The Government plans to adopt a New Trade Policy (NTP) considering recent developments. The development of the NTP is taking place amidst the devastating economic contagion that the Covid-19 pandemic has inflicted on Sri Lanka, resulting in a dramatic collapse of trade and income.
The recovery of Sri Lanka’s largest trading partners in the West is likely to be prolonged, given the efforts to contain the still reverberating health crisis. Making the international market work for Sri Lanka’s development in this context is a daunting challenge. It is incumbent upon the Government to ask some critical questions in re-visiting the orientation of Sri Lanka’s trade policy and how it can optimally contribute to the Government’s short-term Covid-19 recovery plan and its longer-term development objectives.
Development objectives
Before determining the direction of the NTP, it will be critical to clearly define the specific development objectives that the policy plans to achieve — whether an increased rate of economic growth, broader-based and more inclusive growth, greater or more diverse productive capacity, value-added through knowledge and human capital inputs versus value-added through replacement of imported inputs, an export-led versus an import-substituting orientation, and or other non-economic objectives such as national security, environmental sustainability, and promotion of health.
The Government’s ‘Vistas of Prosperity and Splendor’ poses a broad set of economic development objectives to propel economic growth. As a corollary, to promote the Government’s growth objectives, the design of the NTP should also take into consideration the extent to which it should exploit Sri Lanka’s established comparative advantages to cement its market share at home and abroad or incentivise investments in the development of new advantages.
While trade policy can contribute, in different ways, to this multifaceted set of development objectives, one set of policies can likely have, simultaneously, a positive impact in one area and a negative in another area, e.g. promoting competitive exports versus building domestic capacity to replace reliance on imports.
The design of the NTP should also consider the extent to which trade policy itself should directly contribute to more inclusive growth (and therefore the redistribution of wealth) versus allowing trade policy to maximise overall wealth with a reliance on other policies to redistribute wealth after the fact. Striking the right balance, through trade policy and complementary measures, will be critical to make simultaneous progress towards these objectives.
In practice, Sri Lanka is not alone in needing to balance what can be, in practice, a divergent set of development objectives. There is no shortage of evidence formally (empirically) and informally, including our historical performance, on how different approaches have or have not yielded the desired set of outcomes, have forced different trade-offs in terms of outcomes, and or could have been better served by other means.
How can trade policy affect development objectives and what other policy tools may be necessary to achieve impact?
The Government has a broad range of policy levers at its disposal that can be used to meet its development objectives, from tariffs policy, industrial policy, exchange rate policy, subsidies, trade agreements and labour policies.
In some cases, a different set of policies may be most appropriate to achieve the desired outcomes. In other cases, complementary policy tools may be required to realise the benefits. For example, fiscal incentives may be used to promote investment in the production of higher value-added products.
The selection of policy level
These incentives alone may be insufficient if the labour skills needed are scarce. Therefore, additional labour market policies to incentivise workers to gain new skills and or investments in education and training to increase opportunities for skills development may be neededrs should also recognise that each has potential for different spillover effects--intended or unintended, direct or indirect--on different parts of the economy, such as government revenue impacts (that, in turn, affect public spending), household income, and consumption, environmental impacts, and/or the allocation of productive resources (labour and investment).
The allocation of productive resources will ultimately shape the types and value-added of goods and services that are produced in Sri Lanka, and the level of value-addition, the demand for different types and levels of labour skills. Careful consideration of the costs and benefits of each tool should be undertaken to balance the benefits -- in terms of intended contributions to development objectives -- against the costs to other parts of the economy, which may outweigh the expected benefits. For example, while there is enthusiasm by consumers to ‘Buy Sri Lankan’, there is likely an upper limit if higher domestic prices from protection are not mitigated by a quality premium, as well — without which, living standards may be negatively impacted. Another example, that incentivises the allocation of productive resources in the economy is: Tariffs, other restrictions on imports, and even subsidies create incentives, both directly to the sectors in which they are applied, and indirectly to other sectors of the economy that do not benefit from those measures.
For example, if the Government desires to incentivise investment in the production of a particular good (to substitute imports, increase local value-added, or to promote the development of an infant industry) with high tariffs, subsidies, or other measures that favour it over other sectors, it must be cognisant that the resource-pull it causes will also serve to divert resources away from sectors that do not benefit from the policy measure, including those that may already be producing inputs for the favoured sector and or those that are producing the same good for export markets.
In the case of input producers, if their level of nominal protection of protection or subsidisation remains unchanged, in practice, their relative level of support will be less favorable than previously, causing resources to migrate away from the production of inputs, where the effective level of protection is lower, and toward the production of the final good, where the effective rate is higher. In the case of exporters of the final good, they will not benefit from higher tariffs at home, in terms of their profit margin, and will be enticed to divert sales from export markets to an artificially inflated domestic market.
Short and long-term policies and objectives
In the wake of the Covid-19 pandemic, many countries have put in place policies to promote domestic production and consumption using a combination of one-off or temporary policy levers - such as one-off fiscal stimuli (such as cash transfers), or as time-bound measures (such as concessionary loans) - all intended to act as temporary shocks to accelerate recovery.
Others have imposed policies to address immediate constraints, such as limiting imports in the face of limited foreign exchange reserves or export bans on medical equipment and supplies that are facing shortages. While the policies themselves may be short-term in nature, they can have longer-term impacts on the development trajectory.
For example, restrictions on imported inputs may have the unintended impact of causing businesses to fail and unemployment to rise while waiting for domestic production of those inputs to ramp up.
Other countries may use this pause in the global economy to intentionally shape policy measures that can promote longer-term structural transformation using performance-based incentives (e.g. tax incentives or concessionary loan programs) to diversify the economy in terms of the basket of and/or value-added to the goods and services it produces. A careful evaluation of short- versus longer-term objectives is required to understand the potential trade-offs to the economy and strike the right balance.
Market access mechanisms
The Covid-19 crisis may have accelerated the shift away from slow growth Western markets towards relatively fast-growing Eastward markets for many developing and emerging markets.
Access to a larger market is only part of the equation, where efficiency,access to technology, the attraction of investment, and foreign policy objectives are intertwined. If foreign policy considerations take prime the connection between the trade agreement and diplomatic strategy must also be clear. The choice becomes, with whom, with how many and the depth of any agreement Sri Lanka may consider.
As a ‘new normal’ emerges, the Government should take into account the shifting sands and the opportunities for growth in established markets versus smaller but fast-growing markets -- how can structural reform policies, including trade policy and trade agreements, be shaped by these strategic market choices or, conversely, shape the need to pursue new markets.
As market size and composition (in terms of complementary market opportunities) matter, it will be important to compare the costs and benefits of such arrangements -- not only in terms of the longer-term development objectives, but also in terms of speed to market, market size, and the overall impact on or complexity of the incentive environment.
For instance, trade links with growing and technologically sophisticated markets can boost domestic productivity growth depends on the depth of the agreements. Shallow purely tariff preferences rarely provide spillover benefits the agreements often promise.
A region-wide agreement with block members a far superior option to individual bilateral relationships with different market and administrative arrangements, which eventually must synergise with significant costs, unless the single country is large enough to generate market size-related benefits.