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INVITATION TO A DIALOGUE

Industrialisation and the policy of import liberalisation

by Abdur Ran
Professor Rehman Sobhan who commands considerable respect tn academic and official circles (and for whom I have high personal respect) has written on the above subject tn this daily published tn its Issue of November 27, 1992 questioning the wisdom of the World Bank-supported policy of import liberalisation being currently implemented in Bangladesh.
Citing examples of 'Certain developing countries such as Pakistan. India, Brazil. Mexico and even South Korea and Taiwan, where, he observes, significant opening of the protected domestic market to foreign competition did not occur before manufacturing to GDP ratio became more than 15 to 16 per cent, or mostly more than 20 per cent, he opines that in Bangladesh where the manufacturing share in GDP is below these figures, the policy of import liberalisation is premature.
He argues that In this initial phase a restrictive import policy, regime which guarantees a home market sheltered from foreign competition is necessary for creating conditions such as reinvcstible profits and a first generation of entrepreneurs. He. of course, at the same time advocates vigorous export promotion to be mounted along with protective Import-substitution trade policy.
In the article. Professor Sobhan has also made certain observations or cites certain research findings which either contradict or at best weaken his thesis. This, of course, speaks of his magnanimous approach to problems and his readiness to listen to or consider the opposite views/ ideas or research findings.
It hardly needs mentioning that I belong to the opposite camp. As a firm believer In liberalisation policies and having been long associated with the government's Trade and Industrial Policy Reform Programme (TIP) project, I thought that I write here a few lines putting up the case for Import liberalisation.
Case against Restrictive Import Policy
First the general theoretical case against the protective import policy regime. Professor Sobhan thinks that the 'simplistic' policy of import liberalisation has been exposed to theoretical challenge. This ostensible challenge, I think, has been effectively met.
Over last a decade and a half, a considerable body of economic literature has been devoted to this topic propounding the case for liberalising policies which are equated with an export-oriented strategy of development. (Reference in particular can be made to studies made by Jagdish Bbogwati, Ramaswami. Anne Krtjeger, Bela Balassa and Associates and the Kiel Institute of World Economics led by Juergon Dongea. The theoretical case has been backed up by extensive empir-ical studies involving ten coun-tries tn one case, fourteen countries in another caae and fifteen countries in still an-"Hvw c"""' The following are
the general arguments for this strategy and against the protective trade policy favouring Import-substitution strategy.
First, a protective trade policy regime Is essentially a major source of bt»s against export production. Whatever Export promotion measures are grafted on to this regime, export production basically remains grossly discriminated against simply because It receives from the policy regime too little of what economists call effective protection' compared to the level of effective protection received by domestic market-based products.
It is found that tt is th; trade policy-created effective protection or assistance which remains the most Important and often the most relevant incentive that industries generally receive. (Note that investors' may not be very interested in generous tax Incentives since such incentives would matter only when pretax rates of return are sufficiently attractive.)
Thus vigorous export promotion is simply inconsistent with and cannot go along with restrictive import policy favouring Import substitution.
Second, protective trade policy violates the principle of comparative advantage and encourages resources to be Invested In economically less viable or even In economically unviable activities. Therefore, a trade policy that confers different rates of effective protection on different Industries is basically unsound, unethical, and detrimental to promotion of most productive or hlgh-growth industries.
Third, protection often leads to over-capacity expansion in particular industries.
Fourth, protection leads to establishment of high-cost Industries in a limited market situation where economies of scale cannot be fully exploited by production expansion due to market limitation. Losses of such scale economies are found to be significant especially after the first easy stage of Import substitution is passed.
Fifth, protection encourages the establishment of capital-intensive activities and is detrl-ipental to the growth of generally small employment-creating activities.
Sixth, by limiting competition. protection provides no Incentives for operational efficiency and technological Improvement.
Seventh, by increasing the cost of imports or replacing Imports with higher-cost domestic production, protective measures Increase the cost of ' domestic production, which retards general growth and particularly hurts export production and Inhibits backward linkages from export production.
Eighth, by encouraging relatively less efficient (cost effective) production activities, protective policy results In less
than potentially achievable growth with the same amount of resources.
Ninth, protection often leads to creation of largesize industries capable of exercising monopolistic market power, which In turn leads to further economic waste and inefficiency.
Tenth, a restrictive import -substitution policy is also found to be associated with less national saving and investment levels than an outward-oriented policy. This further impedes dynamic growth prospects.
Eleventh, such a policy also encourages inequitable income distribution since export orientation has been found not only to create more employment but also to raise their real wage levels.
Twelfth, export orientation helps casing of foreign ex change scarcity and by so doing it often eases an important
The general anti-export bias is the most serious form of distortion created by the existing import policy regime. Even a currency devaluation cannot correct it since devaluation equally benefits both export and import- substitution industries. Other practicable measures usually used to promote exports remain grossly inadequate.
constraint on development.
Thirteenth, the limited size of the domestic market often poses a major constraint for rapid growth under a restrictive Import-substitution strategy. Furthermore, outward -orientation has been found to help encourage direct foreign Investment as well as greater inflow of multilateral and bilateral aid.
' I hope, by now, this list is weighty and compelling enough to convince one of the appropriateness of import liberalisation policy as a tool for promoting rapid industrialisation. employment growth and equitable income distribution.
Having said all this, economists, however, concede that a reasonable amount of protection Is acceptable on infant Industry grounds and for reasons of externalities. This argument, however, applies equally to both Import- substi-
tution and export-oriented industries. It is not an argument for a restrictive import policy only to protect import-substitution industries.
What Price Protection?
The adverse effects of protection such as those arising due to misallocation of resources In less productive activities, operation of plants at sub-optimal levels due tp limited market (If scale economies cannot be exploited fully), fneffiqient operation of industries due to lack of competition (i.e., exercise of monopoly power), etc, contribute to what is called ’cost of protection' in terms of foregone output or Income and economic growth.
Researchers have attempted to make quantitative
estimates of the cost of protection tn countries that continue^ with import substitution in the second stage (t,e.,ftcr.:lhe first easy stage of Import substitution and when domestic market saturation problems start appearing). Such estimates. however, usually measure coSts due to static allocation inefficiency and do not cover potential dynamic gains from efficient resource allocation. Sometimes, these estimates also do not capture inefficiencies associated with monopolistic practices.
These caveats notwithstanding. estimates made of such costs of protection for some developing countries in percentage of GNP arc Brazil (1966): 7.1 per cent, Chile (1961): 6.2 per cent. Turkey (before 1966): seven per cent (reported in Bela Balassa and Associates, Development
Strategics in Semi-industrial Economics. 1982).
Further estimates of 11 per cent to 15.8 per cent of GNP in 1970 depending on whether surplus labour was employed are reported in the same publication for Colombia. Estimates for Brazil (9.5 per cent in 1966); Chile (6.2 per cent tn 1962); Pakistan (6.2 per cent In 1963-64) and the Philippines (3.7 per cent in 1965) are reported In Bela Balassa and Associates' The Structure of Protection in Developing Countries, 1971.
These estimates suggest that the cost of protection can be quite substantial. Famous trade economist Harry Johnson has shown that the cost of. protection rises more than proportionately with the rate of the tariff. Another economist J Nugent has confirmed Johnson's results and further shown that the disper-
sion of tariffs and the cost of Erotcction are positively corre-tted. It can be presumed that the cost of protection is quite substantial in the current stage of Bangladesh's industrial development.
Other Pointe
Let me now turn to other points. Professor Sobhan advo cates continuation of a controlled import policy regime preferably with import bans for the current phase of industrialisation in Bangladesh to generate more of relnvestible profits, and a class of entrepreneurs. I doubt if this contention is valid for the current stage of Bangladesh's development. Since this polity, has been followed for so many years and in the last decade ■with much of industrial activity
transferred to the private sector, one can raise the question for how longer should such a policy regime be continued for phoducing Professor Sohhan*i’' first round of industrialisation?
One might well point out that the first round Was already occurred as the signs of market saturation are already there with many domestic market based industries not being able to expand or having turned sick because of either market limitation or because of high-cost nature of the activities or for technological decadence or for a combination of such reasons.
The market saturation situation should In fact occur earlier in Bangladesh than in Pakistan or India because of the smaller size of the market due to specially low levels of income and purchasing power among the consumers here.
Hence, the contention that import-substitution strategy would work in all countries at the same manufacturlng/GDP ratio level is not tenable. Even business circles have started realising that future industrialisation prospects in Bangladesh lie not in importsubstitution activities but in export activities.
I think the current real policy issue for Bangladesh is not whether to go in for import liberalisation reform, but the speed at which this reform should be implemented. A phased and gradual programme of import-liberalisation reform was launched since the mid-eighties with World Bank support only after detailed studies of trade and industrial policies with particular focus on effective protection analysis for numerous industry sub-scctors had been carried out over a period of
several years in a Government's Trade and Industrial Polley Reform Programme (TIP) project. The World Bank supported programme of import liberalisation (including tariff reform) being pursued currently is in fact much more gradual than was recommended by TIP.
Some of the findings of TIP studies on the effects of the controlled Import policy regime are worth nbting here. First is the gross anti-export bias of the policy regime. The studies showed that while import-substitution industries received in general a high average level of effective protec tion, in most cases above 100 per cent export industries in general except readymade garments received near-zero or even neirsilve effective om
tection.
Second, a wide dispersion of effective protection levels received even among import -substitution industries was ob
levels ^effective protection to different industries is anomalous. This followed from the wide range of existing nominal tariffs used as well as from the use of direct quantitative restrictions on imports including outright import bans.
Third, a number of industry cases were found (e.g., production of basic steel products, synthetic yarn, silk yarn, certain chemical products, etc) which were net losers of foreign exchange (i.e., they saved or earned less foreign exchange than they incurred In the use of direct and indirect tradeable inputs). This was precisely the outcome of the use of very high protection in the form of import bans or
high tariffs.
Fourth, it was found that many domestic market-based industries incurred high Domestic Resource Costs (DRCs) per unit of output, which meant high economic inefficiency of the industries and which resulted from the general high level of protection being provided by the existing highly restrictive import policy regime.
Irr the event of these research. findings of TIP studies which Professor Sobhan is aware of, I do not know why he should still insist on and advocate the continuation of the same policy regime.
The general anti-export bias is the most serious form of distortion created by the existing import policy regime. Even a currency devaluation cannot correct It since devaluation equally benefits both export and import- substitution indus-
tries. Other practicable measures usually used to promote exports remain grossly inadequate. Furthermore, export industries. especially small enterprises among them, are hurt because they are not always able to get full duty-free access to imported inputs and because they often have to use protected high-cost domestic Inputs. Also, the existing policy discourages the domestic producers. to sell to export industries since thy domestic protected market offers better prices for such goods than the export industries.
It is ironic that while in Indonesia readymade garments produced for export mostly use domestically produced fabrics. tn Bangladesh only two to three per cent of the use of fabrics in readvmadr garments
can be taken from domestic producers. It Is clearly the outcome of the existing trade policy regime which unduly protects production for the domestic market. So Professor Sobhan a contention that a vigorous export promotion drive with development ol backward linkages can go along with a restrictive import policy regime docs not hold.
It is also necessary lo appreciate the nature of the import policy liberalisation that the ongoing programme attempts to accomplish in Bangladesh. It envisages (a) phased removal of all direct controls on Imports except those which can be retained on non-trade grounds of public safety, security, health, religion or social considerations, (b) phased moderation of the high protective tariffs to a maximum of about 30 per cent by the FY 1994-95 or 1995 96, (c) conversion of high tariffs ' on luxury goods by adjusting protective tariffs and using supplementary excise duties, (d) compression of the wide range of tariffs to a small number of rates and upgradation of the too low and zero tariff rates lo a minimum 7.5 per cent (with a few exceptions), and (c) elimination of all user-related trade restrictions and tariff distinctions and removal of all disttnettons between similar products (at HS 4 -digit 'cvfi^can be seen that this trade policy reform would bring about very desirable changes since these would minimise the wide disparities In effective protection being provided by the existing policy regime. This reform would still retain a considerable amount of effective protection for import- substitution industries. Furthermore, this trade policy reform is being supported In part by flexible exchange rate management, exchange rate devaluation which also serves lo protect both import-substi tutiori and export industries. I Ie nee the hue and cry raised about the Import liberalisation measures being undertaken is ^tt^bhan himself has mentioned in his article that there is not enough empirical evidence lo suggest that trade liberalisation measures so far undertaken (reduction in QRs and tariffs) has hurt particular industries. Of course, some Industries which are too inefficient cap be hurt ih the process. But we need not be concerned about It. This is precisely the way we want to see the industrialisation pro cess proceed, stpee this way rfiore efficient Industries would be promoted and more rapid growth ensured.
One glaring example of the beneficial effects of import liberalisation. as analysed In a recent textile sector study, Is the opening of the imports of lex-tile yarn and lowering of Its tariff The Industry has not closed down, rather this part of the textile Industry Is
showing relatively buoyant private sector activity in the face of wide-seak- smuggling.
The other part, fabric industry. which Is almost com plctcly insulated from competition with direct imports (but not from competition with smuggled fabrics or with leaked fabrics from garments sector), is In a very poor shape. So how is restrictive import policy helping our industries? Irt »«!(. restrictive import policy has become counterproductive because It encourages smuggling and It deprives the government of the.customs and other tax revenue It would have earned on legal imports. By limiting healthy competition. restrictive import policy has only encouraged industries lo operate at low efficiency levels and discouraged technological improvements and new
Sobhan has cited South Korea and Taiwan as oountrics where export-oricn-latlon has gone along with restrictive import policies. I -am not quite sure if this observation Is really correct. These are the countries which are well known lo have used moderate tariffs on imports from an early stage. The policy of providing duty-free access to imported inputs for export Industries was very successfully implemented in South Korea. As a matter of fact, tt was the outward-looking policies of South Korea which made It develop at a rapid rate, while India which was at a higher level of development in probably the sixties fell far behind South Korea because of Its Inward-looking policies. India has lately lamented these early Eolicics and Is now going cadlong with liberalisation policies.
Liberalisation policies are being pursued by many developing countries. Some of Bangladesh's neighbouring countries are experiencing higher growth because of more intensified liberalisation policies. Thailand and Malaysia are experiencing industrial booms and are promising soon to join the group of Asian newly industrialising countries (NICs). Even India, Pakistan and Shri Lanka are going ahead of Bangladesh. China, a socialist country, is showing extraordinarily high growth because of its liberalisation policies. Even a country like Vietnam, another socialist country and a war-shattered economy, which was perhaps at a more backward industrial stage than Bangladesh, has been able to attract a lot of foreign Investment and has made consider able headway in export expansion in recent years because of Its more open policies.
Bangladesh has immense promise for development but It Is lagging behind other countries. Both domestic and for-, eign private investment continues to remain sluggish here. There would probably be no surer way for Bangladesh to lose out lo other countries in the race for development than not lo push ahead fast with lib eralisatlon policies.
The author Is currently working with an USAID liberal Italian policy Implementation and analgtlt prefect.