectors, the annual cost of protection exceeds the (one-off) costs of retraining labour Estimated cost of re- training a worker 1,704 529 960 2,352 89 375 221 283 10,260 45,493 employment Graph shows the ten sectors With the highest deadweight losses from protection Tariffs, employment and adjustment

15. Example: In Mauritius, moving to a “duty free island” would displace a small number of workers, but a few sectors would suffer -10.1 -20.6-17.5-34.7 Share of sector employment Share of industrial employment 2005 Male Female Estimated change in industrial employment from removing all duties -3.4 -63.9 Tariffs, employment and adjustment

16. male female Based on regression results on Household Budget Survey 2006/7 data, controlling for age and education of worker. Shows ratio of average wage for women in sector relative to that for women in EPZ manufacturing Displaced workers may end up in sectors with higher wages Tariffs, employment and adjustment

17. Sources of Data Employment/Output –National industrial census –Continuous surveys –UNIDO Wages/Incomes by sector –National labour statistics –Household budget surveys Unemployment –By duration, type of worker, previous sector of employment etc (good luck!) Tariffs, employment and adjustment

18. Overseas markets matter! Market access conditions –Applied tariffs in overseas markets –Export OTRI –Preferences and rules of origin Measuring success in reaching overseas markets –Index of export market penetration

19. Opportunities to aggressively pursue improved access to overseas markets…… Overseas markets matter

20. One way to expand exports is to reach new geographic markets with existing products… and often it has barely scratched the surface of its potential Export Market Penetration Ratio –Compares actual number of bilateral flows with potential number –Potential markets are those that import the products exported by the country concerned –Example: Madagascar exported 705 products in 2004 There were 66873 potential markets for these products The actual number of trade flows was 2450 Hence the export market penetration ratio was 3.7% For Taiwan the ratio was 32.8%, for S. Africa 16.7% Overseas markets matter

21. Enormous potential for developing countries to reach new geographic markets with existing products… Overseas markets matter

22. Albania reaches relatively few export markets for the products it exports….. Overseas markets matter

23. …while Romania reaches more markets for the products exported by Albania Overseas markets matter

24. Sources of Data Foreign Market Access (foreign tariffs) –WITS (UNCTAD and WTO data) –Global Monitoring Report (Market Access OTRI) –ITC MacMap –WTI Foreign Market Penetration –Compute using UN Comtrade data WITS Overseas markets matter

25. Tax and labour policies Investment incentives may – favor large firms over small – favor investment in capital over labor – may cost a lot for marginal additional investment Restrictions on foreign investment – minimum capital requirements, high fees for work permits, discretionary approval process can – discourage investment in small enterprise – discourage investment in services – and limits transfers of technology and know-how as well as access to foreign markets and production chains… Labour market flexibility is important to allow resources to move to more efficient firms and sectors –adjustment costs lower where labour markets more flexible (Bacchetta and Janson)

26. Source: World Bank staff and Sosa (2006) Marginal Effective Tax Rates on Capital Corporate tax policy makes capital cheaper than labor and renders incentives powerless Corporate tax policy makes capital cheaper than labor and renders incentives powerless Incentives: taxes

27. Source: Sosa (2006) Incentives are dominated by tax holidays, but discretion entails substantial distortions…. and a bias against SMEs Incentives are dominated by tax holidays, but discretion entails substantial distortions…. and a bias against SMEs METR without tax holidays METR with tax holidays Incentives: taxes

28. Source: World Bank Tax policy makes capital cheaper than labor and renders incentives powerless… with no apparent rationale Tax policy makes capital cheaper than labor and renders incentives powerless… with no apparent rationale METR without incentives METR with incentives Incentives: taxes

29. Sources of Data Marginal Effective Tax Rate –FIAS (Rich Stern) Investment Incentives –Government authorities –FIAS reports FDI stocks and flows –ITC Investment Map Incentives: taxes

30. Tools TRIST –Use trade and revenue (and production?) data collected by government to evaluate tax and tariff reforms MARTASIM –More sophisticated with computation of effective rates of protection WITS –Retrieve and analyze data on trade flows –Retrieve and analyze tariff schedules

31. TRIST TRIST: A single Excel file containing all data, tariff reform definitions and a simple partial equilibrium model of importing CUSTOMS: Data on imports and tariff, excise and VAT revenue by product and trading partner NATIONAL STATISTICS: Data on domestic output and employment by sector USER: Definition of tariff reform scenarios RESULTS: Imports by product and trading partner Tariff, excise and VAT revenue by product and trading partner Applied tariff rate and price changes by sector Domestic output and employment by sector Tools: TRIST

32. What TRIST offers Results based on ACTUAL import and revenue data -> Use applied tariff rates so we can take into account tariff exemptions at product and partner level and easily account for non-ad valorem tariffs partner level and easily account for non-ad valorem tariffs Answers a range of policy relevant questions -> include VAT and excise tax losses to calculate total fiscal impact -> report results at tariff line level for each trading partner -> reports changes in imports and protection (and domestic output and employment subject to data availability) at sector level (eg. to identify sensitive sectors) Is flexible enough to respond to changes in trade policy scenarios and required analysis -> Any trade policy scenario can be incorporated and results are available immediately -> extensions can be added to respond to ad-hoc questions: Eg. Protection at GTAP level (Nigeria) Is transparent and allows for the incorporation of local knowledge -> TRIST is set up in excel, all formulas and steps taken are visible for user -> flexibility to incorporate local knowledge (eg. elasticities) -> Simple and intuitive modeling and assumptions -> Allows for ongoing stake holder dialogue to improve according to clients’ needs Tools: TRIST

33. WITS / SMART TRIST Data source UNCTAD TRAINS National customs authorities (collection can be cumbersome) Tariff revenue data Calculated as tariff rate x import value -> no exemptions taken into account, problem with non-ad valorem tariffs As collected by customs VAT and excise revenue No As collected by customs Software WITS browser -> installation and access to server is required Excel spreadsheet, all formulas can be viewed and modified by user Domestic Production No Domestic output data by sector, assuming constant ratio between imports and domestic production for products within the same sector CoverageWorldCountry-specific Results Imports, welfare, tariff revenue by HS6 (sometimes HS8) digit product and partner Imports and tariff, excise and VAT revenue at tariff line level and by partner, output and employment Tools: TRIST