Report No. 19591-BD Bangladesh Trade Liberalization Its Pace and Impacts November 23, 1999 Poverty Reduction and Economic Management Unit South Asia Region CURRENCY EQUIVALENTS The external value of the Bangladesh Taka (Tk) is fixed in relation to a basket of reference currencies, with the US dollar serving as the intervention currency. The official exchange rate on October 21, 1999 was Tk 49.35 per US dollar. US$1 = Tk49.35 Tk 1 = US$ 0.020 FISCAL YEAR July 1 - June 30 Vice President: Mieko Nishimizu Country Director: Fred Temple Sector Directors: N. Roberto Zaghal Marilou J. Uy Task Leader: Tercan Baysan ACKNOWLEDGMENTS This report was prepared by a team led by Tercan Baysan. Other members of the core team include: Charles Draper, Zaidi Sattar (South Asia); Kabir Hassan, Abdul Bayes, Ismail Hossain, Farida Khan (consultants). Data International, a Dhaka-based consulting firm, helped with the processing and tabulation of the survey data. Ziaul Ahsan (consultant with the Dhaka Office) assisted with the trade data, import levies, and with the tables/charts. Tyler Biggs, peer reviewer, and James Tybout provided advice on the design of the survey questionnaire. The report benefited from the comments of the peer reviewers Wahiduddin Mahmud and Tyler Biggs. John Williamson, Shekhar Shah, and Kapil Kapoor provided valuable comments. Oxana Bricha and Jennifer Manghinang assisted with the annexes/appendices, processed the report, helped with the communications. The report also reflects on the discussions that took place at a seminar held in Dhaka on September 16, 1999. The report is based on the background work carried out on Bangladesh's trade liberalization, formal and informal trade patterns, and on quantitative analysis that utilized the data collected from a sample of over 150 firns. The survey work was carried out during July-October 1998 and included firms located in Dhaka, Chittagong, and Khulna. The results of the 1992/93 Industrial Study survey (ISS) carried out by the World Bank and the USAID were also used in the study. The report was prepared under the guidance of Pierre Landell-Mills, Fred Temple (Country Directors for Bangladesh), and Roberto Zagha and Marilou Uy (Sector Directors). I TABLE OF CONTENTS Executive Summary .....................................................................i Note to Readers .................................................................... ix Chapter 1 Bangladesh's Trade Liberalization: Has It Been Too Fast? ......................................1 A. Introduction ....................................................................1 Approach, Methodology, and the Outline ................................................................2 B. Progress in Trade Policy Reform ....................................................................3 Introduction ...................................................................3 Trade Policy Reforrns in the 1990s: Was It Too Much, Too Fast ...........................3 Anti-Export Bias Remains Significant ....................................................................7 Pace of Bangladesh's Trade Liberalization: A Cross-Country Comparison ............8 Comparison With the Rest of the World ..................................................................9 C. Other Accompanying Policy Changes .................................................................... 11 Complimentary Policies .................................................................... 11 Business Environment ..................................................................... 11 Exchange Rate Management .............................................. . 12 D. Trade Liberalization and Economic Performance ............................................... 14 E. Conclusions .............................................. 15 Chapter 2 Recent Trends in Foreign Trade ............................................... 19 A. Introduction ............................................... 19 B. Recorded Trade .............................................. 20 C. Trade with India .............................................. 25 D. Conclusions .............................................. 28 Chapter 3 Impacts of Trade Liberalization on Technical Progress and Efficiency in Manufacturing Industries ........................................ 31 A. Introduction ........................................ 31 B. Results ........................................ 33 Technical Efficiency ........................................ 33 Total Factor Productivity Growth (TFPG) .............. .......................... 36 Business Environment and Performance of the Surveyed Enterprises ................... 38 Conclusions and Policy Implications ................................................................... 39 Appendix: Methodology, Data and the Sample Statistics ............................................................ 43 Annexes Annex I ................................................................................................................................................ Table A. 1 Trends in Average and Dispersion of Tariffs, FY91-99 ..................................... 49 Table A.2 Trends in Average and Dispersion of Tariffs on Manufacturers, FY92-99 ....... 50 TableA.3 Tax Incidence on Imports ............................................................. 51 Table A.4 Effective Protection Rates (EPRs) in 40 Sectors in Bangladesh ........................ 52 Table A.5 Protection Related Quantitative Restrictions on Imports, FY92-99 ................... 53 Table A.6 Effective Exchange Rate for Exports (Unweighted) .......................................... 53 Table A.7 Effective Exchange Rate for Exports (Weighted) .............................................. 54 Table A.8 International Comparison of Tariff Regimes ................................................ ..... 55 Table A.9 Bangladesh - Macroeconomic Developments in Openness, 1980-1998 ........... 56 Annex II .. Table B.1 Bangladesh's Recorded Commodity Trade, 1989/90-1997/98: Overview ........ 57 Table B.2 Bangladesh's Recorded Commodity Trade with India: 1989/90-1997/98: Export Composition .............................................................. 58 Table B.3 Bangladesh's Recorded Commodity Trade with India: 1989/90-1997/98: Import Composition ............................................................. 59 Table B.4 Bangladesh's Recorded Commodity Trade with India: 1989/90-1997/98 ......... 60 Annex III............................................................................................................................................... A. Data Envelopment Analysis (DEA) ................................................ .......... 61 B. Estimating Efficiency Indicators and Measuring Productivity Changes ........................ 63 List of Text Charts, Tables and Boxes List of Charts Chart A Structure of Tariffs, 1998/99 ..............................................................4 Chart B Average Tariffs in South Asia, 1998/99 ..............................................................8 Chart C REER for South Asia (1990=100) ............................................................. 12 Chart D Bilateral RER for Sotuth Asia (1990=100) ............................................................. 13 Chart E GDP and Industrial Growth ............................................................. 13 Chart F Relative Technical Efficiency: 1992/93 and 1997198 ..................................................... 35 Chart G Total Factor Productivity Change Between 1992/93 and 1997/98 and its Decomposition ...................................................... 36 List of Tables Table 1.1 Trends in Nominal Protection, 1990/91 to 1998/00 .......................................................5 Table 1.2 Phased Removal of Quantitative Restrictions, 1998/90 to 1998/99 ..................................6 Table 1.3 Effective Exchange Rates for Import Substitutes and Exports .........................................7 Table 1.4 Falling Behind? Bangladesh's Share in World Exports, Selected Countries ...................8 Table 1.5 Average Tariffs and Top Rates in South Asia, 1998 ........................................................8 Table I.6 Intemational Comparison of Tariff Regimes .......................................................9 Table 1.7 Trade Liberalization and Economic Performance .14 Table II.1 Major Categories' Shares of Export and Import Totals and of GDP in Late 1980s and 1990s .22 Table 11.2 REERs and RERs: India and Bangladesh (1990=100) .26 Table II.1 Technical Efficiency Measures: 1992/93-1997/98 .34 Table 111.2 Decomposition of the TFP Change between 1992/93 and 1997/98 .34 Table 111.3 Technical Efficiency Measures and Total Factor Productivity Change (TFPCH) in Manufacturing Firms: 1993-1998. ...................... 40 List of Boxes Box 1.1 What Could Have Been Done Differently in Implenmenting Bangladesh's Trade Liberalization? ..................................................... 10 Box 1.2 Sequencing of Complementary Reforms ..................................................... 13 Box 11.1 Domestic Industrialization Process and the Speed of Trade Liberalization .................... 24 Box II.2 Trade Deficit with India ..................................................... 26 Box 111.1 Micro-Level Findings and Macro-Level Inferences ..................................................... 38 Selected References .69 EXECUTIVE SUMMARY Spurred by the significant trade liberalizationt of the 1990s, Bangladesh 's merchandise foreign trade has nearly doubled in the 1990s, to 30 percent of GDP since the beginning of the decade. With the growing, though still incomplete, openness to international commerce have come signifi cant economic gains, notably an expansion of exports strong enouigh to cover imports and maintain the trade deficit at sustainable levels. Through its commendable progress in eliminating a sizable portion of quantitative import restrictions and in reducing the average rate and dispersion of import tariffs, Bangladesh is restructuring its economiy. It has made a significant departure away from a highly restrictive system focusing on import substitution to a more dynamic, export-oriented structure already competitive in global markets for ready-made garments, knitwear,frozen food, and leather products. Such a sharp change niaturally generates protest. In Banzgladesh, the criticism takes the form of contentions that trade liberalization has moved too fast and that it has 'flooded" markets with goods from abroad, particularly from neighboring countries, which are hurting domestic industries and inhibiting Ban.gladesh 's industrialization. This report examines these concerns. Itfinds them to be both widespread and generally unsupported by hard evidence. The pace of Bangladesh 's trade liberalization, for instance, is comparable to that of many Asian and Latin American countries that are experiencing strong benefits from their reforms. W7hile faster than some of its South Asian neighbors, Bangladesh has not movedfarther than Sri Lanka. Indeed, the remaining anti-export bias of trade policy is considerable. Some trade-related quantitative restrictions still impede importflows. Also, the range between the top and the lowest tariff rates is still very wide, with very high nominal protection rates applying to competingfinal goods. Although more foreign goods are in fact available (some of them smuggled to skirt high protection), it appears that increased supplies of cheaper raw materials/intermediate inputs andfixed capital goods have generally stimulatedfaster expansion in exports and stronger GDP growth to the benefit of the economy overall. As to firms that perform poorly in fields where activity is shrinking, the fault generally does not lie with trade reform but with failures to graduate from the comforting cradle of high and long-standing levels ofprotection. Such enterprises are in the minority; in general manufacturing industries have been performing strongly, notwithstanding all sorts of constraints to doing business in Bangladesh. Mostfirms surveyedfor this study actually experienced sizable productivity growth over a period offive years, suggesting that trade liberalization has had a positive, not a negative, impact in the manufacturing sector. Introduction 1. After a start in the mid-I 980s, Bangladesh's trade liberalization effort picked up its pace in the early 1990s as an important component of the country's structural reform program. Initial steps were ad hoc and focused on the removal of quantitative restrictions (QRs), but in the early 1990s a more comprehensive trade policy reform program extended its reach to both tariffs and non-tariff barriers, though without a pre-announced implementation schedule or phased program targets. Significant progress has since been made in removing QRs and in reducing the maximum and average tariff rates. Since the mid-i 990s, however, movement toward a lower and uniform tariff rate has slowed due to concerns for budgetary revenues, the balance of payments, and, in particular, possible adverse effects of trade liberalization on import-competing industries. In this period as well, some business and ii government circles and researchers have criticized Bangladesh's trade liberalization for being too fast and for flooding domestic markets with foreign goods in amounts that harn local industries. Trade Liberalization in the 1990s: Was it too Fast? 2. In contrast with the highly protectionist, inward-oriented stance of the early 1980s, Bangladesh's trade policy today is far less restrictive, and its anti-export bias, significantly lower. Since 1990/91: the coverage of protective QRs fell from 253 four-digit codes to 28, now affecting mainly textile imports; the maximum tariff rate dropped from 350 percent to 37.5 percent and the (unweighted) average tariff rate to around 17 percent. To put those gains in context, however, Bangladesh, it should be recalled, started with an extremely restrictive set of trade barriers characterized by pervasive QRs and prohibitively hign import tariffs on many finished consumer goods. Thus, a good deal of import "liberalization" in the early 1990s basically amounted to removing QRs (still incomplete) and tariff redundancy. Once existing tariffs became binding and foreign competition more effective, the process slowed down considerably. 3. Although much rationalization and simplification of the import regime remains to be accomplished, Bangladesh has made substantial improvemenits in removing trade barriers and should be given credit for dismantling most of its QRs. The current maximum tariff rate is fairly steep, and, given its 0-37.5 percent range, the existing import tariff structure still shows a high degree of dispersion. The average rate is pulled down substantially because many non-competing imports, such as locally unavailable raw materials and fixed capital goods, enter at zero or very low rates. On the other hand, to protect import-substituting domestic industries, competing imports carry high customs duty rates. These nominal protection levels are augmented further by the other protective levy (the license fee) and also by the protective incidence of the (supposedly) neutral taxes that are in fact asymmetrically applied. In some cases, the VAT, a supplementary duty, and an Infrastructure Development Surcharge significantly raise the nominal protection rates due to the cascading effects of their valuation base, thus further increasing the dispersion of nominal protection rates. In addition, many tariff exemptions/concessions as well as multiple rates for similar categories of goods complicate the nominal protection structure and create significant scope for discretionary decisions by customs officials. 4. The progressive lowering of trade barriers has reduced anti-export bias to the point that the ratio of effective exchange rate for imports to that of exports, a measure of this bias, fell from 1.66 in 1991/92 to 1.26 in 1995/96, and stayed at that level through 1998/99; (the FY00 changes may have lowered the bias only marginally). The remaining bias, however, is still substantial and, coupled with additional costs stemming from infrastructure bottlenecks, corruption and unreliable law enforcement, it puts production for exports at a competitive disadvantage. While enclave-type arrangements (EPZs and the special bonded warehouses) provide duty/tax free access to imports and insulate a narrow range of activities from business constraints, negative factors continue to hinder a large number of potential export activities. 5. Cross-country comparisons. Cross-country comparisons in trade liberalization, while useful in providing an international perspective, should not be taken as criteria for determining the pace and sequencing of country-specific trade liberalization programs. In the present case, a broad perspective escapes the frequent tendency to compare Bangladesh's trade liberalization experience only with those of its neighbors. Except for Sri Lanka, South Asian countries--India in particular--have been very slow to liberalize trade and thus offer poor comparisons. Measured against other liberalizing countries of the world, Bangladesh's trade reforms over a period of 8-1 lyears do not appear unusually fast. Many countries in South East and East Asia and in Latin America and even some in Africa achieved iii significant cuts in average tariffs and reduced the spread between their lowest and maximum rates in 5-8 years time. Most of them, moreover, have gained in both export and GDP growth. Having highlighted the broader international perspective on trade liberalization experience and the resulting positive impacts, the report argues that Bangladesh's economic performance has also improved under trade liberalization. 6. Accompanyingpolicy/institutional changes. Initial economic and institutional conditions of a country embarking on trade liberalization are obviously crucial determinants of the scope, sequencing, and pacing of trade liberalization programs. Bangladesh's record of generally maintaining a sound macroeconomic environment has been a positive factor in carrying out trade liberalization. In addition, specific actions such as the introduction of a VAT in the early 1990s as the centerpiece of a tax reform, the unification of multiple exchange rates and the adoption of a "managed" flexible exchange rate system have also contributed positively. Since its neighbor-competitors -- India, Pakistan, and Nepal-- and other South East and East Asian countries have depreciated their real effective exchange rates and bilateral real exchange rates (vis-A-vis the US dollar) at much faster pace than Bangladesh since 1990, Bangladesh's strong export performance and satisfactory macroeconomic balances may not have paid the highest possible dividends. A more flexible exchange rate policy might have had stronger positive effects on potential exportables and could have contributed to export diversification. 7. Other missed opportunities include scoring more rapid progress in strengthening the financial sector, tackling infrastructure bottlenecks, addressing bureaucratic hurdles, and reforning the highly inefficient state-owned enterprises. Together with external shocks and prolonged political uncertainty, these errors of omission have most likely made adjustments to trade liberalization more difficult and limited its potential benefits. 8. Macroeconomic performance. Although the direct causal connection of trade liberalization to economic performance in general and to GDP growth in particular is difficult to quantify, Bangladesh's overall economic performance-- in terms of export, manufacturing sector and GDP growth rates, and extemal balances and sustainability-- appears stronger in the 1990s than in the 1980s. That change provides some evidence that trade liberalization, far from being harmful, has, on the contrary, contributed together with other market-oriented reforms and sound macroeconomic management to improved macroeconomic performance. The increased availability of cheaper and higher quality imported raw materials, intermediate inputs, capital goods and new technologies, as well as enhanced competitive pressures have obviously been important factors in producing these positive results. (While it is not specifically analyzed in this report, it needs to be highlighted that, aside from these positive impacts listed above, the increased availability of cheaper and better quality goods under trade liberalization has mostly likely generated significant gains in consumer welfare as well). 9. Recommendations. Trade liberalization is incomplete. Further progress requires more measures to rationalize and simplify the existing tariff structure: A key policy objective should be to move from enclave-type arrangements (which help circumvent the restrictive import regime and constraints to doing business) to broader trade liberalization with a view to lowering the dispersion of nominal and effective protection rates, as well as eliminating the protective QRs. In this respect, the tariff rationalization measures announced with the FY00 Budget -- reducing the maximum customs duty rate from 40 percent to 37.5 percent and the number of tariff slabs from 6 to 4, and harmonizing tariff rates on similar goods-- are welcome developments. The new tariffs hikes on some finished goods (e.g., paper pulp and silk), however, would increase their effective protection rates and send mixed signals about the future direction of trade policy. iv * In implementation, one of the major drawbacks of Bangladesh's trade reform program has been not announcing the time table of the planned policy changes in advance. This has obviously contributed to the perception that trade liberalization was "too fast", since some the domestic firms were caught unprepared. In the future, announcing the planned trade reforms in advance will give time to the private sector to adjust. * Improvements in the business environment would help enhance gains expected from freer trade by reducing the costs of doing business and strengthening supply response capacity of local firms (details are in the last section below). Trends in Foreign Trade: Is Domestic Production Being Displaced by Foreign Goods? 10. An economy opened to foreign goods and competition through trade liberalization benefits from that inflow and stimulus in increased investment activity, stronger export and overall economic growth, and greater efficiency in resource use. With sound fiscal/monetary and exchange rate policies, trade liberalization should lead to the balanced growth of exports and imports that is desirable for economic growth without destabilizing external accounts. Overall, Bangladesh is reaping many of those gains, but at the micro-level, some firms claim to be victims of liberalization. In reality, most of these are inefficient firms that have failed to improve their competitiveness despite long periods of high protection. They find themselves under pressure, losing or even leaving markets, and shedding labor as the progressive removal of trade barriers establishes a more neutral incentive regime. Such displacements are a function of inefficiency, not a basis for retreating from trade reform. As other activities become more profitable, new enterprises expand arnd generate new jobs, with the pace depending on how conducive the business environment is in facilitating supply response. Only widespread production and job displacements would indicate adverse consequences of trade reform and would show up in poor sectoral and aggregate economic performances. Bangladesh has not experienced such setbacks. 11. On the contrary, the trade liberalization of the 1990s has most likely been a positive factor in the achievement of the relatively stronger macroeconomic performance observed so far. That progress has accompanied a significant degree of opening up in external trade transactions in parallel with trade policy liberalization. The significant increase in the merchandise trade-GDP ratio (almost doubled) has not, however, led to an unsustainable trend in the merchandise trade deficit. With faster growth in exports, a much larger proportion of import costs are now covered by merchandise exports, which are also more diversified than in the 1980s, though there is still a high degree of export concentration. In the external accounts, the trade deficit as a share of GDP has remained stable and sustainable. 12. At the commodity level, formal trade statistics indicate that increases in merchandise imports induced by trade liberalization have concentrated in raw materials, intermediate inputs, and capital goods. The share of final consumption goods imports in total imports has remained stable, showing no sustained surge. As for the claim that domestic markets are "flooded" with foreign goods that displace domestic production, No widespread production displacement has occurred. Both the official statistics on production trends in manufacturing industries, as well as findings based on a survey of a sample of enterprises indicate that most manufacturing activities have continued' expanding production, capacity, and also employment. Not surprisingly, some enterprises in import-competing manufacturing sub- sectors--cotton textile, vegetable oil, paper, insecticides, rubber footwear, metal products, and some machinery and products--have reduced output and ernployment levels. Despite a long period of protection, these enterprises that apparently failed to improve efficiency and competitiveness now feel the pressures of competition brought by trade liberalization and smuggling. v * In this regard, it is difficult to agree with the proposition put forward by some observers that "Bangladesh's import-substitution strategy has not moved its industrialization process away from export-orientation and that, given Bangladesh's narrow industrial base and the large domestic market, what is needed is continued protection of the domestic producers until they capture domestic markets, become efficient and start exporting. Trade liberalization should then follow". The evidence on this is clear. Despite the prolonged protection, most import-substituting industries have not become efficient enough even to compete at home let alone export--the textile sector is a very good example. Moreover, the significant anti-export bias has limited the scope and depth of export orientation and diversification beyond those activities benefiting from the enclave arrangements. The experience of the recent decades suggests that what is needed is not continued high protection of final goods, but more operness for efficiency enhancement. * The other important issue pertaining to the high protection levels is that they are encouraging significant levels of informal (unrecorded) imports, leaving the existing statutory protection levels partially ineffective and causing substantial loss of customs revenues. But even without trade liberalization, smuggled goods--entering Bangladesh free of duty or tax--would have undercut domestic products and producers. Some of the surveyed enterprises in textiles, flour milling, vegetable oil, and salt specifically reported their difficulties competing with contraband. 13. Recommendations. One proven way of suppressing smuggling is to make it unprofitable. To achieve that end, high tariffs on finished consumer goods need to be cut and QRs on textiles imports need to be eliminated. Such changes would help divert informal trade into formal (official) channels, generate budgetary revenues, and also provide some "effective" protection to such products. At present, high statutory protection deters legal imports while inducing the entry of smuggled goods that avoid not only the protective duty but also the VAT which domestic producers must pay. Among the beneficiaries of curtailed smuggling would be the producers of goods such as sarees and other textile items, sugar, salt, pulses, bicycle and truck parts, fans, and toothpaste. To combat smuggling and under-valuation, a range of likely measures to be taken in combination fall into three groups: * First, thefiscal incentive should be reduced both by cutting customs duty rates and by making basic changes in the VAT administration to strengthen enforcement. The collection point for VAT should be moved as close as possible to the retail-end where smuggled goods would be taxed equitably with domestic products and legal imports. * Second, determined policing efforts are needed, backed by strong political will. Government agents who now support and profit from smuggling activities must be compelled to discontinue their involvement and, if necessary, pursued and prosecuted along with the bootleggers themselves. * Third, to deal with technical smuggling, i.e. the under-valuation of imports that do pass through official channels, the Government needs to contract reputable agents to operate an effective pre- shipment inspection (PSI) scheme in the short-term while it automates and otherwise modernizes the Customs service itself. The introduction of the compulsory PSI system with the FY00 Budget provides an opportunity to move in this direction. 14. Recent developments in formal and informal trade show a sizable trade deficit in favor of India, Bangladesh's largest import source. The proximity and competitiveness of Indian goods, Bangladesh's faster liberalization, as well as the much larger depreciation of the Indian real exchange rate since the mid- 1 980s are among the factors that explain this imbalance. Given that Bangladesh's overall external trade balances are on a sustainable path, a large trade deficit with India is not, on its own, detrimental. These or even larger deficits would have been observed with other countries in any vi case. Therefore, halting Bangladesh's broader trade liberalization or reversing it in response to India's failure to reciprocate Bangladesh's unilateral liberalization would be a harmful policy error. 15. Bangladesh's economy has generally benefited froml economic liberalization, increasing openness, and moves toward neutrality of market incentives. In a period of strong liberalization and globalization that has been sweeping most countries and markets (soon to include textiles) and with the approaching round of WTO negotiations, linking Bangladesh's trade/industrial policies to those of India would not be beneficial. Not possessing a vast domestic market, diverse resource base and much more diversified industrial sector, as India does, for high, sustained economic growth, Bangladesh needs to rely on trade to a greater extent and to strengthen its export base. A more neutral incentive regime with further reductions in the remaining anti-export bias--a policy path adopted by Sri Lanka with results that recommend its model to Bangladesh--would serve this objective. Has Trade Liberalization Improved Efficiency and Productivity of Industries? 16. Trade liberalization--judging from the quantitative analysis of firm-level survey data, from survey questionnaires, and from interview results--has not had any widespread adverse impact on the performance of the surveyed finns. On the contrary, the majority of the enterprises appear to have experienced a positive total (factor) productivity growth between 1992/93 and 1997/98, averaging 29 percent over a period of five years, about 6 percent annually. Without claiming direct causality, it could be argued that the progressive reductions in trade restrictions must have played a positive role in this outcome. By inducing competition, technological change and diffusion, and technical efficiency gains, the stimulus to trade has stimulated an increased productivity of inputs. When these quantitative results are put together with the official statistics on the output performance of manufacturing industries, the resulting picture is generally positive, a refutation rather than a support for the claim that trade liberalization in the 1990s harmed Bangladesh 's manufacturing industries. * During the period under study, export-oriented firms appear to have done better in improving their technical efficiency relative to the best-practice (most efficient) firm(s) in their own sub-group, thus moving closer toward the maximum potential production. The closer initial convergence in technical efficiency between the average export firm and the best performer(s) was to be expected among export-oriented firms that are normally exposed to more intensive competition and market/production knowledge. * Firms competing with imported goods have generally lagged behind the most efficient finns in their own sub-group in improving their relative technical efficiency in resource use. This disparity basically reflects the shelter that protective trade barriers provide to inefficient enterprises as well as to efficient, more dynamic, front-runner import competing firms. The results of interviews indicate that firm-specific problems and business environment constraints also appear to have been important factors in slowing down efficiency improvements and adjustments to trade liberalization. Remarkably, however, the import-competing firms surveyed experienced stronger positive technological progress, on average, than the export-oriented firms over the five-year period. Their gains may stem from two factors: the larger initial technology gap with the outside world that is norrnal for import-competing firms and the stimulus that a less restrictive trade policy fosters for larger leaps in technological progress by the best-practice import-competing firms. As a result, import-competing firms, on average, experienced larger totalfactor productivity growth than export-oriented firms, even though many of the former failed to close the gap with the best practice firm(s). vii * Some import-competing firms--marked by inefficiency and high costs--in iron/steel metal works, engineering, rubber works, and cotton mills might have been adversely affected by trade liberalization. Although such an outcome of foreign competition is to be expected, it is important to emphasize that many of the manufacturing firms surveyed reported other internal and external conditions--constraints to doing business, for example--as other important, contributing, negative influences on their performance. 17. To shed further light on the importance of trade liberalization and to measure various aspects of the business environment affecting the performance and capacity to respond to trade liberalization of the enterprises surveyed, direct interviews were held and qualitative questionnaires were used. Following are some of the findings: * Of the 74 enterprises that answered the question about impacts of trade liberalization, 30 percent found trade liberalization helpful, 14 percent considered it harmful (mainly import-competing firms in rubber industries, soap/detergent and metal works), while the majority indicated no significant perceived impact from trade liberalization. The latter group included some ready-made garments firms, which had started benefiting from trade liberalization much earlier under the enclave arrangements. * With respect to the key constraints to doing business in Bangladesh, only 4 percent of the respondents considered competition from imports as a primary impediment. On the other hand, 21 percent of the respondents saw the lack of business support services (such as assistance in finding/using new technology and in product design as well as instrument calibration, advice for productivity improvement and quality control testing, etc.) as the foremost problem. Other obstacles cited were access to credit (20 percent), inadequate supply of infrastructure (13 percent), corruption, theft and "toll" collection (18 percent). Shortage of skilled labor was also stressed as another important constraint. * Evidence from the "sick "firms and new enterprises surveyed also suggest that trade liberalization has not caused widespread hardships. Of the 12 "sick" firms that could be traced (out of a small sample of 23), 5 of the 6 import-competing firms identified trade liberalization as having hurt their performance. But none of the firms interviewed pointed to trade liberalization as the sole source of their problems/ "sickness." They cited non-availability of finance and working capital, technical production problems, natural disasters, increased domestic competition, and managerial inexperience among the other important reasons for their problems. * The 26 new entrants interviewed (10 export-oriented and 16 import-competing) regarded trade liberalization as helpful, noting duty reductions on raw materials and capital goods. Export- oriented firms were generally more optimistic about their future, while import substitute producers were more cautious. All, however, mentioned the business environment constraints noted above as the main hurdles they faced. 18. Recommendation. An important implication of these findings is that faster improvements in the areas of infrastructure, financial sector reforms, business support services, customs administration, law and order, and the reform of the state-owned enterprise sector would have undoubtedly brought higher returns from the gradual removal of trade barriers. Indeed, addressing these business environment problems will be the Government's most essential contribution to boosting industrial development and, with it, economic growth and the reduction ofpoverty. ix NOTE TO READERS This report on trade liberalization was discussed at a day-long seminar held in Dhaka on September 16, 1999. With opening remarks on the report's findings, the Minister of Finance inaugurated the seminar and led the discussions in which other senior Government officials, as well as representatives from the local Chambers of Commerce and hidustries, research institutions and the local universities took part. Journalists participated in a separate session. Among the issues raised in the report and during these discussions, four drew the most comment. They include: Pace and timing of trade liberalization. Some discussants argued--as the report anticipates and rebuts, particularly in Box 11.1 of Chapter Two--that "slower" trade liberalization would have been more appropriate given the significant business environment constraints in Bangladesh and its very narrow, starting manufacturing base. Trade liberalization and the accompanying changes, in this view, came too fast and without advance notice. In consequence, they contended that unprepared domestic firms were damaged and made "sick" by foreign competition. Some participants argued that Bangladesh's industrialization started with the development of export-oriented activities, such as garment manufacturing, and that its import-substitution strategy has not moved the process of industrialization away from this ongoing export-orientation. "In view of Bangladesh's large domestic market and very narrow manufacturing base," one remarked, "what is needed is to follow the East Asian strategy of continued protection to domestic firms until they capture domestic markets, become efficient through domestic competition, and start exporting. Trade liberalization could then follow." The policy implication of this view is to go slow in future trade liberalization. Sequencing of complementary reforms. Some participants held that Bangladesh should have moved faster on improving the business environment by addressing infrastructure and financial sector problems, bureaucratic bottlenecks, and law and order problems before proceeding with trade liberalization. Chapter 1 has a section dealing with this important topic, and Box 1.2 tackles the sequencing issue. Micro-level findings and macro-level inferences. Several discussants, while commending the report's micro-level quantitative analysis for filling an important gap in terms of enterprise-level efficiency and productivity impacts of trade liberalization, felt that this analysis was not sufficient to draw conclusions about the effects of trade liberalization on the entire manufacturing sector and the economy as a whole. It was remarked that the assessment was incomplete; it did not cover cottage and small-scale industries and included no causality analysis. In response, the report's team explained that the enterprise-level analysis is intended to provide evidence on efficiency and productivity impacts of trade liberalization on Bangladesh's manufacturing firms, without attempting to draw macro-level conclusions or generalizations. Macro-level impacts are, however, assessed using the available macroeconomic performance indicators and the official disaggregated data on the manufacturing sector. All three chapters of the study present the relevant evidence and assessments on this topic, and Box 11. 1 in Chapter 3 presents a more specific response to these comments. Trade deficit with India. The topic of Bangladesh's large trade deficit with India attracted significant attention at the seminar with participants citing India's slower trade liberalization as background for questioning the wisdom of Bangladesh's tolerating a large trade imbalance with its neighbor. x In response, the report's authors and the study itself emphasize that a trade deficit with a particular partner is not a concern as long as the overall trade balance is sustainable. Importing from India, as one benefit of triangular trade, actually saves Bangladesh the higher costs it would have had to pay for acquiring the same necessary imports from sources other than India. Finally, referring to the report's recommendation on this issue, bilateral and multilateral policy dialogue was stressed as the appropriate strategy to address Bangladesh's legitimate complaints. The report weighs this issue in detail in Chapter 2, and Box 11.2 provides a summarized response on the comments made at the seminar. Chapter I BANGLADESH'S TRADE LIBERALIZATION: HAS IT BEEN TOO FAST? A. INTRODUCTION 1.1 Objectives and scope. As a general rule in developed and developing economies alike, the fewer the barriers to trade, the greater is competition in domestic markets, the more neutral are market incentives, and the easier is it to obtain access to cheaper raw materials and modem machinery. Resources are allocated with greater efficiency. Patterns of production more closely match a country's comparative advantage. The consequent export expansion in turn supports stronger overall economic growth. In Bangladesh, for example, the dramatic growth of ready-made-garment (RMG) and knitwear exports has created new jobs and stronger economic growth, results that testify impressively to the benefits of a liberal trade regime, supported by a facilitating business environment. 1.2 In Bangladesh, trade liberalization has been an important component of structural reform efforts since the mid-1980s. Compared to the highly restrictive and inward-oriented nature of the trade regime in the previous decade, today Bangladesh has a far less restrictive, more outward-oriented trade policy environment. This is a result of commendable progress made in eliminating a sizable portion of quantitative restrictions (QRs) and in reducing the average rate and dispersion of import tariffs. With the reduction of prohibitively high tariffs, the trade reform has been successful in reducing substantially, if not completely removing, the tariff redundancy ("water-in-the tariff"'), thus bringing the statutory nominal protection levels into closer alignment with the observed differences between the world and domestic prices. As a result, the anti-export bias of the trade regime has been cut significantly for export activities outside the export processing zones (EPZ) and special bonded warehouses (SBW), which benefit from duty/tax free access to imported inputs. Nonetheless, the remaining anti-export-bias of the trade regime is still considerable. 1.3 Since the mid-1990s, the pace of tariff reform has slowed as the Government faced the greater challenge of tariff rationalization. That step requires confronting both the considerable dispersion around the average rate and the numerous exemptions/concessions in the existing nominal tariff protection structure. Together with the use of discretionary "tariff values" for import valuation and multiple tariff slabs even at highly disaggregated level of commodity classification, these features render Bangladesh's tariff system complex and less than transparent. They give customs officials wide leeway for discretionary decisions and rent-seeking behavior. It is difficult to trace the impact of such a nominal protection structure on the effective protection rates (EPRs), which are affected also by the effects of smuggling and of the remaining QRs on domestic prices. 1.4 Key factors in retarding tariff rationalization/simplification in recent years have been concerns over the possible adverse effects of further tariff cuts on budgetary revenues, on the balance of payments, and on import-substituting domestic industries. Both industrialists and policy makers have voiced negative reactions to trade liberalization. Some of common criticisms argue that: * Bangladesh has liberalized its import regime "too fast"; * domestic markets are flooded with foreign goods, particularly from the neighboring countries; and 2 Chapter 1: Bangladesh's Trade Liberalization: Has It Been Too Fast? * these developments have adversely affected domestic industries, slowing the growth of enterprises that must compete with imports, making some of them "sick," forcing the closure of others and, generally, inflicting damage on the economy. 1.5 This report examines these claims in the context of related developments in the economy in recent years. Specifically, it reviews actual changes in the trade regime as well as other complementary/accompanying economic policy changes and dLevelopments in the business environment that have a bearing on the effectiveness of trade liberalization. Additionally, by looking at some relevant macroeconomic and finn-level developments, the study seeks to identify the impacts of trade liberalization to the degree that any such analysis can overcome the considerable difficulty of establishing causality when so many other factors are also affecting economic performance and outcomes. 1.6 Bangladesh's policy debate about the pace and effectiveness of trade liberalization is important. This report is meant as a contribution to it and to the next phase of trade reforms. The tariff structure still stands in need of considerable simplification and rationalization. Useful as it is to examine the contention that liberalization has gone too fast, it should also be helpful to identify bottlenecks in the business environment that may be impeding the adjustment of manufacturing industries to changes in relative prices and limiting their capacity to respond effectively. Approach, Methodology, and Outline 1.7 Has Bangladesh liberalized its trade regime too fast? No established principle dictates the pace at which a country should push its trade reforms. Even though speed may well serve to preempt lobbying efforts by protectionist groups, it is the country conditions' that are critical determinants not only of the pace, but also of the sequencing of reforms.2 This chapter exarmines those conditions-- the record with respect to macroeconomic stability and the implementation of other accompanying structural reforrns as well as improvements in the business environment. First, however, it reviews Bangladesh's trade liberalization experience during the last decade and assesses its pace relative to the experience of other countries in the region as well as those of other regions, including countries that have successfully liberalized. The subsequent analysis of the broader economic and regulatory setting reflects the ample evidence from international experience of the importance to successful trade liberalization of a sound macroeconomic framework and a conducive/facilitating business environment resting on political stability, law and order, and other structural policy and institutional reforms. Chapter 2 then considers recent trends in Bangladesh's foreign trade patterns--merchandise imports and exports, including trade with India--and external current account balances, looking for evidence of a sudden worsening in external balances and the supposed "flooding" of domestic markets with foreign goods. 1.8 Has trade liberalization hurt manufacturing industries? This report seeks to analyze trade liberalization's impact on Bangladesh's manufacturing sector in three different ways. The first is a micro- level study on production efficiency in input use and on productivity that uses firm-level survey data on "before" and "after" trade liberalization observations with respect to input, output, and costs for a sample of manufacturing enterprises. Chapter 3 presents the results of this exercise with respect to technical efficiency and total factor productivity effects. Second, the replies received to a questionnaire on the key I Some of the key country conditions include: macroeconomic stability, soundness of the macroeconomic framework; business environment (availability of infrastructure, state of the bureaucracy, legallregulatory environment goveming business entry/exit and flexibility of labor markets, availability of skilled manpower, health/efficiency of the financial sector), and the existing economic structure--the extent of diversification in production and the export-base. The literature on the trade policy reform experience and lessons is rich. Some of the recent references include: Michaely, Papageorgiou, and Choksi (1991); Thomas, Martin, and Nash (1991); Dean, Desai, and Riedel (1994); Rajapatirana (1997). Chapter :. Bangladesh's Trade Liberalization: Has It Been Too Fast ? 3 constraints to doing business in Bangladesh and the results of direct interviews with businessmen on the same subject are assessed. Additionally, the latter chapter also includes the feedback obtained from a small sample of the so called "sick" enterprises, focusing on the explanations offered for their ill health. The purpose of the latter two exercises is to identify the factors other than trade liberalization that have affected the performance of Bangladesh's manufacturing enterprises during the 1990s. Finally, Chapter 3 reports on the impact of trade liberalization on business entry decisions, based on the information gathered from interviewing a small number of "new" enterprises. B. PROGRESS IN TRADE POLICY REFORM Introduction 1.9 To set the stage for an analysis of reform's impact, it is useful to evaluate Bangladesh's progress in trade liberalization against the generally accepted concept of liberalization as a move towards "outward orientation". The degree to which trade reforms achieve that orientation is often measured by movement toward: * neutrality of incentives between/within exportables and importables, and between export and domestic sales, and between non-tradables and tradables; • liberality, implying a definite reduction in the level of intervention in external transactions; and 3 * openness, as measured by the importance of trade in the economy. 1.10 Quite apart from the removal of anti-export bias, the essence of trade liberalization, as it is commonly understood, lies in reducing the level of intervention and increasing reliance on the price mechanism. In the specific case of Bangladesh and its progress to date in liberalizing trade, the relevant policy changes to be considered include lowering nominal tariff rates, removing QRs and/or export taxes, and exchange rate policy. 1.11 With regard to the degree of openness achieved, the macroeconomic record is unambiguous. The share of merchandise plus non-factor services trade in the economy, after remaining stable at around 19 percent of GDP throughout the 1980s, has risen rapidly in the 1990s--to 33 percent of GDP in FY98. Exports that stagnated in the 4-6 percent range in the 1980s, rose to 12-14 percent of GDP in FY97-FY98, while imports rose from about 14 percent to 19 percent of GDP over the same period (Table A.9 in Annex I). This growth in foreign trade in the 1 990s evidently owes most of its momentum to activity on the export side. The sharp expansion in exports of ready made garments (RMG) and knitwear has also led to strong expansion in imports of inputs such as fabrics and yam into RMG and knitwear production. As discussed below, evidence indicates that "neutrality" and "liberality" have also marked the intensive phase of trade reforms in the 1990s. Trade Policy Reform in the 1990s: Was it too much, too fast? 1.12 To reach the more outward-looking trade regime of the present, reducing the bias against exports along the way, Bangladesh has accelerated the pace of its reforms in the first half of this decade, emphasizing import tariff reductions and the removal of QRs. Very early in the 1990s, the top tariff rates were drastically cut and QRs rapidly dismantled. At the same time, the Government introduced a unified exchange rate system by eliminating the "Secondary Exchange Market System" and adopted a moderately 3 The trade literature refers to several related concepts of "liberalization", mostly revolving around "neutrality" of incentives, "liberality", and openness. For an extensive coverage and references on this issue, see: Pritchett, L. (1991). 4 Chapter 1: Bangladesh 's Trade Liberalization: Has It Been Too Fast? flexible exchange rate policy. In 1994, Bangladesh accepted the International Monetary Fund's Article VIII obligations, thus committing itself to current account convertibility. 1.13 The achievement of sufficient macroeconomic stability early in the decade facilitated the reform process. So did the switch from a fixed, over-valued exchange rate regime to a managed but moderately flexible regime that has so far prevented any significant appreciation of the real exchange rate. However, the tempo of trade policy reform has slowed significantly over the past couple of years. That hold-up, accompanied by some evidence of backtracking, appears to reflect a perception in the business and policy making circles that reform came "too fast" and needs to be moderated by a new gradualism.4 1.14 Counter to this viewpoint is the contention that most of the tariff cuts at the top end have resulted so far mainly in removing the "water-in-the-tariff'5 and in bringing statutory tariff rates closer to the observed differences between domestic and border prices. The evidence of the existence of the water-in- the-tariff is reflected in the low and flat imports of final consumer goods in the first half of the 1990s. Available information at the 8-digit level indicates that imports of most of the highly protected consumer goods in that period did not show a surge from their very low levels, and the observed insignificant imports of these items were probably associated with the accompanied baggage. In the second half of the 1990s, however, imports of these goods started increasing as the high tariff rates were lowered further. 25 Chart A: Structure of Tariffs, 1999/00 20- 15 - 0 1i 10 5 0 0 5 15 25 37.5 Tariff Rates 1.15 The maximum tariff ("customs duty") rate was reduced from 350 percent in FY91 to 40 percent in FY99, while the (unweighted) average tariff rate fell from 89 percent to 20 percent over the same period. Although the FY00 Budget theoretically cut the maximum tariff rate further to 37.5 percent, the retention of a "temporary" 2.5-percent Infrastructure Development Surcharge (IDS), means that the top tariff rate (inclusive of the IDS) remains at 40 percent,6 a fairly high rate despite the significant drop in maximum as well as average tariff rates. In fact, the average rate is pulled down substantially because many of the non-competing imports--such as locally unavailable raw materials and 4 For a detailed coverage of changes in Bangladesh's trade regirme, see: The World Bank, Bangladesh: Trade Policy Reform for Improving the Incentive Regime, October, 1996. Tariff redundancy resulting from prohibitively high rates and srnuggling. 6 Inclusive of the IDS. In FY99, the average (unweighted) tarifl rate was 20 percent, and it fell to about 17 percent with the FY00 changes. Chapter 1: Bangladesh 's Trade Liberalization: Has It Been Too Fast ? 5 machinery/equipment--enter at zero or very low rates (see Chart A). Competing imports, on the other hand, face higher tariff rates; indeed, nearly 25 percent of tariff lines (mainly finished products) are subject to the maximum tariff rate. In addition, these nominalprotection levels are augmentedfurther by other protective levies (such as the licensefee), as well as by the asymmetrical application of VAT, the supplementary duty (SD), and the IDS, which are in principle protection-neutral taxes.7 Not only has the IDS become de facto an import tax only; in some cases VAT and SDs are levied only on imports, not on domestically produced substitutes. In some instances SD rates levied on imports are higher than those levied on domestic production. Consequently, the unweighted average nominal protection rate--i.e., including import tariffs, other protective taxes and the protective components of VAT and SD--has remained much higher than the average tariff rate (Table 1. 1, and Table A. 1 in Annex I).8 1.16 Moreover, even with the significant decline in average tariffs that is mainly due to reduction in the top rates, the dispersion of tariffs - from 0 to 37.5 percent -- has nevertheless remained high relative to the average rate.9 As noted above, the latter range is further widened due to the other protective import levies. This continuing pattern remains an important shortcoming of Bangladesh's tariff structure, interfering in the allocation of resources based on comparative advantage. On the reforn agenda, further reductions in tanrff dispersion is an important pnrority since both the uniformity and average level of protection are critical stimuli to greater efficiency in allocating and using resources. The other priority step that needs to be undertaken in further rationalizing the tariff structure is to eliminate the existing tariff exemptions and concessions, which complicate the tariff system, promote rent seeking behavior, and also cause revenue losses that might be as large as I 1 percent of tax revenues collected on imports. Table 1.1: Trends in Nominal Protection, 1990/91 to 1998/99 (Figures are averages, %) Manufactures All Tradables Pre-reform, 1990/91: Unweighted 89.0 88.6 Import-weighted 51.8 42.1 Dispersion (CV) 72.4 71.9 In 1998/99: Unweighted 26.0 28.2 Import-weighted 23.8 20.3 Dispersion (CV) 68.3 66.6 Current status, 1999/00: Unweighted 24.2 24.7 Import-weighted Dispersion (CV) 84.1 76.8 Source: World Bank staff estimates. 7 The across-the board license fee is 2.5 percent, and serves as a protective tax. The supplementary duty (SD) rates are differentiated and applied in a non-neutral manner, and VAT is levied on imports of some textiles but not on domestically produced substitutes, and it has a cascading effect on the nominal protection rate. An import- discriminating Infrastructure Development Surcharge (IDS) of 2.5 percent has been in existence for the past two years only to be complicated in FY99 with a post-flood rehabilitation surcharge. The protective effects of all these import taxes are examined in detail in: The World Bank, "Review of the Indirect Taxation Regime", 1999. 9 It fell from 89 percent in FY91 to 28 percent in FY99, and further down to 25 percent in FY00. As measured by the coefficient of variation (CV). The CV provides a measure of deviations from the average value by normalizing these variations with the mean itself. 6 Chapter ]. Bangladesh ', Trade Liberalization: Has It Been Too Fast? 1.17 With the falling but still highly dispersed nominal tariffs, effective protection rates (EPRs) appear to have remained widely dispersed as well. Moreover, there has been a concerted effort to adjust the rates on input tariffs commensurate with drops in output tariffs in order to limit the fall in EPRs afforded to import-competing goods. Crude estimates"0 of industry-wide EPRs indicate a gradual decline in average levels of effective protection--from 76 percent in FY92 to 29 percent in FY98 (Table A.4 in Annex I), but most import-competing lines of production (e.g., textiles) continue to enjoy high EPRs. And the prevalence of high dispersion is evidence of the downward rigidity of protection levels and of the tacit acquiescence by authorities under heavy pressure from domestic protection lobbies. 1.18 Significant progress, however, has been made in reducing the importance of quantitative restrictions as instruments of protection. In FY92, nearly 11.5 percent of the 10,000 tariff lines were subject to QRs, compared to only 3.4 percent today. Less than one-half percent of current imports - mainly in the textile category - are restricted (Table I.2, and Table A5 in Annex I). Table 1.2: Phased Removal of Quantitative Rest:rictions, 1989/90 to 1998/99 (Number of 4-digit H.S. Codes) FISCAL YEAR ; 0Total T Reasons Non4Trade Banned Restricted Mixed Reasons 1989-90 315 135 66 52 62 1990-91 239 93 47 39 60 1995-97 120 5 6 17 92 1997-2002 124 5 6 17 96 Source . Ministry of Commerce, Import Policy Orders for various years. Anti-export Bias Remains Significant l.19 Trade policy in the late 1980s, a period marked by a highly dispersed and anomalous tariff structure, embodied an incentive system that favored production, for the domestic market over exports, protecting many inefficient import-substituting activities and creating a significant anti-export bias. The reforms of the early 1990s, in contrast, aimed at lifting restrictions on foreign trade, gradually removing the anti-export bias, and creating a neutral policy regime. The initended objectives were to enhance domestic competition, remove price distortions and bring domestic relative prices into alignment with international prices so as to boost efficiency in resource use, spur activities that have comparative advantage, and encourage technological progress, innovation and diversification and thus generate dynamic gains. 1.20 These efforts have produced partial success in reducing the anti-export bias of the trade regime, as shown in Table I.3 below. The ratio of effective exchange rate for imports (EERm) relative to exports (EERx) is used as an indicator of the trade regime's anti-export bias--the higher the ratio above 1.00, the more intense is the bias against export activity." Although the structure of relative incentives for '° Estimates are based on operative nominal import taxes, rather than being based on the observed differences between T.he domestic and intemational prices. In the presence of water-in-the-tariff, EPRs calculated on the basis of statutory import levies may only give crude approximations. I I In the present context, for imports EERs refer to nominal exchange rates adjusted for (protective) import taxes (and any scarcity premium that exchange controls may generate). For exports, EERs give the nominal exchange rate after adjustment for the existing export promotion schemes. Accordingly, for imports EERm represents domestic market value of imports worth one unit of foreign currency (US dollar, in the present case). For exports, EERx represents domestic currency equivalent of proceeds from exports worth one unit of foreign currency. Chapter 1: Bangladesh's Trade Liberalization: Has It Been Too Fast ? 7 production of import substitutes declined from 1.66 in FY92 to 1.26 in FY96, it remained essentially unchanged through 1997/98, and might have fallen only marginally following the FY00 tariff changes. While the EERx rose from 38.5 in FY92 to 46.3 in FY98, the EERm fell from 63.8 in FY92 to 51.9 in FY96. It then rose appreciably to 58.4 in FY98 (much of it not explained by the depreciation of the nominal exchange rate), suggesting some reversal of the trend in the last couple of years partly due to the new protective levies. Thus, the structure of trade policy-induced incentives still remains skewed in favor of import-substitutes by about 26 percentage points (according to the1997/98 figure), a rough indicator of the degree of anti-export bias of the current trade regime. It is worth noting that the bias still remains larger in the case of the 'final" consumer goods--the EERm/EERx ratio was 1.90 in FY92 and itfell only to 1.39 by FY98. Table 1.3: Effective Exchange Rates for Import Substitutes and Exports12 Overall un- weighted Nominal Fiscal year protective exchange EERm EERx EERm!/EERx rate rate (- Taka per US$ - 1991-92 67.35% 38.15 63.84 38.53 1.657 1992-93 55.37% 39.14 60.81 39.72 1.531 1993-94 42.43% 40.00 56.97 40.48 1.407 1994-95 31.32% 40.20 52.79 40.53 1.302 1995-96 27.11% 40.84 51.91 41.25 1.258 1996-97 26.85% 42.70 54.16 43.22 1.253 1997-98 28.54% 45.46 58.44 46.25 1.263 Source: World Bank staff estimates (Table A.6 in Annex I). 1.21 In spite of this favoritism for the domestic market relative to exports, the latter, measured in current US dollars, have grown at a significantly high annual rate of 17 percent in the current decade. That achievement is largely due to the special environment created for export production, insulating it from the prevailing trade regime. Enclaves created under various export promotion schemes have provided certain-- but not all would-be -- exporters duty-free access to imported inputs. Special bonded warehouses for the ready made garment (RMG) production/export and export processing zones, complemented by other factors such as export quotas under the Multi-Fiber Arrangement and export financing through back-to-back L/C, have allowed Bangladesh to use its abundant labor resources to develop an efficient RMG and knitwear industry, which accounts for over 70 percent of its gross exports. This impressive success has yet to be replicated in other industries, however, and Bangladesh's export base remains narrow. More importantly, over the past two decades, while many countries gained global market share, Bangladesh's share of world exports has remained relatively unchanged'3 (Table 1.4). And the inefficient system of duty drawback available to exporters is neither sufficient to offset the anti-export bias nor supportive of potential export activities. Further reform is required to continue reducing the obstacles to exporting and to move toward a neutral domestic incentive structure. 12 For more details on the estimnated EERs, including unweighted and weighted EERs for imports, see Tables A.6 and A.7 in Annex I. 13 In general, South Asian countries seemed to have lost relative ground in the world market for exports. 8 Chapter ]: Bangladesh's Trade Liberalization: Has It Been Too Fast? Table 1.4: Falling behind?...Bangladesh's share in World Exports, Selected Countries (percent) Country ~~~~1980 1990 1996 China/a 6.94 9.95 12.81 Indonesia/b 7.20. 4.91 4.13 Thailand 2.75 5.14 5.34 Malaysia 4.76 5.67 6.65 Mexico 7.92 8.97 8.16 Philippines 2.63 2.1:8 2.99 India 4.85 4.29 3.73 Sri Lanka 0.48 0.46 0.42 Pakistan 1.53 1.36 0.85 Bangladesh 0.38 0.45 0.42 Source: World Development Indicators, World Bank 1998; /a: 1982, /b: 1981 Pace of Bangladesh's Trade Liberalization: A C'hart B: Average Tariffs in South Asia, 1998/99 Cross-Country Comparison 40 . I 1.22 Another way of measuring the speed and 30. depth of trade policy reforms in Bangladesh is to 25s compare its achievements to those in other 201 liberalizing countries in South Asia, Africa and Latin '5f America. Starting in South Asia, for which the most s* recent comparable information is available, data o. A show that Sri Lanka --starting in 1977 -- has gone the farthest, continuing on a path of steady liberalization throughout the 1980s and 1990s. Currently, Sri Lanka has a four-band (5, 10, 25, and 35 percent) GUnweighted *Import weighted tariff regime, with the highest rate applying to agricultural products. Taking QR reform into consideration, Bangladesh stands next to Sri Lanka in terms of the pace of trade liberalization. As the following table reveals, excluding Nepal, which has little domestic industry to protect, Sri Lanka and Pakistan have the lowest top rate. However, in terms of average tariffs, Bangladesh would come after Nepal with the FY00 tariff reductions. Table 1.5: Average Tariffs and Top Rates in South Asia, 1998/99 cou es Top rate IAwighted gort-wtd Bangladesh 40 20.0 16.0 India 45 39.6 20.2 Pakistan 35 21.3 20.7 Sri Lanka 35 17.6 10.0 Nepal 80 14.0 9.6 Source: SASPR, World Bank Chapter 1: Bangladesh's Trade Liberalization: Has It Been Too Fast ? 9 1.23 In fiscal year 1999, Sri Lanka, in addition to compressing its tariffs into four slabs,14 also abolished export taxes '5 and limited the application of QRs only to non-trade reasons.16 Sri Lanka is also moving away from a heavy reliance on import duties for revenue: in 1995, customs duties were only 21 percent of total revenue (compared with 33 percent in Bangladesh) and 9.7 percent of actual imports (21 percent in Bangladesh). Although Sri Lanka's trade system retains such drawbacks as the granting of duty waivers and exemptions and the application of surcharges and markups in import valuation, the move to the four-tier tariffs and the elimination of QRs has made Sri Lanka's economy the most open in South Asia. Sri Lanka has also announced plans to move to a two-band regime (10 and 20 percent) in 2000 and to a uniform tariff rate system ultimately. 1.24 In contrast and despite significant import liberalization and tariff reductions, India continues to be highly protectionist. Import bans and other pervasive across-the-board QRs mostly on consumer goods still restrict international competition generally and trade with other South Asian countries as well. Some 200 agricultural, mineral, and metal items are subject to export restrictions. In the past two years, although the maximum import tariff rate has moved closer to that of Bangladesh, entrenched protectionist lobbies in India continue to mount powerful resistance to scrapping QRs. In the face of a general trend in South Asia toward removing remaining trade barriers, India is likely to bend to the wind of change sooner rather than later. Indeed, it recently entered into bilateral free trade agreements with Nepal and Sri Lanka for a phased removal of tariffs and QRs within the next three years or so. Negotiations with Bangladesh are under way for providing market access to a broad spectrum of items.17 1.25 Comparison with the Rest of the World. Although low in the South Asian context, Bangladesh's tariffs are still higher than the average in a number of Latin American and even some African countries that undertook trade reforms during the late 1980s and early 1990s (Table 1.6, and Table A.8 in Annex I). Bangladesh can, however, claim one of the sharpest reduction in tariffs over the reform period as measured by the ratio of average tariffs after and before reforms. Table 1.6: International Comparison of Tariff Regimes Region averages Avg. tariffs Avg. tariffs Tariff ratio* Pre-reforn Post-reformn Bangladesh (1989, 1998) 94 21 0.22 South Asia (1985, 1998) 80 27 0.34 South East and East Asia 29 14 0.48 (1984, 1998) Africa (1983, 1996) 41 31 0.76 Latin America (1984, 1998) 44 13 0.30 (*) Tariff ratio is the post-reform average tariffs over pre-reforn average tariffs. Source: Dean, Judith M. et. al., World Bank (1994); Rajapatirana. (1997; the World Bank (1999b); Ng, Francis and Yeats, Alexander (1999); Table A8(Annex I). 14 The only exception is agricultural products which have a rate of 35 percent. 15 Some export cesses and "royalties" remain on such items as coconut products, tea packets and bags, raw hides and skins, and rubber. 16 Exceptions are some agricultural products, certain used transport vehicles, and certain diesel engines. 17 Reservations are strong in Bangladesh business circles over these free trade negotiations. Low expectations about a positive result stem from recent experience of Bangladeshi exporters who reportedly faced insurmountable non-tariff barriers (even though tariff concessions were offered) in seeking market access to India. 10 Chapter 1. Bangladesh'"s Trade Liberalization: Has It Been Too Fast? 1.26 South East and East Asia. Between 1985 and 1998 tra(ie policy in South East and East Asia became decidedly more liberal. No country in the region, with]in which the character and pace of trade liberalization varied, moved toward more protectionism during this period. QRs were virtually eliminated throughout East Asia, although Vietnam and China still maintain import licensing which may be used as restrictive instruments. Most countries in the region have reduced tariffs, Taiwan, South Korea, and the Philippines most significantly. Exchange liberalization was evident as most of the countries that removed QRs also had little or no black market premium by 1992. Only four of the East Asian countries initiated trade reforms in 1985 with substantial real devaluations: China, Philippines; Indonesia and Vietnam."8 1.27 Latin America. Latin American countries introduced dramatic and significant trade reforms between 1985 and 1998. Trade liberalization was comprehensive, both removing import and export restrictions in the area of commercial policy and liberalizing foreign exchange markets. Concomitant with the removal of QRs, Latin American countries effected significant reductions both in import tariffs and in their dispersion, resulting in average nominal tariffs that are the lowest for any developing region. Export taxes and restrictions were also reduced while support for exports expanded. At the same time, most countries reduced intervention in their foreign exchange market, unified exchange rates to do away with pre-reform multiple rates, and moved to managed floats or crawling peg systems'9 In sum, the Latin American trade reforms could be characterized as a combinatioin of moves towards neutrality and liberality. 1.28 In terms of the content of reforms, trade liberalization iln Bangladesh and Latin America has taken similar paths: removal of QRs, tariff cuts, and diminished intervention in foreign exchange markets. The difference lies in the pace of reforns and the extent of reductions in the average rate and dispersion of tariffs. For instance, Chile, Colombia, Peru and Argentina brought down their average tariffs to below 14 percent between 1985 and 1998, notably farther and faster than Bangladesh, which did handle QRs and foreign exchange liberalization in a like manner. The Latin American pattern attribute of trade reforms that combine neutrality and liberality also describes performrance by Bangladesh so far. Box 1.1: What could have been done Differently in Implementing Bangladesh's trade Liberalization? An imnportant shortcomning of Bangladesh's approach to trade liberalization has been the failure to announce in advance the timnetable of planned changes in the trade policy. Had the Governnent announced in advance the future program of tariff and non-tariff changes, the credibi.lity of the trade reforms would have been enhanced, giving clear and convincing signal to the domestic firms about the intended outward- and market- orientation in the policy environment. This would have given more tirne to the local firms to adjust and respond. At a serninar held in Dhaka on September 16, 1999 to discuss the report, many participants agreed with this view. Indeed it could be argued that one of the reasons why Bangladesh's trade liberalization is perceived as fast- paced is perhaps in part due to the fact that the program was not pre-announced and, therefore, many firns in the private sector were caught unprepared. The policy implication of the foregoing is that in the future it would be advisable to announce the planned changes in the trade policy well in advance. 18 For a detailed coverage of the trade liberalization experience of these cited countries, see, for example: Dean,J., Desai, S., and Riedel, J. ( 994); and Rajapatirana, S. (1997). 19 The exception is Brazil which continues to maintain significant exchange controls under a crawling peg system. Chapter 1: Bangladesh's Trade Liberalization: Has It Been Too Fast? 1] C. OTHER ACCOMPANYING POLICY CHANGES 1.29 Complimentary policies. Trade liberalization in Bangladesh did not stand alone. Rather, it was one component of economic liberalization and market-oriented reforms that entered an intensive phase early in the 1990s. Although the New Industrial Policy of 1981 signaled a major shift to private enterprise and away from the pattern of nationalization and public-sector dominance in the ownership and management of industrial enterprises, actual change came slowly. Significant liberalization of the investment regime for domestic and foreign investors did not actually occur until early in the present decade, excluding only a few sectors deemed vital to national security from the reach of private investors. Notable steps in the sphere of de-regulation and market orientation included financial sector liberalization, privatization of SOEs, and re-structuring and private sector participation in gas, power and telecom sectors. With respect to macroeconomic policies, the Government initiated a major reform to broaden the tax base and improve efficiency in taxation, The centerpiece of the tax reform effort, a value- added tax (VAT) introduced with the FY92 budget at a uniform rate of 15 percent at the manufacturer- cum-import level, largely replaced the earlier structure of differentiated sales taxes levied on imports and excise taxes on domestic goods. 1.30 Partly because policymakers have lacked strong commitment and partly because such vested interests as trade unions, industrialists, and bank defaulters have strongly opposed, Bangladesh's economic reform goals remain unfulfilled at the end of the decade. The privatization program remains stalled; many of the firms identified for privatization are still state-owned. The process of re-structuring gas and power utilities has also been slow, particularly in the matter of unbundling generation, transmission and distribution facilities, although the energy sector has been successful in attracting significant foreign investment. The same is true for the telecommunications sector. What has been painfully slow are the regulatory reforms, enactment of laws and rules for regulating businesses which were the exclusive preserves of public monopolies. 1.31 Business environment depends not only on declared laws and regulations but on their effective enforcement to safeguard contracts and on the continuity of policies that enable businesses to compute risks and returns with a measure of predictability. Measured by these criteria and even acknowledging the fair degree of liberalization that has been achieved, the Bangladesh business environment remains unhealthy. Deep-rooted problems of governance and weak infrastructure services undermine predictability. An intrusive and inefficient bureaucracy acts as a drag on business and industry; substantial non-performing loans (approaching 50 percent of the outstanding loan portfolio when the international standards are applied) burden the financial sector; the legal framework is not geared to the fast pace of modern business; frequent congestion and work stoppages hinder the ports, which also have among the highest handling charges in the region,0 grossly inadequate, the telephone system is not up to the challenge of a rapidly growing economy; power disruptions are frequent; law and order seems to be worrisome; and the politics is confrontational and often destructive of life and property. Together, these fundamental weaknesses raise the cost of doing business in Bangladesh and constrain the growth of domestic and foreign private investment, hampering competition and diversification in the economy. These structural constraints clearly undercut the efficiency and productivity impacts of trade liberalization. 20 A World Bank study estimated that handling charges for a 20-foot container were $640 in Chittagong, compared with $220 in Colombo and $360 in Bangkok. For additional details on the business environ-ment, see: Bangladesh: Government That Works-Reforming the Public Sector, The World Bank, 1996; and Bangladesh: Key Challenges for the Next Millennium, The World Bank, 1999a. 12 Chapter 1: Bangladesh's Trade Liberalization: Has It Been Too Fast? 1.32 One redeeming feature in this discouraging picture is the noticeable improvement in macroeconomic management in the present decade. Evidence suggests that trade liberalization is easier to manage if it is preceded by or contemporaneous with macroeconomic stability--a necessary condition for higher growth performance. Bangladesh's critical macroeconomic indicators, such as fiscal and current account deficits, inflation and interest rates, showed marked improvement early in this decade due to prudent fiscal and monetary management and to the adoption of a moderately flexible exchange rate regime. In line with the evidence from other countries, the elirnination of QRs and reduction of import tariffs in Bangladesh has had little adverse impact on external current account deficits and on fiscal balances. Thus, the relatively stable macroeconomic environment that has accompanied trade liberalization has generally been supportive of business investrment. However, the political uncertainty of the recent years and the related frequent country-wide general strikes have adversely affected private activity and investment decisions. 1.33 Exchange rate management. Unlike the majority of developing countries with severely overvalued currencies that have made and sustained a real depreciation as an integral part of stabilization programs and trade liberalization efforts, Bangladesh avoided a major real devaluation at the outset of trade reforms 2' and adopted a different strategy. After unifying existing multiple exchange rates in 1992, the central bank has pursued a largely successful "managed but flexible" exchange rate policy22 to maintain the competitiveness of exports while keeping domestic inflation at bay. Though the open- market exchange rate premium is not a foolproof indicator of trade liberalization, the fact that these premiums have been consistently low for a sustained period (only 1.75 percent during 1996-99) is one indication of the effectiveness of exchange rate management. Chart C: REER for South Asia 150. (1990=100)* 140 IND 130. X 120. PA iio. ~~~~~~~~~~~~~~~~~~~~NPL X U 0. BGD 8 909 w ~~~~~~~~~~~~~~~~~~~~~~~~~SRL cg80. 70 60 50. 80 82 84 86 88 90 92 94 96 98 Year * Increases represent depreciation Nonetheless, whether we look at basket-weighted real effective exchange rates (REERs) or bilateral real exchanges rates (RERs), in terms of maintaining competitiveness, Bangladesh's exchange rate management, with a real appreciation of about 4 percent in its REER during 1990-98, lagged behind those of India (which had a 35 percent real depreciation), Pakistan (w ith 19 percent real depreciation), and Nepal (7 percent real depreciation)--Chart C. It also trailed some of the competing South East and East Asian countries, including Indonesia, Malaysia, Thailand, and South Korea. In the case of Bangladesh, a 21 The presumption being that the currency was not terribly overvalued in the first place. 22 The central bank has adopted a policy of mini-devaluations, with several small adjustments resulting in a cumulative nominal devaluation of roughly 3-5 percent annually, as opposed to one-time major devaluation. On the other hand, the rate of domestic inflation has fluctuated between 3 percent and 9 percent since 1992/93. Chapter 1: Bangladesh's Trade Liberalization: Has It Been Too Fast ? 13 modest real depreciation is noticeable in the early years of trade reforms through mid-19962 A similar picture is also reflected by the bilateral RERs vis-A-vis the US dollar--see Chart D. Chart D: Bilateral RER for South Asia (1990=100)* 160 150 140 IND 130 a' 120 NPL 110 BGD a100 SRL 80 70. 60 80 82 84 86 88 90 92 94 96 98 Year * Increases represent depreciation 1.34 Although export performance has been strong and macroeconomic balances satisfactory during the 1990s, a more competitive exchange rate policy could have had positive effects on potential exportables and contributed to export diversification. India's large real depreciation may partially explain why Bangladesh's merchandise trade deficit--formal and informal-- with India has been growing rapidly, faster than the pace of Bangladesh's import liberalization alone would justify (this is discussed in more detail in Chapter 2). In any case, Bangladesh requires more than just a competitive exchange rate to foster sustained export growth; structural constraints that inhibit supply response must be addressed on a priority basis. Box 1.2: Sequencing of Complementary Reforms Noting the business environment constraints and the resulting high costs of doing business, it has been argued--and this was also stressed by several participants at the September 16, 1999 seminar --that Bangladesh should have opted for a more gradual approach to trade liberalization thus giving more time for improvements in the business envirom-nent to take place. While it is difficult to speculate on the counterfactual, it can, however, be argued that postponing or slowing Bangladesh's trade liberalization would not have guaranteed accelerated structural reforrns and improvements in the business environment. Yet slowing trade liberalization any further would have left the country even farther behind the rest of the developing world in intemational competitiveness since mnany developing countries had started opening up in the early 1980s and begun capturing market shares. Furthermore, it can be added also that, if anything, trade liberalization has probably intensified the pressure to start implementing at least some of the priority structural reforms. By moving forward with trade liberalization, Bangladesh put in motion the needed adjustments in the economy toward outward-orientation without further delay and started realizing at least some of the expected gains. It is, of course, very critical that the needed reforms and improvements in infrastructure, the financial sector, state-owned enterprises, public administration, business exit, and in law and order are accelerated to foster business confidence, promote private investment, and ease the ongoing adjustments to trade liberalization. Steps to reduce political uncertainty would also be important. 23 Note, however, that the preceding is just to highlight the real exchange rate policy that has been pursued by the South Asian countries since 1990. It does not in any way imply that the RERs/REERs that prevailed in 1990 were equilibrium rates. 14 Chapter 1: Bangladesh''s Trade Liberalization: Has It Been Too Fast? D. TRADE LIBERALIZATION AND ECONOMIC PERFORMANCE 1.35 By any measure of openness--size of trade, removal of QRs, lowering of tariffs, black market premium of foreign exchange-- Bangladesh is a more open economy today than it was in the 1980s. Has this change made any difference to growth? Employment? Investment? Industrial or agricultural performance? Several recent cross-country studies have found a positive relationship between liberalization and economic performance .24 Setting aside problems related to the formulation of a robust index of openness, most studies have also found evidence of a positive correlation between liberalization and productivity growth, a subject discussed in the next Chapter25 1.36 Though rigorous econometric evidence on Bangladesh is awaited, comparable data for the 1980s and 1990s suggest a positive stimulus to growth emanating from increased openness (see Table 1.7). That higher momentum--5 percent annual GDP growth compared to 4 percent in the previous decade -- could be linked to the market-oriented policy changes, including trade liberalization, that occurred early on. Sectoral GDP growth rates in both manufacturing and agriculture seem to have responded favorably, particularly in manufacturing, despite external shocks and extended political uncertainty in recent years. The annual average growth rate of manufacturing GDP reached 7 percent in the 1990s, which contrasts sharply with the 3 percent observed in the 1980s. As elaborateid further in Chapter 2, manufacturing output has also grown at a higher annual average rate in the 1990s than in the 1980s also--at 8 percent through FY98, in contrast with 6 percent realized in the 1980s. Better output performance in the 1990s of the medium and large scale manufacturing sector still holds even when the fast growing RMG/knitwear and the declining export-oriented jute textile sub-sectors are excluded from the averages. In agriculture, one of the factors leading to the acceleration of growth in foodgrain productivity was the decision in the late 1980s to liberalize trade in pumps and engines.26 Table 1.7: Trade Liberalization and Economic Performance Post liberalization iiA0 0zio 0t00t00 t 0000 0 f ; j4 liberalization Annual growth rates VbY1980s2av. FY90 F2 FY94 FY96 FY98 1990s avg. Real GDP 4.0 70 5.0 3.8 5.0 5.6 5.0 Manufacturing 3.0 1.0 10.0 5.0 6.0 9.0 7.0 Agriculture 2.0 10.0 2.5 0.8 3.4 3.0 3.3 Exports (in nominal 7.0 37.0 25.0 4.0 8.0 12.0 17.0 US$) Source: World Bank staff estimates 1.37 Export growth has been phenomenal compared to any tlime in the past. Though the response of domestic investors was modest (except in RMG sector), still private investment as a share of GDP rose by 2 percentage points between FY90 and FY98 to 13.6 percent.27 The liberalized trade and investment 24 Michaely, Choksi and Papageorgiou (1991); Grossman, G. and Helpman, E. (1991); Romer, P. M. (1992), Barro, R.J. and Sala-i-Martin, X. (1995), and Edwards, S. (1998). 25 There are also studies, however, that reflect skepticism over the findings of these empirical studies on the grounds of inappropriate measurement of "trade policy-induced opemness", weaknesses in the methodologies used, and failure to establish the direction of causality: Krugman, P. (1994); Rodrik and Rodriguez (1999). 26 For further details of the trade policy on agricultural inputs and outputs and on the related issues, see: Shilpi, F. (1998a, 1998b); Mitchell, D. (1998). 27 While there appears to be a slowdown in the growth rate of investment activity in the last couple of years, the reasons for this should not be attributed to trade liberalization but to other factors, including: the recent Chapter ]: Bangladesh's Trade Liberalization: Has It Been Too Fast ? 15 regime has also given a boost to foreign direct investment, expected to reach $1 billion by 2000-- from very modest beginnings in the early 1990s. 1.38 By definition, trade liberalization erodes the protection enjoyed by inefficient domestic producers, generally with the deliberate aim of opening the economy to greater foreign competition. The natural cost should be at least a short-term deterioration in the balance of payments, but Bangladesh did not experience even that brief reversal. Instead, both the external current account deficits and reserve position improved following trade reforms. Having averaged 4 percent in the 1980s, the current account deficits as a percentage of GDP declined to 2.7 percent in the 1990s. Import growth was evenly distributed among intermediate, capital and final consumer goods without, contrary to popular belief, the economy being particularly 'flooded' with consumer goods. The pick up in exports, expanding at an annual average of 17 percent in nominal dollar terms until FY98, led to a substantial improvement in the balance of payments position. Foreign exchange reserves rose from about $500 million in 1990 to S 1.8 billion at the close of FY98. Indeed, as evidenced in reform episodes elsewhere, gross reserves accumulated rapidly following trade reforns, rising to a peak of $3 billion in FY95 before declining again. Also, there has been no major adverse effects on budgetary revenues as a result of tariff cuts. The ratio of tariff revenues (CD plus the IDS) to GDP has remained stable around 2.3 percent in the 1990s. It appears that the growth of imports and the introduction of the IDS have more than offset any potential revenue losses from tariff cuts so as to stabilize the tariff revenue-GDP ratio. E. CONCLUSIONS 1.39 Begun in the second half of the 1980s with the dismantling of QRs, Bangladesh's trade liberalization effort became more comprehensive in the early 1990s, covering protective QRs, import tariffs, other levies, and the exchange rate policy. Rather than speeding up, however, the process of liberalizing imports slowed down in the mid- 1990s, without a satisfactory degree of uniforrnity in protection being achieved. Given that incomplete degree of trade liberalization and the good economic performance that accompanied it, Bangladesh can hardly be said to have liberalized its trade too fast. * The significant part of import "liberalization" in the 1980s and early 1990s basically amounted to the still incomplete removal of QRs and of water-in-the-tariff, particularly on final goods. Once existing tariffs became binding and foreign competition more effective, however, the process slowed down. * Given its range of 0-37.5 percent, the current import tariff structure still shows a high degree of dispersion. Additionally, the tariffs accord industries producing competing final goods significant protection, augmented further by other import levies as well as by the protective incidence of supposedly protection-neutral indirect taxes. The latter include the supplementary duty, VAT, and the IDS; asymmetrically applied, they give rise to further cascading nominal protection. Moreover, with tariff exemptions/concessions and low tariff rates on intermediates and high tariffs on finished products, the effective protection rates are undoubtedly pushed up substantially on final goods, resulting in perhaps greater dispersion in EPRs. Indeed, this appears to have been a deliberate policy in guiding tariff adjustments in recent years with textiles serving as a very good example of a high effective protection strategy partially offset in practice by smuggling. devastating floods and the resulting losses in incomes and jobs, which in turn most likely depressed domestic demand; difficulties faced in obtaining bank credit as the banks have become more stringent in extending loans; increasing domestic political tension; and the slowdown in international trade in the aftermath of the Asian crisis. 16 Chapter 1: Bangladesh 's Trade Liberalization: Has It Been Too Fast? * While Bangladesh appears to be one of the faster liberalizing countries in South Asia, behind Sri Lanka, the region in general and India in particular have lagged behind other regions, even behind some countries in Africa, in improving the neutrality and liberality of their trade regimes. India appears to have opted for slower integration into global markets. The vastness of India's domestic economy and the diversity of its resource base, however, make it a poor trade policy match for its smaller neighbor. On the other hand, Sri Lanka, more comparable in economic size and long committed to global markets and the pursuit of export growth, has been steadily liberalizing its trade regime. For Bangladesh, Sri Lanka offers valuable guidance to the tempo and content of trade liberalization, lessons that Bangladesh needs to follow so that a stronger export base and more neutral incentives that further recluce remaining anti-export bias can support higher sustained economic growth. * Going outside South Asia to weigh the experience of other liberalizing countries of the world, Bangladesh's reforms over a period of 8-10 years do not appear particularly fast. In South East and East Asia and in Latin America, many countries achieved significant cuts in average tariffs and reduced the range of their lowest and maximum rates over a period of 5 to 8 years. 1.40 The preceding observations are intended to make the point that Bangladesh's trade liberalization was not particularly fast. Indeed, accepting that it is difficult to establish satisfactorily whether the pace of Bangladesh's trade liberalization was appropriate or not, the report does not try to pass a definite judgement on this matter. However, what the report establishes and argues is that the economy's performance has markedly improved under trade liberalization, providing also a good reason for continuing with the program to further rationalize and simplify the tariff structure. * Although the precise causal role of trade liberalization in overall economic performance and in growth in particular is difficult to determine, available macro-level evidence at least suggests that Bangladesh's economic performance has improved in the 1990s as standard economic models would lead one to expect. (For micro-level impacts on manufacturers, see Chapter 3). * For a country embarking on trade liberalization, initial economic and institutional conditions are obviously crucial determinants of the scope, sequencing, and pacing of trade liberalization programs. The soundness of the macroeconomic framework and of other economic policies as well as the state of the business environment affect economic performance and the prospects of realizing expected gains from trade liberalization directly. The fact that Bangladesh has generally maintained a sound macroeconomic environment has been a positive factor in carrying out trade liberalization. However, the progress (despite a sufficiently long lead-time and availability of external assistance) in strengthening the financial sector, tackling infrastructure bottlenecks, addressing bureaucratic hurdles, and reforming the SO.E enterprise sector has been slow. Together with external shocks and the prolonged political uncertainty, this foot-dragging has most likely made attempts to adjust and respond to trade liberalization more difficult, thus limiting the potential benefits. * Looking forward, the key objective of future trade reform should be to move beyond enclave-type arrangements to broader trade liberalization. The goal that enclaves realize only in part by circumventing import restrictions and other impedimenits to doing business should be to lower the dispersion of nominal and effective protection rates and eliminate protective QRs as well as tariff exemptions/concessions. In this respect, the tariff rationalization measures announced with the FY00 Budget--reducing the maximum rate from 42.5 percent (inclusive of the ISD) to 40 percent and the number of tariff slabs from 6 to 4, and harmonizing tariff rates on similar goods--are welcome developments. However, tariff hikes on some finished goods (e.g., paper pulp and silk) that would increase their EPRs give mixed signals about the future direction of trade policy. Chapter ]. Bangladesh's Trade Liberalization: Has It Been Too Fast ? 17 Improvements in the business environment would help enhance gains expected from freer trade by reducing the cost of doing business and strengthening supply response capacity of local firms. 1.41 Before proceeding to the next chapter, it is important to draw attention to an important aspect of trade liberalization. This concerns the impacts on consumer welfare. Because of its very focussed agenda, no attempt is made in the report to look at the likely size of consumer welfare gains attributable to trade liberalization. Such gains, which are generally substantial, result from lower prices for traded goods and increased choices that trade liberalization facilitates. Therefore, it is important to remember the significant benefits enjoyed by the consumers when the policy debate is carried out on the impacts of trade liberalization. Chapter 2 RECENT TRENDS IN FOREIGN TRADE A. INTRODUCTION 2.1 If Bangladesh has not moved too fast in liberalizing trade, has liberalization nonetheless worsened external balances, flooding domestic markets with foreign goods and thus displacing domestic production? This chapter briefly examines those concerns, the claims made in some business circles that domestic markets are "flooded" with foreign goods that, by implication, are causing difficulties in external accounts and leading to the displacement of domestic production. 2.2 Among the expected consequences of trade liberalization are shifts in resource use toward activities that exploit comparative advantage and improved production efficiency under the pressure of enhanced competition. Long-protected and, yet, inefficient firms that cannot attain competitive strength find themselves under pressure. They lose markets or, if they are not viable under a more neutral incentive regime, go out of business, costing workers their jobs. Such contractions/displacements are natural but not universal results of moving to freer markets, but they do not happen across-the-board and do not go unbalanced by the parallel creation or expansion of job opportunities in the existing as well as in the new fields and activities. If widespread production/jobs displacements were to take place, such adverse impacts would be reflected in poorly performing aggregate and sectoral growth rates, as well as in sluggish investment activity. As discussed in Chapter 1, this is not the situation in Bangladesh. Both the overall and sectoral GDPs have registered higher growth rates in the 1 990s than in the 1 980s, and the overall investment-to-GDP ratio increased by one percentage point, while the private investment increased by two percentage points from FY90 to FY98. (These aggregate and sectoral improvements are also reflected in the firm-level findings discussed in Chapter 3). 2.3 If foreign goods were inundating domestic markets to the point that external balances were destabilized, then export and import patterns would also show adverse and unsustainable trends in external trade and current account balances. What more often happens is that imports made possible by market-opening reforms facilitate higher investment activity, stronger export performance, more vigorous competition, greater efficiency and, in consequence, economic growth. When there is no sustained surge in imports (particularly of final consumer goods), trade liberalization, ceteris paribus, will not cause destabilizing developments in external accounts. In addition, to understand better the effects of trade liberalization on the level and composition of imported goods, it is essential to make a distinction between legal imports and foreign goods that are smuggled into the country. Since high protection encourages smuggling, liberalization may actually reduce those inflows in favor of legal imports. Indeed, in Bangladesh many goods that are still highly protected are reportedly being smuggled in from India. It may be that it is largely smuggled goods that are "flooding" the domestic markets. 2.4 To explore how these expected effects of trade liberalization have played out in Bangladesh, this chapter discusses the country's recorded (format) and also unrecorded merchandise trade in the form border crossings with India.' In summary, it may be noted that: * Bangladesh has become a much more open economy over the past decade or so, a process spurred at least in part by trade liberalization. The ratio of formal merchandise trade (exports plus imports) to GDP almost doubled to 30 percent between FY90 and FY98. Of course, the other channel through which unrecorded trade takes place is the under-valuation of shipments through the regular channels. This part of the unrecorded trade, which might be sizable, is covered only briefly here due to the lack of information (see the end of the chapter). 20 Chapter 2: Recent Trends in Foreign Trade * The trade deficit has remained sustainable in the range ojf 5-6percent of GDP, without showing any upward trend. Growth of merchandise exports (in current US dollars) has exceeded that of imports. The latter have not shown any upsurges. Thus, while in the early 1990s exports financed less than 50 percent of merchandise imports, they covered almost 70 percent by FY98. This is a case of favorably balanced growth of exports and imports, indicating the healthy development in external trade balances that theory suggests. In this regard, it is worth noting, as in the previous chapter, the significant parallels with Sri Lanka, which has gone further than other South Asian countries in outward-orientation, and has benefited from more openness without facing unsustainable developments in her external accounts. * The expansion of merchandise imports was concentrated in capital goods, primary goods/raw materials and intermediates. These developments have rmost likely facilitated the growth in domestic production and exports. Capital goods consistently accounted for around 16 percent of Bangladesh's recorded imports over the past six years, compared with only 7 per cent for final consumer goods The absence of a surge in final consumer goods imports partly reflects the fact that they are still highly protected. * There appears to be sizable unofficial border trade with India, with perhaps only 25 per cent of inward smuggling being covered by counter trade and the rest most likely being financed by workers' remittances (readily available in the hundi market). Many of the smuggled items "flooding" the domestic markets compete with highly protected goods. B. RECORDED TRADE 2.5 Exports. Formal exports have grown rapidly over the past decade, showing an average annual growth rate of about 17 percent (in current US dollars) and reaching over 12 percent of GDP by FY98, compared with only 5 percent of GDP at the beginning of the decade. The growth has been led by even more rapid expansion of woven ready-made garment (RMG) "cut, make and trim" assembly than had already occurred in the mid/late 1 980s and has been supplemented by a mushrooming knitwear industry. Woven RMG and knitwear together accounted for almost three quarters of total exports in FY98, just over twice their 36 percent share in FY89. Their annual growth over the decade averaged 27 percent a year, compared with 7 percent for all other exports combined (see Tables B. 1 and B.2 in Annex II). 2.6 Beyond their very strong contribution to foreign exchange earnings, developments in the RMG/knitwear activities have several positive features in terms of efficient industrialization-- and potential for improvement--especially when compared with the industries like jute and tea which used to dominate Bangladesh's exports: * While value-added may be modest on a unit basis (since the industry must import its fiber, yarn or fabric), it mainly comprises the factor - labor - with which Bangladesh is well endowed, rather than scarce capital or complex technologies. Moreover, the labor can be harnessed efficiently in fairly small units that do not require highly sophisticated management skills. * At least part of the industry--evidenced by Grameen Check--is supporting backward linkages which involve small and micro enterprise, including rural weavers. The industry holds great potential for backward linkages with upstream industries that could expand such ties to the RMG sector by improving the quality and cost competitiveness of their products, an advance they failed to make when they were long sheltered by trade protection and ineffective public support programs. 2 This is according to the Customs data, which are "shipment" based. Due to the "leads and lags", trade statistics based on "payments" show somewhat higher figures for the share of capital goods imports. Chapter 2: Recent Trends in Foreign Trade 21 * A significant number of entrepreneurs now exposed in some way to world trade are gaining increased experience in marketing along with knowledge of foreign markets, of information sources, of quality upgrading, product development, and ways to respond to changing demand patterns. * This same entrepreneurial flourish demonstrates how well the Bangladesh private sector can respond to liberal trade policy - albeit confined to liberalization in the form of SBW/EPZ enclave arrangements designed largely for RMG/knitwear, rather than the more general trade liberalization that would have encouraged a range of exporters. In summary, Bangladesh 'success in RMG/knitwear exports is strong evidence of both the economy's considerable capacity to respond to emerging opportunities under a liberalized and supportive business environment and of the scope for competitive activities based on the abundance of labor. 2.7 While aggregated statistics seem to show export concentration continuing, with the RMG/knitwear products accounting for over 70 percent of merchandise exports, it should be noted that the two sets of products are not homogeneous commodity categories. They offer significant scope for diversification in product variety, design, quality, value-addition, and destination markets, far more than jute/jute products and tea. In addition, unlike the 1980s, export levels (in current and constant US dollar terms) are rapidly rising--though from a low base-- in an increasing number of product categories. These include: frozen foods, specialized textiles, leather goods, agricultural products, other manufactures, chemical products, and engineering goods. Their export levels (in current US dollars) have registered annual average growth rates ranging from 11 percent in the case of frozen foods to 75 percent in the case of "other manufactures" during FY91-FY98 (see Tables B. 1 and B.2 in Annex II). Reducing costs through faster removal of the existing factor market, infrastructure, bureaucratic, and other constraints will undoubtedly enhance the pace and depth of this ongoing diversification. 2.8 Imports. Total legal imports have grown in current US dollars at an average annual rate of 12 percent since 1989/90, much more slowly than exports' 17 percent. The $7.5 billion import bill in 1997/98 was equivalent to almost 18 percent of GDP, compared with around 12 percent during 1989- 1994. Again, however, much of the import growth was attributable to the enclave export activities. The re-exportable inputs for the SBW units (mainly RMG/knitwear producers) and EPZ firms have grown much faster (22 percent annually) than non-enclave imports. The latter registered only a 9.4 percent annual average growth rate, compared with about 12.8 percent for non-enclave exports (see Tables B. 1 and B.3 in Annex II for annual data). 2.9 The non-enclave imports comprise mainly raw materials, intermediates, capital goods, and other goods not produced in Bangladesh -- as well as the final consumer goods that are alleged to have flooded the market at the expense of domestic producers. During the 1990s, imports of final consumer goods have remained around 6-7 percent of total recorded imports and 1 percent of GDP, without showing any sustained surge (Table 11.1). Their average annual growth rate was 10.8 percent, compared with 16.6 percent for primary commodities, 15.7 percent for capital machinery and parts, 19 percent for other capital goods (including vehicles), and 7.6 percent for non-enclave intermediate inputs (see Table B1.3 in Annex II for annual data).3 3 Imports of final consumer goods fell (in current US dollars) significantly during two consecutive years in the early 1990s (in 1990/91 and 1991/92), and subsequently over the period 1992/93-1994/95 there was a significant recovery growth and expansion in these imnports, which then leveled off at around $0.5 billion (current) US dollars during 1995/96-1997/98. 22 Chapter 2: Recent Trends in Foreign Trade Table 11.1: Major Categories' Shares of Export and Import Totals and of GDP in Late 1980s and 1990s % Share of Total % Share of GDP Exports or Imports EXPORTS: 1988/89 19'97/98 1988/89 1997/98 Readymade garments and knitwear 36.7 73.3 1.6 8.9 Frozen foods (mainly shrimp) 11.0 :5.7 0.5 0.7 Jute goods and raw jute 29.5 7.5 1.3 0.9 Leather and leather goods 10.7 4.6 0.5 0.6 All other exports combined 12.1 8.8 0.5 1.1 Total exports 100.0 100.0 4.3 12.2 IMPORTS: Primary commodities 19.6 18.2 1.7 3.2 Intermediate inputs 42.2 27.4 3.6 4.9 Capital machinery & parts 10.8 11.3 0.9 2.0 Other capital goods 4.0 4.8 0.4 0.9 Final consumer goods 8.9 6.6 0.8 1.2 Enclave (B/B SBW + EPZ) estimated 14.4 31.7 1.2 5.6 Total imports 100.0 1)0.0 8.6 17.8 Compiledfrom NBR and Export Promotion Bureau data. 2.10 Several other aggregates also indicate that domestic production, including that based on imported capital and material, was not adversely affected by liberalization-induced imports. Over the decade: * real GDP has expanded by 5 percent annually-a better record than the 4 percent achieved in the 1980s; * the quantum index of medium- and large-scale domestic manufacturing doubled, reflecting an average annual growth rate of nearly 8 percent over a nine-year period; * most manufacturing activities have registered significant expansion according to these official quantum indices. Out of the 57 identified (4-digit level) manufacturing activities, only 18 that are import-competing have shown output contraction in this period. Accounting for about 17 percent of the medium- and large-scale manufacturing sub-sector, these contracting activities included vegetable oil, cotton textile, jute textile, paper, insecticides, rubberfootwear, iron and steel basic industries, fabricated metal and some machinery and equipment. At a more diaggregated level: * 1997/98 evidence collected from a random sample of manufacturing firms (see Chapter 3) indicate that employment levels had expanded in the majority of them; only 28 out of 90 enterprises reported any employment decline-this despite the fact that two-thirds of the firms are import-competing and/or import-intensive. And, * about half of the 90 firms, including many import-competing, reported undertaking investment for expansion, diversification, quality improvement, and modernization/replacement. If these firms had become unprofitable because of sustained losses due to tracle liberalization, they would have refrained from investing. Chapter 2: Recent Trends in Foreign Trade 23 2.11 These macro- and micro-level data and the findings do not support the proposition that Bangladesh's manufacturing production has been displaced generally and significantly by imports during the 1990s. On the contrary, the import growth spurred by trade liberalization appears to have contributed not just to export expansion but also to capital accumulation and thus to economic growth. While some import-competing firms may have been adversely affected by trade liberalization, by and large the economy in general and the manufacturing sector in particular seem to have performed strongly during recent trade liberalization. As elaborated in Section C below and Chapter 3, many of the surveyed import-competing firms reported that trade liberalization was not necessarily the primary reason for their problems. They have been adversely affected by a number of other factors, including domestic competition, smuggled goods, financial and management difficulties, infrastructure bottlenecks, political uncertainty, and disruptions caused by hartals (or general strikes). 2.12 External trade balances. As detailed in Chapter 1, with trade liberalization Bangladesh's recorded, formal external trade expanded significantly faster than the economy as a whole. Merchandise trade alone grew from about 16 percent of GDP in 1989/90 to 30 percent of GDP by 1997/98. At the same time, due to the faster growth of exports, the formal merchandise trade deficit has been fairly moderate over the past decade, averaging 5.5 percent of GDP. An important positive development worth emphasizing has been the steady increase in the coverage of imports by exports: in 1997/98, merchandise exportsfinanced 69 percent of imports, compared to less than 50 percent observed in the early 1990s (Table B. 1 in Annex II). The general improvement in the external current account since the early 1990s and the sustainability of the current account deficit are reflected in the decline since 1990/91 in the ratio of external debt to GDP from about 42 to below 38 percent, and in the debt service ratio from about 13 percent to 8 percent.4 2.13 Bilateral trade imbalances. North America and the European Union are the largest customers for Bangladesh's legal exports, each region taking around $2 billion or 40 percent of all 1997/98 exports (mainly garments of course, especially for North America). Japan and Hong Kong follow with around 2 percent each. Neighbouring India, the largest source of Bangladesh's formal imports, now about $800 million, buys only a paltry $65 million or 1.3 percent of its exports. 2.14 Indeed, Bangladesh has significant imbalances with most of its individual partners. Excluding the mainly fabric imports for SBWs (but including their garment and knit exports), significant surpluses occurred in 1997/98 and previous years with key export destinations: the U.S.A., Germany, France, and the U.K. On the other hand, large formal trade deficits were recorded with India, China, and Japan, the countries that are Bangladesh's main suppliers of raw materials, intermediates, capital goods, and finished consumer goods. Their proximity to Bangladesh and the availability of highly competitive imports from these countries make them preferable sources, in contrast with Europe and North America. Since India and China also compete with Bangladesh for the same export markets, the range of goods Bangladesh could export to them is inevitably limited. Apart from these seven partners (plus Canada with which trade was balanced), the main sources of imports are countries to which Bangladesh barely exports at all: Singapore (mainly entrep6t), Australia, South Korea, Malaysia, Indonesia, Saudi Arabia and Thailand, which together provide almost a quarter of Bangladesh's non-fabric imports. 2.15 Such imbalances are not necessarily a cause for concern. A country can have sizable bilateral trade imbalances based on the proximity and competitiveness of the source markets, as well as the extent of complementarities/similarities among their tradables. As long as overall external trade balances remain sustainable and in line with a sound macroeconomic framework, even a large trade deficit with a given trading partner is not detrimental in and of itself. In triangular trade-e.g., China, the U.S.A., and the Middle East-a trade deficit with one partner is balanced against a surplus with the other. Bangladesh's 4 Also, the present value of Bangladesh's long- and medium-term official debt has declined from around 250 percent of exports of goods and non-factor services in the early 1990s to about 158 percent recently, which is considered well within the sustainable range. 24 Chapter 2: Recent Trends in Foreign Trade growing trade imbalance with India, however, carries political costs. Bangladeshi business circles have criticized the Indian Government for not reducing the high protective QR/tariff barriers and at the Government of Bangladesh for liberalizing the trade regime too fast. Box II.1: Domestic Industrialization Process and the Speed of Trade Liberalization It has been argued, and also stressed by some of the participants of the September 16, 1999 seminar, that Bangladesh's trade liberalization in the 1990s was rapid because it started at a time when the manufacturing sector was still very narrowly-based and the business environment was far from being supportive and the policy changes were introduced at a fast pace. The argument continues by claiming that, "as a result, most manufacturing enterprises, including a large number of small-scale and cottage industries were caught unprepared for the increased foreign competition. This has created many 'sick' enterprises and slowed down investment, with adverse impacts on Bangladesh's industrialization process. Slower trade liberalization would have avoided these adverse effects". An implication of this line of argument, as noted earlier, is that further trade liberalization should be significantly more gradual. Some observers add further that "Bangladesh's industrialization process has been led by export- oriented activities, until the 1980s by the jute manufacturing, and since the 1980s by the fast expanding RMG/knitwear industry. As such, export orientation in Bangladesh has not been affected by the policy of insulating j domestic markets, and that Bangladesh's import substitution strategy has not moved the industrialization process away from export orientation. Given the large size of the domestic rnarket and the small industrial base, what is needed is the protection of the domestic producers until they capture domestic markets, become more efficient through domestic competition, and start exporting, as was the case in Korea and Taiwan, where temporary support also helped the local firms". First, it is difficult to accept the argument that Bangladesh's protracted import-substitution strategy has not adversely affected Bangladesh's export-orientation and potential export activities. It is true that the jute sub-sector led the industrialization process, thanks to Bangladesh's comparative advantage and the stronger world demand for jute products until the 1980s. The RMG/knitwear sector has flourished despite the highly protectionist trade regime sinply because of the enclave arrangements that guaranteed these activities duty/tax free access to imported materials. However, it is also true that the Govermnent deliberately avoided broad-based trade liberalization for an extended period and the trade regime remained highly restrictive until the early 1 990s. This has discouraged the development of other potential export industries due to the significant anti-export bias, thus limiting the extent of export diversification. What the import-substituting policy has done, however, was to lead to the creation of many inefficient activities and firms, which are now complaining about trade liberalization and blaming it for their "sickness". A legitimate question that needs to be raised is "why have these firms failed to improve their efficiency after such a prolonged period of protection and despite the fiscal/financial support?". One highly plausible answer is that this was because of the inward-oriented, protectionist policy which continued far too long. The Government is apparently providing some subsidies to these supposedly ailing enterprises to exit or adjust. The appropriateness of such a policy needs to be reviewed, because most of these sick enterprises have performed very poorly despite all t the support. Using budgetary resources to support unviable or poorly managed firms does not appear desirable. Second, the import substitution strategy and the protectionist trade regime have a long history in Bangladesh, and vanous support programs have also been employed to promote domestic industries --including directed credit and fiscal incentives. Unlike East Asia, these policies have in general failed in promoting wide-scale efficient import substituting industries in Bangladesh. A very telling example is the textile industry, which still enjoys very high protection. Yet, as noted above, it has not been able to become an efficient, competitive activity, and dismally failed in exploiting the huge demand generated for its products by the RMG/knitwear sub-sector. Why should then Bangladesh try to maintain such a policy that has so far not produced good results. The culprit is not trade liberalization. The prolonged protection, direct/indirect subsidies, and the unpaid bank loans have all allowed many inefficient firms to survive, and these are the policies that should perhaps be blamed for Bangladesh's slow and inefficient industrialization. Third, as detailed in Chapter I and in this chapter, available aggregate evidence on GDP growth, investment activity, and macroeconomic balances, as well as the data on manufacturing GDP and output growth support the view that trade liberalization has contributed to Bangladesh's improved economic performance in the 1 990s. Firm-level findings reported in the next chapter show gains in productivity and efficiency under trade liberalization. As expected there are some declining activities and some contracting and exiting firms, but the general outcome for the 1990s is an improved overall economic performance. The evidence simply does not show wide-spread displacement of domestic production under trade liberalization. Chapter 2: Recent Trends in Foreign Trade 25 C. TRADE WITH INDIA 2.16 Official trade. Recorded imports from India generally comprise intermediate goods, notably the cotton yarn and cement that accounted for 10 percent and 8 percent respectively in 1997/98. When a rice crop failure in Bangladesh occasions a surge in imports from India, emergency purchases such as those in the second half of the 1990s tend to exaggerate the level of Indian sales. For example, in 1997/98 Bangladesh imported over $200 million worth of rice from India, 27 percent of that year's total imports from India (Table B.4 in Annex II). After imports of rice, yarn and cement, the next 12 items accounted for between 1 percent and 3 percent each (tyres and tubes, flat steel products, raw cotton, aluminum, dyes, nucleic acids, textile machinery, onions, coal, animal feed, transformers, and phosphatic fertilizer). In other words, two-thirds of total purchases from India are spread over hundred of other goods. Of the important items in 1997/98, the first nine--along with soya oil, apples and occasionally salt and chilies - were relatively more important at the beginning of the decade. 2.17 Still, there is no denying the large imbalances in Bangladesh's trade with India. Some guesstimates of informal border trade indicate that Bangladesh's exports might be covering about 25 percent of informal imports from India. For the formal trade the export coverage is only about 10 percent of merchandise imports from India. Although some observers find that ratio surprising, the reasons behind it are both various and obvious. For instance: * India has a far larger, much more diversified industrial sector than Bangladesh. Even Indian producers of consumer goods that are still highly "protected" by pervasive QRs can profit from legal exports to Bangladesh and elsewhere. India's large domestic markets either (a) support sufficient competition to yield product prices (and quality) much closer to world prices than implied by the (notional) import protection, or (b) facilitate discriminatory pricing practices for those firms seeking scale economies. They are able to sell abroad cheaper than at home and thereby both bring down their average costs and gain market shares abroad. * Indian suppliers enjoy a great transport cost advantage over more distant sources, a geographical asset exacerbated by the high cost of sea transport to and handling in Bangladesh ports. Indian exporters can use either land transport or coastal ships with lower opportunity costs than intemational vessels. * By retaining QRs on many consumer goods, India has kept its markets closed to the type of consumer goods that Bangladesh might be able to produce and supply competitively. Bangladesh, by contrast, has dismantled its protective QRs on all official imports except textiles. * Finally, India's real exchange rate has depreciated faster than Bangladesh's during both this and the previous decade, making Indian exports more attractive to Bangladeshi importers and Bangladesh's potential exports less competitive in Indian markets. India's real effective exchange rate (REER) depreciated by 35 percent during 1990-1998, while Bangladesh's appreciated by 4 percent. Similarly, India's bilateral real exchange rate (RER) vis-a-vis the US dollar depreciated by 33 percent over the same period, far exceeding Bangladesh's 9 percent depreciation (see Table 11.2). 2.18 In reality, the large trade deficit with India does not appear to have any major adverse macroeconomic consequences and, if not with India, would probably have appeared, perhaps as even larger imbalances with any other trading partners that supplied Bangladesh the raw materials, intermediate inputs, capital goods, and essential food items that it needs and needed. In the case of some individual items, tariff cuts in Bangladesh have most likely increased demand for such goods and also their import from India. Cotton yarn is an example. Increased cotton yarn imports (both formal and informal) might have adversely affected some domestic firms that have remained inefficient despite years of protection. Against this, cheaper and higher quality imported cotton yarn (and other textile inputs) have supported competitive downstream activities and their export performance. 26 Chapter 2: Recent Trends in Foreign Trade Table II.2: REERs and RERs: India and Itangladesh (1990=100) \a eeme 1 of: 0RS0i01980 1990 1996 1998 j REER: India 54.1 100.0 132.7 135.1 Bangladesh 90.8 100.0 105.6 96.3 RER (against $US): India 66.9 100.0 133.3 133.4 Bangladesh 82.9 100.0 109.4 108.8 Source: International Monetary Fund. Ia . Increases represent depreciation. 2.19 To complain about a large and growing trade deficit with a single partner is legitimate, particularly when India, the exporter, does not reciprocate Bangladesh's unilateral liberalization. Halting or reversing the reform process, however, would be iniappropriate and more damaging than the imbalance itself. Bangladesh will gain by not linking its economic policies to the action or inaction of any specific trading partner. Instead, its task is to follow the relevant example of Sri Lanka and address the internal obstacles to doing business in Bangladesh. Progress in that area would set the stage for Bangladesh, when the MFA is eliminated in a few years time, to maintain and even expand her foreign market shares in the important RMG and knitwear activities. IHolding and enlarging its competitive reach will depend on improving its business environment and on ensuring that policy reversals do not jeopardize the competitiveness of these activities. More importantly, an improving business environment, a flexible exchange rate policy and a resumption of broader trade liberalization that cuts the remaining high dispersion in nominal and effective protection rates could hasten the badly needed further diversification of domestic production and exports in areas where there is comparative advantage. Box 11.2: Trade Deficit with India The large and increasing trade deficit with India has attracted significant attention from Bangladesh's business and government circles. It was also an important topic of discussion at the September 16, 1999 seminar. In the preceding section it is argued that the large deficit in formal trade with India should not be a concern in and of itself, given Bangladesh's sustainable overall trade balances. This is a result of Bangladesh's own huge trade surpluses with the U.S.A. and Europe. In fact, by being able to meet some of its sizable essential import needs from India, including rice during times of poor harvest, Bangladesh has obviously been able to lower its import costs due to India's proximity and competitive export prices. Bangladesh has good reasons to complain about India's still high barriers to its potential exports, but it stands to benefit from using bilateral and multilateral policy dialogue options and avoiding any backtracking in its trade liberalization program. There is also the perception held by some circles in Bangladesh that trade liberalization is the cause of a large informal border trade deficit in favor of India. This is simply wrong. As elaborated below, one of the principal reasons for the sizable in-bound smuggling is the remaining high protection on imports of most consumer goods. 2.20 Border smuggling. The sizable unofficial border trade with India has been a subject of a number of studies. A recent survey and analysis by Rahman, A. and Razzaque, A. (1 998)5 focused on just five of the approximately 50 thanas with important border crossing points. Due to the small number of points covered, the study's estimates of the inflows and outflows may not be extrapolated to provide 5 Rahman, A. and Razzaque, A. (1998), "Informal Border Trade between Bangladesh and India: an Empirical Study in Selected Areas", for the Asia Foundation, administered by Democracy in Development, Inc., (July). Chapter 2: Recent Trends in Foreign Trade 27 accurate national data. On the other hand, it examined the smuggling mechanisms and commodity composition in more detail than previous studies with wider reach (Gafur, Islam and Faiz, 1990 and 19916; Bakht, 19967; and Alam and Cookson 19958). Thus, its data provide a basis to derive some "guesstimates" of the magnitude of the whole unofficial border trade in 1997/98 and the significant changes in its structure and size since 1994. 2.21 The 1998 study estimates the annual value of unrecorded commodity imports through the five surveyed thanas at $185 million, suggesting that the value for the whole border could be at least as large as the official US$800 million trade or even twice that amount. In sharp contrast, the five-thana estimate for commodity exports including gold (the largest item) is only about $41 million, nationally perhaps between $0.2 and $0.5 billion. Suggesting a considerable increase in illegal trade since 1994, these extrapolations also imply a much larger imbalance in unofficial border trade in favor of India. That deficit must have been financed at least in part by sizable amounts of workers' remittances diverted from official channels to the "hundi" market. 2.22 Recent findings also show a general similarity with the past composition of illegal imports as well as a few changes. Cattle was and remains the largest category. Other important imports include: food items (sugar, rice, pulses, milk powder, spices, salt); textile products (sarees, shawls and cardigans, and thaan cloth); spare truck parts that now appear to have become a relatively more important category of smuggled goods; bicycles and parts; timber; phensidyle (increasingly used as a recreational narcotic); ceiling and table fans; and toothpaste. Less important items include various consumer goods such as cosmetics, toiletries, utensils, electrical products and various other items that are also produced domestically. On the export side, gold appears to be the single largest commodity, accounting for one- third of the five center's exports. Just four other groups made up most of the rest: electronic goods and VCRs, other metals (copper and brass), hilsha fish, and high-count yarn (a re-export, perhaps leaked from SBWs). 2.23 This smuggling of sizable amounts of food items, some textiles and other manufactured goods (medicine, car and truck parts), and a few other consumer goods reflects the persistence of protection not the liberalization of trade. While many of the foreign goods in Bangladeshi markets are smuggled, at least some of them are items that continue to be subject to high protection against formal imports. Increased smuggling activity induced by high statutory protection levels is rendering the intended protection partially ineffective. It is not evidence of failure in trade reform. At a high cost in lost Bangladesh customs revenues, Indian exporters profit from the informal border trade for the same set of reasons that apply to official trade. 2.24 As to the impact of the contraband on domestic industries, adverse effects seem rather limited: * First, a very substantial proportion--perhaps around two-thirds--of the smuggled goods is made up of cattle, rice, pulses, sugar, timber, milk powder, and illegal drugs that do not compete with domestic manufacturing industries, let alone with ones which could conceivably become internationally competitive. * Textile goods not yet subject to official trade liberalization fall into a second large category-- reportedly accounting for about one-quarter of the illegal traffic. Because of the high level of protection through QRs, "tariff values" (TVs), and/or high tariffs, "duty free" smuggled goods are 6 Ghafur, A., Islam, M. and Faiz, N. (1990), "Illegal International Trade in Bangladesh: Impact on the Domestic Economy", Phases I, BIDS; Ghafur, A., Islam, M. and Faiz, N. (1991), "Illegal International Trade in Bangladesh: Impact on the Domestic Economy", Phases II, BIDS. 7 Bakht, Z. (1996), "Cross Border Illegal Trade in Bangladesh: Composition, Trends and Policy Issues", BIDS for the World Bank, (data for 1994). 8 Alam, N. and Cookson, F. (1995), "Cross Border Trade with India", (mimeo). 28 Chapter 2: Recent Trends in Foreign Trade able to compete with domestic production. If quantitative r estrictions on legal imports were removed, tariffs lowered, and VAT imposed effectively on all final domestic sales, the smuggling trade could be severely undermined and modest protection made effective. * Most of the remaining bootleg items are concentrated in a very narrow range of products: truck parts, bicycles, fans, mustard oil, toothpaste, salt, and bicycle tires, whose Bangladesh producers comprise a fairly small but vocal section of manufacturing. And for all the other smuggled manufactured products --e.g., shaving and face creams, stainless utensils, and razor blades-- the volume of such imports appears to be very small for each item relative to domestic production. Of course, many of the products in this third group are still subject to very high tariff/tax rates--in the 50-55 percent range-- and/or inflated TVs when imported legally. Just as for textiles, lowering those tariffs and imposing VAT at the retail-end would probably benefit affected Bangladesh manufacturers by reducing incentives for smuggling. 2.25 Under-valuation. Much less is documented on the magnitude and composition of "technical smuggling" than is known/guesstimated about the unofficial border trade. Under-valuation allegedly takes two forms: false declarations that go uncorrected by inefficient or corrupt Customs valuation staff; and, seemingly much less significant despite frequent allegations of its importance, "dumping" which is not corrected by the prevailing "tariff values" system. 2.26 Strong anecdotal evidence supports the frequency of false customs declarations. The pre- shipment inspection (PSI) scandal that came to light in 1996/97 revealed scams with respect to imports of second-hand cars and perhaps also edible oil and other items. Although much of the blame for the fraud fell on the importer-employed PSI agents, the disclosures suggest an established practice of under- valuation that predated the voluntary PSI scheme and adapted tco it. A general recognition of this culture explains the tenacity with which successive governments have retained the notorious tariff-value system despite its deficiency in combating pervasive importer efforts to evade high tariffs and taxes on imports. In fact, the system's malfunctioning shows that an inefficient or corrupt Customs administration can be far more damaging to the profit levels and competitive success of some relatively efficient import- substituting producers than trade liberalization. For example, unless the posted level of protection is very low, a producer willing either to deceive or conspire with corrupt officials may be able to close down a competitor by paying less than the due payment of duty and tax on its imported inputs. Indeed, rival producers may have more financial incentive to engage in such practices than the commercial importers of goods competing with domestic production. D. CONCLUSIONS 2.27 Bangladesh's trade liberalization during the 1990s has opened its markets to goods from abroad and opened opportunities abroad for its manufacturers without p:roducing either an unsustainable trend in the merchandise trade deficit or even a flood of imports harmful to domestic producers. On the contrary, as trade has risen in relation to GDP, exports have successfully covered a much larger proportion of imports and the trade deficit, as a share of GDP, has remained stable. Moreover, the macroeconomic evidence discussed in Chapter 1 suggests that far from harming the economy, trade liberalization has, if anything, most likely been a positive factor behind Bangladesh's relatively stronger macroeconomic performance in the 1990s. 2.28 As the economy grew stronger, however, imports of final consumption goods as a share of total imports remained stable. On the other hand, purchases of raw materials, intermediate inputs, and capital goods from foreign suppliers rose markedly indicating that trade reform stimulated the kind of merchandise imports that domestic manufacturers could use to produce added output for sale at home and abroad. Trade liberalization, in short, opened no floodgates to foreign goods that displaced domestic production. Instead, Chapter 2: Recent Trends in Foreign Trade 29 * The macro-level evidence shows no widespread production displacement. Both the official statistics on production trends in manufacturing industries, as well as findings based on a survey of a sample of enterprises indicate that most manufacturers have continued expanding production, capacity, and also employment. Not surprisingly, some producers of cotton textile, vegetable oil, paper, insecticides, rubber footwear, basic iron/steel and metal products, and some machinery and products-- all enterprises in the import-competing manufacturing sub-sectors-- have reduced output and employment levels. Despite a long period of protection, a subset of enterprises in these fields appear to have failed to improve their efficiency and competitiveness; many still try to operate with outdated machinery. These are the firms now feeling the sharpest competitive pressure from trade liberalization and smuggling. * Indeed, smuggled goods might have caused difficulties for some of these import-competing activities, given that the contraband comes in "duty/tax free". Some of the surveyed enterprises in textiles, flour milling, vegetable oil, and salt specifically noted having to compete with smuggled goods. 2.29 Those illegal imports can be traced to high protection levels, not to lower tariffs, a cause-and- effect relationship that indicates the relative ineffectiveness of existing statutory protection measures and carries with it substantial losses of customs revenues. Eliminating QRs on textiles imports and reducing high tariffs on finished consumer goods would help divert illegal trade into official channels, generate budgetary revenues, and also provide some nominal protection to such products. In this regard, the decision to reduce the maximum rate with the FYOO Budget is a small step in the right direction. Very high nominal protection deters legal imports while inducing the entry of smuggled goods that avoid not only the protective duty but also the VAT which domestic producers must pay. Lower tariffs, by reducing the incentive for smuggling, could benefit the producers of goods like sarees, other textile items, sugar, salt, pulses, bicycle and truck parts, fans, and toothpaste, which would have at least some nominal protection. 2.30 Measures that need to be taken in combination to combat smuggling and under-valuation fall into three groups: * First, thefiscal incentive should be reduced both through lowering high customs duty rates and through basic changes in the VAT administration. The latter requires both strengthened enforcement and moving the collection point as close as possible to the retail end so as to tax smuggled goods equitably with domestic products and legal imports. Indeed, an effective retail-level VAT would be a good instrument to curtail smuggling. * Second, determined policing efforts are needed, backed by strong political will. The Government's own agents must be made to end the support they now provide to the illegal border trade, and smugglers and their allies must be vigorously pursued and prosecuted. * Third, to deal with technical smuggling, i.e. the undervaluation of imports that do pass through official channels, in the short term the Government needs to contract reputable agents to operate an effective pre-shipment inspection (PSI) scheme while it automates and otherwise modernizes the Customs service itself. The introduction of the compulsory PSI system proposed in the FYOO Budget will provide an opportunity to move in this direction. 2.31 Recent developments in formal trade show a sizable trade deficit in favor of Bangladesh's largest import supplier, India. Proximity and competitiveness of Indian goods as well as much faster depreciation of India's real effective exchange rate are among the factors that explain this outcome. Given that the overall external trade balances of Bangladesh are on a sustainable path, a large trade deficit with India is not, on its own, detrimental to Bangladesh which would otherwise have incurred similar or even larger deficits with other countries. Therefore, halting Bangladesh's broader trade liberalization or reversing it in response to India's failure to reciprocate Bangladesh's unilateral liberalization would not 30 Chapter 2: Recent Trends in Foreign Trade be in the best interest of Bangladesh. Bangladesh's economy has generally benefited from economic liberalization, increasing openness, and moves toward neutrality of market incentives. In a period of strong liberalization and globalization that has been sweeping most countries and markets (soon to include textiles under the MFA), Bangladesh's trade/industrial policies should mirror those of Sri Lanka, not India. IMPA CTS OF TRADE LIBERALIZATION ON Chapter 3 TECHNICAL PROGRESS AND EFFICIENCYIN MANUFACTURING INDUSTRIES A. INTRODUCTION 3.1 The removal of trade barriers makes domestic markets more competitive, which in turn induces local firms to become more efficient in input usage. Improvements in technical efficiency could result as firms reduce input wastage and increase capacity utilization, and exploit the available scale economies' as markets expand. As a result, domestic firms could produce more with the given amounts of inputs and thereby reduce costs of production. Similarly, firms may intensify their efforts to use inputs in optimal proportions in line with the changing relative input prices, hence improve their internal allocative efficiency. Such production efficiency gains in input usage enable firms to "catch up" with the efficient production frontiers, or catch up with the most efficient (or "best practice") firm(s) in the activity/industry. Trade liberalization could also trigger shifts in resources towards activities which become relatively more profitable as a result of tariff cuts and dismantling of QRs. By encouraging resource movements towards more profitable lines of production and more efficient firms, the removal of trade barriers could contribute to improvements in resource allocation efficiency and pave the way to production patterns more in line with the country's comparative advantage. 3.2 Another important channel through which the removal of trade barriers could benefit the economy is the increased availability of new technologies, new products/capital goods, and ideas/knowledge about improved production processes, management, product designs, and quality. By facilitating the inflow of new technologies, improved machinery, knowhow, trade liberalization could help generate gains in productivity through the employment of better and improved production techniques, through learning-by-doing, and increased opportunities for imitation/innovation. In short, freer trade could lead to productivity gains in the economy through technological changes/progress, which would make inputs more productive. Such expansion in production possibilities could be observed by looking at the performance of the most efficient/dynamic and fast adjusting enterprises, which set examples and shift production frontiers outward by responding to and exploiting quickly the new incentives and opportunities created by the removal of trade barriers. These two forces--technical efficiency gains ("catching up" with the efficient production frontier) and technological progress (which shifts the efficient production frontiers)--together enhance the productivity of inputs, leading to growth in total factor productivity. 3.3 The above description of the likely positive impacts of removing trade barriers needs to be qualified however. Productivity gains associated with the induced improvements in technical efficiency at the firm-level and those resulting from technological changes will be moderated or curtailed due to: limitations on the mobility of factors of production caused by, e.g., highly restrictive labor laws and inefficiencies/weaknesses in the financial markets; a lack of well developed secondary markets for second-hand capital goods; regulatory constraints to market exit; and significant infrastructure constraints and bureaucratic bottlenecks.3 Moreover, such business environment constraints might also aggravate the adjustment difficulties of those firms that have remained insulated behind high protection walls for a prolonged period and now are exposed to intensified competition. Particularly, those import- competing firms that are highly inefficient and slow to adjust due to their own internal inertia could face higher dynamic adjustments costs as they try to contract their output/employment levels or try to exit the market. This refers to as "pure" technical efficiency. 2 Refers to "scale efficiency". For further details on country experiences and analysis, see: Michaely, et al. (1991), and Rodrik (1992). 32 Chapter 3: Impacts Of Trade Liberalization On Technical Progress And Efficiency In Manufricturing Industries 3.4 The objective. The purpose of this chapter is to report on the findings of a quantitative investigation carried out to examine the impact of trade libera.lization in the 1990s on the productivity of manufacturing enterprises. To this end, an attempt is made to examine the changes in technical efficiency and technological progress experienced by a sample of manufacturing firms over the period 1992/93 (pre-liberalization) and 1997/98 (post-liberalization), using firrn-level survey data for these two separate years on inputs, outputs, and costs. The information obtained from computations on technical efficiency changes and technological progress is then used to construct indices of total factor productivity (TFP) and to calculate changes in these indices to see which of the surveyed enterprises and groups of activities experienced total factor productivity growth (TFPG) during this period. 3.5 The quantitative analysis described above is intended for finding out whether the expected impacts of trade liberalization on relative technical efficiency and TFP growth have been experienced in Bangladesh, noting however that full "causality" can not be established in view of the diverse factors affecting business performance, as alluded to in the previous chapters. If the results show that most of the enterprises surveyed experienced positive TFPG, then it could be argued that in general trade liberalization has benefited manufacturing enterprises, although some firms might have been adversely affected. The expectation is that export-oriented firms as well as more efficient import-competing enterprises would experience gains in relative technical efficiency and TFP, as they would be more dynamic, quick to adjust, and better conditioned in coping with competition. At the same time, it is expected that inefficient import-substituting firms would be adversely affected as protection levels come down. By failing to improve their relative efficiency, such inefficient firms will lag behind in catching up with the more efficient and dynamic firms-- they may adjust by contracting, if not exiting the market or switching to other activities. 3.6 Approach and the methodology. The survey data collected for 1992/93 and 1997/98 for a sample of 120 manufacturing enterprises were used to calculate changes in technical efficiency and total factor productivity (TFP) of the surveyed firms; (computations were carried out only for 82 firms, for which comparable data could be established). To derive analytically more meaningful results, the enterprise-specific computations are carried out and presented on the basis of the categories of activities in which they are grouped. These categories are determined according to market-orientation (as well as import-intensity) of the surveyed enterprises. Specifically, they include: export-oriented, import- competing, import-intensive, and non-traded production activities; (see Appendix at the end of this chapter for further details on the survey data and the methodology used). 3.7 First, for each of the two observation years (1992/93 and 1997/98), technical efficiency indicators are calculated relative to the efficient production frontiers that are constructed from the enterprise data on actual input-output observations, which make up the production possibilities set. The efficient frontier in each time period represents the "upper" boundary of the relevant production set of that period and it reflects the production performance of the most efficient ("best-practice") firn(s) and their technology. The quantitative technique used in estimating the relative technical efficiency and technological progress indicators does not assume any pre-determined production relationship, but it constructs efficient production frontiers (envelopes) from the input-output relationships of the most efficient firms;4 (technical details of the approach are given in Annex III). The "relative" technical 4 In short, the frontier represents the set of best-practice observations. This means that no other production unit (or linear combination of units) produces as much or more of every output without changing the input quantities used; ( a similar interpretation applies if we were to describe the frontier in terms of input-orientated efficiency). 5 To carry out the computations involved in the construction of efficient production frontiers, in obtaining relative technical efficiency and technological progress indicators, as well as in deriving TFP changes, a non-parametric programming method is applied. This activity analysis method is based on the approach developed and applied by Fare et al (1994), using a linear programming approach. The relevant technical details-- pertaining to the definitions of technical efficiency (and its components, i.e., "pure" technical efficiency and scale efficiency), technological change, the TFP change as a product of the Chapter 3: Impacts Of Trade Liberalization On Technical Progress And Efficiency In Manufacturing 33 Industries efficiency indicators that are calculated have a simple interpretation: if a firm in a given observation year was operating at less than optimal possible efficiency, then the relative technical efficiency measure shows the ratio of the observed to maximum possible output. For example, if the computed relative technical efficiency (TE) measure for a specific firm is 0.85, it indicates that this particular firm produced only 85 percent of what is potentially possible maximum output; had it operated as efficiently as the best-practice firm within the group, it would have raised its production by 15 percent of the maximum level or could have produced the same output level with less inputs. If the relative TE indicator equals 1, then this implies that the firm is efficient and already on the frontier. 3.8 A second exercise is carried out to calculate indices of TFP change between 1992/93 and 1997/98, with a view to examining whether or not the trade liberalization might have led to improvements in total factor productivity. Such enhanced productivity would result from technological progress (technical changes) and gains in technical efficiency (due to the induced "catching up" with the best practice firms). Trade liberalization would be a significant factor leading to technological changes by facilitating: greater access to new technology (embedded in imported machinery), know-how (through increased interaction with foreign markets and increased volume of trade), higher quality imported inputs, and increased scope for imitation and learning-by-doing. And by exposing the domestic markets to foreign competition, trade liberalization would induce firms to improve their efficiency. In this process, best practice firms in the post-liberalization period would have been the ones responding more quickly to greater access to imported inputs/capital goods, changes in the domestic relative prices and to increased competition, and would have led the way in technological change during 1992/93-1997/97 and in pushing the efficient production frontiers outward. It is worth noting that the most efficient firm(s) in 1992/93 and 1997/98 would not necessarily be the same ones; the methodology used here finds the most efficient ones for each of the observation years on the basis of the enterprise survey data on inputs and outputs. 3.9 In the study, these quantitative results are complemented by the qualitative assessments and observations made from direct interviews held with the owners/managers of the surveyed firms as well as from responses received to questions related to the business environment. B. RESULTS Technical Efficiency 3.10 The results indicate that export-orientedfirms have in general improved their relative technical efficiency, with the (unweighted) average indicator rising from 0.88 in 1992/93 to 0.95 in 1997/98 (see Table I1I.1 and Chart F for aggregate results). Findings also show that the principal source of this gain is the improvements in relative scale efficiency--related to the scale of production. Compared to 1992/93, in 1997/98 pure technical efficiency is showing only a slight regress relative to the most efficient firm(s) of the later year. This outcome could be interpreted as indicating that export-oriented manufacturing firns have generally adjusted faster in closing the relative gap with the best-practice firmn(s) or the frontier, which itself also shifted outward. Note, however, that the export-orientedfirms had smaller gap (closer convergence) with their own group efficiency frontier in 1992/93 than the import-competing firms, and that in the subsequent years the stronger catching up has made this convergence even closer (Chart F). This finding is consistent with the expected outcomes. Having been already exposed to export markets and intensive competition, it is expected that export-oriented firms would have started with smaller gaps from the most efficient firms in their own sub-group, and that they would in general show faster adjustments to changing relative prices and market competition. latter two changes, the Malmquist productivity indices, and the formulation of the programming problems--are presented in Annex III. 34 Chapter 3: Impacts Of Trade Liberalization On Technical Progress And Efficiency In Manufacturing Industries At the enterprise level, the results show that almost all firms in the export-oriented category experienced improvements in their scale efficiency. With respect to the relative efficiency in input usage (i.e., pure technical efficiency), two finns showed iimprovements (faster catching up with the most efficient firm(s)), while two others showed increasing relative gap, reflecting slower adjustment and catching up. (For firm-level detailed results, see Table III.3). Table III.1: Technical Efficiency Measures: 1992/93-1997/98 [Relative to their own-group (separate)frontier] Efficiency measures - TE PTE SE Group (obs.) 4- 1993 1998 1993 1998 1993 1998 1. Market Orientation Export (8) 0.88 0.95 0.98 0.96 0.89 0.99 Import (61) 0.81 0.65 0.87 0.77 0.93 0.85 Import competing (47) 0.81 0.66 0.87 0.80 0.93 0.83 Import intensive (14) 0.84 0.63 0.88 0.67 0.96 0.94 Non-tradable (13) 0.89 0.72 0.93 0.76 0.96 0.96 2. Size Small (27) 0.83 0.60 0.90 0.76 0.92 0.79 Medium (38) 0.84 0.72 0.88 0.77 0.96 0.94 Large (17) 0.81 0.79 0.91 0.88 0.89 0.90 3. City Chittagong (28) 0.81 0.77 0.87 0.80 0.94 0.96 Dhaka (45) 0.83 0.64 0.90 0.77 0.92 0.83 Khulna (9) 0.88 0.72 0.92 0.77 0.96 0.94 TE: technical efficiency; PTE: pure technical efficiency; SE: scale efficiency Table 111.2: Decomposition of the TFP Change between 1992/93 and 1997/98 [Estimated relative to separate (group-specific) frontier] TFPCH TECHCH EFFCH PTECH SECH ASl $2, W 153 G S 0:89 0R .9$' 1. Market Orientation Export (8) 1.17 1.08 1.09 0.98 1.12 Import (61) 1.29 1.57 0.82 0.89 0.92 Import competing (47) 1.34 1.59 0.84 0.93 0.90 Import intensive (14) 1.12 1.47 0.76 0.78 0.98 Non-tradable (13) 1.39 1.72 0.81 0.82 1.00 2. Size Small (27) 1.24 1.68 0.73 0.85 0.87 Medium (38) 1.34 1.55 0.87 0.89 0.98 Large (17) 1.27 1.30 0.98 0.96 1.01 3. City Chittagong (28) 1.45 1.52 0.95 0.94 1.02 Dhaka (45) 1.22 1.56 0.78 0.87 0.90 Khulna (9) 1.17 1.42 0.83 0.83 0.99 TFP: total factor productivity; TFPCH: total factor productivity change; TECHCH: technological change; EFFCH: efficiency change; PTECH: pure technical efficiency change; SECH: scale efficiency change. 3.11 In contrast, import-competing and non-tradable goods enterprises have generally shown declining technical efficiency relative to the best practice (or most efficient) firm(s) in their own-group, indicating that they have in general lagged behind the fast adjusting, best practice import-competing Chapter 3: Impacts Of Trade Liberalization On Technical Progress And Efficiency In Manufacturing 35 Industries firms during this trade liberalization period. In other words, the gap between the TE of an average import-competing firm and that of the best-practice import-competing firm(s)--or what is potentially possible in terms of efficient use of inputs--widened, although these firms might have nevertheless improved their absolute efficiency over the period 1992/93-1997/98. Specifically, the results indicate that relative to the best practice firm(s), average relative technical efficiency measure fell from 0.81 in 1992/93 to 0.66 in 1997/98 for import-competing firms, and from 0.89 to 0.72 for non-tradable goods firms. A similar result holds for import-intensive enterprises, many of which are import-competing. Chart F: Relative Technical Efficiency: 1992/93 and 1997/98 1,2 1Best Practice Firm(s) 1.4 Best Practice Firm(s) 1.2- 0.8 - O Export oriented 1.0 - . ....0.5 , Import competing O.: 0. E Import intensive 0.4 0.202 0 0 0.0 1992493 1997-98 3.12 Why have import-competing and non-tradable goods producing firms shown slower adjustment and catching-up with the most efficient firm(s) in their own sub-sectors during this period? As pointed out earlier, this should not be seen as an unexpected result. Many of these firms have remained insulated from intensive competition due to the trade barriers, and have survived despite their growing inefficiencies and obsolete machinery. With the reductions in trade barriers, these firms started facing competitive pressures-- some were already facing it from smuggled goods-and have had difficulty in achieving faster improvements in their TE in input use, thus regressing relative to more modem, dynamic and better managed enterprises in the same sub-sectors. (As elaborated below, the findings indicate that the import-competing firms on average experienced faster technological progress, but some manufacturing firms failed to keep up). Evidence collected from direct interviews indicate that other factors related to business environment have in general been more important in affecting their performance and thus also adversely affecting their response capacity to trade liberalization (these are elaborated on below). 3.13 It is worth emphasizing that not all import-competing and non-traded goods producing firms experienced declining relative TE. Indeed, 13 out 61 import-competing/import-intensive firms appeared to have shown gains in their relative TE (see Table 111.3). As detailed below, it is also important to note that the majority of import-competing/import-intensive enterprises showed positive TFP growth during this period. This is an evidence of technological change and an indication of more efficient use of inputs (in some cases) when compared to 1992/93. 36 Chapter 3: Impacts Of Trade Liberalization On Technical Progress And Efficiency In Manufacturing Industries Chart G: Total Factor Productivity Change Between 1992/93 and 1997/98 and its Decomposition Total Factor Productivity Change Technological Change Efficiency Change 2.W0 2.00 2.00 l E Export oriented 1.70- 5 1.75 1.7S 01 Import competing 1.50 15 1.25 125- 125 X Import intensive 0.75O75-0.75 0.0 0-0 0.50- 0.5 025--0.25L 0.00 .000 1992/93. 1997/98 1992/93 .1997)98 1992/93-1997)98 Total Factor Productivity Growth (TFPG) 3.14 Turning to changes in TFP over the period 1992/93-1997/98, results show that on average the sample finns experienced a TFP growth of 29 percent in five years (about 6 percent annually). This would imply that in 1997/98 an average firm was more productive than in 1992/93, capable of producing more with the same amount of inputs (see Table 111.2 and Chart G). As noted earlier, this could have been due to many factors, including technological progress, learning-by-doing, better quality inputs, induced improvements in management and teclnical efficiency. While not claiming full causality, it could be argued that trade liberalization has most likely induced at least some of these positive changes. Indeed, if the multitude of adverse developmnents that occurred during these five years are considered, trade liberalization could be credited for inducing TFPG in these surveyed finrs--and most likely in the rest of Bangladesh's manufacturing industries. The TFP increases happened against the background of several negative developments in this period, including: floods, a prolonged political crisis and the associated uncertainty, frequent hartals (general strikes) that crippled economic activity, disruptions at the country's lifeline Chittagong port, and frequent power cuts. 3.15 Computation results also show that the major force behind the TFP increase was technological change, showing an average technological improvement of 53 percent among the surveyed firms. However, the relative technical efficiency--relative to the best-practice frontier--in general regressed, showing about 15 percent decline in five years. As explained earlier, this means that, on average, the surveyed firms lagged behind in "catching up" with the frontier or with the efficiency of the best- practice firns. Nonetheless, the positive technological change was strong enough to create a sizable overall TFP growth (Chart G). 3.16 In terms of specific groups, the surveyed export-orientedfirms, on average, showed an 8 percent positive technological change and a 9 percent improvement in their relative technical efficiency, thus realizing more than 17 percent TFP growth in five years (or 3.5 percent annually). Individually, out of 8 surveyed firms in this group, all firms showed TFP gains, with only two showing deterioration in technological change and only one firn indicating regress in relative technical efficiency. 3.17 The results show a much stronger--59 percent (above 11 percent annually)--average technological improvement for the sampled import-competingfirms, and 47 percent improvement for the import-intensivefirms (many of which are import-competing), and taken together an average 57 percent increase (Table 111.2). At the same time, these firms experienced deterioration in their relative TE, with the two groups jointly showing an average 18 percent decline in their relative efficiency 6 This is the change (between the two observation years) in how far the actual production is from the maximum potential output--the latter being represented by the observed production of the most efficient firm(s) in the group. Chapter 3: Impacts Of Trade Liberalization On Technical Progress And Efficiency In Manufacturing 37 Industries which implies that between these two years they have lagged behind in moving toward the maximum potential production. However, these two forces taken together still led, on average, to a significant 29 percent increase in TFP among the import-competing and import-intensive firms. The latter TFPG is larger than what the export-oriented firms appear to have experienced. 3.18 This is not a surprising outcome however. In a liberalizing environment, it should not be seen as unexpected that viable enterprises in the hitherto protected/isolated sectors might show the largest leaps in technological change. This is because they would be the ones with the largest scope for significant technological improvements, as they have probably lagged significantly behind the ongoing technological advancements abroad. And a few, front-running, dynamic, best-practice firms could lead the way in this process with the opening up of the economy and the increased opportunities to access better technologies and know-how. On the other hand, due to longer exposure to the outside markets, export-oriented firms would normally show a much closer convergence to the available frontier technologies. 3.19 At the firm-level, all of the 61 import-competing/import-intensive firms experienced some degree of positive technological change. And not all of them experienced deteriorating relative technical efficiency between 1992/93 and 1997/98--over 21 percent (13 of them) showed improvements in their relative technical efficiency (Table 111.3). However, because of their poor performance in relative technical efficiency, 18 out of 61 (about 30 percent) firms in this groups showed declining TFP. These poor performing firms are mostly in metal works, steel re-rolling/engineering, and rubber products. 3.20 The non-traded goods producing firms showed results with similar performance patterns as those of import competing firms: positive technological change and deteriorating relative technical efficiency. However, because of stronger technological improvements, 11 out of the 13 sampled firms (85 percent) in this group showed positive TFP growth between the two observation years, with the average TFPG in five years reaching 39 percent (almost 8 percent annually) for the sub-group. In terms firm-size and location, the results do not reflect a clear pattern, though medium-size firms appear to have done better in achieving larger TFP gains (34 percent on average, compared to 24 percent for smaller ones), while those located in Chittagong experienced higher (45 percent) TFPG than those located in Dhaka or Khulna, perhaps due to being in the principal port city of the country. 3.21 The survey data and observations made at the interviews provide additional evidence supporting the generally positive impacts of trade liberalization implied by the TFP analysis. Among the sampled firms only 28 of 90 reported a decline in employment, and this is despite the fact that the majority of firms included in the sample are import competing. The firms that experienced employment contraction were mostly in jute mills, iron and steel, rubber works, spinning, cotton mills, rice mill, and soap/detergent. But, only some of these 28 firms mentioned trade liberalization as one of the reasons for their problems. Most of them mentioned smuggled goods, domestic competition, decreased demand (such as jute products),financial problems, management issues, political crisis and hartals as sources of their problems, rather than singling out trade liberalization as the main culprit. Given that the majority of the interviewed firms are import competing, the observation about the employment situation is an indication that there was no widespread contraction. Furthermore, 51 percent of the firms reported undertaking investment recently for expansion, diversification, automation, quality improvement, modernization/replacement, and new machinery-a sign of positive expectations about the future. Indeed, 47 percent of the sample firms indicated higher profits, 31 percent less, and 22 percent reported no change. 38 Chapter 3. Impacts Of Trade Liberalization On Technical Progress And Efficiency In Manufacturing Industries Box 111.1: Micro-Level Findings and Macro-Level Inferences One questioxn that was raised at the September 16, 1999 seminar concemed the issue of whether the mnicro-level evidence provided in the report on impacts of trade liberalization constituted a basis for macro-level inferences. Also related to this, some participants argued that the situdy's assessment of imnpacts on the manufacturing sector was incomplete in that it did not cover the cottage/small-scale industries and that there is not much information on exits and new entries. The fimn-level analysis of the report is intended to demonstrate that Bangladesh's trade liberalization has had positive impacts on factor productivity growth, without making, sweeping generalizations. However, the report uses (in Chapters 1 and 2) the available information on macroeconomic performance as well as the fairly disaggregated official data on manufacturing industries to assess macro-level impacts of trade liberalization. In addition, the report includes some evidence on perceived impacts of trade liberalization on the so called "sick" finns. As discussed below, the feedback obtained from a sample of "sick" firms indicate that trade liberalization was not even a major reason for their problems. Beyond this, a more comprehensive coverage of closed and sick firms was not undertaken in the study due to the information constraints faced and the high cost of tracing these firms. Nonetheless, the evidence provided in the report is adequate to argue that Bangladesh's trade liberalization has been successful in improving economic performance and that the manufacturing sector has not experienced any wide-spread production displacement. Business Environment and Performance of the Surveyed Enterprises 3.22 To shed further light to the question of how important trade liberalization has been in affecting the surveyed enterprises and what aspects of the business environment might have affected their performance and their capacity to respond to trade liberalization, direct interviews were held and qualitative questionnaires were used. The following are some of the findings: * Of the 74 enterprises that answered the question about impacts of trade liberalization, 30 percent found trade liberalization helpful, 14 percent considered it harmful (mainly import competing firms in rubber industries, soap/detergent and metal works), while the majority indicated no perceived impact from trade liberalization. The latter group included some RMG firms, which had started benefiting from trade liberalization much earlier under the enclave arrangements. * With respect to the key constraints to doing business in Bangladesh, only 4 percent of the respondents considered competition from imports as their primary obstacle to pursuing their business activities. On the other hand, 21percent of the respondents saw the lack of business support services (such as assistance in finding/using new technology and in product design as well as instrument calibration, advice for productivity improvement and quality control testing, etc.) as the foremost problem. This is followed by access to credit (20 percent), inadequate supply of infrastructure (13 percent), corruption, theft and "toll" collection (18 percent). Shortage of skilled labor was also stressed as another important constraint. * Evidence from the "sick "firms and new enterprises surveyzed also suggest that trade liberalization has not caused widespread hardships. Of the 12 "sick" finns that could be traced (out of a small sample of 23), only the import competing firms (5 out of 6) identified trade liberalization as having adverse effect on their performance. But none of the firms interviewed indicated trade liberalization as the sole reason for their problems/"sickness". Non-availability of finance and working capital, technical production problems, natural disasters, increased domestic competition, and managerial inexperience are among the factors mentioned as being the other important reasons for their sickness. Chapter 3: Impacts Of Trade Liberalization On Technical Progress And Efficiency In Manufacturing 39 Industries * The 26 new entrants interviewed (10 export-oriented and 16 import-competing) regarded trade liberalization as helpful for their business, noting duty reductions on raw materials and capital goods. Export-oriented firms were generally more optimistic about their future, while import substitute producers were more cautious. However, they all mentioned the above cited business environment constraints as the main hurdles faced in carrying out their business. Conclusions and Policy Implications 3.23 To summarize: * The evidence obtained from quantitative analysis, survey data, and the interviews does not indicate any widespread adverse impact on the performance of the sampled firms that can be attributed to Bangladesh's trade liberalization. On the contrary--without claiming causality-- the majority of the enterprises appear to have experienced positive TFP growth between 1992/93 and 1997/98, and it could be argued that the progressive reductions in trade restictions must have played a positive role in this outcome by inducing technical efficiency gains, technological progress/diffusion, and thus enhanced productivity of inputs. When these quantitative results are put together with the published statistics on the output performance of manufacturing industries, the resulting picture is a generally positive development, which does not support the claim that trade liberalization harmed Bangladesh's manufacturing industries. * The export-oriented firms appear to have done better in improving their relative technical efficiency and thus in further catching up with the best practice firm(s)--or moving toward the maximum potential production. Import competing firms have generally lagged behind the most efficient firms in improving their relative efficiency in resource use. Firm-specific problems and the business environment constraints faced appear to have been factors in slowing down efficiency improvements and adjustments to trade liberalization. However, it is also worth noting that the surveyed import competing firms, on average, experienced stronger positive technological change than the export-oriented firms, perhaps reflecting the larger beginning technology gap and the scope for larger leaps in technological progress. This in turn enabled the import competing firms to experience larger TFP growth. * Some import competing firms (in iron/steel metal works, engineering, rubber works, and cotton mill) might have been adversely affected by trade liberalization. This is an expected outcome of trade liberalization: inefficient/high cost firms will suffer from increased foreign competition. However, it is important to highlight that many of the manufacturing firms surveyed listed other internal and external conditions--such as the cited constraints to doing business--as also important factors that adversely affected their performance. * An important implication of these findings is thatfaster improvements in the areas of infrastructure, financial sector reform, business support services, the customs administration, and law and order would have undoubtedly led to stronger benefits from the trade liberalization effort. Indeed, addressing these problems will be the most critical undertaking that the Government can do to boost industrial development. 40 Chapter 3: Impacts Of Trade Liberalization On Technical Progress And Efficiency In Manufacturing Industries 1ellL3:: Te iaEffidyL yFadwrolty mh 1at-199M MF : d f0a* :f0 Pa R; Tc FO Fnml(JuAhlls) Cigg Mi 0.853 0 1.000 LOOO 0.853 O LL21 0.990 L132 1.000 1.132 FRm2(Siikd) Ui1g Mian 1.000 LOOO 1.000 L00Xi 1.0C LCOO L073 1.073 LOOO 1.OCO 1.0l0 Firmn3 (fany) Ilka Sfian 0.953 LCOO 1.000 100 0Q953 L00 L309 1247 L(F0 1.0Q 1.05Q Fhm4(4t) Ih" lian 0.891 0L'97 1.000 0.800 0.891 06 L020 1.14) 0.95 0.8CO 1.119 HIMS (Gmis) f a Q a q699 (189 1.000 d0. OS069 9O8 L034 G822 1L28 0.88 1.430 1Rn6(al) DI" LarQ 0919 1L000 1.0Q LOOO 0919 LOO L304 1.199 LOSS 1.00 0 1.088 FhTr7 (Sfi1) Kuhi I'k¶im 0.811 Q940 0.888 (09 0.913 13961 L121 0.966 L160 1.103 1.052 F=m8(Sm d Th1im 1I2 879 LOOO 0Q99 10OO 0.907 LOOO lA06 1.237 1137 1.032 1.102 ;XC0000090000000;000000 0 8% (19t00 (7 00892 0)0 1.174 1.077 1.090 0,977 } 116 RL : V D *0 II~jxn (I~nt: 0 0T0st u:; ;000V0000y00XW000 S;0 0 0000000 0 0000 @ t000fi: 0 1A003 9 _ Fi Eau 1T ¶3l Rin9(Akjrirur Uitgxg sm1 09799 Q5S8 0.942 Q632 0.848 UNE4 L051 1.504 0Q9 0671 1.042 fim 10 (Sat) Cit1ag SiTE 0691 Q664 0.693 QT7 0997 Q939 L615 1.682 0.Q90 1.010 0.941 RimlI (QI) (ittagr lbim 0.0 OM2 0784 0543 0.901 Q960 L09 1.447 0.739 0.693 1.066 imn12(Sa1t) Qitag Mxkiin 0962 LOOO 1.000 LOO 0962 LOOO 2216 2131 1040 I.Q)O 1.040 Rimn13 (Sop) Gitapg NIdiun 0.668 L00 0 671 LOOO 0.995 LOOO 2.319 1.549 LV7 1.490 1.005 Hmn14(Sop&Qiica1) Eiugg Iviai 0Q636 LOOO 0.650 D 1000 0.978 LOOO 2.721 1.730 L573 1.539 1.02 FnmTS (Hournlls ) i1t.OC Md1 1.000 10L ) 1.000 1 1.0W LOOD L326 1.326 1L00 1.0OG 1.0Q nm16CIedi1e& srayni1) QiMa9 law 0Q582 0.648 0757 100 0Q769 Q648 L997 1.434 L114 1320 0844 Tn 17 (h(al a&g) Citagg La 0854 0Q673 Q908 0912 0941 0737 L032 1.311 al(97 1.0G 0.783 FRn 18 (&) Qaig IaW 0688 Q812 0878 0814 O783 Q998 L6(5 1.435 L181 0927 1.274 Fuml9(fx QiCgE Iaw 0.874 Q962 0.877 Q9S2 0996 LOOO L263 1.147 101 1.037 10N4 Flnn26(9) lb"a ai11 0781 0.448 1.0)0 0954 0781 04A6 L012 1.76 0Q573 0.954 0601 Fi,n21( 9ig * 11 srsll 0943 Q562 1.030 Q939 0943 0Q 09 64 1.617 OS96 0.939 0635 Hnn22(NiV) 9 Isll Q m 0818 QS29 0923 0S33 0887 0.635 L10 1.717 (1646 0.903 0.715 FiRm23 (S) 13aka s81 1.000 0430 1.0 00 LOOO 1.0OC 0.430 0745 1.733 0430 1.0OC 0430 Fin24 TIs) Dn-z all 1.010 O1A09 1.000 0AtQ 6 1.0)) O 0 1628 O49 0480 0852 inn25(~Wa) I32 S411i 0Q841 Q.412 1.000 LOOO 0.841 0412 0S5 1.827 0.490 1.03 049S) Ffim26(Soep) DI §mll 0.798 Q070 1.0 10 LOOO Q798 Q708a L567 1.765 M888 1.00G 0888 Rim27(NW) [lria Snl 0Q617 0.610 078) LOOO 0791 0.610 L727 1.748 QS98 1.282 0771 Rin28 (firte) E3h 8m1 0857 Q447 1.000 Q.63 0857 0.645 L007 1.929 (522 0.693 0753 Thi2(GM) DI sm]1 0671 Q543 1.000 Q59 0Q671 M971 1241 1.532 Q810 0.559 1.449 Fkn330>r&S=mRntrf) Dh 3.Ml 0Q919 L1O 0921 LOO1 0.997 LOBO 2.149 1.975 LOS8 1.085 1.113 Chapter 3: Impacts Of Trade Liberalization On Technical Progress And Efficiency In Manufacturing 41 Industries 1,Lr CodiqTFw (tom) GtIl Si& e 1.Etg j21AS K3 so I 1 E!H SOL Fumn3l (Thtirng) Dhaka Smal 0.983 1.000 0.996 1.000 0.987 1.000 2.143 2.107 1.017 1.004 1.013 Fnm32 (fcen&Rublb) L8alm Sm11 0.810 Q657 0.817 0.660 0.991 0.997 1.2S8 1.549 0.812 0.808 1.005 Fnm33(Rubbff) daka sma1l 0.711 0.516 0711 0Q556 0999 0.927 1368 1.887 0.725 0.782 0.927 Fim 34(RUbbe) Ihala Small 0.612 0573 0.612 0.576 0999 0.995 1.533 1.638 0.936 0.940 0.996 Firm35(Seel) E"a1 9snm 0.722 0440 0.724 0.796 0.997 0.553 1.034 1.695 0.610 1.099 0.555 Frm36(m) DLaka mll 0.914 0537 1.Q00 0.753 0.914 0.714 027 1.483 0588 0.753 0.781 Firm 37 ([Ir) lDhaka 9r1 0.891 0.595 0.894 0.637 0.996 0.934 1.231 1.843 0.668 0.713 0.937 Firm38 (Rubb) Eiakca m1a 0.942 0.526 0956 0.606 0.985 0.69 M908 1.624 0.559 0.633 0.883 Fnm39([eal) Dhaka small 0.608 0.962 0.725 0.963 0.839 0.999 1.812 1.145 1582 1.329 1.190 F=m40(Thnry) Uia]c a1iinn 0.822 0.941 0.831 0.957 0.989 OM83 1.405 1.227 1.145 1.152 0.994 Fimn4 41 Wa) raka INv M 0.750 05.34 0.805 0.542 0.931 M985 1.158 1.626 0.712 0.673 1.058 Fnm42 (Soap) Elia1 Mfiumn 0.850 0.500 0.883 0553 0.962 0.903 1.064 1.810 0588 0.626 0.939 Fnm43 (Theilenills) hliaka miiurn 0.939 0.749 L.0)0 0.820 0.939 0.913 1.051 1317 Q798 0.820 0.973 Fum44 (Clay) Dhaia Iiium 1.0Q) 0.612 'L.0QO Q803 1.0Q 0.762 0Q926 1.513 0.612 0.803 0.762 Firm45 (ClIa) Elaa aidrn 1.0Q) 0.832 1.000 1.000 [.000 0.832 L172 1.409 0.832 1.0Q, 0.832 Fmn46 (TbrIas &WWkingsn&d) Eiima kmrn 0.653 0373 0.725 .397 0.90D 0.938 0.845 1.480 0.571 0547 1.044 Fnm47 (aYtc ) lia Nlodiwn 0.813 OA55 0.831 0.504 0.978 0.903 0.867 1.548 0S60 0.607 0,923 Fum48(Shae) Dhaka MQdizn 0.901 0.771 0.907 1.000 0.993 0.771 1.269 1.482 0.856 1.102 0.777 Finn49 (ldicare) Dlaka MD&i=m 0.670 OS79 0.673 1.000 0.996 0.879 2.068 1.577 1.311 1.486 0.882 Ffrm 50 (Soya) Dhaka Mv6iin 0.606 0.517 0.607 0.521 0.999 0.992 1A25 1.671 0.83 0.859 0.993 Fnm 51 (Texileernils) lhiaka Large 0.700 0.514 0.953 0.804 0734 0.640 1.136 1.546 0.735 0.843 0.872 Furn 52 (edis) Ebaka LIrge 1.03) 1.000 1.Q)O 1.000 1.000 1.000 1.621 1.621 1.000 103) 1.000 Fnn53 (Meta) Khulr m n 1.03) OM80 1.000 .809 1.000 0.717 0.754 1.300 0580 0.809 0.717 Fnm54([Rice) Ehulim 1ium. 0.653 Q653 0.698 Q740 0.935 Q882 1.782 1.780 1.001 1.060 0.944 Fmnm5siceMrills) Kium Large 0.607 0.402 0.746 0.419 0.814 0.959 1.074 1.622 Q662 0.562 1.178 veul . Q 06 WI661 .870 0797 9 933S 1591 03 0.929 0 Frnm 56 (ht& Scl) Chtag Mvdirn 0.633 Q343 0.664 0.362 0.953 0S48 Q927 1.710 0.542 0,545 0.994 Finn 57 (Alwunrm ataguE NiRn lOO Q620 1.0I) Q635 1.000 0.975 0.824 1.329 0Q620 0.635 0.976 Fmrm58Rfiiyy&Vergable rtuds) (hittag Lae 0,786 1.0 0.860 1.000 0.915 1.000 1.897 1.491 127 1.163 1.094 Fin59(1mn&Seel) Cittagorg Large 0.564 OA98 0.659 Q545 0856 0.915 1A72 1.665 0.884 0.827 1.069 Fum60(VegableOils) ittag Lrge 0.825 0.919 0.832 0.919 0992 1.000 1.143 1.026 1.114 1.105 1.008 Fim 61 (Steel) ittag Lage 1.0) OM20 1.000 0.931 .ODO 0S88 0.924 1.004 0.920 0.931 0.988 Firm 62 (Fx Lalka soall 0.795 0.336 0829 0.372 0,958 0.902 0.785 1.856 0.423 0.449 0.942 FrTn63 (Meta) lEaka Small 1.03) 1.000 1.03) 1.000 1.OD 1.000 2.016 2.016 1.000 1.03) 1.000 Fim 64 (Ccmmal Rinnrt snioll 0.891 0.438 0.893 Q440 0.999 0Q995 0.709 1.444 0Q491 0.493 0.996 Fnm 65 ([bb1) Ebaka sQu 0.886 Q478 0,923 0.520 0.959 0918 0.834 1.547 0S39 0.563 0.957 Fimn66( aint&Ch iacaD Dlhaa 9mll 0.936 0.702 0,973 0.705 0.962 0.996 1.091 1.455 0750 0.724 1.036 Fmn67( MFaRnture&FiXDtes) Etla MIIUnM 0.574 Q509 0.584 Q646 0983 0.788 1.298 1.463 .887 1.107 0.801 Fmrn68 (Cotam) Laa Lae 0.751 OA59 1.0) 0.699 0.751 0.657 0.895 1.462 0.612 0.699 0.876 Fim 69 (C(mnrls) Khulma IkMn 1.03) QS87 1,000 0.620 1.000 0.947 0.855 1.457 OS7 0.620 0.947 tan q.832 0 62671 0.953 .938 1.119 1 760 0.6 979 42 Chapter 3: Impacts Of Trade Liberalization On Technical Progress And Efficiency In Manufacturing Industries CNlhhtAeOoLk Qy 0000*000;0:XS0:0 0:0 10f:Aut;iSA;f0;);F:CR i; : t:0: 0 :X i :f Sam FMTois) Qitt x ig n 0.875 1.000 0.965 1.000 0.907 1.OD 2.003 1.752 1143 1.036 1.103 Fn1n (Bids) Giah g NMxin 0.869 0.453 0.923 (461 0.942 OM 1A1 2689 (6as 0.52a) 1.042 Fbm72(Bid(s) Gi1 r N ihn as93 4663 0.912 a.s O.7" 0.93 191 2279 a742 0.732 1.014 EHm73(Eid) aitig Mhtv n 0896 0.6w0 1.00 0.709 s896 OM8 1.093 1.440 1759 0.709 1.071 Flm74(Eidcs) Quigag Ivdun 0.873 LO.O 0.950 1.OOD 0.919 1.000 1318 1.150 L146 1.052 1089 Fxnm75(fid&) cit Mvikn 0a696 a621 0a70s5 (4 0.987 Qs4s 1906 2137 0ass2 0.92 0.960 Fhm76(Bid(s) aitgiig Nlun 0s29 (1386 0.871 0.431 0.952 0U% 0.984 2116 0.465 0.494 0941 Fdm77(ki&) Qaii g lkllzn 0701 0Qs7 0.717 0.602 a978 0.991 O063 2424 as1 0.840 1.013 Him7~8 qvk~ B*Wing) auit g Iaqp ICCO0 1.000 1C00. 1.000 IAXLO 1.000 0.835 0.835 LOOO 1o03 L.3D Fm79 (Ridcs) a I. law 0.967 V702 L.3 10 09 OL72Z 1224 1.686 (1726 1.(D) 0.726 Fn(BADk) 1jijn L.ao as67 1.033 0.70 LOO( 0Qss7 1065 1.228 (67 0870 0997 Fum8l (id) IQum N.axDn 1.033 0.663 1.033 0667 1.000 0Q995 13S6 2045 166k3 0667 a9s4 Eim582(Bdcs) Kium 1vizn 1.03) Q 778 1,.C0 Q779 1.00) 0.999 1.156 1.486 0.778 0.779 0.999 ~~ 4 ~~~ 1.392 1 m 715 O.W ~ 995 te: Technical Efficiency pte: Pure Technical Efficiency se: Scale Efficiency TFPCH: Total Factor Productivity Change TECHCH: Technological Change EFFCH: Efficiency Change PTECH: Pure Technical Efficiency Change SECH: Scale Efficiency Change Chapter 3: Impacts Of Trade Liberaliation On Technical Progress And Efficiency In Manufacturing 43 Industries Appendix to Chapter 3 METHODOLOGY, DATA AND THE SAMPLE STATISTICS 1. Since the production technology of afully efficient firm(s) in a given industry is not known, in practice it must be estimated from observations. Three main approaches have been applied in empirical studies on efficiency frontiers. One is an economic frontier approach, using a pre-defined production function or a cost function. The second is a pararrmetric linear programming frontier approach. The third is a nonparametric frontier approach. Though each approach has its merits and shortfalls, the third approach is employed here. It has several advantages. First, its data requirement is less than the other approaches; second, it does not require a priori specifications about the underlying technologies, and it does not assume that production is already taking place on the efficient frontier; third, it provides firm- level productivity indexes; and finally, it can easily identify sources of productivity growth. 2. The nonparametric frontier approach--Data Envelopment Analysis (DEA)--is designed to construct piece-wise linear production frontiers and then to compute the level of efficiency (inefficiency) that might be present in the production process. As a result, it provides meaningful scalar efficiency scores, which can serve as measures to gauge the efficiency of firms within a multiple output/input framework (see Annex III for technical details and explanations). 3. In the present context, the DEA frontier represents a set of efficient observations for which no other production unit (or linear combination of units) employs as little or less of every input without changing the output quantities generated or produces as much or more of every output without altering the input quantities used. However, this approach abandons the possibility of determining the precise statistical significance of results. Nonetheless, this technique has become a standard in efficiency studies; (see Fare et al, 1994, for a recent application of the technique to the question of technical efficiency and technological progress in affecting total factor productivity changes in 17 OECD countries). Empirical design for efficiency estimations 4. Two separate sets of annual efficiency frontiers are estimated specifically for the years 1992/93 and 1997/98, using panel data on a sample of manufacturing firms. A key advantage of having panel data is the ability to observe each firm more than once over a period of time. This is critical in a continuously changing business environment, because the technology that is most efficient in one year may not be the most efficient in another year. And in a period of changing market incentives associated with, say, trade liberalization, firms may decide to change their production technologies. Furthermore, by examining two observation years, the problems related to not being able to take into account random errors in the DEA approach are alleviated, at least to an extent, by allowing an efficient (inefficient) firm in one year to be inefficient (efficient) in another year, assuming that the errors owing to luck or data problems are not consistent over time. Survey Data 5. The data used in this study are obtained from two (manufacturing industry) surveys. The first is the 1992/93 Industrial Study (ISS) survey carried out jointly by the World Bank and the USAID. It covered over 1200 firms. The second is the 1997/98 survey carried out for this report. The latter survey includes a sub-sample (about 10 percent) of randomly picked firms from those included in the ISS 44 Chapter 3: Impacts Of Trade Liberalization On Technical Progress And Efficiency In Manufacturing Industries survey. Accordingly, the 1997/98 survey has about 120 firrns. However, for the efficiency/productivity analysis, only 82 were found to have comparable/usable data. 6. To carry out a more meaningful analysis on the efficiency/productivity effects of trade liberalization, the surveyed firms are classified by market-orientation and size, such that any discernable differences in response pattems to trade liberalization could be identified and analyzed. For this reason, firms are grouped as: export-oriented (those that are producing for export, such as RMG, leather, sea foods, and indirect exporters); those producing non-tradables (e.g., bricks, and some service activities); and import-competing (the rest of the sample firms). Firms that are producing import-intensive products (such as vegetable oil, apparels, iron and steel, aluminum works, printing and packaging, dyers, plastic products, medicine, etc.) are also identified separately to see if such firms responded differently to the dismantling of trade barriers. Thus, out of 82 firms, 8 are classified as export-oriented, 13 non-tradable, 47 as import-competing, and 14 as import-intensive; (13 firms in the latter group are import-competing). In addition, firms are classified by size, as small, medium, anid large. The criterion used in the size classification is based on the number of employees. However, depending on the nature of the product involved, different employment ranges are used in classifying firms by size; (this is approach is adopted from the 1992/93 survey work). For example, in knitwear, a firm with less than 18 employees is classified as "small", while in jute the relevant threshold figure is 366 employees. Of the 82 firns included in the quantitative impact analysis, about 33 percent are small, 46 percent medium-size, and the rest are large. Regarding their location, 55 percent of the firms are located in Dhaka, 34 percent in Chittagong, and 11 percent in Khulna. 7. In computations, the input vector includes: labor, raw materials, andfixed capital. The amount of labor is measured by the number of full-time employees on the payroll. In effect, this amounts to assuming that the sample firms maintained the same skill cornposition in their employment between 1992/93 and 1997/98. Material inputs are also treated as one composite input, since only one cost figure is available, and the GDP deflator is used to deflate the nominal material expenditure figures. Fixed capital stock is calculated by summing the value of machinery, transport equipment, and factory structures/premises . 8. The survey data do not have disaggregated information on material input expenditures and on their unit prices, and reliable price deflators for various kinds of imported and domestically produced capital goods are not available. These data limitations necessitated the use of only one deflator to find changes in real magnitudes of material inputs and different kinds of fixed capital goods between the two observation years. This creates the possibility of an increased incidence of extreme observations. For example, a firm that experienced significantly different price changes than what is implied by the GDP deflator between the observation years for its material inputs and/or fixed investment goods could easily emerge as an "extreme" observation in terms of its technical efficiency. This could distort the results by affecting the outcome on the "best practice" frontier. Therefore, given the sensitivity of the results to extreme observations, an effort is made to ensure that such outliers are excluded from computations. (In the computations, one such observation-- a firm producing leather products--had to be eliminated). Grouping Sample Firms by Market-Orientation 9. As indicated above, in carrying out the quantitative analysis, the sample firms are grouped by their market-orientation to come up with analytically meaningful results. Consequently, firms that are 7 Land is excluded from the calculations to avoid any biases that speculative land holdings might cause in the estimation results. Firm specific capital stock figures for 1992/93 are available, so are finn-specific investment figures for 1994 through 1997. The 1997/98 capital stock figures are derived applying the perpetual inventory method--using GDP deflators to obtain the real investment figures and depreciating the capital stock figures by 8 percent per annum. Chapter 3: Impacts Of Trade Liberalization On Technical Progress And Efficiency In Manufacturing 45 Industries producing different products--and most likely using different technologies--are put together. For example, in the import-competing group there are firms producing textiles, metal products, rubber goods, and soap and detergent. Of course, further sub-groupings of import-competing enterprises that produce similar goods with similar technologies could have been formed. But this would have naturally required a very large sample of firms, so that a sufficiently large number of firms are included in each sub-group in order to compute separate "best-practice" frontiers. Because of the very high cost of such a large sample, the sample had to be restricted to 120 firms in the study. However, it is worth drawing attention to the fact that in practice firms producing similar products use different technologies, with the scale, vintage, and the level of sophistication of capital equipment changing from firm to firm, depending on firms' size, age, and the extent of modernization undertaken by them. 10. Tne approach adopted here is not expected to distort the results. This is because the technical efficiency indicators and comparisons are based on relative performance--that is relative to the benchmark frontiers computed from observations pertaining to the best practice (most efficient) firms. Consequently, the technical efficiency rankings among firms within the same product category will not be affected since their efficiencies are all measured relative to the best-practice frontier. Similarly, comparisons of the relative technical efficiencies of firms producing different goods but included in the same market-orientation category remain meaningful. Because, this is like simulating a situation where relative efficiencies of many activities that can be used in the production of one composite good--call it an import-substituting product--are compared, as in the case of "activity analysis". ANNEXES Annex I 49 Table A.1: Trends in average and Dispersion of Tariffs, FY91-99 (in percentages) Description FY91 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 Average CD (unweighted) 88.6 56.7 46,8 35.8 25.4 22.2 21.5 20.7 20.2 16.7 AverageCD(collection) 42.1 24.1 23.6 24.1 20.8 17.0 18.0 16.1 14.1 Standard Deviation 63.8 40.7 30.7 24.5 19.2 16.5 16.3 15.4 14.6 13.7 Dispersion (Coeff. of 72.0 71.9 65.6 68.2 75.6 74.4 7537 74.4 72.4 82.1 Variation) Numberoftariffslabs 17 17 14 11 5 6 6 6 6 4 Infrastructure dev -- -- -- -- -- -- -- 2.5 2.5 2.5 surcharge Average License Fee 1.2 1.4 1.5 1.5 1.2 1.3 1.3 1.0 -- (collection) Top CD rate 350 350 300 300 60 50 45 42.5 40 37.5 Trends in Average Nominal Protection Panel B All Tradables Manufacturing Sector (Un-weighted Rates) (Un-weighted Rates) Fiscal Year CDLF+1DS SD VAT Over-all CD+LF-IDS SD VAT Overall 1990/91 88.6 0.04 -- 88.6 89.0 0.04 -- 89.0 1991/92 58.1 0.05 9.2 67.4 58.1 0.05 9.7 67.8 1995/96 23.7 0.1 3.3 27.1 23.4 0.1 3.4 26.9 1998/99* 23.4 0.4 3.3 27.2 23.3 0.4 3.5 27.3 1999/00 19.5 2.2 3.0 24.7 19.2 2.5 3.2 25.0 * Postflood rehabilitation surcharge on supplementary duty inclusive All Tradables Manufacturing Sector (Weighted Rates)* (Weighted Rates)* Fiscal Year CD+LF+lDS SD VAT Overall CD+LF+IDS SD VAT Overall 1990/91 42.1 0.0 -- 42.1 51.8 0.0 -- 51.8 1991/92 25.3 0.0 3.3 28.7 23.6 0.0 3.7 27.3 1995/96 18.2 1.4 2.7 22.3 19.0 2.1 3.1 24.1 1998/99 17.1 1.1 2.1 20.3 19.5 1.6 2.8 23.8 * Import-weighted rates unavailable for 1999/00 CD =custom duty; LF = license fee; IDS = infrastructure development surcharge; SD = supplementary duty 50 Annex I Table A.2: Trends in Average and Dispersion of I'ariffs on Manufactures, FY92-99 (in percentages) Customs Supplementary VAT CD+VAT+SD+IDSC License Fee Description Duty Duty FY 1999-00 Average (weighted) Average (unweighted) 16.5 3.3 11.7 35.5 -- Coefficient of Variation 84.0 -- Maximum 37.5 270.0 15.0 2.5 FY 1998-99 Average (weighted) Jul-Jan99 15.8 4.1 13.3 35.2 1.2 Average (unweighted) 20.0 3.8 16.1 39.4 -- Coefficient of Variation 73.9 Maximum 40.0 270.0 15.0 2.5 FY 1995-96 Average (weighted) 17.6 2.5 13.6 33.8 1.3 Average (unweighted) 22.1 1.3 15.7 37.2 -- Coeff. of Variation 76.0 Maximum 50.0 350.0 FY 1991-92 Average (weighted) 22.5 0.8 12.1 35.4 1.1 Average (unweighted) 56.9 0.9 23.6 82.0 -- Coeff. of Variation 72.4 -- Maximum 350.0 25.0 Annex 1 51 Table A.3: Tax Incidence on Imports (in percentages) Customs fDutv Supplementary VAT CD±VAT±SD+CDSC Description Dty FY 1998-99 Average (Weighted) Jul-Jun99 14.1 2.6 10.3 29.1 Average (Unweighted) 20.2 2.2 13.1 39.2 Coeff. of Variation 72.4 Maximum 40.0 270.0 15.0 FY 1997-98 Average (Weighted) 16.1 2.4 11.8 32.3 Average (Unweighted) 20.7 1.7 13.7 38.6 Coeff. of Variation 74.4 Maximum* 42.5 350.0 15.0 FY 1996-97 Average (Weighted) 18.0 2.2 12.9 33.1 Average (Unweighted) 21.5 1.0 13.8 36.6 Coeff. of Variation 75.7 Maximum* 45.0 350.0 15.0 FY 1995-96 Average (Weighted) 17.0 1.8 11.8 30.6 Average (Unweighted) 22.2 0.8 13.7 37.0 Coeff. of Variation 74.4 Maximum* 50.0 350.0 15.0 FY1994-95 Average (Weighted) 20.8 1.1 12.8 34.8 Average (Unweighted) 25.4 0.7 14.0 40.5 Coeff. Of Variation 75.6 Maximum* 60.0 350.0 15.0 FY 1993-94 Average (Weighted) 24.1 0.5 14.5 39.1 Average (Unweighted) 35.8 1.8 16.7 54.1 Coeff. Of Variation 68.2 Maximum* 300.0 350.0 15.0 FY 1992-93 Average (Weighted) 23.6 0.3 13.8 37.6 Average (Unweighted) 46.8 1.5 18.9 67.1 Coeff. of Variation 65.6 Maximum* 300.0 350.0 15.0 FY 1991-92 Average (Weighted) 24.1 0.6 11.5 36.2 Average (Unweighted) 56.7 0.7 22.3 79.6 Coeff. of Variation 71.9 Maximum* 350.0 25.0 15.0 Source: World Bank StaffEstimates. 52 Annex I Table A.4: Effective Protection Rates (EPRs) in 40 sectors in Bangladesh (in percentages) Effective rates, of protection: Sl # Sector Name 1992/93 1993/94 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 01. Rice -8.0 0.9 2.4 -5.8 -5.7 -5.4 -5.3 -4.7 02. Wheat -3.9 8.5 11.0 2.0 2.2 2.6 2.8 0.2 03. Coarse Grains -4.9 -4.1 -0.8 -0.2 -0.2 0.1 0.1 0.4 04. Jute 64.4 67.2 30.6 31.8 32.0 32.4 32.5 26.8 05. Sugar Cane 68.4 71.3 14.2 14.8 15.0 15.2 15.2 15.8 06. Cotton 4.8 5.4 -2.0 -1.7 -1.7 -1.5 -1.5 -1.4 07. Tobacco 12.5 -0.9 10.2 11.8 12.1 11.1 11.3 12.2 08. Potato 58.9 60.4 48.8 36.7 35.7 26.9 24.5 23.1 09. Other Vegetable 71.7 43.6 44.5 32.1 32.2 32.1 32.1 26.9 10. Pulses 19.9 18.1 17.4 16.9 17.0 18.2 11.3 8.3 11. Oil Seeds 53.8 42.7 35.6 24.6 24.7 22.8 22.8 19.7 12. Fruits 58.2 60.5 44.9 40.2 39.9 38.1 36.3 33.1 13. Tea 82.7 85.1 66.0 48.7 48.8 46.4 43.4 41.0 14. Other Crops 64.9 40.4 41.5 28.3 28.6 28.1 27.2 22.5 15. Livestock 74.3 54.0 42.0 33.2 32.8 28.8 28.0 24.8 16. Fish 78.4 45.3 45.1 28.4 28.5 27.9 28.0 23.2 17. Forestry 38.8 32.7 23.9 22.7 22.9 19.7 19.2 16.9 18. Other Fruits 489.2 327.4 88.5 88.3 86.0 76.7 68.3 66.9 19. Edible Oil 74.8 46.5 39.6 55.6 53.7 41.4 35.3 35.0 20. SugarandGur 96.3 42.3 52.3 51.1 51.4 40.0 38.5 31.1 21. Salt 51.4 61.6 43.5 37.2 34.6 30.7 29.1 29.6 22. Yam 68.0 57.4 60.9 51.7 35.0 34.2 33.7 30.5 23. Cloth: Mill 189.7 147.5 131.6 98.0 110.2 86.2 78.2 72.7 24. Cloth: Handloom 157.7 128.5 114.6 87.6 94.9 75.5 68.8 64.6 25. Readymade Garments 237.2 130.0 84.1 53.7 57.4 65.4 60.5 58.9 26. Jute Textile 98.2 93.5 81.0 55.7 56.0 48.4 44.1 43.5 27. Paper 68.3 74.1 48.8 25.4 22.7 12.7 11.3 15.5 28. Leather and Leather 98.6 87.3 42.3 20.7 15.8 8.8 5.90 6.5 Products 29. Chemical Fertilizer -5.6 -2.2 -5.0 -3.6 -3.0 0.4 0.5 0.6 30. Pharmaceutical 1.5 -2.2 -2.5 -2.6 -1.4 0.7 0.6 -1.7 31. Chemical 30.3 15.4 14.9 12.5 13.8 15.2 16.1 9.7 32. Petroleum Products 40.2 32.8 45.7 35.5 35.7 32.3 31.2 27.3 33. Cement 56.0 30.6 21.4 18.5 19.1 19.0 20.3 21.2 34. Steel and Basic Metal 40.9 27.2 27.4 25.1 24.6 25.0 25.1 19.5 35. Metal Products 52.7 43.3 25.1 25.8 27.0 18.2 17.3 15.4 36. Machinery 47.5 28.9 15.1 12.6 12.3 9.3 9.6 5.2 37. Transport Equipment 69.9 49.1 41.9 38.0 22.8 21.8 19.8 17.9 38. Woodand WoodProducts 124.0 81.0 48.1 47.3 47.3 32.9 32.9 31.8 39. Tobacco Products 133.6 69.9 89.7 85.0 86.7 81.9 74.7 68.5 40. Other Industries 72.7 65.1 38.5 37.3 29.6 21.9 21.0 19.9 a) Average ERP 75.7 56.7 40.6 33.0 32.4 28.6 26.8 24.5 b) Standard Deviation (SD) 84.4 57.0 31.2 25.7 26.9 23.0 20.9 20.0 c) Coefficient of Variation 111.5 100.6 76.9 77.7 82.6 80.4 78.2 81.6 Source: Latest estimates by Bangladesh Tariff Commission, based on 1992-93 Bangladesh 1-0 Table. Note: These estimates, which uses the Bank's Sintia-1O procedure, could be regarded as crude estimates, not based on observed but derived differences between international and domestic prices. Annex I 53 Table A.5: Protection Related Quantitative Restrictions On Imports, FY92-99 Quantitative restrictions FY 91-92 FY 96-97 FY 98-99 T'ariff Imports Tariff Import Tariff Imports lines (mil. US$) lines (mil. US$) lines (m. US$) Totalno.ofHSCodes 5987 2618 6106 4796 6106 5113 Total no. of tariff lines 10238 -- 9649 -- 9855 -- BANNED 410 -- 14 -- 20 -- RESTRICTED 81 45.65 28 5.77 30 5.78 BANNED/RESTRICTED 688 62.93 293 11.40 288 16.84 TOTAL 1179 108.58 335 17.17 338 22.62 Percentage of total 11.52 4.15 3.47 0.36 3.43 0.44 Note: POL products are restricted mainly for non-trade reasons and their imports in FY1991/92 were $398 million, in FY 1996/97 $464 mnillion, and in FY1997/98 $507 million. Imports above do not include POL products. Table A.6: Effective Exchange Rates for Exports (Unweighted) Cash- Cash Export Interest interest Nominal Fiscal Export Subsidy credit Interest rates (%) subsidy subsidy Exch. Rate Year (bil. Tk.) (bil. Tk.) (bil. Tk.) Export General Diff. (mil. Tk.) (% of exp.) in Taka EERx (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) 1991/92 75.2 .025 11.8 9.6% 15.8% -6.2% 0.0097 0.0100 38.15 38.53 1992/93 88.0 .022 15.8 9.0% 17.2% -8.2% 0.0147 0.0149 39.14 39.72 1993/94 98.0 .078 18.0 9.0% 15.1% -6.1% 0.0112 0.0120 40.00 40.48 1994/95 13.1 .029 19.6 9.0% 13.1% -4.1% 0.0060 0.0082 40.20 40.53 1995/96 13.8 .045 19.3 9.0% 13.9% -4.9% 0.0069 0.0102 40.84 41.25 1996/97 16.6 .080 22.6 9.0% 14.3% -5.3% 0.0072 0.0121 42.70 43.22 1997/98 17.3 .020 22.7 9.0% 13.5% -4.5% 0.0059 0.0174 45.46 46.25 Effective exchange rate for Import substitutes:- Imports Un-wveighted Protective Rates Overall Nominal Exch. Fiscal Year (bil, Tk.) CC)LFi SD VAT | Protective Rate in Tk. EERm EERmEERx EERx/EERm iDS S rate (1) (2) (3) (4) (5) (6) (7) (8) (8) 1991/92 10.0 58.1% 0.05% 9.2% 67.4% 38.25 63.84 1.66 0.60 1992/93 10.7 48.3% 0.10% 6.9% 55.4% 39.14 60.81 1.53 0.65 1993/94 11.3 37.2% 0.04% 5.2% 42.4% 40.00 57.97 1.41 0.71 1994/95 16.1 27.5% 0.06% 3.8% 31.3% 40.20 52.79 1.30 0.77 1995/96 20.1 23.7% 0.13% 3.3% 27.1% 40.84 51.91 1.26 0.80 1996/97 20.5 23.3% 0.20% 3.3% 26.9% 42.70 54.16 1.25 0.80 1997/98 23.3 24.6% 0.32% 3.3% 28.2% 45.46 58.44 1.26 0.79 54 Annex I Table A.7: Effective Exchange Rates for Exports (Weighted) ;:0 ; ;Cash Export Interest Cish-Interest :Nominal Fiscal0 F.x14r PSubsidy cei i:nterest ratesaN (ssidy subsidy Exchb,Rate Year (bi I. Tk.) (bil. Tk.)_ (bil. 'rk.) Export General Diff. (mil. Tk.) (% of exp.J in Taka ER (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) 1991/92 75.2 0.025 11.8 9.6% 15.8% -6.2% 0.0097 0.0100 38.15 38.53 1992/93 88.0 0.022 15.8 9.0% 17.2% -8.2% 0.0147 0.0149 39.14 39.72 1993/94 98.0 0.078 18.0 9.0% 15.1% -6.1% 0.0112 0.0120 40.00 40.48 1994/95 13.1 0.029 19.5 9.0% 13.1% -4.1% 0.0060 0.0082 40.20 40.53 1995/96 13.8 0.045 19.3 9.0% 13.9% -4.9% 0.0069 0.0102 40.84 41.25 1996/97 16.6 0.080 22.6 9.0% 14.3% -5.3% 0.0072 0.0121 42.70 43.22 1997/98 17.3 0.020 22.7 9.0% 13.5% -4.5% 0.0059 0.0174 45.46 46.25 Effective exchange rate for Import substitutes:- Fiscal Imports Weighed Protctive Rats Overall - NomiaV Year (bil Tk.) CD+LF+1D SD VAT protective Rate inr Ek.M ERm EERmEERx EERx/EER S 00 f :ftt;;tS;-0yg ;;y ;f:fQ000-;0 jrate m00 lt:000000000 n (1) (2) (3) (4) (5) (6) (7) (8) (8) 1991/92 10.1 25.34% 0.00% 3.32% 28.67% 38.15 49.09 1.274 0.785 1992/93 10.7 25.00% 0.00% 3.23% 28.23% 39.14 50.19 1.263 0.791 1993/94 11.3 25.57% 0.00% 3.71% 29.28% 40.00 51.71 1.278 0.783 1994/95 16.1 22.25% 0.72% 3.15% 26.12% 40.20 50.70 1.251 0.799 1995/96 20.1 18.24% 1.40% 2.70% 22.34% 40.84 49.96 1.211 0.826 1996/97 20.5 19.32% 1.72% 2.98% 24.02% 42.70 52.96 1.225 0.816 1997/98 23.2 19.34% 1.80% 2.75% 23.89% 45.46 56.32 1.218 0.821 Annex 1 55 Table A.8: International Comparison of Tariff Regimes Country Avg. tariffh Recent Avg. tariffs Tariff ratio* Pre-reform (in percentages) (in percentage) South Asia 80 27 0.34 Colombia (1984, 1998) 61 12 0.20 Peru(1988, 1998) 66 13 0.20 Brazil (1987, 1998) 51 15 0.29 Costa Rica (1985, 1992) 53 15 0.28 Chile (1984, 1998) 35 11 0.31 Argentina (1988, 1998) 38 14 0.37 Uruguay (1987, 1998) 32 12 0.38 Venezuela (1989, 1998) 37 12 0.32 Mexico (1985, 1998) 24 13 0.54 Latin America 44 13 0.30 Madagascar (1988, 1996) 46 7.3 0.16 Kenya(1988, 1996) 40 14 0.34 Nigeria (1984, 1995) 35 29 0.83 Ghana (1983, 1996) 30 13 0.42 Egypt(1989, 1995) 47 28 0.59 Tunisia (1987, 1998) 33 30 0.91 Africa 41 31 0.76 China (1986, 1998) 38 18 0.47 Indonesia (1985, 1996) 27 13 0.48 Malaysia (1988, 1997) 17 9 0.53 Thailand (1989, 1998) 40 18 0.45 Philippines (1988, 1998) 28 11 0.40 Singapore (1989, 1996) 0.4 0.4 1.00 Taiwan(1984, 1994) 31 11 0.36 South Korea (1984, 1996) 22 9 0.41 South East and East Asia 29 14 0.48 (*) Tariff ratio is the recent average tariffs over pre-reform average tariffs. Source: World Bank (1994, 1996) and Rajapatirana (I 997) 56 Annex I Table A.9: Bangladesh-Macroeconomic Developments in Openness, 1980-1998 (million UFY8 FY8 FY82 FY3 FY4 FY85 FY86 FY87 FY88 FY89 FY90 Export of goods and 723 932 840 889 1033 1162 1043 1301 1486 1598 1903 non-factor services Import of goods and 2622 2717 2759 2517 2544 2864 2587 2876 3252 3701 4156 non-factor services GDPatmktprice 17441 19405 17484 16618 19052 21129 21025 23728 25764 27662 30200 Export/GDP 4% 5% 5% 5% 5% 5% 5% 5% 6% 6% 6% Import/GDP 15% 14% 16% 15% 13% 14% 12% 12% 13% 13% 14% Export+Import/GDP 19% 19% 21% 20% 19% 19% 17% 18% 18% 19% 20% Exchange Rate (period 15.49 16.26 20.07 23.8 24.94 25.96 29.89 30.63 31.24 32.14 32.92 avg.) (million USS) FY91L FY2 FY93 FY04 FY95 FY96 FY97 FY98 Export of goods and 2113 2467 2906 3057 4144 4508 5083 5879 non-factor services Import of goods and 3829 3932 4519 4693 6449 7614 7655 8049 non-factor services GDPatmktprice 30746 31163 31934 33559 37614 40343 41345 42647 Export/GDP 7% 8% 9% 9% 11% 11% 12% 14% Import/GDP 12% 13% 14% 14% 17% 19% 19% 19% Export+Import/GDP 19% 21% 23% 23% 28% 30% 31% 33% Exchange Rate (period 35.68 38.152 39.13 40.001 40.2 40.86 42.7 45.45 avg.) Annex II 57 Table B.1: Bangladesh's Recorded Commodity Trade, 1989/90 - 1997/98: Overview Fiscal year: 89/90 90191 9W/92 92/93 .93194 94195 95196 96/97 917/98 US$mailion Total exports 1524 1718 1994 2383 2534 3473 3883 4418 5161.2 Estinated SBWexport(25%VA) 641 831 993 1164 1376 2070 1908 2107 2517.4 ExportProcessingZone exports 34 48 68 110 103 205 278 370 539.0 Derivednon-SBW/EPZexports 848 839 932 1109 1055 1197 1696 1941 2104.7 Total imports 3226 3687 3445 3700 3970 5762 6612 6779 7514.2 SBWBlB UCfabricimports 481 623 745 873 1032 1553 1431 1581 1888.1 Export Processing Zone inports 32 40 63 85 121 197 261 402 493.7 Non-SBW/EPZ imports 2713 3024 2637 2742 2817 4013 4920 4796 5132.5 Total trade (X + M) 4750 5404 5438 6083 6504 9235 10495 11197 12675.4 Trade surplus or deficit(-) -1703 -1969 -1451 -1317 -1436 -2290 -2729 -2360 -2353.1 SBW+EPZsurplus 162 216 253 316 326 526 494 495 674.7 Non-enclave deficit -1865 -2185 -1705 -1633 -1762 -2815 -3223 -2855 -3027.7 Arnwalgrowdi mie (i pefrcetages) Total exports . 18.0 12.7 16.1 19.5 6.3 37.0 11.8 13.8 16.8 Estimated SBWexport(25%VA) 29.5 19.6 17.2 18.2 50.4 -7.8 10.4 19.5 ExportProcessingZoneexport 112.5 41.2 41.7 61.8 -6.4 99.0 35.6 33.1 45.7 Derivednon-SBW/EPZexport -1.1 11.1 19.0 -4.9 13.5 41.7 14.4 8.4 Total imports 44.0 14.3 -6.6 7.4 7.3 45.1 14.7 2.5 10.9 SBWB/BIJCfablicimports 29.5 19.6 17.2 18.2 50.4 -7.8 10.4 19.5 ExportProcessing Zone imports 113.3 25.0 57.5 34.9 42.4 62.8 32.5 54.0 22.8 Non-SBW/EPZ imports 11.4 -12.8 4.0 2.7 42.5 22.6 -2.5 7.0 Total trade(X X+) 34.5 13.8 0.6 11.9 6.9 42.0 13.6 6.7 13.2 Trade surplus or deficit (-) 79.3 15.6 -26.3 -9.2 9.0 59.4 19.2 -13.5 -0.3 SBW+EPZ surplus 32.9 17.5 24.7 3.2 61.2 -6.0 0.2 36.3 Non-enclavedeficit 17.1 -22.0 -4.2 7.9 59.7 14.5 -11.4 6.0 Percent of GDP Total exports 5.0 5.6 6.4 7.5 7.6 9.2 9.6 10.8 12.2 Estimated SBW export (25%VA) 2.1 2.7 3.2 3.6 4.1 5.5 4.7 5.1 5.9 Export Processing Zone exports 0.1 0.2 0.2 0.3 0.3 0.5 0.7 0.9 1.3 Derivednon-SBW/EPZexports 2.8 2.7 3.0 3.5 3.1 3.2 4.2 ° Total imports 10.7 12.0 11.1 11.6 11.8 15.3 16.4 16.5 17.8 SBWB/BlUCfabricimports 1.6 2.0 2.4 2.7 3.1 4.1 3.6 3.9 4.5 ExportProcessing Zone inports 0.1 0.1 0.2 0.3 0.4 0.5 0.6 1.0 1.2 Non-SBW/EPZ imports 9.0 9.8 8.5 8.6 8.4 10.7 12.2 11.7 12.1 0.0 0.0 Totaltrade(X+AM) 15.7 17.6 17.5 19.0 19.4 24.6 26.0 27.3 29.9 Trade surplus or deficit (-) -5.6 -6.4 -4.7 -4.1 -4.3 -6.1 -6.8 -5.8 -5.6 SBW+EPZ surplus 0.5 0.7 0.8 1.0 1.0 1.4 1.2 1.2 1.6 Non-enclave deficit -6.2 -7.1 -5.5 -5.1 -5.3 -7.5 -8.0 -7.0 -7.2 Memorandum Item: 30,190 30,755 31,165 31,934 33,560 37,614 40,304 41,036 42,322 GDP in US$'million 58 Annex II Table B.2: Bangladesh's Recorded Commodity Trade, 1989/90 -1997/98: Export Composition Fiscal year; 89X90 91 910; 9/92 92/93 93/94 94195 95/96 96/97 97/98 M inifiian Readymadegarments 609.3 735.6 1064.0 1240.5 1291.6 1835.1 1948.8 2237.9 2843.3 Knitwear 14.8 131.2 118.6 204.5 264.1 393.3 598.3 763.3 940.3 Frozen Foods 138.1 141.8 130.5 165.3 210.5 305.6 314.6 320.7 293.8 Jute Goods 331.3 290.4 301.6 292.4 283.8 318.8 328.9 317.9 281.4 Leather 178.9 134.3 144.5 147.9 168.2 202.1 211.7 195.5 190.3 Othermanufactures 2.6 5.1 12.0 25.3 39.9 76.1 115.0 148.6 184.4 Raw Jute 124.6 104.2 85.5 74.3 57.0 79.5 90.0 116.3 107.8 Chemical products 22.8 39.7 24.9 55.0 53.9 107.3 98.5 108.5 74.2 Specialized textile, house linen 4.3 23.2 18.4 29,0 31.8 32.9 41.3 52.0 58.2 Leather goods 0.0 2.8 4.4 10.7 23.8 23.2 29.5 26.6 48.1 Tea 39.3 43.2 32.4 41.1 38.2 32.8 33.4 38.1 47.5 Agricultural products 10.5 7.9 9.7 14.5 15.5 12.5 21.5 28.7 39.1 Engineeringproducts 11.5 6.2 9.5 17.5 3.6 9.8 15.0 16.1 19.6 Naphtha,furnaceoil, bitumen 16.9 32.5 8.3 36.8 15.6 13.5 10.9 16.4 10.9 Fish 7.6 5.6 4.1 5.7 10.8 5.9 3.6 5.1 6.5 Handicrafts 5.2 5.2 8.7 5.4 7.3 6.5 6.4 5.7 6.0 Others 0.9 1.9 3.8 7.5 9.9 11.6 10.4 15.3 4.6 Sharkfins, fishmaws 0.9 1.1 1.0 3.7 0.7 4.1 1.0 2.0 2.4 Electronics 0.0 0.0 4.8 0.8 2.5 1.3 1.6 1.9 1.7 Stainless steel cutlery 0.0 0.0 0.1 0.2 0.1 0.4 0.6 1.5 0.8 Animal casings 0.4 0.1 0.1 0.1 0.0 0.0 0.1 0.1 0.2 Crude Fertilizer 0.5 0.5 0.6 1.6 4.2 0.0 1.6 0.0 0.1 Total 1523.7 1717.6 1993.5 2382.9 2533.9 3472.6 3882.8 4418.3 5161.2 S:are of total flu(f pen': !g" Readymade garments 40.0 42.8 53.4 52.1 51.0 52.8 50.2 50.7 55.1 Knitwear 1.0 7.6 5.9 8.6 10.4 11.3 15.4 17.3 18.2 Frozen Foods 9.1 8.3 6.5 6.9 8.3 8.8 8.1 7.3 5.7 JuteGoods 21.7 16.9 15.1 12.3 11.2 9.2 8.5 7.2 5.5 Leather 11.7 7.8 7.2 6.2 6.6 5.8 5.5 4.4 3.7 Othermanufactures 0.2 0.3 0.6 1.1 1.6 2.2 3.0 3.4 3.6 RawJute 8.2 6.1 4.3 3.1 2.3 2.3 2.3 2.6 2.1 Chernical products 1.5 2.3 1.3 2.3 2.1 3.1 2.5 2.5 1.4 Specializedtextile,houselinen 0.3 1.4 0.9 1.2 1.3 0.9 1.1 1.2 1.1 Leather goods 0.0 0.2 0.2 0.5 0.9 0.7 0.8 0.6 0.9 Tea 2.6 2.5 1.6 1.7 1.5 0.9 0.9 0.9 0.9 Agricultural products 0.7 0.5 0.5 0.6 0.6 0.4 0.6 0.6 0.8 Engineering products 0.8 0.4 0.5 0.7 0.1 0.3 0.4 0.4 0.4 Naphtha, fumace oil, bitumen 1.1 1.9 0.4 1.5 0.6 0.4 0.3 0.4 0.2 Fish 0.5 0.3 0.2 0.2 0.4 0.2 0.1 0.1 0.1 Handicrafts 0.3 0.3 0.4 0.2 0.3 0.2 0.2 0.1 0.1 Others 0.1 0.1 0.2 0.3 0.4 0.3 0.3 0.3 0.1 Sharkfins, fishmaws 0.1 0.1 0.1 0.2 0.03 0.1 0.03 0.05 0.05 Electronics 0.00 0.00 0.24 0.04 0.10 0.04 0.04 0.04 0.03 Stainless steel cutlery 0.00 0.00 0.00 0.01 0.00 0.01 0.01 0.04 0.02 Animal casings 0.03 0.01 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Crude Fertilizer 0.04 0.03 0.03 0.07 0.17 0.00 0.04 0.00 0.00 Annex II 59 Table B.3: Bangladesh's Recorded Commodity Trade, 1989/90 - 1997/98: Import Composition Fiscal ycar 89/90 90791 91/92 92193 93/94 94/95 95/96 96/97 97198 Exclding ,on-S8 Wbond. baggage and diplomatic USS$mion 1. Primary Commodity 694 1124 653 761 718 1166 1379 1164 1367.3 a. Food & vegetable product 323 247 279 359 357 640 734 497 681.8 b.Miningproducts 150 705 224 213 183 250 253 229 228.6 c. Animals,forestry & other 221 172 150 188 177 276 392 438 456.9 2.1ntermediateInputs 1151 1125 1168 1163 1236 1592 1900 1962 2060.7 3. Capital Goods 602 539 647 575 564 839 1167 1169 1207.8 a. Capital machinery & parts 427 423 520 426 397 565 815 738 849.9 b.Othercapitalgoods 176 115 128 149 167 274 352 431 357.9 4. Final Consumer Goods 266 236 174 241 300 413 470 501 496.6 Subtotal non-enclave 2713 3024 2643 2740 2817 4011 4915 4796 5132.5 5. Enclave 513 663 802 961 1153 1752 1696 1982 2381.8 a. B/B L/C SBWFabric 481 623 752 875 1032 1555 1435 1580 1888.1 b. Export processing zone 32 40 50 85 121 197 262 402 493.7 Total recorded imports 3226 3687 3445 3700 3970 5762 6612 6779 7514.2 Share of total (in percent) 1. Primary Commodity 21.5 30.5 19.0 20.6 18.1 20.2 20.9 17.2 18.2 a.Food&vegetableproduct 10.0 6.7 8.1 9.7 9.0 11.1 11.1 7.3 9.1 b. Mining products 4.7 19.1 6.5 5.8 4.6 4.3 3.8 3.4 3.0 c. Animals,forestry & other 6.9 4.7 4.4 5.1 4.5 4.8 5.9 6.5 6.1 2. Intermediate Inputs 35.7 30.5 33.9 31A 31.1 27.6 28.7 29.0 27.4 3. Capital Goods 18.7 14.6 18.8 15.5 14.2 14.6 17.6 17.2 16.1 a. Capitalmachinery&parts 13.2 11.5 15.1 11.5 10.0 9.8 12.3 10.9 11.3 b. Other capital goods 5.4 3.1 3.7 4.0 4.2 4.8 5.3 6.4 4.8 4. Final Consumer Goods 8.2 6.4 5.1 6.5 7.6 7.2 7.1 7.4 6.6 Subtotal non-enclave 84.1 82.0 76.7 74.0 71.0 69.6 74.3 70.8 68.3 5. Enclave 15.9 18.0 23.3 26.0 29.0 30.4 25.7 29.2 31.7 a. B/B L/C SBW Fabric 14.9 16.9 21.8 23.7 26.0 27.0 21.7 23.3 25.1 b. Export processing zone 1.0 1.1 1.5 2.3 3.0 3.4 4.0 5.9 6.6 Total recorded imports 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Annuagrowth rate (in percent) 1. Primary Commodity 36.3 62.0 -41.9 16.5 -5.7 62.5 18.3 -15.6 17.5 a. Food & vegetable product 10.7 -23.4 12.9 28.8 -0.7 79.3 14.7 -32.3 37.1 b. Mfining products 346.2 369.3 -68.2 -4.8 -14.0 36.6 1.2 -9.7 -0.2 c. Animals,forestry &other 20.1 -22.3 -12.8 25.4 -5.8 55.4 42.2 11.6 4.4 2. Intermediate Inputs 4.8 -2.3 3.8 -0.4 6.2 28.8 19.3 3.3 5.0 3. Capital Goods 55.9 -10.6 20.2 -11.2 -2.0 48.9 39.0 0.2 3.3 a. Capital machinery & parts 51.5 -0.8 22.8 -18.1 -6.8 42.4 44.2 -9.4 15.2 b. Other capital goods 67.4 -34.4 10.7 17.0 11.7 64.6 28.3 22.4 -16.9 4. Final Consumer Goods 14.5 -11.3 -26.1 38.3 24.7 37.6 13.7 6.7 -0.9 Subtotal non-enclave 21.9 11.4 -12.6 3.7 2.8 42.4 22.6 -2.4 7.0 5. Enclave 3320.0 29.2 21.0 19.7 20.0 51.9 -3.2 16.8 20.2 a. B/B L/CSBWFabric n.a. 29.5 20.7 16.4 17.9 50.6 -7.7 10.1 19.5 b. Exportprocessing zone 113.3 25.0 26.1 68.9 42.0 63.0 32.6 53.6 22.8 Total recorded imports 44.0 14.3 -6.6 7.4 7.3 45.1 14.7 2.5 10.9 60 Annex II Table BA: Bangladesh's Recorded Commodity Trade with India: 1989/90 - 1997/98 Panel A: Annual Imports Yalues : F0isc i: 0 year: 90191i 7. ;:91/92 D /93 0 93194 - 94/95 95/96 96/97 97/98: Shipment, excluding back-to-back S'milion 200 261 363 590 883 714 779 growth rate 30.5% 39.1% 62.5% 49.7% -19.1% 9.1% Source: Customs data on imports Panel B: Top 15 importsfrom India in 1992-1998 Fiscal year: 91/92 ~~~~~ ~ ~~~~92/93 97198 $'million Share $'million Share $'million Share Rice 211.1 27.1% Cotton yam 15.3 8% 28.0 11% 78.0 10.0% Portland, aluminous, slag, supersulphate, similar hydraulic cements 5.9 3% 22.7 65.7 8.4% New pneumatic tyres & tube, of rubber. 10.7 5% 12.7 5% 20.8 2.7% Flat-rolled products or iron or non-alloy steel. 21.7 8% 19.9 2.6% Raw Cotton 5.0 2% 17.9 2.3% Unwrought aluminium 8.7 4% 10.5 4% 16.7 2.2% Synthetic organic colouring matter 4.5 2% 6.4 2% 13.3 1.7% Preparations of a kind used in animal feeding 13.1 1.7% Heterocyclic cmpnds w/ nitrogen hetero-atom(s); nucleic acids/salts 5.5 2% 12.2 1.6% Machines and parts for preparing textile fibres 8.2 4% 12.0 1.5% Onions 26.2 13% 10.6 4% 11.8 1.5% Coal; briquettes, ovoids, sim. solid fuels manufactured from coal 10.4 4% 11.0 1.4% Elec. transformers, static convtrs (e.g. rectifiers) and inductors 10.6 1.4% Mineral or chemical fertilizers, phosphatic 10.3 1.3% Soya-bean oil and its fractions, maybe refined, not modified 15.9 6% Synthetic filament yam 5.1 2% Apples, pears and quinces, fresh. 3.9 2 % 4.4 2% Eggs 4.4 2% Parts and accessories of vehicles 3.9 1 % Chillies, dry 17.1 9% Salt 13.8 7% Insulated (including enamelled or anodised) wire, cable 6.0 3% Parts and accessories of vehicles. 3.5 2% Machines and mechanical appliances n.e.s. 3.3 2% Aluminium stranded wire, cables etc. not elec. insulated. 2.5 1 % Staple fibres 2.5 1 % All other goods 67.5 34% 93.8 36% 254.1 32.6% Total 199.5 100% 261.1 100% 778.6 100.0% Annex III 61 THE METHODOLOGY A. DATA ENVELOPMENT ANALYSIS (DEA) Farrel (1957) posited that the overall cost (economic) efficiency (CE) of a firm can be decomposed into two components: (1) technical efficiency (TE), which reflects the ability of a firn to generate maximum output from a given set of factors of production, and (2) allocative efficiency (AE), which reflects the ability of a firm to use the factors of production in optimal proportions, given their respective prices. Many studies have also decomposed the overall technical efficiency into two components, one due to pure technical efficiency (PTE) and one due to scale efficiency (SE). The AE and TE concepts can be better illustrated under the assumption of constant returns to scale (CRS), thinking of a hypothetical firm, f which uses only two factors of production, say labor (L) and capital (K) to produce a single good, y, as in Figure 1. Whereas, the further decomposition of TE into its PTE and SE components can be better depicted with one input (L) and one output (y) case relaxing the CRS assumption as in Figure 2. If we know the unit isoquant (production technology) of the best-practice firm, such as I- I' in Figure I and On or prstuv in Figure 2, we can measure the overall cost and technical efficiency of our hypothetical firm f Isoquant 1- I' shows the whole set of technologically efficient combinations of K and L for producing a given level of output, y, . Isoquants further to the right are associated with higher levels of output, those to the left with lower levels of output. For instance, the output level corresponding to isoquant III- III, y3, is greater than y,. The isocost line, as represented by c-c in Figure 1, shows alternative combinations of K and L that the firm can buy for a given outlay. Obviously the slope of the isocost line reflects relative factor (input) prices. The least cost position is given graphically by the tangency point between the isoquant and the isocost line. Given the factor prices and available technology, the optimal combination in Figure 1 is at point e. Any alternative combination of the inputs along the c-c'isocost line would bring about less output for the same cost. If the observed combination of inputs used by our hypothetical firm, f to produce y, is at pointf in Figure 1, it can be seen that the firm is inefficient because the point e was shown above to correspond to the most efficient combination of K and L to produce y,. Figure 1. Cost Efficiency (CE) Figure 2. Technical Efficiency (TE) II' I' III' y K lontie U V CE=Oa/f t b JJJ(y~~~~~~~~~~~~~~~) ~FT-n7tier II (v2) 0 c L 0 p L CE =AE xTE TE = PTE xSE CE = Oa/ Of TE '=km/kf AE = Oa/ Ob PTE = ks / kf TE = Ob / Of SE krn/ks 62 Annex III In Figure 1, to demonstrate allocative and technical efficiency of the firm, a line is drawn from the origin, 0, to the pointf (dotted line, O). Farrell proposes that the technical inefficiency (TIE) of the firm could be represented by the distance bf which is the amount by which K and L could be proportionally reduced without a reduction in output. Stated differently, the combination of K and L associated with point f should enable the firm to produce a level of output, y3, which is greater than y,. Efficiency (inefficiency) measures are generally stated in percentage terms. For example, the TIE of the firmf is represented by the ratio bf/ Of, which reflects the percentage by which all inputs could be reduced. Thus the overall technical efficiency (TE) of the firm is given by: TE = I - TIE = I - (bfl OJ) = Ob / Of TE will take a value between zero and one and a value of one will indicate that the firm is fully technically efficient. For instance, if both firns b and f produce y. level of output, the firm b which lies on the frontier is fully technically efficient, whereas f is not. If the TE of the firmf is say 80%, then this implies thatf would be able to reduce the consumption of all inputs (K and L) by 20% without reducing its output if it were operating on the frontier like the firm b. Allocative efficiency (AE) stems from the right input combinations given input prices. If we also know the input price ratio, represented by the isocost line c-cl we can also measure allocative (price) efficiency. The allocative efficiency (AE) of our hypothetical firm. operating atf is expressed as follows: AE = Oa / Ob. The firmf is also allocatively inefficient since the distance ab represents the potential reduction inf 's production costs that would occur if production were to occur at the allocatively (and technically) efficient point e, instead of at the technically efficient, but allocatively inefficient, point b. Hence, the distance ab corresponds to additional production expenses resulting from the suboptimal allocation of inputs. The distance af can also be regarded as a potential for cost reduction. It shows the amount by which the total production costs of the firmf can be lowered by eliminating both technical inefficiency (the distance b]) and allocative inefficiency (the distance ab). This gives rise to overall cost efficiency (CE) measure, which is simnply the product of allocative and technical efficiency: CE == AE x TE, in other words, CE = (Oa / Ob) x (Ob / Of) = Oa / Of The CRS assumption is only justifiable when all firms are operating at an optimal scale (i.e. one corresponding to the flat portion of the long run average cost curve). However, firms in practice might face either economies or diseconomies of scale because of imperfect cornpetition, constraints on finance, etc. In 1984, Banker, Chames and Cooper proposed an extension of the CRS model to account for variable retums to scale (VRS) cases. If one makes the CRS assumption when all finns are not operating at the optimal scale, the computed measures of TE will be confounded (contaminated) with scale efficiencies (SE). The VRS assumption, on the other hand, will provide the measurement of 'pure" technical efficiency (PTE), which is simply TE devoid of these SE effects. Further decomposition of TE into its PTE and SE components can be accomplished by conducting both a CRS and VRS specification upon the same data. If there appears to be a difference in the two TE scores for a particular firm, then this indicates that the firm has scale inefficiency. Thus the scale inefficiency can be obtained from the difference between the VRS TE and the CRS TE score. Figure 2 illustrates the decomposition of TE for one input (L) and one output (y) case by means of CRS and VRS frontiers. Under both assumptions, the firm which operates at point f in Figure 2 is technically inefficient. Under CRS, the technical inefficiency of the point f is the distance mf, while under VRS the technical inefficiency would only be sf The difference between these two measures, ms, is attributed to scale inefficiency, which simply indicates that the firmf can produce its current level of output with fewer inputs if it attains CRS. In Figure 2, CRS frontier is represented by On, and it simply depicts the optimal level of output, which can be obtained for given input levels. In other words, CRS frontier shows what is attainable and what is unattainable with the given technology, and thus the firms either lie on or below it. The constituents of overall technical efficiency (TE), PTE and SE, for the firmf can also be expressed in ratio form: PTE = ks / kf and SE = km / ks. The technical efficiency of the firmf is thus simply the product of PTE and SE: TE = PTE x SE (ks / k]) x(km / ks) = km / kf. Annex III 63 B. ESTIMATING EFFICIENCY INDICATORS AND MEASURING PRODUCTIVITY CHANGES Approach. As elaborated in the main text, trade liberalization induces domestic firms to improve their competitiveness through enhanced technical efficiency in input use as domestic markets are opened to foreign competition. Also, with the increased availability of new/modem capital goods, new products, information about new technologies, and increasing opportunities to imitate and innovate, domestic firms can undertake technological changes. These two impacts--improvements in technical efficiency and technological progress--induced by trade liberalization create productivity gains in the economy as factors of production become more productive. To estimate the impact of trade liberalization on technical efficiency of domestic firms--i.e., on how efficiently inputs are being used as competition intensifies--a relative technical efficiency approach is used in this study. Accordingly, for each of the two observation years, "efficient production frontiers" are constructed from the input-output observations of the best practice (most efficient) firms in each of the identified groups of firms.1 A (non-parametric) Data Envelopment linear programming model--described below--is used to construct these frontiers. The solutions of the model, where appropriately defined objective functions are optimized subject to a set of constraints for each finn, identify the best-practice finns on the basis of the criteria defined by the constraints.2 The latter group's input-output relations make up the "best-practice" production frontier. For each group, these frontiers constitute the "benchmark technology", and each firm's technical efficiency indicator is measured relative to the benchmark frontier of that particular observation year. Shifts in the efficient production frontiers over the two observation years represent "technological progress" facilitated (at least in part) by trade liberalization, while positive changes in relative "technical efficiency" of each firm over the same period indicate improvements in "catching up" with the best-practice finns. These two effects taken together--i.e., their product-give a measure of total factor productivity growth (TFPG). Here, the specific index used for measuring TFPG is the Malmquist index. Measuring efficiency and productivity changes: the Malmquist Index3. There are two basic indexes in the literature to measure productivity change in decision making units (DMUs): the Tomqvist (1936) index and the Malmquist (1953). In order to investigate the impact of trade liberalization on firm productivity, we choose the Malmquist productivity index, which is dubbed after Sten Malmquist, a Swedish ecnomist and statistician. We measure productivity change as a geometric mean of two Malmquist productivity indexes. The Malmquist index is preferable to Tomqvist index in conducting productivity analysis because the former unlike the latter uses exclusively quantity information and thus demands neither problematic price information nor a restrictive behavioral assumption in its calculation. Also, unlike the latter index which is translog, the former index can be obtained by utilizing a nonparametric approach, which yields deterministic index numbers, yet does not necessitate a possibly unwarranted specification of production function. Furthermore, the Malmquist index has informational advantage over the Tomqvist index in the sense that it allows one to isolate catching up to the frontier (efficiency change) from shifts in the frontier (technology change). Within the context of consumer analysis, Malmquist (1953) used input distance functions to compare two consumption bundles, e.g., one observed in year t2 and one observed in year t,, with respect to a reference set, e.g., indifference curve of a consumer. In this sense, his quantity index is a measure showing by what factor the quantities in year t, should be scaled to give a consumer the same utility in year t,. In 1982, Caves, Christensen and Diewert (henceforth, CCD) carried the Malmquist's idea to production analysis. When ' The production function of the best-practice (fully efficient) firm in an industry is not known in practice and thus must be estimated from a sample of observations on the firms operating in the industry. The data envelopment analysis (DEA) linear programming model, as a member of nonparametric frontier family, estimate a non-stochastic envelopment frontier over the data points such that all observed points lie on or below the frontier. 2 The constraints are defined so as to ensure that only the best practice firms lie on the efficient (benchmark) production frontier of that particular observation year. This mean that no other firm (or linear combination of firms) produces as much or more of every output without changing the input quantities used; (or, put in terms of input-orientated efficiency, no other firm or linear combination firms uses as little or less of every input without reducing output levels). 3 This section draws on Fare et al. (1994), summarizing the Malmquist productivity index approach they developed and applied to 17 OECD countries to examine the relative importance of technological changes and technical efficiency gains in explaining TFPG in these countries. 64 Annex III measuring the scale factor, CCD exploited the Shephard concept of distance functions. Unlike CCD, Fare et al. (1985) defined the Malmquist index by exploiting the relationship of distance functions to the technical efficiency measures of Farrel (1957). Also, CCD demonstrated that the Tomqvist index is equal, under certain conditions, to the geometric mean of a pair of Malmquist indexes.4 However, CCD presumed that production is always efficient, an assumption with which it is impossible to trace the sources of productivity growth. Fare et al. (1989) adapted the Malmquist index to the case of inefficient observations, which made it possible to decompose productivity change into its components. As in Fare et al. (1994), we adopt the output-orientated Malmquist index to measure productivity change. Consider that N, firms employ p inputs to produce q outputs for each time period t = 1, 2, ..., T. Transformation of the vector of inputs, xt - e9 p, into the vector of outputs, y, eE q during the production process is represented by the function, F,: F, = (x, y): x canproducey at time t}, (1) which is simply the production possibilities set, the set of all feasible combinations of inputs and outputs, at time t.5 By forming the upper boundary (frontier) of F, the best-practices in the sample define the efficient production technology at time t. The frontier constructed, however, is not static but subject to change perhaps due to innovation, shocks (crises), changes in the market structure and regulatory treatment of firms over time, or perhaps some other factors. Letting that x, and y, represent the observed input and output vectors of a firm at time t, respectively, the Shephard (1970) output distance function relative to the technology existing at time t is defined as: dt (xt, yt) = inf {b: (x,, y, / ,) f F}. (2) which gives a normalized measure of the distance from the location of a firm in the input/output space to the production frontier at time t in the hyperplane, where inputs are held fixed. Thus, the distance of a combination of x, and Y, to the frontier can be as low as zero and as high as one if measured relative to the contemporaneous technology (i.e., 0 < dt (x,, yt) S 1), but it can be higher than one if measured relative to the technology of another period (i.e., 0 < dt+1 (x, y,) [< or >1 1). Using a simple case of single-input/single-output and constant return to scale (CRS), Figure 3 illustrates these concepts. Assume that in year t, a firn was observed at the combination (x,, y,), whereas in year t+1, it was observed at the combination (x,+,, y,+,). In this multi-period setting, there are two corresponding benchmark firms for both observations. The first year observation (xe, y,) can be compared with either the efficient point on its contemporaneous frontier (x, y') or the efficient point on the next year t+1~~~~~~~~~~~~~+ frontier (x, , y,'+ ). Likewise, the second year observation (x,+,, y,+,) can be assessed with respect to either the efficient point on its contemporaneous frontier (x,+>, y'++ I) or the efficient point on the previous year frontier (x,t1 , y,'). When measured relative to their own contemporaneous frontiers, both observations represent feasible but technically inefficient production points because they are interior to the frontiers. However, the firm observed at t+I (x,,1, y,+i) does better than the benchmark efficient firm at t, (x,+1, y' I), i.e., the firm at t+l became able to produce more output, d, than the corresponding efficient firm at t would do in the previous year, e, with the same level of input, x,+,. The conditions are that all second-order terms must be constant over time and the Lnderlying functional form for technology must be translog. 5F, is assumed to satisfy certain conditions which mnake it possible to obtain meaningful output distance functions (see Shephard, 1970). Annex III 65 Figure 3. The Output distance functions and Malmquist output-orientated productivity index Y A t+1~~~~~~~~F+ f=yt+1- f t+I ------------------ --- - ------/ d=yt+1.,. . 1 (x1÷1,y,+l) d yt+ ____-_-------------- -7 /X+/ /,] t+ I e = Y l .. ./ .. .. ...... b=yi 0 xt x,+, x Fare et al. (1994) specifies the output-orientated Malmquist total factor productivity change (TFPC) index, M, as the geometric mean of two Malmquist productivity indexes: 11/2 -M(Yr,xt+I;Ytxd = dt(XI+ Y,+d X dt+l (XI+] ,Y+) (3) d(xt,,y9) yt_d,+, _ xf_ y (MI) (M2) The first term in the above equation (M2) represents the Malmquist productivity change index obtained relative to the benchmark technology in period t, whereas the second term (M) represents the Malmquist productivity change index calculated relative to the benchmark technology in period t+]. The representation of productivity change as geometric mean of these two output based Malmquist TFP indexes (M = (Mix M2)1f2] precludes arbitrariness in choosing the reference technology. M defines the productivity of the production point (x,+,,r, y+) with respect to the production point (x,, y,) according to both years' technologies. M can attain a value greater than, equal to, or less than unity depending on whether the firm I experiences productivity growth, stagnation or productivity decline, respectively, between periods t and t- 1. Fare et al. (1989, 1992) wrote the equation (3) in such a way that one can determine the sources of the productivity change: - ~~~~~~~~1/2 (yt+1 t+1t t t+1 t+1' t+1 x_ t( t+'Yt+ x t_ t t_ d (x,y d (x y d (x ,y) (4) t t t t+1 t+1 Yt t+1 t TFPCH EFFCH TECHCH When written in terms of output distances on the y-axis, the equation (4) takes the following form: 66 Annex III Od ) (Ob). (Od/Oe ) (Oa/Ob 12 M(yt+1,xt+1;yt,x,) = (Of Oa OdT/Of) K Oa/Oc M(yt+,,xt+z;y,,x,) = Od) x Oa) x Oe) x Obc (S) TFPCH EFFCH TECHCH In the above two forms, (4) and (5), the Malmquist Total Factor Productivity change index (TFPCH), M, is defined simply as the product of efficiency change (EFFCHY), how much closer a firm gets to the efficient frontier (catching up), and technological change (TECHCH), how much the benchmark production frontier shifts at each firm's observed input mnix (innovation or shock). EFFCH index takes a value greater than 1 in case of efficiency increase, I in case of no efficiency change, or less than I in case of efficiency decrease, between periods t and t+l. Similarly, TECCH attains a value greater than 1 in case of technical progress, 1 in case of no change, or less than I in case of technical regress, between periods t and t+l. In order to measure the productivity change, we obtain M utilizing a mathematical programming technique, Data Envelopment Analysis (DEA). For the time being, we assume that CRS technology exists: all firms are scale efficient, but later we will relax this assumption to decompose EFFCH in addressing scale efficiency issues. To get M, we need the four component distance functions in the equation (3), which involves four linear programming (LP) problems for each firm in the sample. First, d, (xt, y) is obtained solving the following CRS output-orientated LP: [d, (xt, y )] = max) 0, S. t. - !YY i + Y Ž 0, (6) xi( -XtA 2 O, A2 Ž0, The remaining three LP problems, (7), (8), and (9), are simple variants of (6): [dt+ (xt+,, y,+ )]- = maxo,A 0, S.t. -oYYi,1+- + YtJLA > 0, (7) xit+l- Xt+]A i 0, A Ž 0, [dt(x,+,y,+,)]-l = max0,A ob, S. t. -OYyi+, + Y'A 2 O, (8) xi,t+ I-XtA > 0, A >0, Annex III 67 [dt+1(xt,y)] = maxo,2 9, S. t. -9YYid + Y+1A > 0, (9) xit -Xt+,Sl 2 O, A2 0, where 's represent intensity variables showing at what intensity a particular activity (i.e., each firm) may be used in production. Also, 1 < 0 < x and 0 -I is the proportional increase in outputs that could be realized by the i'th DMU, with input quantities held constant. The 0 and 2's are likely to take different values in the above four LP's. Farrel technical efficiency (TE) index is given by 1/0 and attains a value between zero and one. In LP's (8) and (9), where production points are compared to technologies from different time periods, the t parameter need not be > I, as it must be when calculating Farrel efficiencies. It may be that the point could lie above the feasible production set. This will most likely arise in LP (8) where a production point from period t+l is compared to technology in period t. If technical progress has occurred, then a value of 0 < 1 is possible. It could also possibly occur in LP (9) if technical regress has occurred, but this is less likely. Finally, we can also decompose the technical change into scale efficiency and pure technical efficiency components (EFFCH = PEFFCH x SCH). This requires the calculation of distance functions under variable retums to scale (VRS) (instead of a CRS) technology, requiring us to solve two additional LP problems (when comparing two production points). 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