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BUILDING RESILIENCE, SUPPORTING GROWTH

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Preparing the Domestic Private Sector for Trade Liberalization

17 February 2017

At a meeting of private sector chambers on 4th April 2016, the Minister of Development Strategies and International Trade together with senior officials of the Ministry, indicated that the Government of Sri Lanka plans to embark on an ambitious trade liberalization effort during 2016 and 2017 and is seeking ideas from the private sector on what measures can be put in place to help domestic businesses adjust to meet the challenges and opportunities of this process.  
 
While specific proposals on support measures could only be indicated once the specific scope of the liberalization exercise was informed, the Chambers were asked to submit initial ideas. To this end, the Ceylon Chamber of Commerce submitted a note on the overarching framework for consideration, as well as recommendations on specific support measures. This note is now being updated and published for wider dissemination, and to stimulate discussion, and action, on next steps. 

 

Part 1: Conceptual Considerations 

  • The following factors can be considered as ‘overarching considerations’ in the liberalization process:  
  1. Trade policy must be looked at holistically; i.e., to see imports and exports together. Imports are an essential dimension of the export agenda and one cannot be isolated from the other.
  2. Trade policy changes must consider both the producer perspective as well as the consumer perspective; in terms of the impact on choice, quality, and price for consumers as a result of trade liberalization.  
  3. Trade liberalization impacts on revenue must be considered in a dynamic framework. Trade policy changes (particularly reductions in border taxes) would no doubt have revenue impacts, and at a time when Sri Lanka’s fiscal situation is precarious, this would be a challenge. Yet, the revenue impacts of border tax reductions must be seen alongside potential revenue increases due to increases in trade volumes and overall economic growth. This calls for taking a dynamic view of trade policy reforms rather than a static one, and effectively engaging with the business community to help understand this process.
  • The government would need to consider the effect on, and support to, two types of firms. The nature of support may be very different, but some aspects could be common to both. 
  1. Firms that are likely to experience a negative fallout (at least in the immediate term) of trade liberalization and draw down of protectionism.
  2. Firms that are capable and ready to quickly take advantage of trade liberalization – by, among other factors, growing their product portfolio, expanding to new markets, accessing new technology to upgrade their products and operations, and enhancing their business. 
  • In evaluating the possible impacts of a trade liberalization effort, the government would need to consider three types of effects:
  1. Competition effects (among producers of the imported goods)
  2. Production cost effects (among firms using the imports as inputs)
  3. Productivity effects (driven both by increased competition and from access to lower-cost, higher-quality inputs)
  •  The following elements may help the government to consider the possible channels of impact, including measuring/modeling/estimating possible impacts: 
  1.  Gains from trade due to access to new imported inputs (variety) as well as lower tariffs of imported inputs: For instance, see Goldberg et al. (2010)1 for an excellent analytical framework to estimate changes in markups postliberalisation. This study is recognised as one of the best pieces of work in this area.
  2. Effect on markups (price-cost margins): Evidence from some countries has shown that costs fell faster than prices, so that in the near term producers gained more than consumers – i.e, the lower cost of inputs was not fully passed on in terms of lower prices.
  3. According to Topalova and Khandelwal (2010)2, who explored evidence in the case of India’s trade liberalization, they report the following: “Pro - competitive forces, resulting from lower tariffs on final goods, as well as access to better inputs, due to lower input tariffs, both appear to have increased firm - level productivity, with input tariffs having a larger impact . The effect was strongest in import - competing industries and industries not subject to excessive domestic regulation. While we find no evidence of a differential impact according to state level characteristics, we observe complementarities between trade liberalization and additional i ndustrial policy reforms”. 

 
Notwithstanding the obvious caveat that these findings were for the case of India (and noting the peculiarities of India’s large domestic market), they provide a useful reference point. The methodologies used in these analyses could provide useful guidance in conducting simulations for the Sri Lankan case.

 

Part 2: Recommendations on Support Measures 

In designing possible policy approaches to help with firms’ adjustment to liberalization, the government can consider the following 11 recommendations: 


 1. Formulate and articulate an adjustment strategy 

The government, in consultation with the private sector, must proactively chart out an adjustment strategy to help firms cope with liberalization and help firms take advantage of new opportunities. Such a strategy must be announced early, it must clearly articulate what the state will and will not do, and provide a rationale or framework for how the state will decide on support measures. The strategy needs to also build confidence (among private sector stakeholders) in the capacity of the state to deliver the promised support programmes, including demonstrating the allocated resources and ensuring all agencies are on-board from day one. 

 2. Institutional streamlining and pro-business orientation 

Prior to the liberalization, all line ministries and agencies that deal with businesses (either in a promotion/facilitation or regulatory capacity) and across functional areas of labour, taxation, environmental standards, quality standards, licensing, etc. should be reoriented to be more ‘industry facing’ and business friendly. In an atmosphere of flux during the liberalization process, adjustment will be tricky for firms. They may need to deal with many different government agencies and regulatory bodies. Minimizing the friction and inefficiencies in this interaction is key to avoid frustration on the part of firms, and ensure better support for firms’ survival and growth. 

 3. Tackle trade facilitation, non-tariff, and regulatory barriers early 
 
Relevant government agencies need to quickly address well-known pain-points in trade facilitation, including non-tariff barriers, customs delays, testing and standards issues, and regulatory gaps. This can help reduce transactions costs for firms, which is particularly important during an adjustment phase. For a useful overview of these issues, refer the CCC’s note released in February 2017 titled ‘Tackl ing Constraints Closer to Home: An Overview of Regulatory and Administrative Barriers faced by Sri Lankan Export and Import Traders’ . 

 4. Re-calibrate export promotion schemes 
 
Government funding and other support lines for export promotion need to be recalibrated, to ensure that they are meeting the envisaged objectives, reaching the right firms, and making the desired impact. For instance, EDB support on trade fairs and exhibitions can be reoriented to provide grants for SMEs to go to self-selected fairs/exhibitions. Export promotion funds can be allocated better or streamlined to support foreign market development/market exploration.  

 5. Special financing facilities 
 
Make available specialised and dedicated funding lines/loans schemes from the banking sector to support the adjustment. This means that, for firms impacted by the liberalization, special lines of credit be available to help with restructuring. This also applies for firms able to take advantage of liberalization, to enable special loan schemes to help them re-invest, embark on new projects, access technology, and expand their business. 

 6. Industrial estate utilization 
 
Make better utilization of existing (and underutilized) industrial parks and estates to help affected firms (small, import-substitution firms) relocate to better facilities. This can be coupled with assistance on technology upgrading as well as modernizing of facilities in existing industrial estates based on a priority needs assessment. 

 7. Enable technology upgrading 
 
Improving access to technology and technology absorption can help firms become resilient and also take advantage of new opportunities brought on by liberalization. Initiatives like a technology voucher scheme, collaborative grants programme, and technology linking scheme (linking businesses to technology solutions in universities and public research institutes), can be introduced to help firms upgrade and invest in product and process innovation to both face new competition (from lower-tariff imports) and also expand overseas with new competitive products. 

8. Bridge market information gaps 
 
Firms can gain from knowing more about new market opportunities at home or abroad - they can be helped by reducing the cost of market information and intelligence The EDB, Department of Commerce, and Sri Lankan diplomatic missions abroad, can help bridge foreign market information gaps, which are often a quasi-public good and costly for individual firms to bear, as well as partially or fully fund market exploratory studies. 

 9. Help firms go digital 
 
Assisting more firms to get online (to find buyers and suppliers), and leverage on digital technologies like e-commerce, can substantially cut search costs and grow new businesses. The ICTA can launch a special programme that builds capabilities among entrepreneurs to use these tools. 

 10. Reform labour market constraints 
 
Introduce measures to make labour markets more flexible to allow workers to adjust to structural and sectoral changes in the economy that would come alongside trade liberalization. 

  • To assist workers move to new sectors, there needs to be supportive job search and job re-training programmes.
  • Regulatory rigidities in labour market regulations that prevent the efficient re-allocation of labour between sectors that lose and sectors that gain should be addressed, while of course considering social safety nets.  

 11. Provide specialised SME support 
 
There would need to be a special scheme catering to smaller firms, as their needs and capabilities may be different. Given that 93% of all industrial establishments are ‘microenterprises’ (fewer than 5 employees) and over 61% of export firms have less than 25 employees (albeit contributing less than 1% of export value), it is important to consider these groups for targeted programmes, given the catalytic impacts SMEs have on poverty, employment and inclusive growth. 
 
 

 

The Ceylon Chamber of Commerce

Economic Intelligence Unit

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