67362 Trade Competitiveness Diagnostic Toolkit José Guilherme Reis • Thomas Farole Trade Competitiveness Diagnostic Toolkit Trade Competitiveness Diagnostic Toolkit José Guilherme Reis Thomas Farole © 2012 The International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org All rights reserved 1 2 3 4 :: 15 14 13 12 This volume is a product of the staff of the International Bank for Reconstruction and Development / The World Bank. The findings, interpretations, and conclusions expressed in this volume do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: pubrights@worldbank.org. ISBN: 978-0-8213-8937-9 eISBN: 978-0-8213-8938-6 DOI: 10.1596/978-0-8213-8937-9 Library of Congress Cataloging-in-Publication Data Reis, Jose Guilherme. Trade competitiveness diagnostic toolkit / by Jose Guilherme Reis and Thomas Farole. p. cm. Includes bibliographical references and index. ISBN 978-0-8213-8937-9 — ISBN 978-0-8213-8938-6 (electronic) 1. Foreign trade promotion. 2. Competition, International. I. Farole, Thomas. II. Title. HF1417.5.R45 2012 382'.63—dc23 2011039745 Cover design: Debra Naylor, Naylor Design, Inc. CONTENTS Foreword xi Acknowledgments xiii Abbreviations xv Introduction to the Toolkit 1 Overview and Guidelines for Conducting a Trade Competitiveness Diagnostic 3 Understanding Trade Competitiveness: Issues and Current Debates 3 The TCD Framework 6 Organizing to Conduct a TCD 7 Module 1 Summary: Conducting the Trade Outcomes Analysis 9 Module 2 Summary: Conducting the Competitiveness Diagnostics 18 Module 3 Summary: Moving from Analysis to Policy Options 26 Notes 27 References 27 Module 1 Trade Outcomes Analysis 29 Growth and Share: The Intensive Margin 29 Diversification: The Extensive Margin 41 Quality and Sophistication: The Quality Margin 44 Entry and Survival: The Sustainability Margin 54 Annex A. Product Classifications 59 Notes 60 References 61 Module 2 Competitiveness Diagnostics 63 Market Access 63 Incentive Framework: Trade and Investment Policy 75 Incentive Framework: Domestic Policies and Institutions (Competition, Business Environment, and Governance) 88 Factor Conditions: Access to Finance 97 Factor Conditions: Labor Markets, Skills, and Technical Efficiency 100 Factor Conditions: Intermediate Inputs and Backbone Services 105 Factor Conditions: Trade Facilitation and Logistics 110 Trade Promotion Infrastructure: Export and Investment Promotion 119 Trade Promotion Infrastructure: Standards and Certification 124 Trade Promotion Infrastructure: Special Customs Regimes and Special Economic Zones 140 Trade Promotion Infrastructure: Industry Coordination and Sector Support 144 Trade Promotion Infrastructure: Innovation 148 Notes 159 References 160 v vi Contents Module 3 Policy Options for Competitiveness and Case Studies 163 Market Access 163 Trade and Investment Policy 164 Domestic Policies and Institutions: Business Environment and Governance 167 Access to Finance 169 Labor Markets, Skills, and Firm-Level Technical Efficiency 172 Intermediate Inputs and Backbone Services 174 Trade Facilitation and Logistics 175 Trade and Investment Promotion 177 Standards and Certification 181 Special Customs Regimes and SEZs 183 Industry Coordination and Sector Support 184 Innovation 186 References 187 Appendix A: Summary of Recent Papers on Determinants of Trade Competitiveness 189 Olivier Cadot, Céline Carrère, and Vanessa Strauss-Kahn. 2011. “Trade Diversification: Drivers and Impacts.� World Bank, Washington, DC. 189 Jean-Jacques Hallaert, Ricardo Cavazos Cepeda, and Gimin Kang. 2011. “Estimating the Constraints to Developing Countries Trade.� Organisation for Economic Co-operation and Development, Paris 191 Murat S˛eker. 2010. “Trade Policies, Investment Climate, and Exports across Countries.� World Bank Policy Research Working Paper No. 5654, World Bank, Washington, DC. 194 Ana Paula Cusolito. 2010. “Export Competitiveness and the Intensive and the Extensive Margins of Trade.� World Bank, Washington, DC. 196 Notes 198 Boxes A The World Bank and the Trade and Competitiveness Agenda 2 B Appropriate Use of the Toolkit 2 O.1 Key Issues and Debates 5 O.2 Using Trade Competitiveness Diagnostics to Develop Policy Notes 8 O.3 A Note on Data for the Services Sector 12 O.4 Why Firm-Level Analysis? 13 O.5 Example Questions 17 O.6 Linking Supply-Side Constraints to Trade Outcomes—Econometric Approaches 21 O.7 Value Chain Analysis 25 1.1 Gravity Models 37 1.2 The Drawbacks of PRODY and EXPY 50 2.1 Key Issues and Debates—External Market Access 70 2.2 Tariffs, Preferences, and ROOs 71 2.3 Quotas in Textiles and Clothing 72 2.4 Catfish and the Politics of Antidumping 73 2.5 The Increasing Importance of Standards 74 2.6 Sanitary and Environmental Concerns as an NTB 74 2.7 Use of Export Restrictions by Developing Countries 81 2.8 Avenues to Reduce Tariffs 84 2.9 Investing Across Borders—Reviewing Good Practices 86 2.10 Maximizing the Benefits of Regulatory Reform—Factors for Success 94 2.11 Doing Business Data and Enterprise Surveys—Facts and Shortcomings 95 2.12 Financing Trade in a Postcrisis World 99 2.13 Channels Linking Trade and Productivity 102 2.14 The Gap Between Industrial and Developing Countries in Trade Logistics 118 2.15 Examples of Existing Handbooks, Manuals, and Diagnostic Tools for Standards Assessment 127 2.16 Analytical Challenges and Issues for Consideration 132 Contents vii 2.17 Standards in South-South Trade 134 2.18 Definitions 135 2.19 Sectoral Differences in Compliance Costs 137 2.20 Kenya’s MUB Program 143 2.21 Upgrading Quality for Competitiveness in Pakistan’s Sialkot Surgical Instruments Cluster 146 2.22 WTO Prohibitions against Export Subsidies—the SCM Agreement 147 2.23 Moving up the Production Ladder in Finland—Sector Linkages, Diversification, Sophistication, and Exports 156 2.24 Linear Model of Innovation 158 3.1 Case Example of Good Policy Practice—Securing Market Access through a South-South Bilateral Trade Agreement 164 3.2 Case Examples of Good Policy Practice—Trade and Investment Policy 165 3.3 Case Examples of Good Policy Practice—Domestic Policies and Institutions 167 3.4 Case Examples of Good Policy Practice—Access to Finance 169 3.5 Case Examples of Good Policy Practice—Training, Skills Development, and Technical Efficiency 172 3.6 Case Examples of Good Policy Practice—Intermediate Inputs and Backbone Services 174 3.7 Case Examples of Good Policy Practice—Trade Facilitation and Logistics 175 3.8 Case Examples of Good Policy Practice—Export and Investment Promotion 177 3.9 Case Examples of Good Policy Practice—Standards and Certification 182 3.10 Case Examples of Good Policy Practice—Special Customs Regimes and SEZs 183 3.11 Case Examples of Good Policy Practice—Industry Coordination and Sector Support 184 3.12 Case Examples of Good Policy Practice—Innovation 186 Figures O.1 Evolution of Trade Share of GDP, 1970–2008, and Trade Share of GDP by Region, 2008 4 O.2 The Three Pillars of Trade Competitiveness 4 O.3 TCD Framework 6 O.4 Work Stages for the Trade Competitiveness Diagnostic 9 O.5 Decomposition of Export Growth—a Framework for Measuring Trade Competitiveness 10 O.6 Steps to Conducting the Trade Outcomes Analysis 10 O.7 Linking Trade Outcome Categories to Competitiveness Challenges 16 O.8 Competitiveness Diagnostics Components 18 O.9 Steps to Conduct the Competitiveness Diagnostics 18 1.1 Openness to Trade 30 1.2 Adjusted Trade Openness—Examples 31 1.3 Analyzing Broad Trends in Trade Growth, Indonesia, 1990–2008 31 1.4 Compound Annual Growth Rate (%) of Goods and Services Exports, 1998–2008 32 1.5 Change in Costa Rica’s RCA, 2000–08 34 1.6 Share of Parts and Components in Manufacturing Exports for Selected Countries 35 1.7 Market Share for Selected Manufacturing Products: Indonesia versus China in the European Union, 2000–08 36 1.8 Change in Morocco’s Exports by Destination, 2000–08 36 1.9 Example of Gravity Model Analysis of Senegal’s Bilateral Trade 36 1.10 Trade Complementarities Index for ECOWAS Countries, 2007 38 1.11 Macro Analyses of Export Competitiveness 38 1.12 Orientation of Exports and Destinations, Pakistan, 2008 39 1.13 Alternative Assessment of Product-Market Orientation, Pakistan, 2008 40 1.14 Intensive and Extensive Margins 42 1.15 Examples of IEMP in Selected LIC and LMIC versus Germany, 1999 and 2008 43 1.16 Market Reach of Exports 44 1.17 Technological Content of Morocco’s Exports 45 1.18 Decomposition of Export Growth across Key Products, Mongolia, 2002–07 46 1.19 Analysis of Indonesia’s Unit Price Trends for Top Five Garment Exports to the European Union Relative to Main Competitor, 1988–2008 46 viii Contents 1.20 Quality Ladder for Women’s Cotton Blouses and Shirts Imports to the European Union, 1998 and 2008 47 1.21 Change in Senegal’s Market Shares and Relative Quality in the Food, Textiles and Clothing, and Footwear Products in the European Union 48 1.22 The Relationship between Income and Export Sophistication, 2003–05 49 1.23 Evolution of Export Sophistication 49 1.24 Revealed Factor Intensity 51 1.25 Product Space Maps of Pakistan—Overview 52 1.26 Pakistan’s Exports, Mapped in Product Space, 1993–2008 53 1.27 Characteristics of Exporting Firms in Selected Indonesian Manufacturing Sectors, 2004 54 1.28 10-Year Export Survival Plots, 1998–2008 55 1.29 Export Relationships: Intensive and Extensive Margins 55 1.30 Decomposition of Export Growth 56 1.31 Export Flows and Factor Endowments, Nepal 59 2.1 Overall Trade Restrictiveness Index, 2006–09 68 2.2 The Main Components of Market Access 70 2.3 Quotas and Tariffs under Different Market Conditions 72 2.4 The Trade-TFP Relationship 80 2.5 Framework on the Relationship between Trade Policy and Competitiveness 83 2.6 The Main Determinants of Productivity at the Factory or Farm Gate 103 2.7 The Channels of Impact of Labor Legislation on Firm Productivity and Profits 104 2.8 Comparison of Rwanda LPI Performance 115 2.9 Relationship between Logistics Performance and Exports, 2008 117 2.10 Distinguishing between Factors Influencing Competitiveness 128 A.1 Contributions of within- and between-Groups to Overall Concentration, All Countries 190 Tables O.1 Considerations in Establishing Objectives of the TCD 7 O.2 Main Data Sources for Trade Outcomes Analysis 11 O.3 Summary of Data Classification Systems 12 O.4 Sources of Firm-Level Data—Benefits and Drawbacks 13 O.5 Summary of Indicators and Issues—Level, Growth, and Market Share 14 O.6 Summary of Indicators and Issues—Diversification 15 O.7 Summary of Indicators and Issues—Quality 16 O.8 Summary of Indicators and Issues—Entry and Survival 17 O.9 Checklist of Primary Factors Impacting Competitiveness 19 O.10 Summary of Country and Sector Context Provided in the TCD Toolkit 20 O.11 Summary of Key Analytical Tools for Desk-Based Analysis 22 O.12 Main Data Sources for Competitiveness Diagnostics Desk Research 23 O.13 Summary of Key Analytical Tools for the Assessment 24 O.14 Illustrative Summary of Diagnostic Results 24 O.15 Summary of Broad Policy Areas Linked to Diagnostic Components 26 1.1 Adjusted Trade Openness Ratios, 2006–08 30 1.2 Annual Growth Rates and Share of Services Exports, 1998–2008 32 1.3 Change in Costa Rica’s Shares of Exports, 2000–08 33 1.4 Concentration of Goods at HS Two-Digit Level, 2000–08 41 1.5 Examples of Unit Values of Exports to the United States, 2008 45 1.6 Destinations of Declining Exports of Senegal 57 1.7 Declining Exports of Senegal 57 1.8 Export Performance across Products and Markets, 2004–08 58 2.1 Market Shares of Major Exporters of HS 6204 (Women’s Suits) in 2008 in Selected Markets 65 2.2 How Tariffs Differ across Trade Partners 66 2.3 Summary of Main Components of Trade Facilitation and Logistics Assessment 114 2.4 Summary of Key Trade and Investment Support Measures 121 2.5 Assessing the Quality System 129 Contents ix 2.6 Examples of Specific Quality Services 130 2.7 Actors in Standards Setting 138 2.8 Summary of Special Customs Regimes and Economic Zones 142 2.9 Framework for Analysis of Innovation Characteristics and Trade Competitiveness 153 2.10 Comparative Industrial Classification 155 2.11 Sectoral Groups According to Degrees of Tradability and Differentiation 155 2.12 Sector Innovation Patterns and the Main Components of Learning and Innovation 157 A.1 Diversification Drivers in a Panel Data Set, 1990–2004, 87 Countries 190 A.2 Fixed-Effects Regressions of Diversification Index on Liberalization Status 191 A.3 Results for the Unrestricted Sample 193 A.4 Estimation Results with Pooled OLS Method 195 A.5 Impacts of Improvements in Investment Climate Indicators on Exports 196 A.6 Impact of Export Competitiveness Determinants on the Extensive and Intensive Margins of Trade 197 Foreword The pace of global trade integration over the past two decades has been nothing short of extraordinary. Developing coun- tries have been the biggest beneficiaries of trade expansion and the pursuit of “export-led� growth. But leveraging trade for broad-based economic growth is no simple matter—some paths may be better than others, and different countries have had varying degrees of success in achieving this. While the rapid expansion of trade in recent decades was supported by trade policy reforms across the globe, improved market access has not translated into sustainable export growth and diver- sification for many developing countries. At the same time, in high-income countries that have benefited greatly from an open trading system, trade with developing nations is often viewed more as a threat than as an opportunity. Clearly, openness to trade and low levels of trade protection, although necessary and important, is not sufficient to ensure sustained export growth and greater diversification. The recent global crises and associated policy responses have shown that most countries remain strongly committed to trade integration, but complementary policies are critical to manage adjustment costs and the effects of volatility. Reflecting this, in recent years the focus of governments has turned toward a broader “trade competitiveness� agenda, aimed at addressing supply-side constraints to investment and trade expansion as well as ensuring an open trade regime. Trade competitiveness is a core pillar of the World Bank’s new Trade Strategy, and is also an important dimension of its approach to private sector development. At the operational level, World Bank country teams are increasingly requesting analytical support to understand the factors affecting competitiveness in current traded sectors, along with the prospects for diversification. But what exactly is “competitiveness?� Where does it begin and end? And how can we assess it and develop policies to shape it? As a concept, competitiveness is intuitively attractive. But it can be frustratingly difficult to pin down and opera- tionalize. Tackling the multifaceted nature of competitiveness requires a deep understanding of the wide range of factors that can contribute to it or constrain it. As these factors are often highly endogenous and interrelated, a piecemeal approach to reform is unlikely to be effective; in practice a comprehensive approach to understanding the determinants of competi- tiveness is needed. This Trade Competitiveness Diagnostic Toolkit has been developed with the aim of offering guidance to assess an economy’s trade competitiveness. The Toolkit offers a framework and analytical instruments that can be used to undertake a systematic assessment of a country’s position, performance, and capabilities in export markets. Combining quantitative and qualitative tools, the Trade Competitiveness Diagnostic Toolkit allows for a rich analysis of a country’s trade performance, identification of the main factors that constrain it, and development of targeted policy responses to improve the competitiveness of its firms. The Toolkit is designed to be useful both to decision makers as well as for practitioners—it provides a wealth of materials, including policy case studies, tools and indicators, and guidelines for field research, as well as background reading on key pol- icy areas and instruments that affect competitiveness. Members of the World Bank’s Trade Department have worked with country teams to pilot and apply the Toolkit in almost a dozen countries, starting in 2010. These countries span most regions of the world. The resulting rich and diverse experience generated important lessons that have been reflected in the present document, and have confirmed that the Toolkit can be a very useful instrument to identify specific factors that can contribute to improved competitiveness. We are confident this Toolkit will be a valuable resource for policy makers, practitioners, and analysts who are engaged in policy analysis related to trade, investment, and private sector development. Otaviano Canuto Bernard Hoekman Vice President Director Poverty Reduction and Economic Management International Trade Department The World Bank The World Bank xi Acknowledgments The Trade Competitiveness Diagnostic Toolkit was prepared by José Guilherme Reis (task team leader) and Thomas Farole in the International Trade Department of the World Bank (PRMTR), along with a team including Swarnim Waglé (Trade Out- comes and Market Access), Jose Daniel Reyes (Trade Outcomes), Mariem Malouche (Trade and Investment Policy), Michael Friis Jensen (Standards), and Juan Julio Gutierrez (Innovation). The section on Trade Facilitation and Logistics is based heavily on PRMTR’s Trade and Transport Facilitation Assessment Toolkit, for which the team is indebted to Jean Francois Arvis and Monica Alina Mustra. The team would also like to thank others who contributed their input and expertise in the development of this Toolkit, including: Gladys Lopez-Acevedo, Guillermo Arenas, Olivier Cadot, Leyla Castillo, Ana Paula Cusolito, Ana Margarida Fernandes, Raphael Kaplinsky, Charles Kunaka, Daniel Lederman, Toni Matsudaira, Gerard McLinden, Martha Denisse Pierola, Sebastian Saez, Murat Seker, Cornelia Staritz, and Daria Taglioni. Thanks also to the peer reviewers and advisers for their valuable input, including Najy Benhassane, Paulo Correa, Jose Luis Guasch, Vincent Palmade, David Rosenblatt, and especially Eric Manes, who was not only a peer reviewer but also a supporter of the Toolkit by leading the first pilot Diagnostic. Thanks also to the other task team leaders that supported pilots of the Diagnostic, including Paulo Correa, Julia Devlin, Aurora Ferrari, and Sjamsu Rahardja. Additionally, thanks to the many others who provided comments and input during the concept and final review meetings as well as throughout the development process, including Kazi Al-Matin, Paul Brenton, Ian Gillson, Harun Onder, Barbara Rippel, and Ravindra Yatawara, and to participants of various seminars including at the World Bank (Latin America and the Caribbean and South Asia Regions) and at the Organisation for Economic Cooperation and Development. Finally, we are grateful to Cynthia Abidin-Saurman, Shienny S. Lie, Rebecca Martin, and Marinella Yadao for their assis- tance on administrative issues, and to Stephanie K. Chen who supported the publication process. We also thank the World Bank’s Office of the Publisher for efficient management of the publication process, in particular Rick Ludwick, Stephen McGroarty, and Denise Bergeron. This Toolkit was prepared under the direction of Mona Haddad (sector manager) and Bernard Hoekman (director) of the International Trade Department. xiii ABBREVIATIONS AAA Analytical and Advisory Assistance ACP African, Caribbean and Pacific AGOA African Growth and Opportunity Act ASEAN Association of Southeast Asian Nations ASYCUDA Automated System for Customs Data ATC Agreement on Textiles & Clothing BACI Base pour l’Analyse du Commerce BoP balance of payments BPO business process outsourcing BRIC Brazil, Russia, India, and China BTA bilateral trade agreement CAN Confederazione Nazionale Artigianato CEM Country Economic Memorandum CEPEX Centre de Promotion des Exportations de la Tunisie CEPII Centre d’études prospectives et d’informations internationales CFA Catfish Farmers of America CFAD Sustainably Managed Forest Concessions CI CzechInvest CIF cost, insurance, freight CIMO Programa de Calidad Integral y Modernización CINDE La Coalición Costarricense de Iniciativas de Desarrollo CMM capability maturity matrix COFEMER Comisión Federal de Mejora Regulatoria COMESA Common Market for Eastern and Southern Africa CVD Countervailing Duty DB Doing Business DBP Development Bank of the Philippines DEC Development Economics Unit of the World Bank DRC Domestic Resources Cost DTIS Diagnostic Trade Integration Study EBA Everything But Arms ECA Export Credit Agency ECGA Export Credit Guarantee Agency ECOWAS Economic Community of West African States EDB Singapore Economic Development Board EIA environmental impact assessment EICC Electronic Industry Code of Conduct EM extensive margin EP entitlement proportion xv xvi Abbreviations EPA Economic Partnership Agreement; also export promotion agency EPZ export processing zone ERP effective rate of protection ES Emergency Safeguard; also Enterprise Survey ESW Economic and Sector Work EU European Union EXPY (Revealed) income content of export basket FAMEX Fonds d’ accès aux marchés extérieurs FDI foreign direct investment FSC Forestry Stewardship Council FTZ free trade zone FVO Food and Veterinary Office GATS General Agreement on Trade in Services GATT General Agreement on Tariffs and Trade GCI Global Competitiveness Index GDP gross domestic product GFSME Guarantee Fund for Small and Medium-Scale Enterprises GFZB Ghana Free Zones Board GIPB Global Investment Promotion Benchmarking GLI Grubel-Lloyd Index GLOBALGAP Global Partnership for Good Agricultural Practice GMP Good Manufacturing Practice GNI gross national income GSP Generalized System of Preferences GSTP Global System of Trade Preferences HACCP Hazards Analysis Critical Control Points HAI Human Assets Index HH(I) Hirschman-Herfindahl (Index) HS Harmonized Commodity Description and Coding System IAB Investing Across Borders IAF International Accreditation Forum IATA International Air Transport Association ICA Investment Climate Assessment ICRG International Country Risk Guide ICS Investment Climate Survey ICT(ES) information and communications technology (enabled services) IE International Enterprise Singapore IEMP Index of Export Market Penetration IFC International Finance Corporation IFI international financial institutions IIA Investment Incentive Act ILO International Labour Organization IM intensive margin IMF International Monetary Fund IMO International Maritime Organization IMP/IMP2 Industrial Master Plan / Second Industrial Master Plan I-O input-output IP intellectual property IPA investment promotion agency IPC Instituto Politécnico Centroamericano IPR Intellectual Property Rights Abbreviations xvii ISIC International Standard Industrial Classification ISO International Standards Organization IT information technology ITAF Industrial Technical Assistance Fund ITC International Trade Commission ITU International Telecommunications Union KILM Key Indicators of the Labor Market JIBC Japan Export Import Bank km kilometer L/C letter of credit LDC least developed country LIC low-income country LMIC low- and middle-income countries LPI Logistics Performance Index (MA)OTRI /TTRI (Market Access) Overall Trade Restrictiveness Index/Tariff Trade Restrictiveness Index MAS Modernization and Automation 2 Scheme MDB multilateral development bank MFA Multifiber Arrangement MFN Most Favored Nation MITI Ministry of Industry and Trade MNC/E multinational company/enterprise MPIP Multipurpose Industrial Park MSC Marine Stewardship Council MSTQ Metrology, Standardization, Testing, and Quality MUB manufacturing under bond N/A not applicable or not available NAFIN Nacional Financiera NAFTA North American Free Trade Agreement NAMA Non-Agricultural Market Access NCP National Competition Policy n.e.s. not otherwise specified NGO nongovernmental organization NTB/NTM nontariff barrier/measure OECD Organisation for Economic Co-operation and Development OHSAS Occupational Health and Safety Accreditation Standard OLS ordinary least squares PIA Promotion of Investment Act PIO Pioneer Industries Ordinance ppb/ppt parts per billion/parts per trillion PPP purchasing power parity PREM Poverty Reduction and Economic Management PRMTR International Trade Department (World Bank) PROCOMER the Foreign Trade Corporation of Costa Rica PRODY (Revealed) income content of product PROMPEX Peruvian Commission for Export Promotion PSDC Penang Skills Development Council PTA preferential trade agreement R&D research and development RCA Revealed Comparative Advantage RFI Revealed Factor Intensity RHCI Revealed Human Capital Index xviii Abbreviations ROO rules of origin RPCI Revealed Physical Capital Index RTA Regional Trade Agreement SAD Single Administrative Document SAFTA South Asian Free Trade Area SCM Subsidies and Countervailing Measures SEI Software Engineering Institute SGS Societe Generale de Surveillance SI(T)C Standard International (Trade) Classification SEZ special economic zone SMEs small and medium enterprises SOE state-owned enterprise SPS sanitary and phytosanitary SQF Safe Quality Food STEM science, technology, engineering, mathematics T&C textiles and clothing TBS Tanzania Bureau of Standards TBT technical barriers to trade TCD Trade Competitiveness Diagnostic TCI Trade Complementarities Index TE technical efficiency TEU twenty-foot equivalent units TFP total factor productivity TII Trade Intensity Index TKC Trans-Kalahari Corridor TNC transnational companies TRAINS Trade Analysis and Information System TRQ Tariff Rate Quota TSG Traditional Speciality Guaranteed TTFA Trade and Transport Facilitation Assessment UDE Unidad de Desregulacion Economica UN United Nations UNCTAD United Nations Conference on Trade and Development UNESCO United Nations Educational, Scientific, and Cultural Organization UNIDO United Nations Industrial Development Organization USAID United States Agency for International Development VAT value added tax VER voluntary export restraint WDI World Development Indicators WEF World Economic Forum WHO World Health Organization WIPO World Intellectual Property Organization WITS World Integrated Trade Solution WTI World Trade Indicators WTO World Trade Organization INTRODUCTION TO THE TOOLKIT This Trade Competitiveness Diagnostic (TCD) Toolkit pro- including from Poverty Reduction and Economic Manage- vides a framework, guidelines, and practical tools needed to ment (PREM), Financial and Private Sector Development conduct an analysis of trade competitiveness. The toolkit (FPD), and other networks, it is also designed for use by can be used to assess the competitiveness of a country’s over- donors and development agencies, government ministries all basket of exports, as well as specific traded sectors. It and agencies, and academic and policy institutions. Given includes guidance on a range of tools and indicators that can the diverse objectives and interests of this target group, be used to analyze trade performance in terms of growth, users are encouraged to make selective use of the Toolkit on orientation, diversification, quality, and survival, as well as the basis of their interests, contexts, and capacities. quantitative and qualitative approaches to analyze the To make this toolkit useful to different audience needs, market and supply-side factors that determine competi- it is divided into two main sections: tiveness. The toolkit facilitates the identification of the • Overview and Guidelines for Conducting a Trade main constraints to improved trade competitiveness and Competitiveness Diagnostic—summarizes the main the policy responses to overcome these constraints. issues and offers a step-by-step guideline to conduct a The output of a TCD initiative can be used for a wide diagnostic of trade competitiveness. This section is variety of purposes. In the World Bank, it could be a appropriate for all audiences, including policy makers stand-alone product (such as Economic and Sector Work and managers overseeing a TCD exercise. [ESW]) or could contribute to existing World Bank prod- • Implementation Toolkit—provides detailed practical ucts—for example, it could form a substantial part of a information and tools for actually carrying out the Diagnostic Trade Integration Study (DTIS), a chapter TCD. This is appropriate for practitioners conducting within a Country Economic Memorandum (CEM), or the the analysis and for task team leaders organizing and basis for programs within a Competitiveness Develop- managing the exercise. The Implementation Toolkit is ment Policy Loan. divided further into three modules: Overall, the TCD is designed to be used in a modular way—full-country diagnostics can be undertaken or vari- ° Module 1: Trade Outcomes Analysis (indicators and tools) ous parts of the toolkit can be used to address specific ° Module 2: Competitiveness Diagnostics (analytical frame- works, indicators, and interview guides) questions of interest to the country team. The output from a TCD will identify issues to be addressed in more ° Module 3: Policy Options for Competitiveness and Case Studies detail by technical experts, client-country policy makers and other stakeholders, and development partners. In The modules include a list of references to works cited some cases, it may identify issues that require another in the toolkit. In addition, Module 1 offers an annex that level of analysis using existing products from the World describes the two-digit product classifications for Harmo- Bank or other development partners. In other cases, it nized Commodity Description and Coding System (HS) will lead to engagement between client countries and spe- and Standard International Trade Classification (SITC). cific experts. The book also includes an appendix that summarizes some The TCD Toolkit is intended for policy makers and prac- recent papers on trade competitiveness that contributed to titioners involved in analysis of trade performance the preparation of the TCD Toolkit. and design of trade and industrial policy. Although the Updates and details on the TCD Toolkit are on the primary audience is World Bank country and regional staff, World Bank’s Trade website at www.worldbank.org/trade. 1 2 Trade Competitiveness Diagnostic Toolkit Box A. The World Bank and the Trade and Competitiveness Agenda The World Bank and other multilateral organizations have played an important role in promoting trade through support for the adoption of liberal trade and investment policies. In recent years, the agenda to support trade growth has moved beyond trade policy and market access to embrace behind-the-border issues. Indeed, competitiveness lies at the core of the Bank’s new Trade Strategy (World Bank, 2011d). At the operational level, country teams are increasingly requesting analytical support to understand the factors affecting competitiveness in current traded sectors, along with the prospects for diversification. This has been reflected in the growing emphasis on trade and competitiveness in the Bank’s lending and technical assistance portfolio. Two-thirds of Country Assistance Strategies now recognize trade and competitiveness as a priority and trade-related lending has grown significantly (World Bank 2009d). As of September 2009, more than 250 active Analytical and Advisory Assistance (AAA) projects and 195 active lending products listed competitiveness as a priority. Within World Bank operations, since 2007, a large and active export competitiveness network has facilitated knowledge sharing throughout the World Bank and with clients and development partners. Although the Bank is in a good position to deploy its expertise across most the issues related to trade competitiveness, it still needs (1) to be able to analyze competitiveness more effectively ex ante to respond to competitiveness challenges in a systematic fashion, and (2) to identify the most important constraints to competitiveness in order to prioritize policy responses. This is a particular challenge, given the broad-based, often fuzzy nature of the concept of competitiveness. The Trade Competitiveness Diagnostic Toolkit is designed to help address this challenge. Source: Authors. Box B. Appropriate Use of the Toolkit This version of the toolkit is not designed to do the following: • Pick winning sectors or products: Although a combination of the analytical tools available in the Trade Outcomes Analysis could be used to identify sectors or products for the purposes of industrial policy intervention, the existing toolkit is designed for diagnostics rather than for opportunity identification per se. Thus, no step-by-step guide is provided to conduct product-level analysis and prioritization. • Sector-specific diagnostics: This version of the toolkit is designed primarily to analyze a country’s overall export basket. It has the potential to conduct a sector-level analysis as a “lens� through which to view competitiveness of the overall trade sector. Although it is possible to conduct a sector-specific diagnostic using the framework in this toolkit, a version 2.0 of the toolkit will develop a series of tailored modules to analyze specific sectors. In this version, we provide broad guidelines on the types of issues that may be more or less important for specific sectors (light manufacturing, agribusiness, tourism, and business services). • Detailed policy prescriptions: This version of the toolkit includes discussion of broad policy areas and options for consideration in addressing the specific constraints identified through the Diagnostic exercise. It also includes case studies of good practice highlighting policies that were effective in addressing trade competitiveness constraints across a range of countries. Given the highly context-specific and endogenous nature of policy development for competitiveness and the critical importance of taking into account political economy considerations, the toolkit does not provide prescriptive advice on the specific policies that should be adopted. Source: Authors. OVERVIEW AND GUIDELINES FOR CONDUCTING A TRADE COMPETITIVENESS DIAGNOSTIC Understanding Trade Competitiveness: technological progress. The recent literature on heteroge- Issues and Current Debates neous firms also emphasizes that exporters on average are Trade, Growth, and Convergence more productive, capital-intensive, larger, and pay higher wages than nonexporters (cf. Bernard et al. 2007). For devel- Since the 1980s, when most developing countries aban- oping countries, exports are a main source of hard currency doned wholesale import substitution models in favor of necessary to finance the import of capital goods and other export-led growth, global trade integration has proceeded inputs. Indeed, the gains to trade are as much derived from at a rapid pace. Trade has arguably been the most impor- imports as from exports—openness to imports also acts as a tant driver of global growth, convergence, and poverty disciplining force on domestic markets, leading to lower- alleviation over the last quarter century. Developing cost, higher-quality inputs for producers. countries in particular have benefited—annual exports The Competitiveness Approach from low- and middle-income countries grew 14 percent annually since 1990 compared with only 8 percent from What are the constraints that prevent countries from exploit- high-income countries. Despite the recent global eco- ing trade potential for long-term economic gain? Tradition- nomic crisis, a consensus remains on the positive rela- ally, the focus has been on reducing barriers to market tionship between trade and long-run economic growth. access—through such trade policy measures as reducing tar- This relationship runs in both directions: the richer iffs and quotas, granting preferences, and encouraging countries become the more they tend to trade; more broader liberalization efforts. But even with the benefit of importantly, countries that are most open to trade grow preferential market access, many developing country richer more quickly. The East Asian experience of export- exporters are unable to compete in global markets. The barri- led growth over the past three decades provides powerful ers they face are many and diverse, including the following: evidence of the role of trade in facilitating growth. macroeconomic policies that distort efficient market entry However, regions still vary widely in the degree to which and competition; poor factor conditions (cost and skill of they are integrated into global markets as illustrated in labor, cost of capital), infrastructure and backbone services, figure O.1.1 Within regions, the variance is even more and transport and logistics inefficiencies that raise produc- dramatic—for example, Vietnam’s trade is 158 percent of tion and trade costs; and information and coordination its gross domestic product (GDP), Thailand’s trade is 136 failures and the underprovision of public goods, which pre- percent, and Cambodia’s trade is 113 percent, whereas vent the exploitation of intra- and interindustry spillovers. neighboring Lao People’s Democratic Republic has a The realization of these enduring barriers to export success trade share of only 47 percent of GDP. has contributed to the emergence of the “behind-the-border� The economic benefits of exporting have a long- or “competitiveness� agenda, which targets the supply-side established theoretical basis. Specifically, these include static constraints to export performance. efficiency gains derived from exploiting comparative advan- Thus, the competitiveness approach seeks to address the tage and improved allocation of scarce resources, as well as microeconomic environment that shapes individual firms’ dynamic gains in the more productive export sector engi- capacities and incentives on a daily basis. This competitive- neered by higher competition, greater economies of scale, ness policy framework can be structured in three pillars, as better capacity utilization, knowledge dissemination, and illustrated in figure O.2. 3 4 Trade Competitiveness Diagnostic Toolkit Figure O.1. Evolution of Trade Share of GDP, 1970–2008, and Trade Share of GDP by Region, 2008 60% 80% 68% 50% 70% 64% 58% 60% 40% 60% world avg. 30% 50% 42% 40% 40% 20% 30% 10% 20% - 10% 19 0 19 2 19 4 19 6 19 8 19 0 19 2 19 4 19 6 19 8 19 0 19 2 94 19 6 20 8 00 20 2 20 4 06 08 7 7 7 7 7 8 8 8 8 8 9 9 9 9 0 0 19 19 20 20 0% AFR EAP ECA LAC MENA SAR low & middle income high income Source: World Bank 2011c. Note: GDP = gross domestic product. Figure O.2. The Three Pillars of Trade Competitiveness • Removing economic biases arising from tariff and non-tariff barriers, real exchange Aligning macro rate misalignment, and distortive tax regimes ensuring overall fiscal health of the incentives economy, efficient labor market operation, product and factor market conditions, property rights protection, effective regulation, and ease of firm entry and exit. • Improving backbone services and inputs such as energy, telecommunications, Improving backbone finance, and other services inputs; improving capacity and coordination of services and reducing government agencies at the border, international transit arrangements, regional transactions costs and multilateral agreements, and policy reforms that ensure more competitive markets for international transport, logistics, and other services that facilitate trade transactions. • Promoting technology creation and adaptation, streamlining product standards Proactive policies for and certifications, providing trade finance, supporting industry clusters, facilitating overcoming special economic zones and other spatial developments, and ensuring government and coordination of economic actors and linkages and spillovers to the local economy. market failures Source: World Bank International Trade Department 2008. Trade Competitiveness: Issues and Current Debates networks. The latter is the source of cross-hauling—or two-way trade in similar end products—that allows for For most countries, particularly in middle- and high- the intense two-way trade within high-income countries income economies, the large majority of export growth in areas like automobiles (for example, Fiats to Germany takes place at the intensive margin—that is, by selling and BMWs to Italy), clothing (for example, Zara to Swe- more of the same products to the same markets (Brenton den and H&M to Spain), and commonplace food items and Newfarmer 2009). This deepening of trade relation- like yogurt, juice, and ice cream. For developing countries, ships is supported by increasing specialization, which may however, growth at the extensive margin—including both be across or within products. Within-product specializa- new product discovery and selling existing products to tion can be observed through levels of intra-industry new markets—remains critical to driving exports and trade, which may derive from specialization in stages of employment. Indeed, the reduced vulnerability to external production as well as from specialization at different levels shocks that results from a diversification of exports is critical of the quality ladder (what we call the quality margin). to long-run growth. For new trade flows to be sustainable The former is the source of the trade in components—or and deliver broad-based growth, however, it is important intermediate inputs—that characterizes global production that a large cross-section of firms is able to take advantage Overview and Guidelines for Conducting a Trade Competitiveness Diagnostic 5 of trade opportunities and that these firms are able to Box O.1 Summarizes some of the key ongoing issues overcome the many constraints that threaten the export and debates in research and policy in relation to trade survival of firms in their initial years. competitiveness. Box O.1. Key Issues and Debates • Trade openness: The recent global economic crisis led to a reemergence of the debate over the benefits of openness. Analysis of the crisis suggests that more open economies tended to see their trade and gross domestic product (GDP) levels fall more rapidly than economies who were less integrated in global markets (Eichengreen 2011). On the other hand, the countries and regions (for example, East Asia) that were most integrated into the global economy bounced back more quickly. And despite the concerns that the crisis would lead to a return to protectionism, little evidence indicates that this has been the case. Indeed, most policy makers appear to be convinced of the benefits of openness, while also aware of the risks it brings and the need to adopt policies that can minimize these risks (for a detailed discussion of these issues, see Haddad and Shepherd 2011). • Services trade: Trade in services, particularly business services, has become a dynamic component of trade as well as another source of export diversification in developing countries. During 2000–07, trade in services grew as fast as trade in goods, at an average rate of 12 percent per year. India’s success is well known: Exports of software and business process services account for approximately 33 percent of India’s total exports. Brazil, Costa Rica, and Uruguay export professional and information technology–related services; Mexico exports communication and distribution services; Chile exports distribution and transportation services. African countries are also participating. Morocco, Tunisia, Kenya, and South Africa provide professional services to Europe, and Arab Republic of Egypt has developed a world-class call center sector. Health services are successfully exported by the Philippines and Thailand. • South-South trade: Trade among developing countries tripled between 1996 and 2006, and it now accounts for more than 12 percent of all world trade. More than 45 percent of imports in developing countries were supplied by other developing coun- tries in 2008. This trend is driven by the rapid growth in economies like China and India, which is driving trade in both com- modities and processed goods. Reductions in the average level and the dispersion of tariffs have been a significant force behind South-South trade. The average tariffs imposed by Brazil, the Russian Federation, India, and China (BRIC) decreased 44 percent during 1996–2008. Tariffs in lower-middle-income countries declined by 31 percent during the same period. • Diversification or reconcentration? Imbs and Wacziarg (2003) uncovered an unexpected nonmonotonic relationship between production diversification and GDP per capita. Past a certain level of income (US$9,000 in 1985 purchasing parity power [PPP] dollars), countries appear to reconcentrate their production structure. Klinger and Lederman (2006) as well as Cadot, Carrère, and Strauss-Kahn (2011) analyze the issue from a trade perspective and find the same U-shaped pattern but at higher levels of GDP per capita (more than US$22,000 in 2005 PPP dollars). • The productivity and diversification nexus: Although the link between trade and productivity has been long recognized, the direction of its causality has been less clear. The new trade models based on firm heterogeneity (cf. Bernard and Jensen 1999; Melitz 2003; Helpman, Melitz, and Rubinstein 2008) have made important progress in showing how productivity, at the firm level, contributes to export participation. At the same time, this new literature shows that at an aggregate level, export participa- tion contributes to economywide productivity increases. • A natural resource curse? The traditional view (cf. Sachs and Warner 1995, 1999) of natural resources (and commodities) as being a “curse,� constraining the long-term growth of developing countries, has been challenged by new emprical research and changes in global commodities markets. Evidence suggests it is not natural resources dependence per se that increases risk but rather the concentration of exports (Lederman and Maloney 2007). Indeed, with the demand for commodities rising and likely to be sus- tained over the medium term, diversification into agriculture and commodities is rising on the agenda of low-income countries. • Sophistication or quality? One key debate is whether export competitiveness is best achieved through an evolutionary process of upgrading—selling lower-quality goods to regional markets and building capabilities before moving into more competitive, sophisticated global markets—or leapfrogging immediately to sophisticated goods or rich-country markets. Rodrik (2006) and Hausmann, Hwang, and Rodrik (2007) argue that certain goods provide greater opportunities for growth because of the greater potential to upgrade vertically within the industry (for example, cars versus bananas) and to benefit from interindustry spillovers of knowledge. Coming at it from a different angle, Mattoo and Subraimanian (2009) find that, contrary to conventional wis- dom, many of the recent successful emerging economies have grown not only by following comparative advantage but also by using industrial policies to defy it. Others question the premise of “sophistication�—that selling rich-country products is more likely to make you rich—arguing that quality is not ingrained in the product but rather the process (Harrison and Rodrìguez- Clare 2009; Lederman and Maloney 2009; Schott 2004; Xu 2010). • Export discovery or export survival? Research by Hausmannn and Rodrik (2002), Klinger and Lederman (2004), and Hausmann, Hwang, and Rodrik (2007) argues that firms in developing economies tend to underinvest in export “discovery,� fearing the erosion of their margin by market followers who would not face the same level of sunk costs of investment borne by first movers. On the other hand, recent research on survival (Brenton and Newfarmer 2009) documents extensive experimentation in low income countries and argues that the problem is that these export relationships are short-lived; indeed, in a study of African exporters, Cadot et al. (2011) find that less than 20 percent of export relationships survive the first year. Although the former set of findings suggests policies (for example, subsidies, export promotion) to support the discovery process, the latter indicate the need for greater focus on addressing the constraints to sustaining export flows. • Export agglomeration and spillovers: The recent research on export survival suggests that exporting has an element of “learn- ing by doing�—experience with exporting the same product to other markets or different products to the same market are found to strongly increase the chance of export survival. Perhaps more interestingly, export survival appears to be affected by spillovers. For example, Cadot et al. (2011) find that the chances of a firm’s exports surviving increase with the number of other firms also exporting a specific product to a specific market (and this effect is stronger for heterogeneous goods that for homog- enous ones). These findings suggest the importance of knowledge spillovers across exporters and point to the potentially valu- able role of export promotion agencies to facilitate information exchange and collective action. Source: Authors. 6 Trade Competitiveness Diagnostic Toolkit Ultimately, the aim of trade for policy makers is sustain- The Trade Outcomes Analysis provides a quantitative able, broad-based economic growth. Thus, an important and qualitative assessment of historic trade performance question remains: How can a country translate trade into using the decomposition of the margins of trade growth as growth and poverty reduction? Not all sectors are equally the framework to explore trade competitiveness. Specifi- predisposed to contribute to spillovers and broad-based cally, we define four principal factors on which a country’s economic growth. trade competitiveness performance can be determined: What matters for competitiveness is not only the capa- (1) the level, growth, and market share performance of bility to be productive in a static or slowly evolving external existing exports (the intensive margin); (2) diversification environment but also the ability to adjust and adapt to of products and markets (the extensive margin); (3) the structural changes. Being able to remain competitive and quality and sophistication of exports (the quality margin); adapt to changes requires redeploying resources (capital, and (4) the entry and survival of new exporters (the sus- labor, institutions) to higher-value activities. Policies that tainability margin). promote entry and exit in both product and factors mar- Understanding a country’s relative performance (overall kets are also important, as inefficient factor and product or at a sector level) on these various aspects of trade markets, as well as high costs of entry and exit, may lead provides a summary of its competitiveness in global mar- firms to incur otherwise-unnecessary adjustment costs kets. But this is only half the story. To have a chance to whenever a shock hits an economy.2 improve competitiveness, it is necessary also to understand The multifaceted nature of trade competitiveness thus the main determinants of competitiveness, the factors that requires a deep understanding of the wide range of factors are most constraining, and the policy levers that might that may contribute to or constrain it. And as these factors be pulled to overcome these constraints. This is no simple are often highly endogenous, a piecemeal approach to task, particularly given the broad-based nature of competi- reform is unlikely to be effective. At the very least, a com- tiveness.3 The second component of the TCD, the prehensive approach to understanding the constraints and Competitiveness Diagnostics, provides a framework for how they affect the trade sector is necessary. analyzing determinants of trade competitiveness across three broad areas: The TCD Framework 1. Market access focuses on the external trade policy envi- Figure O.3 presents the overall TCD framework, linking ronment that may facilitate or constrain exporters from explanatory factors to observed trade performance. The entering and maintaining competitiveness in markets. figure illustrates two main components: Trade Outcomes 2. Supply-side factors cover a broad range of determi- Analysis and Competitiveness Diagnostics. nants, including governance and macrofiscal, trade, Figure O.3. TCD Framework TRADE OUTCOMES ANALYSIS Growth and share Diversification Quality & sophistication Entry & survival (intensive margin) (extensive margin) (quality margin) (sustainability margin) Channels Entry costs Factor and transaction costs Technology and efficiency COMPETITIVENESS DIAGNOSTICS Supply side factors Trade promotion Market access infrastructure Incentive framework Factor conditions Source: Authors. Overview and Guidelines for Conducting a Trade Competitiveness Diagnostic 7 and domestic policies that establish the incentive factors. This sets the agenda for the Competitiveness Diag- framework faced by the private sector, as well as the fac- nostics that follows, which focuses on understanding the tor inputs that determine competitiveness at the factory underlying policies, and structural dynamics that shape this or farm gate. observed performance. 3. Trade promotion infrastructure covers the range of interventions by government to address market failures (coordination challenges, asymmetric information) and Organizing to Conduct a TCD government failures that restrict export participation Establishing the Objectives and performance, including traditional export promo- tion, special economic zones (SEZs), industry coordina- The starting point for undertaking a Trade Competitive- tion bodies, and standards regimes. ness Diagnostic is to define the objectives of the assess- ment. Objectives will vary from one country to the next, Each of these components shapes observed trade per- depending on its challenges, its trade and industrial formance through its impact on individual firms in one (or strategy, and the planning and policy processes into which more) of three channels: the fixed costs (and risk) of pro- the assessment will contribute. Before undertaking the duction and export entry, the factor and transactions costs assessment, at minimum, the issues outlined in table O.1 that determine factory-gate competitiveness, and the level should be considered. of technology and efficiency at which the sectors and firms Because the TCD has been designed in a modular way, operate. In an efficient and a competitive context, capital the potential scope and output may vary considerably from will be allocated to the most productive firms in the most project to project. Full-country or sector-level diagnostics productive sectors. But in cases in which the policy environ- can be undertaken, and various tools of the TCD can be ment protects certain sectors or firms, it may create an anti- used to address specific questions of interest. Box O.2 export bias or a gap between areas where capital can appro- describes one way to use the TCD to develop a series of priate the greatest rents and areas where it is most efficient policy notes on trade competitiveness. from an economywide perspective. Equally, in cases in The issues outlined in table O.1 need not be mutually which structural competitiveness gaps exist, firms may exclusive, and any TCD exercise may pursue multiple underinvest in sectors that should otherwise be a source of objectives. In any case, it is important to start with a comparative advantage. clear understanding of what the TCD aims to achieve In practice, the two components—Trade Outcomes and how it will be used. This not only will guide and Analysis and Competitiveness Diagnostics—are usually focus the analysis but also will be critical to facilitate conducted separately and sequentially. First, the Trade Out- communication with stakeholders who will be involved comes Analysis gives a picture of trade performance, identi- in the project, as well as with internal and external fies key areas of weakness or risk in trade competitiveness, clients who will use its outcomes (and may contribute and raises questions and hypotheses about the contributing resources to fund it). Table O.1. Considerations in Establishing Objectives of the TCD Objectives of export • How important has the export sector been and what are the perceptions of recent and future performance? strategy • Is there an emphasis on diversification? Upgrading? How will the results • To feed into a national export, trade, or industrial strategy be used? • To inform policy dialogue on opportunities to improve trade performance and remove constraints to export sector • To identify specific projects or programs as part of a wider initiative designed to improve competitiveness Scope of the National versus sectoral assessment • Is there a need to understand the structure and performance of the overall export portfolio—for example, to assess the economies process of adjustment? • What are the specific sectors—economically critical or potential future opportunities—on which the assessment will focus? Broad versus focused • Will the assessment take a comprehensive approach to diagnose “binding constraints� to competitiveness, or are there specific issues (for example, trade promotion, trade logistics, and so on) that will be the main focus? Source: Authors. 8 Trade Competitiveness Diagnostic Toolkit Box O.2. Using Trade Competitiveness Diagnostics to Develop Policy Notes The Trade Competitiveness Diagnostic (TCD) can provide a useful set of tools with which to engage governments on a broad discussion of competitiveness. One way to organize the TCD to facilitate such a dialogue is to plan for the preparation of a series of policy notes derived from the analysis. The first stage of the TCD—the Trade Outcomes Analysis—provides a detailed quantitative assessment of trade performance across several measures of competitiveness. This analysis not only can be packaged as a useful note in its own right but also can be used to identify specific sector-level analysis or questions that can guide the TCD efforts and serve as topics for additional policy notes. For example, the Outcomes Analysis might raise important questions like (1) Why has the country been unable to penetrate fast-growing Asian markets with exports that are doing well in Latin America, Europe, and North America? (2) What factors are preventing the country from upgrading in the light-manufacturing sector? and (3) Why are survival rates for exporters particularly low for intraregional trade? The TCD can then be organized around answering those specific questions, giving three clear policy notes as outputs. Finally, the findings from across the three analyses can be brought together to derive overall lessons for trade competitiveness, which could serve as a fifth and final policy note. Source: Authors. With the objectives clarified, the next step is to ensure Counterparts and Stakeholders that resources are mobilized to undertake the TCD and In addition to the team leading the data collection and that a clear workplan is put in place. A number of project analysis, the success of the TCD will depend on input from management issuess need to be considered. a wide variety of stakeholders in the country, including government officials and the private sector. The inclusion of stakeholders is important not only for planning and Who Should Be Involved? conducting the TCD, but also and most important for TCD Team reaching consensus on the priority actions and policies The TCD is designed to be led by a relatively small core that emerge from the process. team, most likely including three or four staff members. At Identification and engagement with stakeholders should least one team member should be a trade economist with begin in the early stages of developing the TCD workplan. an understanding of trade policy and competitiveness This will ensure that key stakeholders agree with the issues, as well as technical skills to analyze trade data. The approach and will also facilitate access to information and task team leader (TTL) ideally should have some trade key contacts. Although consultation will take place through experience, but most important, should have in-depth individual and focus group interviews, it may also be useful country knowledge and experience. Given that the TCD is to organize a steering group to oversee the TCD exercise. not intended to conduct in-depth technical analysis, it Such a steering committee should include both public and should not be necessary to involve technical experts for private sector members. Its main role would be to advise and each component of the diagnostic. If certain topics are seen intervene at key points in the TCD process, including the fol- to be critical from the outset—in particular innovation, lowing: (1) endorsing the proposed workplan and methodol- skills and productivity, or trade facilitation—it may be use- ogy; (2) reviewing and endorsing the Trade Outcome Analy- ful to bring in specialized technical expertise to lead those sis Report; (3) reviewing and endorsing of the TCD final components. report; and (4) preparing and endorsing the proposed policy To conduct the Trade Outcomes Analysis, it will be recommendations and program of action. important to have a skilled trade data analyst who is Given the broad nature of competitiveness, such a familiar with the main data sources used in this Toolkit committee may need to draw on members from across a and has some experience using the Stata statistical pack- number of different government agencies and industry age. The World Bank International Trade Department has sectors. A key challenge in this respect will be ensuring automated much of the process and can provide Stata inclusivity while avoiding making the committee too large “do� files that automatically run the analysis and prepare to function efficiently. the graphs and figures needed in the Trade Outcomes Analysis. In a second phase of the Toolkit implementa- How Will the TCD Be Conducted? tion, it is expected that fully automated tools will be avail- able online that will enable users to input data and The TCD will be conducted in three main steps as outlined retrieve results. in figure O.4. This includes (1) the preparation of the Trade Overview and Guidelines for Conducting a Trade Competitiveness Diagnostic 9 Figure O.4. Work Stages for the Trade Competitiveness Diagnostic Stage 1: Time: 2–4 weeks Activities: desk-based trade data analysis Trade outcomes assessment Output: trade outcomes note, including hypotheses on key issues to address in the diagnostic Time: 2–3 weeks Stage 2a: Activities: desk-based compilation of quantitative Initial diagnostic analysis indicators (benchmarking) and review of key policy and and fieldwork preparation strategy documents Output: pre-mission note outlining key issues for research, data requirements, interview targets Time: 4–6 weeks Stage 2b: Activities: in-country interviews and data collection Fieldwork Output: aide memoire summarizing main findings and next steps Stage 3: Time: 4–6 weeks Analysis and preparation of Activities: analysis of diagnostic findings and preparation final diagnostic of report outlining potential policy responses Output: final TCD report Source: Authors. Outcomes Analysis; (2) initial diagnostics and field prepa- (2) diversification of products and markets (the extensive ration, followed by in-country diagnostics field research; margin); (3) the quality and sophistication of exports (the and (3) analysis and preparation of the final TCD report. quality margin); and (4) the entry and survival of new exporters (the sustainability margin). Figure O.6 shows the four main steps to conduct a Trade What Time Will Be Required? Outcomes Analysis. The Trade Outcomes Analysis is largely The TCD is designed to be completed within a period of a desk-based exercise that involves assessing a series of indi- four months. This would include four to six weeks of field- cators and analytical tools. The key to a success, however, work (although it could be as few as two weeks in a small lies not in the creation of the tables and figures but in their country), as shown in figure O.4. interpretation, and in the conclusions and hypotheses that are drawn from them. Thus, it is important that the analysis is grounded strongly in the country context. This means Module 1 Summary: Conducting the Trade ensuring that members of the country team are directly Outcomes Analysis involved (if the analysis is being conducted by an anchor The Trade Outcomes Analysis guides a systematic genera- unit or a consultant) and, if possible, conducting limited tion of hypotheses about a country’s export performance, field research. This research will allow for a stronger analysis prospects, and challenges by analyzing what it exports, to and will ensure that the quantitative report can be illus- whom, how much, and for how long. It is designed to not trated with relevant examples and anecdotes that shed light only measure past performance but also assess the likely on the actual situation. The remainder of this section pro- future trajectory of a country’s trade position. The Trade vides a basic guideline to carrying out each of the four steps. Outcomes Analysis uses the decomposition of the margins Step 1: Select Peer Countries of trade growth as a framework for exploring trade compet- itiveness, as outlined in figure O.5. We define four prinicipal It is important to decide which comparator countries will factors on which a country’s trade competitiveness be included in the analysis. Some of the indicators will performance can be determined: (1) the level, growth, and focus on country-specific analysis and others on position- market share performance of existing exports (the inten- ing the country of interest in the global landscape; for the sive margin) of exports as well as market share performance; majority, however, it will be useful to select peer countries 10 Trade Competitiveness Diagnostic Toolkit Figure O.5. Decomposition of Export Growth—a Framework for Measuring Trade Competitiveness Intensive margin: higher volumes of existing products to existing destinations Quality margin: higher quality in existing products New products Extensive margin: new trade Export growth flows New destinations Sustainability margin: entry and survival of new products and destinations Source: Authors, derived from Carrere, Strauss-Kahn, and Cadot 2011. Figure O.6. Steps to Conducting the Trade Outcomes Analysis Step 1: Step 2: Step 3: Step 4: Select peer Download and Analyze and Identify the countries compile data interpret main competitiveness challenges Source: Authors. for comparison. The purpose of a peer country is to act as a important to reach consensus on the peer countries before benchmark against which the relative performance of the any final results are presented. Normally, the selection crite- country can be assessed. ria will include some combination of neighboring coun- Although stakeholders are often particularly interested tries; countries of similar size, economic development, and in such comparators, the purpose of the peer countries is economic structure; and possibly countries with whom the to set the country’s performance in context and not to con- country’s exporters compete in global markets. duct a comprehensive ranking or benchmarking exercise. Thus, it is not necessary to include the full range of possible Step 2: Download and Compile Data comparator countries. Moreover, from a practical perspec- tive, interpreting the accompanying figures and graphs will Data Sources be difficult if too many comparators are included. Thus, The Trade Outcomes Analysis focuses on the assessment of somewhere between four and six peer countries is nor- time-series and cross-sectional trade data. Although mally ideal. detailed and useful data may be available from national sta- Given the sensitivity of many stakeholders to the coun- tistical agencies, comparability across countries and time is tries that are considered peers, outlining a clear set of crite- critical. As such, the analysis makes use of a few standard- ria for the selection of the peer countries is important. ized data sources (see table O.2). The majority of measures Indeed, although benchmark comparisons can play a valu- in the Trade Outcomes Analysis use a single data source— able role in engaging in the dialogue with country counter- the United Nations Comtrade database that can be accessed parts, the perception that certain peer countries are deemed via the World Integrated Trade Solution (WITS) website, a inappropriate can undermine a good analysis. Thus, it is software tool developed by the World Bank in collaboration Overview and Guidelines for Conducting a Trade Competitiveness Diagnostic 11 Table O.2. Main Data Sources for Trade Outcomes Analysis Source / Location Description and main use World Integrated Available online http://wits.worldbank.org/ Provides detailed time-series data on imports and exports by Trade Solution wits/ (registration required) country and trade partner based on a range of statistical (WITS) classifications. Primary source of data for almost all indicators used in the Trade Outcomes Analysis. World Trade Available online Provides precalculated indicators on measures relating to trade Indicators (WTI) http://info.worldbank.org/etools/wti/1a.asp growth, services trade, and diversification. ITC TradeMap Available online Provides a wide range of indicators and tools (for most of which, http://www.trademap.org/ (registration the TCD uses WITS instead); in TCD used mainly for mapping of required) growth orientation. World Available online Provides a detailed set of time-series socioeconomic data across Development http://data.worldbank.org/data-catalog/ all countries; used in TCD mainly for Indicators (WDI) world-development-indicators • Basic trends in trade growth • Data for context on population, GDP, etc. • Technology content of exports. World Bank Unit values database (PRMTR) • Time-series database with unit values at detailed product level Proprietary for exports to EU countries from all countries; in TCD used for data sources analysis of export quality. Customs transactions database (DEC) • Detailed time-series firm-level data on exporters based on customs transactions; available in approximately 30 countries; in TCD used for analysis of export dynamics, entry and survival. Revealed factor intensity database (PRMTR) • Database mapping factor conditions of all countries (physical capital, human capital endowments) against products to show revealed factor intensity of products; in TCD used to analyze sophistication of exports and comparative advantage. Other CEPII—available online http://www.cepii.fr/ • Data set for development of gravity models. anglaisgraph/bdd/gravity.htm Product Space Explorer and Product Space • Tool for analyzing product space. Parser—available online www.chidalgo.com Source: Authors. Note: EU = European Union; GDP = gross domestic product; ITC = International Trade Commission; TCD = Trade Competitiveness Diagnostic. with United Nations Conference on Trade and Develop- Description and Coding System (HS) and (2) Standard ment (UNCTAD), International Trade Commission (ITC), International Trade Classification (SITC). These are sum- World Trade Organization (WTO), and the United Nations marized in table O.3. SITC has the advantage of a much Statistical Division. longer series since 1962 and fewer revisions. For the Trade Module 1 of the toolkit provides details on the data Outcomes Analysis, the level of aggregation of data is tai- sources for each of the indicators and tools of the Trade lored depending on the tool used. For sectoral composition Outcome Analysis. Some of these indicators are available and growth, HS two-digit suffices, whereas for meaningful precalculated from World Trade Indicators (WTI) or can product-level analysis, either SITC four-digit or HS four- be calculated using simple online tools from WITS or ITC digit are required. HS six-digit data offers the most dis- Trade Map. The World Bank International Trade Depart- aggregation and is the preferred option. Trade data are ment has automated much of the process and can provide disaggregated further at the national level, but they can- Stata “do� files that automatically run the analysis using not be used for comparison or benchmarking because WITS data and prepare the graphs and figures needed for they have not been harmonized across countries. the Trade Outcomes Analysis. In a second phase of the toolkit implementation, a set of automated tools will be Use of Mirror Data available online, enabling users to input data and retrieve The use of different sources and techniques to process raw results. data could result in trade data varying tremendously across countries. Export data reported by developing Data Nomenclature, Classification, and Degree countries are often less accurate than the import data of Aggregation reported by high income countries for the same flow. This is Comtrade’s data use two principal classification systems because administrative capacities are stronger in industrial for merchandise trade (data for services trade is much countries. Additionally, because import data are needed to less detailed- see box O.3): (1) Harmonized Commodity calculate tariffs, importers tend to show greater diligence 12 Trade Competitiveness Diagnostic Toolkit Box O.3. A Note on Data for the Services Sector In recent decades, with the advent of new technologies and policy reforms, services are being increasingly traded between countries. In 2009, global trade in merchandise was valued at US$12.1 trillion and trade in commercial services was valued at US$3.3 trillion.a There is, however, a severe lack of disaggregated data for services, which prevents analysis of rigor at par with what can be conducted for merchandise trade. This imbalance, driven by data availability, is reflected in this toolkit. The broadest definition of services includes all activities outside agriculture, mining, and manufacturing that have intangible outcomes. This definition permits a highly heterogeneous inclusion of activities, from banking and insurance, telecommunications and accounting, hotels and architecture, to audio-visuals, education, health, and construction. In 2007, close to 70 percent of the world’s gross output was accounted for by value addition in services. Yet, because many of these activities were “untradable� until recently, the share of services in global trade is only around 25 percent. Since the 1980s, however, trade in services has grown faster than trade in goods. Because of policy deregulation and information technology–enabled technologies, some forms of trade in services no longer require a simultaneous presence of both the producer and consumer, which used to be one of the distinguishing characteristics of this trade. Trade in services also subsumes the important subject of direct investment under the logic that services can be provided through “commercial presence� in a foreign market by owners of capital belonging elsewhere. According to the United Nations Conference on Trade and Development (UNCTAD), in 2006, 62 percent of inward stock of foreign direct investment (FDI) was accounted for by services, up from 49 percent in 1990. Despite growing importance, the quality and availability of data on cross-country trade in services is poor. The main existing source is the International Monetary Fund Balance of Payments statistics. But this does not capture all categories and most likely understates services trade. The World Development Indicators (WDI) provides the same information in a more accessible manner with some disaggregation into insurance and financial services, travel, and transport. UNCTAD has information on FDI flows and stocks as well as sales by affiliates of multinational companies. Source: Authors. Note: a. See http://www.wto.org/english/news_e/pres10_e/pr598_e.htm. Table O.3. Summary of Data Classification Systems Classification Degree of disaggregation available Time period of coverage and revisions HS Up to six-digit levels for more than Available since 1988 with revisions of nomenclature in 1988/92 (HS0), 5,000 products 1996 (HS1), 2002 (HS2) and 2007 (HS3) SITC Up to five-digit levels for more than Available since 1962; third revision (SITC Rev3, from 1988–2007) is widely 1,000 products used because it gives maximum comparability over long sample periods; SITC Rev4 launched in 2007. Source: Authors. Note: HS = Harmonized Commodity Description and Coding System; SITC = Standard International Trade Classification. and regularity in their recordkeeping. For most of the Trade Outcomes Analysis, two main sources of firm-level data can Outcomes Analysis, therefore, mirror data should be be considered: (1) an industry census, a registry database used—for example, if calculating exports of Nigeria, instead (usually including accounts and/or balance sheet data), or of using the Comtrade data for Nigeria showing its reported enterprise surveys; and (2) a database of customs transac- exports to the world, take the data for all countries showing tions. These sources are summarized in table O.4. their reported imports from Nigeria. Step 3: Analysis and Interpretation Firm-Level Data In addition to the aggregate data sources discussed in Following is a brief summary of each component within table O.2, a much richer analysis of export dynamics, the Trade Outcomes Analysis. including detailed measurement of entry and survival, can be achieved with access to data about individual firms (see Level, Growth, and Market Share: Intensive Margin box O.4). It is therefore valuable, wherever possible, to An analysis of the basic orientation of trade is crucial to access firm-level microdata. Unfortunately, these data judge whether a country’s trade structure is conducive to remain difficult to come by and comparability across coun- economic growth. The assessment of level, growth, and tries may be limited. Even in individual countries, accessing market share (the intensive margin) covers a range of firm-level data is often difficult (where available) because of issues reflecting the structure and competitiveness of the concerns over data confidentiality. To conduct the Trade existing export basket. Table O.5 summarizes the key Overview and Guidelines for Conducting a Trade Competitiveness Diagnostic 13 Box O.4. Why Firm-Level Analysis? Firms are heterogeneous in characteristics and performance. Moreover, important changes in production models are taking place worldwide, which are deeply affecting the transmission mechanisms of the economies, domestically and internationally. Macro aggregations miss the critical features and effects of firm heterogeneity on the macro-economy. They are not adaptable to changes and innovations in the business landscape within countries and internationally. Hence, at times of structural change they may give a partial or distorted perception of underlying economic realities. This explains why in recent years many macro indicators seem to have lost relevance for explaining trade outcomes and why some policy initiatives do not seem to deliver the expected results in terms of employment, domestic growth, and export performance. Going deeper in the understanding of firm-level dynamics can improve not only aggregate assessments of competitiveness but also the identification of its drivers and the reaction of the real economy to policy intervention. In short, complementing more aggregate assessments with firm-level data can lead to improved policy toward raising countries’ competitiveness. For example, firm-level analysis has distinct advantages when assessing the mechanisms governing the generation of output, the division of production and labor, and the allocation of resources across countries, within countries, and within industries. Drilling down into the various key indicators by detailed firm makes it possible to carry out panel data analysis rich in cross-sectional and time variation data (i.e., it allows controlling for relevant aspects of the activity of businesses). Source: Authors. Table O.4. Sources of Firm-Level Data—Benefits and Drawbacks Benefits Drawbacks World Bank (DEC) Data available from around 30 countries, Lack of data on firm characteristics Export Growth and so possible to create benchmark comparisons Only covers exporters, so no data to compare Dynamics Project Detailed data available on export volumes across time, exporters and nonexporters Database or customs products, and trade partners make it possible to transaction data create a detailed picture of firm dynamics and study acquired for specific patterns of entry, growth, and survival countries on ad Data available from a number of low-income countries hoc basis Census data, Allow for links between exports (participation and Ad hoc availability and access—varies significantly Registry data, and volume) and other characteristics of firms by country; usually restricted to middle- and Enterprise Surveys (e.g., size, productivity, and so on) upper-income countries Provide data on both exporters and nonexporters, Lack of details on exports—usually no data on allowing for comparisons of characteristics specific products and markets Source: Authors. Note: DEC = Development Economics. issues and indicators covered in this part of the analysis, exports and the markets they serve; (2) the degree to along with the types of questions that might be which the export portfolio is aligned with products and answered—or, indeed, raised—by the analysis. It also import markets that are growing in the world economy; provides a reference to the page in module 1 of the toolkit and (3) the evolution of the market reach of specific where detailed information on the indicator can be exports (successful or unsuccessful) over the past decade found. (see table 6). Diversification: Extensive Margin Quality and Sophistication: Quality Margin The main argument for diversification of exports is to lessen What goods countries produce and how they produce risk and vulnerability arising from a reliance on too much them both matter for export-led growth. Products can be income from a narrow range of products. Such vulnerability disaggregated only by so much, and the quality of products can occur through volatility in international prices and within an internationally harmonized category (such as HS external shocks beyond an exporter’s control. Recently, six-digit or SITC five-digit) can vary immensely. All else diversification and discovery of new exports have been equal, goods that embody greater value addition in terms proven to contribute positive externalities and facilitate of ingenuity, skills, and technology fetch higher prices in higher productivity, ultimately leading to improved long- world markets. Upgrading product quality, therefore, can term growth prospects. This section provides tools to be a secure source of both export and economic growth. assess the following: (1) the concentration of a country’s This section provides tools to analyze (1) the technology, 14 Trade Competitiveness Diagnostic Toolkit Table O.5. Summary of Indicators and Issues—Level, Growth, and Market Share Issue Indicators Questions and implicit hypotheses Page Trade Openness Trade-to-GDP ratio (1) Relative to countries at comparable levels of 29 Adjusted trade-to-GDP ratio income, how integrated is a country in the world? How does the ratio change when it is adjusted to control for population, remoteness, and cost of inland trading? (2) How has the ratio evolved over the past decade? Trend in Trade Growth Evolution of export volumes of both goods (3) Has growth of exports of goods and services 31 and services, annual growth rates of total been steady? Has trade share of GDP grown in exports, and share of merchandise tandem with GDP or faster? What explains trade in GDP deviations from the trend, if any? Export Composition, Total exports (US$) by each (disaggregated) (4) How have exports grown at the sector level? 31 Revealed Comparative sector, including services, and its share in Has competitiveness (say, in terms of RCA) Advantage (RCA), total exports evolved differently over time across sectors? and Trade Integration RCA of each sector Have there been dramatic changes in certain Compound annual growth rate in exports sectors? Why? over a period of 5 to 10 years (5) How has real exports per capita evolved over the past 30 years compared with peer countries? Real export per capita (6) Are export earnings emanating from a diversified Share of manufactured trade in parts and economic base? components (7) Is the country taking part in global production Grubel-Lloyd Index networks? What is the share of intraindustry trade? Market share Comparative market share performance (8) Is a country growing its share in world, regional, 35 in key product or specific country imports in key sectors and products? How are they performing relative to key competitors? Trade Partners Difference between predicted and actual (9) Does a country “overtrade� or “undertrade� 36 exports to individual partners obtained with individual partners, especially those that are from a gravity model rich, large, nearby, or fast growing? Trade Intensity Index (10) What is the role of preferential trade Trade Complementarities Index agreements in boosting bilateral or regional trade? (11) Does a country have an unusually high or low level of penetration with partners that could be considered natural trading allies? (12) What is the degree of fit between a country’s export profile and a potential partner’s import profile? Growth Orientation of Scatter plot of import growth by countries (13) What is the orientation between world growth 38 Portfolio against a country’s share in those markets rate of products and their shares in national Scatter plot of world growth of products portfolio? Are there slow-growing products or against a country’s share in those products markets that a country relies on excessively? (14) What is the experience of exporters in emerging and fast-growing markets? What is inhibiting them (e.g., search costs, market access, competitiveness)? Source: Authors. Note: GDP = gross domestic product. income, and factor contents of exports to test whether a more than a few years. Analysis of firm-level data is critical country produces sophisticated and high-value products; to improve the understanding of the process of entry, exit, and (2) the product space to know the sectors in which a and survival in export markets. Assessing the dynamics of country has acquired or lost revealed comparative advan- export participation and survival not only is valuable for tage over time, thereby giving a glimpse of the pace of understanding the competitiveness of a country’s trade structural transformation in the economy (see table O.7). sector but also provides a critical bridge to the diagnostics stage of the TCD. The nature of firm participation and Entry and Survival: Sustainability Margin survival in export sectors helps to identify which broad The majority of export relationships (at the product-country factors (entry costs, factor costs, technology, and effi- level) forged by developing countries do not survive for ciency) may be the biggest constraints to competitiveness. Overview and Guidelines for Conducting a Trade Competitiveness Diagnostic 15 Table O.6. Summary of Indicators and Issues—Diversification Issue Indicators Questions and implicit hypotheses Page Measures of Share of top three or five products in exports (1) How concentrated are exports in a narrow range 41 Concentration Share of top three or five markets in exports of products, or markets? (2) Is this concentration benign? Does growth in Hirschman-Herfindahl Index concentrated products generate benefits that Theil’s Entropy outweigh potential cost from vulnerability? Concentration of exports across firms Intensive and Hummels-Klenow Extensive and Intensive (3) Over a decade, has a country added economically 42 Extensive Margins for both products and markets significant new products to its portfolio? Has it Margins become a bigger player in products that it had a decade ago? In other words, is a country big in what it exports and how much do those exports matter globally? (4) Is a country big in markets it exports to, and how much do those markets matter globally? (5) Who were the entrepreneurs that made those breakthroughs? What is their story? Market Reach Index of Export Market Penetration (IEMP) (6) What were the products that substantially 43 of Exports increased the number of markets they served over a 10-year period? (7) Are there many new products or deaths? Which were the notable ones and why? (8) Compared with peer countries, how many of the potential export relationships has a country exploited? Source: Authors. This section explores (1) the general structure of the export larly where they have been experiencing declining share sector; (2) basic descriptive statistics (number, mean, performance in key export products (across markets), the median) of duration of a country’s export spells at the proximate problems are normally cost-related constraints product-country level; (3) the decomposition of export that affect competitiveness at the factory or farm gate. growth into intensive and extensive margins, and the sur- Extension (diversification) and upgrading (quality). In vival rate of export relationships; and (4) the extent to cases in which unit price performance has stagnated or which the cause of death of exports is their defiance of declined relative to competitors, or in which the export comparative advantage derived from relative factor endow- base remains concentrated with little success in diversifica- ments (see table O.8). tion, proximate problems are typically quality and innova- Although both aggregate (macro) data and firm-level tion related, including constraints related to technology data can be used to explore these issues, the use of firm- and efficiency. level data gives a much richer and more accurate picture of the dynamics of exporting. Markets In cases in which countries have been experiencing declin- ing share performance in key export markets (across most Step 4: Drawing Conclusions from the Analysis— products) or in cases in which diversification of existing Identifying the Main Competitiveness Challenges exporters and products into new markets has been weak, After a thorough assessment of trade performance is the competitiveness challenges most likely relate to market undertaken under the four themes, the next step is to home penetration. in on the proximate causes of competitive weaknesses that will be the focus of the Diagnostic exercise. In general, the General Export Environment many issues with trade competitiveness can be boiled Finally, if a country has a limited export base, with insuf- down to a problem with products, markets, or the general ficient creation of new exporters or low survival rates of environment for exporters, as illustrated in figure O.7. new exporters, the competitiveness challenges most likely are driven by weaknesses in the general export Products environment. Cost competitiveness. In cases in which countries are In addition to identifying the main issue areas on found to have problems at the intensive margin, particu- which to focus in the Diagnostic exercise, it may be useful 16 Trade Competitiveness Diagnostic Toolkit Table O.7. Summary of Indicators and Issues—Quality Issue Indicators Questions and implicit hypotheses Page Technological Relative shares of high-, medium-, (1) Over a decade or so, has there been a shift away from the 44 Content and low-technology goods in total country’s dependence on resource and primary exports to exports medium- and high-technology exports? Unit Values Cross-country comparison of unit (2) Given the unconditional nature of unit value convergence, 45 values at the SITC five-digit or how likely is product upgrading as a strategy to become a HS six-digit level secure source of economic growth? (3) What share of a country’s exports is in industries that are deemed to be price elastic relative to industries that are quality elastic (revealed quality elasticity)? Sophistication PRODY and EXPY (4) What is the income content of a country’s exports? Does it 47 produce what rich countries produce? (5) Can a country count on the existing portfolio of exports for future growth, or will it need to augment the process of export discovery? (6) Is sophistication illusory when taking into consideration the share of imported parts and components in final value? Revealed Factor RPCI and RHCI (7) Are the biggest export earners above or below the capital 49 Intensity content of the median export? (8) What is the physical and human capital content of exports? What does this imply for efforts to improve long-term national endowments? Product Space Proximity between products on (9) How has the economy transformed over the past 20 to 50 the product space 30 years in terms of exports in which a country has (had) a revealed comparative advantage? (10) Are certain products stuck and has there been no movement along the product space (e.g., from garments to machinery)? (11) What new products have emerged? What is the policy narrative behind them? (12) Which products embody latent comparative advantage, and what kind of industrial policy is needed to nurture them? What industries are protected or subsidized? How can they be oriented toward industrial upgrading? How active a coordinating role will the state have to play to nudge the movement of products on the product space? Source: Authors. Note: EXPY = (Revealed) income content of export basket; HS = Harmonized Commodity Description and Coding System; PRODY = (Revealed) income content of product; RHCI = Revealed Human Capital Index; RPCI = Revealed Physical Capital Index; SITC = Standard International Trade Classification. Figure O.7. Linking Trade Outcome Categories to Competitiveness Challenges TRADE OUTCOMES ANALYSIS Growth and share Diversification Quality & sophistication Entry & survival (intensive margin) (extensive margin) (quality margin) (sustainability margin) Products General export Markets Extension environment Penetration of existing Cost competitiveness (diversification) and Sustainable entry of new and new export markets upgrading (quality) exporters Source: Authors. to identify the broad questions around which the Diag- the sectoral level that may serve as a proxy to answer nostic exercise can be organized (see an example in box broader questions about constraints to competitiveness in O.5). It also will be useful to identify specific questions at the export sector. Overview and Guidelines for Conducting a Trade Competitiveness Diagnostic 17 Table O.8. Summary of Indicators and Issues—Entry and Survival Issue Indicators Questions and implicit hypotheses Page Firm dynamics Number of firms; number of (1) What has been the trend of export participation? 54 exporters; nature of exporters Is exporting accessible for most firms? (size, FDI share); export share (2) How large are typical exports and how reliant are of production exporters on domestic v export markets? (3) How important is FDI for the export sector? Longevity Kaplan-Meier survival function; (4) What is the mean and median duration of a country’s export Nelson-Aalen cumulative hazard relationship? Of the median firm’s export relationship? Is this function; extended mean graphs low or high when compared with peer countries? (5) What export relationships were sustained over an extended period? Which sector do they belong to (machinery, electronics)? What types of firms? (6) Which countries had such sustained relationships? What explains this beyond geographical, historical, or linguistic ties? Is there a preferential trade agreement in effect? (7) Of the spells that lasted only one year or so, is there a dominant group of products or countries? Why? (8) Decomposing export growth, which constituent of the intensive 54 and extensive margins contributed most and least to export growth? Was it as expected (i.e., the intensive margin was more robust for well-established exporters, and the extensive margin was more dynamic for start-up developing countries)? Nature of Export Growth and survival rates of (9) Have a country’s exports risen when analyzed at the country- 55 Relationships export relationships product level and not just at the product level? (decomposition (10) What is the extensive and intensive margin of export relationships, of growth and and what is the survival rate? Is survival of relationships associated death) with trade finance, exchange rates, and so on? Exports Relative Distance between national (11) Is the death of exports associated with the products’ deviation 57 to Factor endowment and the factor from the national endowment point? Endowment intensity of exports (12) Among new entrants that are ahead of a country’s endowment point, is there a case for government support? Source: Authors. Note: FDI = foreign direct investment; BTA = bilateral trade agreement; RTA = regional trade agreement. Box O.5. Example Questions Following are questions that arose from the Trade Outcomes Analysis in Pakistan: 1. What is preventing the extension of existing export products to new markets? 2. What will it take to shift the export basket to more dynamic markets in Asia, Latin America, and other areas (products and competitiveness, market access issues, and so on)? 3. Why are average trade relationships of such low value? What are the constraints to deepening trade relationships? 4. What explains the low rates of export survival outside traditional products and traditional markets? 5. What is preventing Pakistan from expanding exports in more sophisticated export products? 6. What is holding back quality upgrading in traditional sectors? Source: Authors. The output of this step—the Trade Outcomes Analysis Diagnostics, but it should be a valuable output in its own Report—serves not only as a guide to the second-stage right as a comprehensive assessment of trade performance. Note: Module 1 of this Toolkit provides an implementation guide to a series of measures and analytical tools that can be used to assess trade performance for each of the components discussed in this section. Each tool is described, the main data sources are identified, a basic description of how to conduct the analysis is provided, and an example is shown. 18 Trade Competitiveness Diagnostic Toolkit Module 2 Summary: Conducting the ii. Factor conditions affect the cost and quality of Competitiveness Diagnostics production; these include access to finance, scale economies, labor regulations and skills, firm-level Following the Trade Outcomes Analysis, the Competitive- technical efficiency, land and infrastructure, interme- ness Diagnostics moves through a logical approach to assess diate inputs, services inputs, and trade facilitation and how various factors may contribute to trade performance. logistics. The Diagnostic exercise includes three broad areas of 3. Trade promotion infrastructure covers the range of assessment, as illustrated in figure O.8: interventions by government to address market failures (coordination challenges, asymmetric information) 1. Market access focuses on the external trade policy envi- and government failures that restrict export participa- ronment that may facilitate or constrain exporters from tion and performance, including traditional export entering and maintaining competitiveness in markets, promotion and special economic zones (SEZs), industry including tariffs and quantitative restrictions, preferential coordination bodies, standards and certification, and agreements, and standards and other technical barriers. innovation. These same issues are covered in the incentives section on trade policy. In that section, however, the focus is on how Figure O.9 illustrates the four main steps to conduct the it affects imports; here, the focus is on exports. Competitiveness Diagnostics. The remainder of this section 2. Supply-side factors cover a broad range of determi- provides a basic guideline to carry out each of these steps. nants in two subcategories: i. The incentive framework includes factors that estab- Step 1: Identify Primary Areas of Focus lish the broad environment that influences private for Diagnostics Analysis sector investment and participation in exports, including the macrofiscal environment, exchange The broad-based nature of competitiveness is one of the rates, trade and investment policy, competition, and main challenges for conducting a TCD. The TCD focuses the governance and regulatory environment. on issues that affect the trade sector directly, in the short Figure O.8. Competitiveness Diagnostics Components (Shaded Boxes) TRADE OUTCOMES ANALYSIS Growth and share Diversification Quality & sophistication Entry & survival (intensive margin) (extensive margin) (quality margin) (sustainability margin) Channels Entry costs Factor and transaction costs Technology and efficiency COMPETITIVENESS DIAGNOSTICS Supply-side factors Trade promotion Market access infrastructure Incentive Factor conditions framework Source: Authors. Figure O.9. Steps to Conduct the Competitiveness Diagnostics Step 1: Step 2: Step 3: Step 4: Identify primary Desk-based analysis Field research and Analysis and areas of focus for and benchmarking interviews conclusions diagnostics analysis Source: Authors. Overview and Guidelines for Conducting a Trade Competitiveness Diagnostic 19 to medium term, avoiding detailed assessment of deep competing choices. For example, trade and investment determinants such as institutions, basic education, and policies have a bigger role to play if the Trade Outcomes health that will affect trade outcomes through observable Analysis suggests that the county’s openness to trade and channels like skills, productivity, and the regulatory and structure of production is misaligned with its comparative governance environment. But even with this focus, the advantage, whereas the role of technology absorption, range of issues included in the Competitiveness Diagnos- innovation, and labor skills is likely to loom large if the tics is wide. Thus, an important first step in the Diagnostics country has persistently failed to upgrade the quality of its is to review the Trade Outcomes Analysis results and assess exports. There is, however, no one-to-one mapping of a the likely candidates for the initial analysis. symptom to a cause. This is akin to what Sachs (2005) calls The premise of the TCD approach is that trade compet- clinical economics, in which a range of diagnostic tests and itiveness is not determined by any single constraint. Instead, understanding of context need to be employed to home in the constraints are likely to be multiple and intertwined on the proximate causes of distress. and possibly tied to cross-cutting issues for which the trade Table O.9 provides a checklist of the most likely factors sector may not have direct policy fixes. The Diagnostic affecting competitiveness for each of the broad challenge helps prioritize the incremental alleviation of the most areas that will be defined from the Trade Outcomes Analy- binding constraints to export competitiveness in a world sis. As can be seen, in cases in which the main challenges characterized by scarce resources and trade-offs among are in export entry and cost competitiveness, a wide set Table O.9. Checklist of Primary Factors Impacting Competitiveness Main challenges General Product identified from the export Cost extension Market trade outcomes analysis→ environment competitiveness and quality penetration Page Channels Fixed entry costs ✓ ✓ ✓ Factor costs ✓ ✓ ✓ ✓ Technology and efficiency ✓ ✓ ✓ Market Tariffs and quantitative access restrictions ✓ ✓ ✓ Nontariff barriers ✓ ✓ ✓ 63–74 Preferential trade arrangements ✓ ✓ Supply-side Incentive Macrofiscal environment ✓ factors framework Exchange rates ✓ ✓ ✓ 75–87 Trade and investment policy ✓ ✓ ✓ Competition ✓ ✓ ✓ 88–96 Regulatory environment and governance ✓ ✓ ✓ Factor Access to finance ✓ ✓ 97–99 conditions Scale economies ✓ ✓ Labor regulations and skills ✓ ✓ 100–104 Firm-level technical efficiency ✓ ✓ Land and infrastructure ✓ Intermediate inputs ✓ 105–109 Services inputs ✓ ✓ Trade facilitation and logistics ✓ 110–118 Trade Export and investment promotion promotion ✓ ✓ ✓ 119–123 infrastructure Standards and certification ✓ ✓ ✓ 124–139 Special customs regimes and SEZs ✓ ✓ 140–143 Industry coordination bodies ✓ ✓ ✓ 144–147 Innovation ✓ 148–159 Source: Authors. 20 Trade Competitiveness Diagnostic Toolkit of factors may need to be analyzed to identify the main Table O.10. Summary of Country and Sector Context constraints. On the other hand, when market penetration Provided in the TCD Toolkit emerges as the main challenge, it may be possible to focus Country contexts Sector contexts on a much narrower set of issues. The analysis can be taken • Small (population) and • Light manufacturing in stages to ensure a more efficient use of resources. For remote/landlocked • Agriculture • Resource rich • Tourism example, if market diversification is a major problem in a • Low income, labor abundant • Business services country, a logical point of enquiry is to analyze market • Middle income access barriers and trade facilitation and logistics. If neither Source: Authors. of these is particularly problematic, secondary lines of inquiry may turn to standards and the export promotion quantitative analysis based on data from any existing infrastructure. Some factors may affect firms in several dif- country-specific surveys or census; and (3) quantitative ferent ways, and in fact are endogenous with other compet- benchmarking comparing performance against a set of itiveness factors. Perhaps most noteworthy in table O.9 is peer countries. Table O.11 presents a brief summary of the impact of trade and investment policy not only on the each of these analytical approaches. incentive framework that determines whether firms decide The data sources for comparative analysis of Diagnos- to export but also on the cost and quality of goods and tics are more dispersed than for the Trade Outcomes. services inputs in their production process. However, a number of the most important sources are The checklist in table O.9 is based on the broad existing summarized in table O.12. Specific details on the range of experience of analytical work on trade competitiveness. indicators relevant for each topic are included in module 2 Although developing a generalized model linking supply- of the toolkit. These cover mainly the quantitative data for side constraints to trade outcomes is difficult given the the benchmarking exercise. The qualitative analysis will endogeneity of many competitiveness factors, some prelimi- necessarily be dependent on what reports have been done nary efforts are under way, through both cross-country and in the specific country of interest. within-country econometrics exercises (see box O.6). As The results from this analytical exercise will indicate these are refined further, the breadth of analysis that needs to which competitiveness factors a country performs par- be undertaken in the Competitiveness Diagnostics may be ticularly well or poorly. This information can establish significantly reduced. At the moment, however, they can be additional hypotheses to test in the field and questions taken only as general tools to guide the focus of the analysis. for further research. The desk research should compile In addition to identifying the main areas of focus for the contact information for individuals and organizations to Diagnostics, it is also important to consider how the scope be contacted for meetings as part of the field research. and focus of the research and analysis may need to be tai- Module 2 of the toolkit includes a list of potential con- lored to take into account the specific context of the coun- tacts for each component. try and, if the analysis is being done at the sectoral level, of the focus sector(s). For each of the main competitiveness Step 3: Field Research and Interviews components, module 2 of this Toolkit provides a basic guide for how certain country and sector contexts may Field research is critical to conducting any TCD. This require an adjustment to the focus of the research. These research normally provides the critical insights that con- categories are shown in table O.10. nect quantitative benchmarks with observed performance. Depending on the level of detail required and the number of issues being covered, field research can take anywhere Step 2: Desk-Based Analysis and Benchmarking from just a few weeks to six weeks or more. Three primary Taking the econometrics as an initial guide of where to forms of analysis are used in the TCD for conducting field focus, the Diagnostics analysis begins with desk-based research: semi-structured stakeholder interviews, surveys, research focused on each of the areas identified in table and value chain analysis (see table O.13). O.9. The purpose of the desk-based research is twofold: Value chain analysis (see box O.7) can provide the most to make full use of the existing quantitative and qualita- detailed output and, in fact, would normally include inter- tive evidence available to assess how specific factors views and surveys as part of its approach. As such, many influence trade competitiveness, and to assist in prepar- Diagnostic exercises may use the value chain approach as ing the field research. This step involves three main types their main analytical framework. To obtain specific results, of research: (1) qualitative analysis making use of sec- however, the value chain analysis must be done at a level ondary sources, including recent studies and reports; (2) more discrete than even the sector—normally at the level Overview and Guidelines for Conducting a Trade Competitiveness Diagnostic 21 Box O.6. Linking Supply-Side Constraints to Trade Outcomes—Econometric Approaches Cross-country econometric analysis using firm-level dataa Based on the stylized facts emerging from the descriptive overview of the firm-level evidence, an econometric model can be designed to link observed trade performance to supply-side determinants. The model starts by organizing the constraints around the three main channels through which they affect exporters: entry costs, factor and transactions costs, and technology and efficiency. The basic specification is based on insights from models of international trade with firm heterogeneity (cf. Melitz and Ottaviano 2008; Del Gatto, Mion, and Ottaviano 2006; and Ottaviano, Taglioni, and di Mauro 2009) and controls for standard trade determinants, including developments in foreign demand, tariffs, preferential trade agreements, exchange rates, and measures correlated with fixed costs to export entry. If data from structural business statistics are available, it is possible to control further for firm-level determinants, which are, however, affected by domestic policy. These include measures of firm performance, measures of financial dependence of the firm (e.g., amount of financing from debt, debt type, debt terms such as interest rate, amount of financing from equity and equity type), measures of intangible capital assets such as investment in R&D and innovation, and measures that allow tracking down foreign sourcing. The analysis can be carried out at the economy-wide, broad-sectoral and broad-regional levels with data broken down by all these dimensions. Country-specific econometric analysis In a background paper prepared for the development of the TCD present additional empirical evidence on the relation between total factor productivity, export performance, and foreign direct investment (FDI) inflows in 18 developing countries,b based on firm-level data from the World Bank Enterprise Surveys. Of particular value for use in the TCD are the country-level findings on the percentage contribution of groups of investment climate variables to export and FDI performance. This information indicates their relative importance in determining competitiveness. A comparison of the consolidated summary results for African countries and Latin American countries is shown in the chart. Although total factor productivity (TFP) is most important for both sets of countries, beyond that the factors vary considerably, exporting by firms in African countries is affected most by factors like power and internal bureaucracy, and Latin American firms are affected most by informality and bureaucracy at borders. Percent Absolute Contributions of Investment Climate Groups of Variables to the Probability of Exporting Africa Latin America TFP 21.58 TFP 18.08 power 9.36 informality 16.68 internal bur. 8.33 bur. at border 11.95 age 6.79 corp. gov. 9.06 corp. gov. 6.02 labor skills 6.70 bur. at border 5.79 transport 5.20 transport 5.45 IT 3.69 competition 4.88 capacity 3.55 IT 3.76 internal bur. 2.99 labor skills 3.64 competition 2.69 informality 3.50 power 2.55 firm size 2.89 innovation 2.54 security/crime 2.53 firm size 2.20 financing 2.04 age 1.73 openness 2.02 training 1.69 other 1.70 security/crime 1.58 capacity 1.50 access 1.36 industrial zone 1.36 financing 1.05 innovation 1.26 openness 0.98 corruption 1.15 other 0.90 access 0.95 quality 0.86 0.94 solvency 0.83 labor relations corruption 0.71 quality 0.86 labor relations 0.34 training 0.68 industrial zone 0.10 solvency 0.57 water 0.00 water 0.47 0 5 10 15 20 0 5 10 15 20 25 % contribution % contribution Sources: Authors; Escribano, Pena, and Reis 2010. Note: a. Ottaviano, Taglioni, and di Mauro 2007, 2009. b. Brazil, Chile, Columbia, Costa Rica, Arab Republic of Egypt, Guatemala, Honduras, India, Kenya, Malaysia, Mexico, Morocco, Nicaragua, Pakistan, Peru, Senegal, South Africa, and Turkey. 22 Trade Competitiveness Diagnostic Toolkit Table O.11. Summary of Key Analytical Tools for Desk-Based Analysis Analytical tools Role and comments Risks and shortcomings Qualitative analysis • Focus on learning from previous assessment • Qualitative analysis of secondary sources should of competitiveness factors always be confirmed through interviews • This should draw on secondary sources • Can be biased depending on the sources of (Country Strategy reports, CEMs, DTISs, information policy analyses, sector studies, etc.) from the • Risk that information and conclusions become World Bank, other IFIs, donors, obsolete quickly governments, etc. Census and survey data • Detailed firm-level data may be available to • Unlikely to be comparable across countries provide valuable time-series indications • Unavailable in most developing countries on factors contributing to competitiveness • Often data problems; require significant care (input costs, factor proportions, productivity, etc.) and cleaning of data Quantitative benchmarking • Given the relative nature of competitiveness, • Of limited use in identifying which constraints comparisons are an appropriate analytical tool are most binding and often fails to identify • Effective way to communicate performance links across components—treats issues in a nontechnical way individually • Helps not only to gauge performance but • Risk of irrelevant comparisons and risk of also to give parameters on the potential jumping to conclusions without controlling levels of improvement that are possible properly (critical to have an appropriate peer sample) Source: Authors. Note: CEM = Country Economic Memorandum; DTIS = Diagnostic Trade Integration Study; IFI = international financial institutions. of a product or small group of products. Moreover, the cost focus primarily on understanding existing challenges and time required to undertake value chain analysis will and process, as well as proposed policy changes; pri- not always be feasible or practical. In some cases, simply vate sector interviews should focus on identifying combining detailed interviews of firms and other stake- binding constraints and exploring how firms respond holders with the desk-based analysis can generate the to the competitiveness challenges and constraints insights needed to understand how identified constraints identified. affect competitiveness. • Communicate effectively in advance of the meeting: Module 2 of this Toolkit provides guides for conducting Provide a letter or e-mail outlining clearly the objectives interviews on each of the competitiveness components, and the issues to be covered in the discussion. including a list of potential interview targets. Following are • Ensure that the interviewee(s) is (are) the right person some suggestions and tips for planning and conducting (people): It is critical that interviewees are in fact the field interviews: people who are knowledgeable about the subjects to be discussed; ask specifically in advance communications • Recognize the crossover in topics: Particularly in inter- to ensure that certain people and positions are repre- views with the private sector, the same individuals may sented. need to be interviewed on more than one topic. Careful • Number of interview participants: For the purposes of planning is needed to ensure that organizations are not credibility, it is important to have people with specific contacted twice and that as many of the issues that need experience with and knowledge about the subjects to be to be covered are well integrated into a single interview discussed. But this needs to be balanced with keeping session. the team small enough not to overwhelm the intervie- • Plan to ensure a balanced sample: The sample frame wee(s) or to make the meeting inefficient. A team of two for interviews will need to balance public versus private to three members is usually ideal. sector versus other stakeholders; mix of sectors; firm • Clarify objectives up front: Restate the context, objec- sizes; local versus FDI firms; and so on. Ensuring that tives, and agenda for the meeting up front. the sample is relatively balanced is critical to avoid bias • Time expectations: Few interviewees will want to plan in the input received. for more than one hour. On the other hand, if they are • Different focus and strategy for public v private sector engaged in an interesting discussion, many will be meetings: Interviews with the public sector should happy to continue. Set some expectations upfront and Overview and Guidelines for Conducting a Trade Competitiveness Diagnostic 23 Table O.12. Main Data Sources for Competitiveness Diagnostics Desk Research Relevance by component Market Incentive Factor Trade Source/Location Description access framework inputs promotion World Trade Available online Precalculated indicators on ✓ ✓ ✓ Indicators (WTI) http://info.worldbank.org/ measures relating to tariffs etools/wti/1a.asp and other trade policy restrictions by country WITS – TRAINS Available online Detailed time-series data on ✓ ✓ ✓ database http://wits.worldbank.org/wits/ tariffs by product and trade (registration required) partner World Bank http://www.doingbusiness.org Comparative cross-country ✓ ✓ Doing Business indicators on investment climate characteristics World Bank http://www.enterprisesurveys Detailed firm-level data available ✓ ✓ Enterprise .org/ (registration required across most countries on Surveys for microdata) factors relating to investment climate World Economic http://gcr.weforum.org/ Comparative data on measures ✓ ✓ Forum Global gcr2010/ of competitiveness—includes Competitiveness hard data and perceptions Index from surveys ILO Key Indicators http://www.ilo.org/kilm Time-series data covering ✓ of the Labor 20 indicators of national labor Market markets International www.worldbank.org/data/ Cross-country comparative ✓ Comparison icp price data on a range of Program key inputs (at consumer level) Data Set ITU ICT Indicators http://www.itu.int/ITU-D/ict/ Time-series data across ✓ Database publications/world/world.html countries for 150 different telecommunication and ICT statistics World Bank http://go.worldbank.org/ Comparison of indicators of ✓ ✓ Logistics 88X6PU5GV0 perceived trade facilitation Performance and logistics environment Index across 155 countries UNCTAD FDI http://unctadstat.unctad.org Time-series data on FDI ✓ database flows by country and broad sectors WIPO Patent http://www.wipo.int/pctdb/en/ Time-series data on patent filings ✓ database WTO Trade Policy http://www.wto.org/english/ Reports (qualitative and ✓ Reviews tratop_e/tpr_e/tp_rep_e quantitative) assessing .htm#bycountry countries’ trade and investment policy environments Source: Authors. Note: FDI = foreign direct investment; ICT = information and communications technology; ILO = International Labour Organisation; ITU = International Telecommunications Union; UNCTAD = United Nations Conference on Trade and Development; WIPO = World Intellectual Property Organization; WTO = World Trade Organization. aim for something in the range of one to one-and-a-half Step 4: Analysis and Conclusions hours. Combining a number of the different quantitative and • Semi-structured approach: Use the communicated qualitative tools discussed in this section can allow the agenda as a guideline but focus on having an open- practitioner to identify the main elements connecting ended discussion rather than a question-and-answer supply-side factors to trade competitiveness. The specific session. An open-ended discussion is more likely to keep insights generated by each tool will contribute to increase the interviewee interested and provides greater scope the accuracy of the Diagnostics, narrowing down the for unscripted issues to be introduced. number of candidates to be identified as constraints for 24 Trade Competitiveness Diagnostic Toolkit Table O.13. Summary of Key Analytical Tools for the Assessment Analytical tools Comments Risks and shortcomings Semi-structured • This should be the core tool used in the data • Risk of “camels and hippos� scenario—that is, stakeholder collection process drawing conclusions from the people who are in the interviews • Selection of interview targets should be broad, market and excluding those who cannot or choose not covering all key stakeholders to operate • Should draw on a relatively standardized • Risk of biased input due to vested interests or biased questionnaire or discussion guide, but managed perceptions (critical to have broad sample) as a semi-structured discussion • Risk of obsolescence and volatility of response due to time-specific issues Surveys • In most cases, the TCD can take advantage of • Risk of “camels and hippos� scenario existing surveys undertaken by the World Bank • Risk of obsolescence and volatility of response due to Group, in particular the enterprise surveys, but time-specific issues additional business surveys may also need to be • If undertaking original surveys, sample selection is conducted as needed critical to avoid bias Value chain • Provides detailed quantitative and qualitative • Must be done at the product level analysis assessment of competitiveness from the • Resource-intensive approach perspective of an investor • Data often necessarily based on limited number of • Identifies constraints at the sector level, looking firms, so cost averages must be viewed cautiously at all activities from sourcing through all levels • Risk of obsolescence as conditions and cost structures of production, packaging, and delivery to can change quickly end markets Source: Authors. Table O.14. Illustrative Summary of Diagnostic Results Primary Product extension and quality Trade competitiveness challenges Secondary General export environment Market access Tariffs and quantitative restrictions — Preferential tariff arrangements + Standards and TBTs X Supply side: Incentive Macrofiscal environment — framework for trade Exchange rates — Trade and investment policy X Regulatory environment and governance X Competition — Supply side: factor Access to finance X inputs Scale economies + Labor regulations and skills XX Technical efficiency XX Land and infrastructure — Intermediate inputs — Services inputs — Trade facilitation and logistics X Trade promotion Standards and certification XX infrastructure Export and investment promotion — Innovation XX Special customs regimes and SEZs — Industry coordination bodies — Source: Authors. Note: SEZs = special economic zones; TBTs = technical barriers to trade. + positive impact on competitiveness Typical areas of focus based on primary trade — no major impact on competitiveness competitiveness challenges X some negative impact on competitiveness Typical areas of focus based on secondary trade competitiveness challenges XX significant negative impact on competitiveness Overview and Guidelines for Conducting a Trade Competitiveness Diagnostic 25 Box O.7. Value Chain Analysis A value chain describes the full range of activities that brings a product or service from its conception to its end use (and disposal), including design, the sourcing and transformation of raw materials, production, packaging, marketing, and distribution. At an industry level, it combines the industry supply chain with the concept of the value that is added in each step of the process. The value chain analysis framework centers around three major segments that describe each production link in the value chain: source, make, and deliver. Each activity mapped in the value chain diagram can be represented by a cost breakdown. In addition to mapping the value chain, a value chain analysis typically includes measurement of the chain’s performance, establishment of benchmarks (for example, of cost, time, and quality relative to other countries), and, finally, analysis of the performance gaps and the factors that contribute to them. Example: Apparel Value Chain Research & Value-Adding Development Design Production Logistics Marketing Services Activities Raw Materials Textiles Final Products Distribution & Sales Markets MARKET Natural & Yarn & Distribution Apparel Supply MARKET Synthetic Fabric & Production Chain Fibers Production Sales MARKET Business, Education, Trade & Infrastructure Government Information, NGOs & Testing, & Professional & Finance Services Technology Standards Training Associations Services Supporting Environment In a diagnostic focusing on a specific sector (for example, apparel as outlined above), value chain analysis could cover core components of the diagnostic, including all aspects of factor inputs and factory-gate competitiveness, transport and trade facilitation, standards and certification, and parts of the internal and external trade policy environment. This would be supported by other tools (for example, standard interviews and textual analysis) to analyze aspects of the incentive framework and the trade promotion environment. Sources: Gereffi and Frederick 2010; World Bank 2009b. trade competitiveness. Although the intention is to avoid a One way to identify the relative importance of the laundry list of policy areas to be addressed, it may not be constraints is to combine the findings from the first and possible to arrive at a simple diagnosis, let alone to identify second stages of the TCD to identify areas of weak com- a single binding constraint. The use of different tools may petitiveness performance in factors that typically mat- well suggest different conclusions at some points of diag- ter most for the competitiveness challenges identified nostic. This is unavoidable, and the only way to address this in the Trade Outcomes Analysis. In the example shown in problem is through the judgment of the practitioner. table O.14, the Trade Outcomes Analysis identified the Therefore, the team doing the final analysis should include primary competitiveness challenge to be product a combination of trade expertise, subject expertise (some- related, particularly in terms of quality upgrading, with one who will have seen it all before in a different context), a secondary challenge related to the dynamics of export and most important, country expertise (someone who has entry and survival. The example country is performing an in-depth understanding of the local context). particularly poorly on several components that typically 26 Trade Competitiveness Diagnostic Toolkit determine competitiveness along these dimensions, With the primary issues identified, the practitioner can specifically in labor regulations and skills, technical effi- move on to consider the potential policy responses to the ciency, standards, and innovation. main competitiveness constraints. Note: Module 2 of this Toolkit includes a detailed implementation guide on each component of the Competitiveness Diagnostic, covering its relevance to competitiveness and how to measure it, as well as interview guides. Module 3 Summary: Moving from Analysis Stakeholder Consultation and Workshop to Policy Options As part of the process of moving to policy recommenda- Once the main constraints are identified through the Com- tions, the team conducting the TCD should consider petitiveness Diagnostics, the next step is to translate these including some process of stakeholder review and consul- constraints into policy and technical assistance projects tation. This may include not only individual consultations that address the specific constraints. Policy is complex and with key individuals but also a wider stakeholder work- almost always context dependent. Therefore, it is not realis- shop. The workshop could be a half-day or one-day meet- tic to merely outline a detailed set of prescriptions linked to ing during which the main findings are presented and dis- each of the possible constraints that may be identified cussed. The stakeholder workshop is designed to test the through the Diagnostics. results from the analysis as well as some the policies and projects being proposed. The stakeholder workshop Identifying Policy Remedies and Project Components should ideally be held only after a draft final report has Table O.15 presents an overview of broad policy areas linked been reviewed and endorsed by the steering committee (if to each main component of the Competitiveness Diagnos- there is one). Results from the stakeholder workshop tics. The table references the relevant page numbers in mod- should then be incorporated into the final report and pol- ule 3 of the of Toolkit where the practitioner can find more icy recommendations. details on potential policy measures and project components. Table O.15. Summary of Broad Policy Areas Linked to Diagnostic Components Market Supply side: Supply side: Trade promotion Broad policy areas access incentive framework factor inputs infrastructure Page Market access ✓ 163 Trade policy ✓ ✓ ✓ ✓ 164 Investment policy ✓ ✓ ✓ 164 Business environment, governance and institutional policy ✓ 167, 169 Competition policy ✓ ✓ 167 Labor markets and skills ✓ 172 Intermediate inputs ✓ 174 Infrastructure and energy ✓ 174 Transport and logistics policy ✓ 175 Investment and export promotion policy ✓ ✓ 177 Standards ✓ ✓ ✓ 181 Sector and spatial policy ✓ ✓ 183, 184 Science and innovation policy ✓ 186 Source: Authors. Note: Module 3 of the Toolkit provides more details to assist in thinking about policy options, including the following: • Brief summaries of potential policy remedies and technical assistance project components that may be relevant to the specific issues identified; and • Case studies of good policy practice from developing countries. Overview and Guidelines for Conducting a Trade Competitiveness Diagnostic 27 Notes Harrison, A., and A. RodrÌguez-Clare. 2009. Trade, Foreign Investment, and Industrial Policy for Developing Countries. Cambridge, MA: 1. Trade share is affected significantly by factors unrelated to compet- National Bureau for Economic Research. itiveness, including natural endowments and, most important, country Hausmann, R., J. Hwang, and D. Rodrik. 2007. “What You Export Mat- size and geographic location. This explains, for example, the large gap in ters.� Journal of Economic Growth 12: 1–25. traded shares of Germany’s economy versus that of the United States. Hausmann, R., and D. Rodrik. 2002. “Economic Development as Self Dis- 2. See, among others, Caballero, Engel, and Micco (2004) and covery.� CEPR Discussion Papers 3356, Centre for Economic Policy Caballero, Cowan, Engel, and Micco (2004) for a discussion of the role of and Research, London. microeconomic flexibility on productivity growth in Latin America and Imbs, J., and R. Wacziarg. 2003. “Stages of Diversification.� American Eco- in Chile in the end of the 1990s. nomic Review. 93 (1): 63–86. 3. For example, the World Economic Forum’s Global Competitiveness Klinger, B., and D. Lederman. 2006. “Diversification, Innovation, and Imi- Index (World Economic Forum 2008) covers 12 “pillars� of competitive- tation Inside the Global Technological Frontier.� Policy Research ness, ranging from microlevel business sophistication to such broad Working Paper Series 3872, World Bank, Washington, DC. factors as macroeconomic stability and health and primary education. Klinger, B., and D. Lederman. 2004. “Discovery and Development: An Although these issues no doubt all play a role in determining economy- Empirical Exploration of ‘New’ Products.� World Bank, Washington, wide and firm-level competitiveness over the long run, in the case of the DC. TCD, we focus on the issues that affect the trade sector directly and in the Lederman, D., and W. Maloney. 2007. Natural Resources: Neither Curse short to medium term. Nor Destiny. Washington, DC: World Bank and Stanford University Press. Mattoo, A., and A. Subramanian. 2009. “Criss-Crossing Globalization: References Uphill Flows of Skill-Intensive Goods and Foreign Direct Investment.� Policy Research Working Paper Series 5047, World Bank, Washington, Bernard, A., J. Bradford, J. Redding, J. Stephen, and P. Schott. 2007. “Firms DC. in International Trade.� CEPR Discussion Papers 6277, Centre for Melitz, M. J. 2003. “The Impact of Trade on Intra-Industry Reallocations Economic Policy and Research, London. and Aggregate Industry Productivity.� Econometrica 71 (6): 1695–1725. Bernard, A. B., and J. B. Jensen. 1999. “Exporting and Productivity.� NBER Melitz, M., and G. I. P. Ottaviano. 2008. “Market Size, Trade, and Produc- Working Paper No. 7135, National Bureau of Economic Research, tivity.� Review of Economic Studies 75 (1): 295–316. Cambridge, MA. Ottaviano, G. I. P., D. Taglioni, and F. di Mauro. 2009. “The Euro and the Brenton, P., and R. Newfarmer. 2009. “Watching More Than the Discovery Competitiveness of European Firms.� Economic Policy, 24 (57): 5–53. Channel to Diversify Exports.� In Breaking into New Markets: Emerg- Ottaviano, G. I. P., D. Taglioni, and F. di Mauro. 2007. “Deeper, Wider and ing Lesson for Export Diversification, eds. R. Newfarmer, W. Shaw, and More Competitive? Monetary Integration, Eastern Enlargement and P. Walkenhorst, 111–126. Washington, DC: World Bank. Competitiveness in the European Union.� ECB Working Paper No. Caballero, R. J., E. Engel, and A. Micco. 2004. “Microeconomic Flexibility 847, European Central Bank, Frankfurt. in Latin America.� NBER Working Paper No. 10398, National Bureau Rodrik, D. 2006. “What’s So Special about China’s Exports?� China and of Economic Research, Cambridge, MA. World Economy 14: 1–19. Caballero, R. J., K. N. Cowan, E. Engel, and A. Micco. 2004. “Effective Labor Sachs, J. D. 2005. The End of Poverty. New York: Penguin Press. Regulation and Microeconomic Flexibility.� NBER Working Papers Sachs, J. D., and A. Warner. 1999. “The big push, natural resource booms 10744, National Bureau of Economic Research, Cambridge, MA. and growth.� Journal of Development Economics 59 (1): 43–76, June. Cadot, O., C. Carrére, and V. Strauss-Kahn. 2011. “Trade Diversification: Sachs, J. D. and A. Warner. 1995. “Economic Reform and the Process of Drivers and Impacts.� In Trade and Employment: From Myths to Facts, Global Integration.� Brookings Papers on Economic Activity 1995(1): eds. M. Jansen, R. Peters, and J.M. Salazar-Xirinachs, 253–283. 1–118. Geneva: ILO. Schott, P. 2004. “Across Product versus Within Product Specialization in Cadot, O., L. Iacovone, D. Pierola, and F. Rauch. 2011. “Success and Failure International Trade.� Quarterly Journal of Economics 119, no. 2 (May): of African Exporters.� Policy Research Working Paper Series 5657, 646–677. World Bank, Washington, DC. WEF (World Economic Forum). 2008. The Global Competitiveness Report Del Gatto, M., G. Mion, and G. I. P. Ottaviano. 2006. “Trade Integration, 2008–2009. www.weforum.org. Firm Selection and the Costs of non-Europe.� CEPR Discussion World Bank. 2011c. World Development Indicators. Washington, DC: Papers 5730, Centre for Economic Policy and Research, London. World Bank. Eichengreen, B. 2011. “Managing Openness: Lessons from the Crisis for World Bank. 2009b. Clusters for Competitiveness: A Practical Guide and Emerging Markets.� In Managing Openness: Trade and Outward- Policy Implications for Developing Cluster Initiatives. Washington, DC: Oriented Growth After the Crisis, ed. M. Haddad and B. Shepherd, International Trade Department, World Bank. 11–26. Washington, DC: World Bank. World Bank. 2009d. “Lessons for Reformers: How to Launch, Imple- Escribano, A., J. Pena, and J. G. Reis. 2010. “Trade Competitiveness and the ment, and Sustain Regulatory Reform.� World Bank, Washington, Investment Climate: An International Comparison,� Mimeo, World DC. Bank, Washington, DC. World Bank. 2011d. Leveraging Trade for Development and Inclusive Gereffi, G., and S. Frederick. 2010. “Global Apparel Value China, Growth: The World Bank Group Trade Strategy, 2011–2021. June 10, Trade, and the Crisis: Challenges and Opportunities for Develop- 2011. Washington, DC: World Bank. ing Countries.� Policy Research Working Paper No. 5281, World Xu, B. 2010. “The sophistication of exports: Is China special?� China Bank, Washington, DC. Economic Review 21: 482–493. Module 1 Trade Outcomes Analysis Growth and Share: The Intensive Margin curve is an ordinary least squares (OLS) regression line of Trade Openness the trade-to-GDP ratio on the log of GDP per capita as well as its squared value. This curve reflects a stylized fact that Indicators Summary of data needs and sources countries tend to trade more, relative to nominal GDP, as Trade-to-gross Collect variables as follows for specific domestic product years for all countries: total export and their per capita incomes rise, but they do so at a decreasing (GDP) ratio; import of goods and services, GDP per rate. When trade is divided by real GDP in PPP terms (and Adjusted capita, and population (World not nominal GDP), the relationship is slightly different trade-to-GDP Development Indicators database); ratio remoteness calculated from GDP and because real openness corrects for distortions created when bilateral distance data from CEPII; cost nontraded goods are priced differently across countries of inland trade from Doing Business report. Run a cross-country regression. (Alcala and Ciccone 2004). It can also be valuable to look at the changes in trade openness over time to assess the rela- tive degree to which a country has integrated into global The trade-to-gross domestic product (GDP) ratio is one of markets. For example, as shown in figure 1.1, panel B, the most basic indicators of openness to foreign trade and although Pakistan’s trade openness has remained stagnant economic integration. It weighs the combined importance in the past decade, countries like China, India, and Viet- of exports and imports of goods and services in an econ- nam have experienced remarkable growth in integration. omy. The ratio gives an indication of the dependence of It is difficult to say whether a country’s ratio is low or domestic producers on foreign demand and of domestic high without putting other characteristics in context. All consumers and producers on foreign supply. A narrower else equal, large countries in terms of geography and pop- measure of the ratio of exports to GDP is also used to ulation tend to have a lower trade-to-GDP ratio than assess the general acceptability of home commodities at smaller countries because they have the option of under- competitive prices and standards in foreign markets. How- taking a bigger share of trade within their borders. The ever, because imported inputs can play a big role in the suc- large countries to the right of the global median income, cess of exports, a combined look at imports and exports is such as Brazil and the United States, trade less than what common. Furthermore, a measure of real outward orienta- would be predicted for countries at their level of income tion has been suggested to adjust export-to-trade ratios per person; small-size rich countries, such as Belgium and with the imported input share by industry (UNCTAD the Netherlands, trade much more than would be expected 2009). This reflects how secure an export industry is not for countries at their level of income. only to changes in sales prices but also to exchange rate But income is not the only determinant of a country’s fluctuations. The intensive data requirements, however, openness. Structural characteristics such as population and mean that this measure is not commonly used. geography greatly matter as well. All else equal, landlocked Figure 1.1, panels A and B, show scatter plots of aver- countries are more disadvantaged to trade than countries aged trade-to-GDP ratios from 1996 to 1998 and from with access to the sea. A better measure of what a country 2006 to 2008 against the log of GDP per capita in purchas- can be expected to trade given its structural characteristics ing power parity (PPP; constant international dollars). The can be obtained from a parametric analysis of trade-to- broken line indicates the world median income, and the GDP ratios regressed on GDP per capita, population, 29 30 Module 1: Trade Outcomes Analysis Figure 1.1. Openness to Trade remoteness, and a measure for general cost of trading Module 1 (which is correlated with being landlocked). Panel A. 1996–98 In table 1.1, the predicted trade ratios (columns 2 to 5) Openness to trade 1996–98 differ substantially from the actual trade ratio (column 1) 250 depending on the specification used. Column 2 is a trade to GDP (%), 1996–98 predicted trade ratio when the actual trade ratio is 200 regressed on per capita income. For a country at its level of per capita income, Liberia appears to be much more inte- 150 BEL grated than its peers. Burundi’s actual trade ratio is NLD 100 PRY slightly lower than what is predicted; yet when the square VNM CRI of the log of per capita income is included as an additional LBR GBR 50 ZMB DEU regressor (column 3), the predicted trade ratio for UGA PAK CHN AUS BDI IND USA Burundi is identical to its observed ratio. When popula- BRA 0 tion and the cost of trading1 are included as additional 6 7 8 9 10 11 regressors (column 4), the gap between actual and pre- log of GDP per capita (PPP, average 1996–98) dicted trade ratios narrows, confirming that large coun- tries like India and the United States rely more on domes- Panel B. 2006–08 tic trade. When remoteness is added as a regressor Openness to trade 2006–08 250 (column 5), the predicted trade ratio of remote2 countries like Australia is closer to the actual ratio. Even after adjust- trade to GDP (%), 2006–08 200 ing the trade ratio to take account of additional character- BEL istics, larger countries tend to trade less than smaller VNM 150 NLD countries relative to the size of their economy. LBR PRY Figure 1.2 reflects the adjusted openness for some land- 100 CRI DEU locked countries. The ratios are residuals of the regression ZMB CHN BDI in column 5 for two time periods 10 years apart (1996–98 GBR 50 UGA IND AUS PAK BRA USA and 2006–08). Negative residuals mean that even after 0 controlling for a country’s structural characteristics, it 6 7 8 9 10 11 trades less than predicted. Figure 1.2 shows that over the log of GDP per capita (PPP, average 2006–08) past decade, Bolivia and Uganda have both narrowed their “undertrading�, while Zambia and Paraguay remain Source: Authors. Note: GDP = gross domestic product; PPP = purchasing power parity; vibrant traders. And while Bhutan has increased its CHN = China; IND = India; PAK = Pakistan; VNM = Vietnam; BEL = Belgium; adjusted openness substantially over the past decade, NLD = Netherlands; DEU = Germany; GBR = Great Britain; AUS = Australia; USA = United States. Nepal has seen its level of integration shrink dramatically. Table 1.1. Adjusted Trade Openness Ratios, 2006–08 (1) (2) (3) (4) (5) Actual Potential Potential Potential Potential trade/GDP trade I/GDP trade II/GDP trade III/GDP trade IV/GDP Liberia 114.5 68.2 57.6 70.4 71.3 Burundi 57.7 68.2 57.7 57.5 54.7 China 70.3 88.4 91.4 55.9 50.9 United States 28.2 104.6 99.5 64.7 52.7 India 49.2 83.4 85.5 50.9 48.4 Australia 42.6 102.6 99.4 88.7 69.0 Source: Values in column 1 from World Bank 2011c; values in columns 2–5 obtained from regression analysis. Note: GDP = gross domestic product. Growth and Share: The Intensive Margin 31 Trends in Trade Growth Figure 1.3. Analyzing Broad Trends in Trade Growth, Module 1 Indonesia, 1990–2008 Summary of data needs Indicators and sources Panel A. Growth rate of total exports Evolution of export Data from World Development volumes, annual Indicators database; Growth rate of total exports growth, and trade basic calculations and plots. Indonesia, 1990–2008 150 40 total exports (US$ billion) share in GDP annual growth rate (%) 20 100 One of the first indicators of export orientation is to begin by looking at the broad trend in growth of trade over 0 the past 15 to 20 years. How has total exports (of goods and 50 –20 services) grown? Is growth sustained? In Figure 1.3, panel A, Indonesia’s growth of total exports (in nominal US dol- 0 –40 lars) is seen to have grown from under US$30 billion in 1990 1995 2000 2005 2010 1990 to more than US$150 billion in 2008. Growth has year been steady and impressive, except during the aftermath of export value (US$ billion) growth of exports the 1997–98 Asian financial crisis as well as a smaller dip Panel B. Share of merchandise trade in GDP after 2001. Share of merchandise trade in GDP In figure 1.3, panel B, the share of merchandise exports 100 Indonesia and Peers, 1990–2008 and imports in GDP are plotted for Indonesia and an aggre- gate category of lower-middle income countries to which it 80 share (%) belongs. As countries become richer over time, they trade more. This is confirmed by the lower-middle-income coun- 60 try aggregate whose volume of goods trade, relative to the 40 economy, rose from 35 percent in 1990 to 60 percent in 2008. The corresponding share of goods trade for Indonesia 20 falls within this range, between 41 to 52 percent over the 1990 1995 2000 2005 2010 period but GDP shrank during the Asian crisis elevating the year share of goods trade to “abnormal� levels between 1998 Indonesia lower-middle-income countries and 2001. The growth of constituent product categories Source: Authors. within goods exports is covered in the next subsection (composition of exports); notably, many low-income countries depend on a narrow range of commodity exports. In such export growth is driven by rising world prices for such com- cases, the analyst should decompose the extent to which modities versus an increase in output. Composition of Exports (Goods and Services), Revealed Figure 1.2. Adjusted Trade Openness—Examples Comparative Advantage, and Trade Integration 26.8 Summary of data needs 30 22.7 Indicators and sources 20 Total exports (U.S. dollars) Disaggregate overall export by each (disaggregated) figures (from WITS) into 10 4.54.4 6.9 2.9 sector, and its share in meaningful categories, such 0 total exports as that proposed by Hanson Revealed comparative (2010) or Leamer (1984); –10 –9.0 advantage (RCA) of calculate RCA and changes –11.3 each sector for comparison between two –20 –13.6 Compound annual growth time periods; share of trade –23.5 –21.9 rate in exports over a in parts and components –30 –25.4 period of 5 to 10 years can be calculated by coding ay da a an ia al bi liv ep gu Real export per capita ut an Comtrade categories as m Bo N Bh ra Ug Za Share of parts and being either ‘final goods’ or Pa 1996–98 2006–08 components in ‘parts and components’ manufactured exports as per Athukorala and Grubel-Lloyd Index Menon (2010). Source: Authors. 32 Module 1: Trade Outcomes Analysis Table 1.2. Annual Growth Rates and Share of Services Exports, 1998–2008 Module 1 Average growth rate in Average growth rate in Share of services in Share of services in services exports, 1998–08 goods exports, 1998–08 total exports, 2008 total exports, 1998 East Asia and Pacific 17.31 17.73 11.44 11.80 Europe and Central Asia 9.58 19.92 13.84 28.37 Latin America and Caribbean 7.88 12.08 11.86 16.47 South Asia 17.29 15.66 27.61 24.91 Sub-Saharan Africa 8.92 16.58 11.26 20.02 Source: Computed from data in WDI (World Bank 2011c). Export Composition Table 1.2 reports similar growth rates as well as the share of services exports in total exports for five developing To assess how a country’s exports have performed, it is use- regions of the world. ful to compare the changing shares of export by industries In table 1.3, merchandise exports are clustered across over time. Ideally, this is to be done for both goods and serv- industries, following Hanson (2010), that share similar fac- ices. Reliability of cross-country data for export of services tor intensities and are likely to rely on similar technological is poor, however. For an indicative exercise, table 1.2 com- or institutional foundations as a basis for production. For putes the compound annual growth rate of exports in both example, the first sector includes land-intensive activities services and goods between 1998 and 2008 for five develop- surrounding agricultural production; the second includes ing regions of the world as well as selected countries. The manufacturing activities that use agriculture, forestry, and data on services exports are calculated by subtracting mer- other land-intensive inputs.4 chandise exports from combined export of goods and serv- ices in the World Development Indicators (WDI) database.3 However, the export-related data in WDI reflect figures Revealed Comparative Advantage reported by the exporting countries themselves—that is, In table 1.3, columns 1 and 4 state the total value of exports they are not based on mirror data. Therefore, the quality of by sector (in nominal terms) across two periods (2000 and the data must be viewed with some suspicion. 2008, for Costa Rica in this example). When divided by Figure 1.4 illustrates the growth rate in nominal US population and expressed in real terms, exports per capita dollars of the expansion in the exports of merchandise goods can be a good indicator to judge how successful a country and services for some countries. India’s annual growth rate in has been in facing international competition. Columns 2 services between 1998 and 2008 was higher than its growth and 5 indicate the share of those export sectors in the two rate for goods, whereas the reverse is true for China. time periods that, when divided by the world share of those sectors in total world exports, gives the RCA in columns 3 Figure 1.4. Compound Annual Growth Rate (%) of Goods and 6.5 and Services Exports, 1998–2008 x ik Xi Senegal 9.46 RCAik = (1.1) 7.87 x wk Xw 10.87 Morocco 16.98 An RCA index above 1.0 indicates that a country’s share India 18.27 of exports in a sector exceeds the global export share of the 20.49 same product. Because high export volumes can result 5.79 from subsidies or other incentives provided, including Costa Rica 12.77 undervalued exchange rates, RCAs have been argued to be a misnomer in the sense that they are a better measure of 22.76 China competitiveness than comparative advantage (Siggel 2006). 20.51 Table 1.3, column 7, shows the annual average of the goods services growth rate of export sectors. Column 8 captures the Source: Authors. change in Costa Rica’s share of each sector in the world Table 1.3. Change in Costa Rica’s Shares of Exports, 2000–08 Panel A. Shares of goods exports (1) (2) (3) (4) (5) (6) (7) (8) Exports 2000 Share 2000 Exports 2008 Share 2008 Aggregate Sectors (US$ ‘000) (%) RCA 2000 (US$ ‘000) (%) RCA 2008 (%) Competitiveness 1 Agriculture, meat and dairy, seafood (HS 1–10, 12–14) 2,110,849 29.55 7.05 4,164,910 24.4 6.05 7.03 –0.0056 2 Food, beverages, tobacco, wood, paper (HS 11, 15–24, 44-48) 538,538 7.54 1.18 1,261,659 7.38 1.31 8.89 0.0007 3 Extractive industries (HS 25–27, 68–71) 117,777 1.65 0.12 213,379 1.25 0.06 6.12 –0.0010 4 Chemicals, plastics, rubber (HS 28–36, 38–40) 365,840 5.12 0.44 867,462 5.07 0.39 9.02 –0.0008 5 Textiles, apparel, leather, footwear (HS 41–42, 50–65) 943,280 13.21 1.77 426,861 2.50 0.50 –7.62 –0.0111 6 Iron, steel, and other metals (HS 26, 72–83) 118,069 1.65 0.24 391,492 2.29 0.23 12.74 –0.0001 7 Machinery, electronics, transportation equipment (HS 84–89) 2,693,129 37.70 0.90 8,566,144 50.09 1.46 12.27 0.0256 8 Other industries (HS 37, 43, 49, 66–67, 90–97) 255,563 3.58 0.51 1,219,026 7.13 1.20 16.91 0.0054 Source: Computed using mirror data in Comtrade. Panel B. Shares of services exports (1) (2) (3) (4) (5) (6) (7) (8) Exports 2000 Share 2000 Exports 2008 Share 2008 Aggregate Sector (US$ ‘000) (%) RCA 2000 (US$ ‘000) (%) RCA 2008 (%) Competitiveness 1 Services 1,940,271 25 1.28 4,034,862 29.66 1.43 9.58 — Source: Computed using data in WDI (World Bank 2011c). Note: — = not available. 33 Module 1 34 Module 1: Trade Outcomes Analysis Figure 1.5. Change in Costa Rica’s RCA, 2000–08 Module 1 textiles, apparel, leather other industries machinery, electronics iron, steel, and other metals food, beverages, tobacco, wood extractive industries chemicals, plastics, rubber agriculture 0 1 2 3 4 5 6 7 8 RCA_08 RCA_00 Source: Authors. multiplied by the share of world exports for each sector in transport equipment) and 8 (miscellaneous manufactur- total world exports in the initial year (2000). This is one of ing), requires a much-detailed analysis at the country level. several ways to measure competitiveness. To trace the pattern of trade flow between countries, Ideally, table 1.3, panels A and B, would be merged to Athukorala and Menon (2010) and Athukorala (2010) treat goods and services exports (as well as their con- extract products at the SITC five-digit level that are “parts stituents) in a comparable manner so that a shift in the econ- and components� and not final manufactured goods. They omy from goods to services or vice versa could be tracked. reach a policy conclusion that trade in parts and compo- When sources of data are different, however, they will not be nents is less sensitive to relative price changes; therefore, the comparable with precision. Here, goods data is collected exchange rate is likely to be less effective in balance of pay- from mirrored statistics in Comtrade, whereas services data ments adjustment in countries that rely heavily on trade of is from balance of payments statistics in WDI. Despite this parts and components.6 caveat, it is not difficult to see that services exports are To explore the extent to which countries play a role in becoming more important in Costa Rica, with an increase in global production networks, trade data could be regrouped revealed comparative advantage (RCA) over eight years. into components and final goods, and the evolution of In goods exports between 2000 and 2008, we note two export and import shares charted over time. An assessment major structural changes: (1) the absolute value as well as of parts and components is also important to determine the national and global share of textiles, apparel, leather, whether the level of sophistication of a country’s export and footwear (sector 5) dropped significantly; and (2) the basket as judged by looking at final goods is illusory. In share of machinery, electronics, and related manufacturing 2006–08, according to WDI, countries with the largest share (sectors 7 and 8) expanded significantly. These changes are of high-tech goods in total manufactured exports included confirmed by the changing values of RCA (see figure 1.5). the China, Costa Rica, Côte d’Ivoire, Cuba, Gabon, the The country remains competitive in the agricultural sector Philippines, and Thailand alongside Ireland, the Republic of as well as agribusiness (sectors 1 and 2). It therefore Korea, the Netherlands, Singapore, and the United States. appears to have a dual competitive presence in sophisti- Some of these countries contribute only to the final assem- cated goods, such as electronics and some machinery, as bly of high-value intermediate inputs made in other coun- well as in primary goods. tries. When it is difficult to trace and assign value added to different phases of production, it is instructive to look at the share of parts and components in exports and imports. Ris- Trade Integration ing imports of parts and components indicate a country’s When analyzing export composition of manufactured trade, increased assembly activity, whereas a rise in their export it is now increasingly important to distinguish between trade suggests its growing importance in the global supply chain. in final goods and trade in parts and components. The Trade in components offers opportunities to less-developed expansion of global production sharing over the past two countries to specialize in niches rather than an entire decades, especially in the SITC categories 7 (machinery and production chain. But competitiveness in this form of trade Growth and Share: The Intensive Margin 35 requires a mix of policy openness, low wages, and good this, the Southeast Asian trade bloc (the Association of Module 1 infrastructure, what Golub, Jones, and Kierzkowski (2007) Southeast Asian Nations [ASEAN]) performs a much term “service links�. higher share of intraregional intraindustry trade than any As shown in figure 1.6, the share of parts and compo- other trade bloc in the developing world (Brülhart 2008). nents in total manufactured exports at the HS six-digit level (excluding agricultural and extractive industries) for China rose from 19 percent to nearly 32 percent between ∑ E −M i i 1998 and 2008. China remains a big consumer of parts and GLI = 1 − i ∑E +M (1.2) components as it continues to have a large role in the final i i i assembly of goods, but it is also increasing its share of the production of intermediate parts and components, which Market Share usually have high capital content. Despite the suggestion that Vietnam has been a laggard in global production shar- Indicators Summary of data needs and sources ing, unlike other East Asian countries, its share has Overall market Data from Comtrade (WITS) on market shares share; relative of key importers by relevant market at improved because of distorted foreign direct investment share growth disaggregated product level (six digit); (FDI) priorities in the 1990s.7 Its share of parts and com- scatterplots on Stata. ponents in nonagricultural goods exports more than dou- bled from 5 percent to almost 11 percent in a decade. India’s export of parts and components is also rising, albeit A standard definition of export competitiveness, popular- from a lower base than China’s. ized by the OECD, is the degree to which, under open market In the absence of detailed data on parts and compo- conditions, a country can produce goods and services that nents, one could also compute the Grubel-Lloyd Index meet the test of foreign competition while simultaneously (GLI) to measure the scale of intra-industry trade. In sector maintaining and expanding domestic real income. One way i, E and M are values of exports and imports, respectively. A to measure this is a country’s share in world exports over GLI of one indicates maximum intra-industry trade and a time. In 2002, China’s exports constituted 4.9 percent of the GLI of zero indicates the presence of only interindustry world total compared with the United States’ 10.2 percent. In trade. This index is relevant for countries seeking to diver- 2008, China’s share had risen to 8.8 percent whereas that of sify exports not across industries but rather within an the United States had fallen to 7.7 percent. In absolute terms, industry. One purpose of bilateral or regional trade agree- the exports of the United States did not fall, but China’s ments (BTAs or RTAs) is to enhance competitiveness by expanded rapidly. These ratios portray a country’s depth of taking advantage of regional markets and supply chains. In integration in the world economy, but to know what prod- ucts constitute those trade baskets, the figures need to be dis- aggregated by sector. Indeed, measuring market share by specific sectors and Figure 1.6. Share of Parts and Components in specific products provides a good measure of performance Manufacturing Exportsa for Selected Countries of a country’s exports over time. This must be taken in con- text with growth, however. For example, many countries 35 31.6 have experienced fairly robust growth in exports in manu- 30 facturing sectors but still show declining market share per- 25 formance over the past decade, as a result of the huge 20 19.3 growth in China’s market share. Figure 1.7 illustrates one 15 13.3 way to analyze a country’s market share performance—that 10.8 is, by looking at relative performance against a specific 10 9.4 5.0 competitor (in this example, analyzing Indonesia’s market 5 share performance versus China in the European Union, 0 for a range of manufacturing products). The graph in fig- a a am in di ure 1.7 is split in four quadrants: those in the upper right Ch In tn e Vi 1998 2008 indicate market share gains for both Indonesia and China over the decade; those in the lower right indicate gains for Source: Computed from data in Comtrade and coding of parts and Indonesia and losses for China; the upper left shows gains components from Athukorala (2010). Note: a. Excludes HS chapters 1–24, 44–48, 25–27, 68–69 and 71. for China and losses for Indonesia; the lower left shows 36 Module 1: Trade Outcomes Analysis Figure 1.7. Market Share for Selected Manufacturing simply nearby. Figure 1.9 applies a gravity model for Sene- Module 1 Products: Indonesia versus China in the European Union, gal to assess if Senegal trades as would be predicted with 2000–08 potentially important partners. It plots actual export amounts (divided by 1,000 and then converted to log)8 Sectoral growth of EU-25 import share, 2000–08 (% pt) earned in those markets against amounts that were pre- 100 dicted by a regression model described in box 1.1. It is apparent that Senegal trades less than would be expected sectional import share from with notably large countries like the Brazil, China, Ger- CHN, 2000–10 (% pt) 50 many, and the United States (located above the 45-degree line), and has a stronger export relationship with India, 0 Italy, Mali, and Spain. Its trade with Côte d’Ivoire and France is inline with predictions of the gravity model. –50 Figure 1.8. Change in Morocco’s Exports by Destination, 2000–08 –100 –30 –20 –10 0 10 20 sectional import share from IDN, 2000–10 (% pt) 80 75.3 70 Source: Authors. 58.7 Note: IDN = Indonesia. 60 losses for both. As the figure illustrates, the majority of 50 products show market share gains for China and losses for 40 Indonesia. 30 22.5 20 13.9 Trade partners 11.1 10 6.4 3.8 1.1 3.4 3.9 Summary of data needs and 0 Indicators sources IC 5 n A r he -2 pa US BR ot EU Ja Difference between Trade data from WITS; gross predicted and actual domestic product–related exports to individual variables from World share in 2000 share in 2008 partners obtained from a Development Indicators; gravity- Source: Authors. theory-grounded gravity related variables from CEPII; Note: BRIC = Brazil, Russia, India, and China. model regression run on Stata Trade Intensity Index following precise technical Trade Complementarities steps as per Helpman, Melitz, Figure 1.9. Example of Gravity Model Analysis of Senegal’s Index and Rubinstein (2008). Bilateral Trade Senegal’s trading partners Where do a country’s exports go? How has the share of predicted v actual exports exports in a particular market changed over time? A simple 14 analysis of change in market share of a country’s total log of predicted exports, 2008 exports by destination can reveal trends in the country’s 12 GIN FRA dynamism in its ability to reorient or diversify exports. In BRA CIV MLI figure 1.8 for Morocco, it can be seen that the European MAR ESP 10 USA DEU GMBGBR ITA Union remains the most important trading partner. The CHN NGA JPN RUS IND share, however, has declined from 75 to 59 percent over eight ZAF ARG PRT 8 AUS KOR years. Exports have been reoriented substantially toward GHA EGY higher growth markets, like BRIC (Brazil, Russia, India, and China), whose share grew from 6 percent to 14 percent 6 6 8 10 12 14 between 2000 and 2008. Other major growth destinations log of actual exports, 2008 have included Mexico, Pakistan, and Saudi Arabia. The increase in the US market is modest despite the presence of a Source: Authors. Note: AUS = Australia; ARG = Argentina; BRA = Brazil; CHN = China; CIV = bilateral trade agreement. Cote d'ivoire; DEU = Germany; EGY = Egypt; ESP = Spain; FRA = France; Gravity models can be used for a more disaggregated GBR = United Kingdom; GHA = Ghana; GIN = Guinea; GMB = Gambia; IND = India; ITA = Italy; JPN = Japan; KOR = Korea, Republic of; MAR = analysis of areas where more exports ought to be going, for Morocco; MLI = Mali; NGA = Nigeria; PRT = Portugal; RUS = Russian example, destinations that are large or rich or growing, or Federation; USA = United States; ZAF = South Africa. Growth and Share: The Intensive Margin 37 Module 1 Box 1.1. Gravity Models Gravity in economics is one of the field’s most successful empirical models. First applied by Dutch economist and Nobel Laureate Jan Tinbergen (1962), it asserts that two large economic clusters interact more with each other than smaller ones, and nearby clusters attract each other more than far-off ones.a In trade, the gravity model presumes that distance (proxying for actual shipping cost, policy barriers, and informational asymmetry) and mass (gross domestic products [GDPs] of exporting and importing countries) explain a large share of bilateral trade. One can gauge whether a country is “underexporting� to a destination country of interest by comparing actual export values in a given year with a predicted export value obtained from a regression that controls for the standard gravity variables, such as absolute bilateral distance, GDP, and per capita incomes. Because two countries are likely to trade more if they share a common language, a common border, and similar legal systems (and possibly the same colonial relationships), gravity equations also include dummy variables for these shared characteristics.b Furthermore, gravity models ought to incorporate three recent innovations. First, as suggested by Anderson and van Wincoop (2003), “multi-lateral resistance terms� should be incorporated in regressions because bilateral trade depends not only on absolute trade costs or distances between pairs of countries but also on relative distances. Second, instead of dropping observations when bilateral flow is not recorded, the Heckman sample selection correction method should be used to add the probability of being included in the sample as an explanatory variable, that is, having a nonzero trade flow. When observations with nonexistent bilateral trade are dropped, as an ordinary least squares (OLS) method does in a log-linearized model, the dependent variable is not really measuring bilateral trade, but one contingent on a relationship existing. Therefore this technique corrects for a potential bias in regression estimates when the probability of selection is correlated with GDP or distance. Third, following Helpman, Melitz, and Rubinstein (2008), the model could control for firm heterogeneity (without using firm-level data). This decomposes trade flows into intensive and extensive margins to take note of the fact that firms vary in terms of productivity, and it is usually the more productive firms that export. This may require making assumptions about how firm productivity is distributed. With these steps, the gravity results of whether a country “overtrades� or “undertrades� with particular partners are better grounded on trade theory.c Source: Authors. Note: a. See Brakman and van Bergeijk (2010) for details and recent theoretical advances on the gravity model. b. It is also common to include a dummy variable to indicate whether the two countries are members of the same preferential trade agreement. If importer and exporter fixed effects are used, one can drop country-specific information such as GDP, GDP per capita, and remoteness. c. Econometrically, this involves a two-step estimation process. First, a probit estimation is run to obtain predicted probabilities. These are then used to construct controls for sample selection bias and firm heterogeneity bias. These controls are then included in the second-stage regression, which can be estimated parametrically or semiparametrically. See Helpman, Melitz, and Rubinstein (2008) for details. When discussing bilateral or regional trading partners, country’s imports from the world, implying that the two another measure of interest is the Trade Intensity Index countries stand to gain by trading more with each other (TII). This index is similar to the RCA index introduced when one has a comparative advantage in products in which earlier, but it applies to export markets and not to products. the partner has a comparative disadvantage. Algebraically, TCI i It is measured as country i’s exports to country j relative to is expressed as follows: m k is product k ’s share in country i’s j its total exports divided by the world’s exports to country j total imports, xk is product k’s share in country j’s exports to relative to the world’s total exports. For example, in 2008, the world. A maximum score of 100 indicates that the two Senegal’s TII with France was 2.93, indicating that its countries are ideal trading partners. A lower score indicates exports to France represent a much greater share of its total that the two countries export similar products and there may exports than the share of the world’s export to France. In not be much scope in expanding one’s exports to the other. contrast, Kenya’s TII with France in 2008 was less than ⎡ mk − x kj ⎤ i ∑ 0.61. This indicates that Senegal’s export presence in an TCI ij = 100 ⎢1 − ⎥ (1.4) important EU member nation is stronger than Kenya’s ⎢ 2 ⎥ presence. With Germany, however, Kenya’s TII was 0.38, ⎣ k ⎦ higher than Senegal’s 0.15. x ij TCI can be particularly useful when analyzing the poten- tial gains from a bilateral or regional trade agreement, as Xi TII ij = well as when determining which countries stand to gain the x wj (1.3) most from lower trade barriers. Figure 1.10 shows an exam- Xw ple of the trade complementarity indexes for each Eco- nomic Community of West African States (ECOWAS) To judge whether there’s a good fit between what a coun- member country as measured against the trade basket for try exports and what a potential partner imports, the Trade ECOWAS as a whole. It shows relatively low levels of com- Complementarities Index (TCI) is a useful measure. Cadot, plementarity overall but suggests that Senegal has the great- Carrère, and Strauss-Kahn (2011) describe it as a correlation est potential to gain from ECOWAS trade, whereas Guinea, between a country’s exports to the world and another Guinea-Bissau, and Liberia have trade structures that are 38 Module 1: Trade Outcomes Analysis Figure 1.10. Trade Complementarities Index for ECOWAS Countries, 2007 Module 1 40 35 34 30 28 26 25 23 24 20 20 17 14 15 15 12 12 10 10 8 8 5 4 0 Benin Burkina Faso Cape Verde Cote d’lvoire Gambia, The Ghana Guinea Guinea-Bissau Liberia Mali Nigeria Senegal Sierra Leone Togo Niger Source: Authors. Note: ECOWAS = Economic Community of West African States. poorly aligned with the intraregional opportunities. From a Figure 1.11. Macro Analyses of Export Competitiveness policy perspective, an analysis showing low complementar- ity may suggest a search for new partners and a heightened Panel A. Exports per capita, BRIC, 1978–2008 role for export promotion agencies. 1500 (constant 2000 US$) Growth Orientation export per capita Summary of data needs 1000 Indicators and sources Scatterplot of import Trade and growth data computed growth by countries from WITS; ITC Trade Map also 500 against a country’s has data at the HS four-digit share in those markets level. Scatterplot of world growth of products 0 against a country’s 1980 1990 2000 2010 share in those products year India Brazil China Russia One measure often used as an indicator of export com- petitiveness is exports per capita, which tests the degree of Panel B. Exports and growth prospects presence in foreign markets (Wignaraja and Taylor 2003). 28 Figure 1.11, panel A, gives an example of this indicator. Just 26 per capita, 2006–08 as income per capita is not always a good measure of log of real export human well-being, however, export dollars per capita is Ukraine 24 Algeria also not an adequate measure of export success. It matters whether countries earn high export dollars from a domes- 22 tic production base that is well diversified and not from a narrow range of sectors, such as oil, gas, and minerals. The 20 former can expect a more sustainable growth pattern. As in 18 figure 1.11, panel B, it will be useful to draw real exports 25 50 75 100 per capita against a measure of economic diversification manufacturing and services, indicated by the combined share of manufacturing and % of GDP in 2006–08 services in GDP. McKinsey (2010b) argues that, as coun- Source: Authors. tries develop, they tend to meet both the objectives of earning Note: BRIC = Brazil, Russia, India, and China; GDP = gross domestic product. Growth and Share: The Intensive Margin 39 foreign exchange to finance capital imports needed for Figure 1.12. Orientation of Exports and Destinations, Module 1 investment (real export per capita) and developing a Pakistan, 2008 diverse source of growth away from natural resources and Panel A. Exports agriculture. Pakistan: Orientation of exports, 2008 In Figure 1.11, panel B, countries in the first and second 7 quadrants have a diversified economy.9 Those in the first and of products (2000–08) log of world growth fourth quadrants earn above-average export income, but in 6 an economy that is less diversified. As an example, both 5 Algeria and Ukraine have comparable export earnings per person, but Algeria derives that income from an economic 4 base that is half the share of manufacturing and services in 3 Ukraine’s GDP. All Sub-Saharan African countries, except South Africa, are in the low-exports-per-capita and less- 2 diversified quadrants. Generally, countries in the second and –2 –1 0 1 2 third quadrants are in transition, and the role of public pol- log of product's share of exports (%) icy is to nudge them toward the first. Panel B. Destinations Openness to trade often goes hand in hand with open- Pakistan: Orientation of destinations, 2008 ness to FDI. Like the trade-to-GDP ratio, the outcome of openness to FDI can be assessed by looking at the ratio of 6.5 of countries (2000–08) log of import growth the inflow of FDI (or stock of FDI) relative to GDP. Unlike 6 tariffs in trade, however, no summary statistic is universally accepted to measure policies directly related to openness 5.5 of FDI. 5 Looking at how a country’s current export basket and competitiveness may shape future performance is a critical 4.5 part of the analysis of the intensive margin. Plots of export 4 shares against the world growth rate of products and –2 –1 0 1 2 3 countries can give a portfolio view of one’s exports: Is the log of destination’s share in exports (%) country exporting products that are growing in demand in Source: Authors. the world? Is one exporting to countries that are not only large and rich, but also growing fast? As the examples in figure 1.12, panels A and B, show, a weak, positive correlation exists between Pakistan’s top It would be important to learn what the experience of exports—cotton, apparel, leather, and cereals—and their Pakistani exporters has been in trying to break into the rate of growth in the world market. But for Pakistan’s newer fast-growing markets. What enabled those that have exports to be “pulled� further by the world growth of prod- been successful? To those that have not, what factors have ucts that it exports, that relationship ideally has to be been the biggest hindrance? If it is search costs or lack of stronger. In terms of destinations, Pakistan relies heavily on information, export promotion might have a role to play; if Europe and the United States, but it has not made break- it is policy barriers in foreign markets, trade agreements throughs in countries that are growing fast and that have will have a role; and if it is lack of competitiveness, the onus the potential to be richer in the future. With the exception is on the domestic productivity agenda. of China, and to a lesser extent Turkey, Pakistan’s partners In terms of products, some of Pakistan’s most impor- are not among those that have seen the highest rates of tant exports like cotton and leather have not been growing import growth between 2000 and 2008. Because the richest as fast as other sectors (for example, fruits, grain, oil seeds, economies of the world (the European Union, Japan, and cereals, chemicals, cement, and plastic) in which Pakistan the United States) are slow growing,10 countries that trade has a decent production base. What would it take to aug- the most with them will have a downward growth orienta- ment the performance of some of these promising sectors? tion for their destinations. This is likely to be the case for an Figure 1.13, created by the ITC TradeMap, essentially con- overwhelming majority of countries. This kind of analysis, firms the previous result, but it names countries and prod- therefore, could exclude rich countries and be used to ana- ucts and shows the growth orientation for a more recent lyze a country’s relationship only with emerging economies. period (that is, 2004–08). 40 Module 1: Trade Outcomes Analysis Figure 1.13. Alternative Assessment of Product-Market Orientation, Pakistan, 2008 Module 1 Panel A. Prospects for market diversification Product : Total all products 35 India annual growth of partner countries’ imports from 30 Scale: 3% of world imports Oman the world between 2004–2008, % United Arab Emirates 25 Saudi Arabia China Bangladesh Turkey 20 Iran (Islamic Republic of) South Africa Netherlands Spain Sri Lanka 15 United States of America France 10 Belgium Italy Germany Hong Kong (SARC) 5 United Kingdom Afghanistan 0 0 5 10 15 20 share of partner countries in Pakistan’s exports, 2008, % Pakistan export growth to Pakistan export growth to N.A. reference bubble bubble size is proportional International partner < Partner import partner > Partner import to the share in world imports Trade growth from the world growth from the world of partner countries for Centre the selected product Panel B. Size of national supply and growth of international demand for export products of Pakistan - 2008 30 15 - Animal, vegetable fats and oils, cleavage products, etc. annual growth of world imports between 2004–2008, % 27 - Mineral fuels, oils, distillation products, etc. 10 - Cereals Scale : 700 US million 25 20 25 - Salt, sulphur, earth, stone, plaster, lime, and cement 71 - Pearls, precious stones, metals, coins, etc. 90 - Optical, photo, technical, medical, etc. apparatus 39 - Plastics and articles thereof 95 - Toys, games, sports requisites 15 84 - Nuclear reactors, boilers, machinery, etc. 42 - Articles of leather, animal gut, hamess, travel goods 57 - Carpets and other textile floor coverings 63 - Others made textile articles, sets, worn clothing etc. 10 61 - Articles of apparel, accessories, knit or crochet 17 - Sugars and sugar confectionery 22 - Beverages, spirits, and vinegar 52 - Cotton 55 - Manmade staple fibres 5 62 - Articles of apparel, accessories, not knit or crochet 41 - Raw hides and skins (other than furskins) and leather 03 - Fish, crustaceans, molluscs, aquatic invertebrates 0 0 2 4 6 8 world market share of Pakistan, 2008, % Pakistan has lost world Pakistan has increased reference bubble size is International market share for this world market share for bubble proportional Trade product product to export value Centre Source: ITC 2011. Diversification: The Extensive Margin 41 ∑(S ) Diversification: The Extensive Margin 2 Hi = Module 1 ij (1.5) j Measures of Concentration Summary of data needs Another measure of export concentration is the Theil’s Indicators and sources Entropy. High entropy values indicate a diversified export Share of top three or Trade data from WITS; alternatively, portfolio. If one good is all that a country exports, the five products in exports the ITC Trade Competitiveness Share of top three or Map displays precomputed data as entropy is zero. If n goods have an equal share, the maxi- five markets in exports does the World Trade Indicators. mum value is the log of n. Theil’s Entropy can be computed Hirschman-Herfindahl for subgroups of exports and decomposed additively to Index measure concentration within and among groups of Theil’s Entropy exports. The most concentrated subgroups have the highest weights. A portfolio with high concentration of specific subgroups of goods produces an HHI closer to one and an All else equal, a more diversified structure of production is entropy value closer to zero. Table 1.4 calculates concentra- in most cases preferable to one that relies on a few goods, tion indexes for six countries in 2000 and 2008. It shows especially primary commodities. It may also be better to that the two measures (HHI and entropy) both indicate rely on a greater number of export destinations than fewer. changes in concentration in the same direction. Two questions to answer when measuring product or mar- ket concentration are as follows: • In a given year (or over the past few years), what share of Ei = − ∑S log(S ) j ij ij (1.6) total exports has been accounted for by the top three or five products (at a suitable level of disaggregation, such In manufacturing, Easterly, Reshef, and Schwenken- as HS six-digit or SITC four-digit levels)? berg (2009) show that for every country they assessed, • What share of the country’s total exports is sold in the exports are dominated by a few “big hits.� They find that top three or five markets? success in exports, and specialization, is driven by a narrow range of specific exports to specific markets. For example, according to the ITC’s Trade Competitive- Although this appears to undercut the argument for ness Map, in 2008, at the HS four-digit level, only 12.5 per- export diversification, Imbs and Wacziarg (2003) find cent of Germany’s exports were accounted for by its top that economies tend to diversify over most of their devel- three products, whereas in Nigeria, the top three exports opment path. Only after reaching a relatively high accounted for 94 percent of total. In terms of markets, three threshold of income is further growth associated with top partners buy 23.3 percent of Germany’s exports whereas specialization. Klinger and Lederman (2004) find a simi- for Nigeria, the share of its top three destinations is close to lar inverted U relationship between income and export 60 percent. Formally, the Hirschman-Herfindahl Index activity. Diversification is important for developing coun- (HHI) can be used to estimate export concentration.11 S is tries because it allows them to develop competence over a the share of export j in the total exports of country i. A coun- broader range of manufactured goods. Countries develop try with a perfectly diversified export portfolio will have an by learning to make new things, and through entrepre- index close to zero, whereas a country which exports only neurial dynamism and growth, not by relying only on one export will have a value of one (least diversified). what they have traditionally done well. Table 1.4. Concentration of Goods at HS Two-Digit Level, 2000–08 HHI 2000 HHI 2008 Concentration Entropy 2000 Entropy 2008 Concentration Chile 0.29 0.41 Increased 1.49 1.23 Increased Costa Rica 0.25 0.19 Decreased 1.66 1.81 Decreased Morocco 0.21 0.17 Decreased 1.77 1.86 Decreased Senegal 0.24 0.20 Decreased 1.61 1.78 Decreased Vietnam 0.23 0.18 Decreased 1.65 1.88 Decreased South Africa 0.18 0.22 Increased 1.87 1.69 Increased Source: Authors. 42 Module 1: Trade Outcomes Analysis Intensive and Extensive Margins i of products exported by country i, Xk the dollar value of i’s Module 1 w Indicators Summary of data needs vand sources exports of product k to the world, and X k the dollar value Hummels-Klenow Trade data from WITS: country exports, of world exports of product k, then the intensive margin extensive and global imports trade-weighted by (IM) below calculates a country’s share in its representative intensive margins product and by market. for both products products. The extensive margin (EM) calculates the and markets breadth of one’s export portfolio relative to all exports that exist in the world. Export growth can take place at the intensive margin ∑X i i k ∑X i w k (selling existing products to existing markets) or at the IM i = k EM i =k extensive margin (selling existing products to new markets, new products to new markets, and new products to exist- ∑Xk i w k k ∑X w w k (1.7) ing markets). There are multiple definitions of the inten- sive and extensive margins. In this Toolkit the concepts are In figure 1.14, panels A and B, the Hummels-Klenow invoked in the context of diversification as well as survival intensive and extensive margins are plotted jointly on an of exports. In the former, the attempt is to explore to what intensive–extensive margin space for Costa Rica and Viet- extent countries have been able to add new products and nam, first with respect to products and second with respect new markets—that are economically significant—to their to markets. Costa Rica’s share in exports that the rest of the portfolios. When the two margins are discussed in the con- world also exports (intensive margin) has increased slightly text of export survival, the attempt is to decompose export over the last 10 years, but the global importance of export growth into constituents capturing growth of old products items it has a foothold in has dropped. The intensive mar- in old markets versus the rest. gin as measured here indicates how big Costa Rica is in In the context of diversification, how has a country per- what it exports, and the extensive margin measures how formed on the intensive margin (IM) and the extensive globally important is what it exports. This is probably margin (EM) of exports, say, over the past decade? Draw- driven by its improved performance in semiconductors. ing on Hummels and Klenow (2005), it is possible to infer Had Costa Rica not exported any semiconducters in 1998, (1) how big a player a country is in what it exports (IM), the extensive margin would have significantly increased. and (2) how important what it exports is to the world Furthermore, several textile and apparel items, which (EM). This approach improves on the method of simply remain a major export globally, are no longer produced in counting how many new export items have been intro- Costa Rica. In contrast, Vietnam managed to increase its duced by weighing the new products by their share in share of export in goods that the rest of the world produces world trade. So, adding pencils to the export portfolio is (intensive margin) as well as the breadth of its export port- not the same as adding high-value chemicals. If Ki is the set folio relative to all exportable products (extensive margin). Figure 1.14. Intensive and Extensive Margins Panel A Panel B Intensive and extensive margin in products, 1998–2008 Intensive and extensive margin in markets, 1998–2008 .5 .5 Vietnam Vietnam .4 .4 intensive margin intensive margin .3 .3 .2 Vietnam .2 Vietnam Costa Rica Costa Rica Costa Rica Costa Rica .1 .1 .0 .0 78 84 90 96 99 99.2 99.4 99.6 99.8 100 extensive margin extensive margin 1998 2008 1998 2008 Source: Authors. Diversification: The Extensive Margin 43 Extending this to analyze destination markets, Costa number to assess how much export opportunities a coun- Module 1 Rica’s export share in countries to which it currently try is exploiting. As an example, Brenton and Newfarmer exports (intensive margin) has increased, as has its reach to (2009) compare Albania’s IEMP with that of the Czech markets that cumulatively are larger relative to the world in Republic. In 2004, Albania exported 955 products and the 2008 than in 1998 (extensive margin). In contrast, Vietnam Czechs exported 2,863 products (using a common level of increased its existing share of exports to existing markets, commodity classification). At the extreme, if Albania but it did not add new markets that are globally significant exported all its exports to all the countries that import to its portfolio of destinations.12 what Albania exports, it would have formed 90,350 export Market Reach of Exports relationships. In reality, it only exploited 2.27 percent of the potential. In contrast, the Czech Republic exploited Summary of data Indicators needs and sources around 20 percent of the potential. No country ever exports all its exports to all the countries that import them. Index of Export Market Trade data from WITS: target Penetration (IEMP) country exports; sum of all In fact, one of the world’s most successful exporting Scatterplot of the value of country nonzero imports of nations, Germany, exploits only around 50 percent of its specific exports against the product (as described below). potential, and this can serve as a best-case benchmark. number of markets reached Brenton and Newfarmer (2009) calculate the IEMP as How successful are a country’s individual exports? How follows, where exporter j, for whom Iij is the set of products many markets do they reach and how much do they earn in (i) in which positive exports are observed, Yijk = 1 for aggregate? In this section we review two ways of looking at Xijk = 1, else Yijk = 0 and Zik = 1 for Mik > 0, else Zik = 0, the future potential for market expansion. where Xijk is the value of exports of product i from exporter One measure is the Index of Export Market Penetra- j to importer k, and Mik is the value of imports of product i tion (IEMP). This index looks at a country’s total number by importer k. ∑ ∑Y of exports, and the number of markets that each of those products reaches. Then, the number of countries in the rest ijk i εI ij IEMPi = (1.8) k ∑∑Z of the world that import each of the products (which the country of interest exports) is counted. Pairing products ik i εI ij k and countries this way, we obtain the maximum potential number of export relationships that a country can establish Figure 1.15 gives an example of the IEMP for several given its export portfolio at present. The actual number of low- and lower-middle-income countries, including export relationships is then divided by the potential Germany as a global benchmark. It is clear from the data Figure 1.15. Examples of IEMP in Selected LIC and LMIC versus Germany, 1999 and 2008 60.0% 50.8% 50.0% 45.1% 41.5% 40.0% 30.0% 26.9% 28.3% 20.0% 18.6% 10.6% 10.0% 6.7% 4.6% 4.7% 2.0% 2.2% 3.0% 1.4% 0.0% Tunisia Morocco Pakistan Vietnam India China Germany 1999 2008 Source: Authors. Note: LIC = low-income countries; LMIC = lower-middle-income countries. 44 Module 1: Trade Outcomes Analysis that penetration of export markets by most of these coun- uct stories that may be worth further analysis to under- Module 1 tries is far below not only that of Germany but also of stand, for example, why a new product managed to so China, which has substantially increased its market pene- quickly reach a large number of countries (was it the tration over the past decade. nature of the product? specific trade promotion efforts? or One major limitation of the IEMP is that unlike the other factors?) or why an established product across many Hummels-Klenow indexes explained earlier, it does not countries is no longer being exported to any. These find- weigh exports by their relative importance. Therefore an ings may be valuable at the product level and also may be insignificant export to a small economy counts the same as generalizable cases for the wider export sector. a major export breakthrough in a large economy. Like all the indicators discussed in this Toolkit, this index should Quality and Sophistication: The Quality not be used in isolation but rather in conjunction with Margin other indicators to portray a more complete trade picture. Nonetheless, a country whose IEMP is inexplicably low Technology Content could generate, for example, a hypothesis regarding prod- Indicators Summary of data needs and sources uct quality or the efficacy of its export promotion agencies. Radar graph of the Data. available up to 2006 at http://info. A second measure is the number of export destinations share of high-tech, worldbank.org/etools/prmed/; the World reached per product. Figure 1.16, panels A and B, illustrate medium-tech, low- Development Indicators database also has the success of individual Russian exports. Over the eight- tech, primary and indicators of the share of high-tech resource-based exports in manufactured exports, year period, 2000–08, Russia expanded the number of exports together with the share of fuel or export markets that at least one of its products (at the HS minerals and ores exports. six-digit level) serves from around 80 to more than 100. In both 2000 and 2008, 1,396 products reached at least 10 Although deciding which exports embody high-level markets. In this subgroup, 975 products reached a higher technology, or which country is engaged in the most number of markets than in 2000, and 348 products reached technology-intensive phase of production, can be contro- a smaller number. The value of individual export products versial in an era of global production sharing, a basic clas- has also grown. The most prolific products are vodka and sification of final exports into broad categories of high, oil. The total value of Russia’s existing products (gray) in medium, and low technology—and whether exports are the newly expanded or existing markets has increased. The primary and resource based—gives an indication of how light gray dots indicate products that were not exported in a country’s export basket has transformed over a period. 2000 but were in exported 2008, which proxy for new dis- In figure 1.17, the technological content13 of Morocco’s coveries. The black dots are products that were exported in exports is gradually improving, but its sophistication of 2000, but not in 2008, possibly indicating death or suspen- goods exports remains relatively low. Comparing figures sion. Some new exports in 2008 have already reached across a decade from 1996 to 2006, Morocco’s exports around 25 markets. The analysis identifies particular prod- exhibited some diversification away from agriculture and Figure 1.16. Market Reach of Exports Panel A Panel B Number of export destinations Number of export destinations by product 2000 by product 2008 value of exports (HS6), in log value of exports (HS6), in log 20 20 15 15 10 10 5 5 0 0 –5 –5 0 20 40 60 80 0 20 40 60 80 100 number of markets number of markets Source: Authors. Quality and Sophistication: The Quality Margin 45 Figure 1.17. Technological Content of Morocco’s Exports amount of export per capita is to increase the value of Module 1 export per unit. Hwang (2006) finds strong evidence of high tech convergence in product quality: When countries introduce 40 a new product, they are usually low in quality, but their 30 unit prices tend to converge to the global frontier at a rate 20 of about 5 percent per year. The variance in the unit price resource-based 10 low tech of goods signals opportunities for countries to upgrade 0 quality and to grow faster. Because upgrading of quality is potentially a secure avenue to boost growth, it is imperative to assess not only what a country produces but also what primary products medium tech the quality of exports looks like. Table 1.5 gives an example of how unit values of seem- 1995 2008 ingly similar products (at the SITC five-digit level) differ.15 Source: Authors. The table includes unit values of imports into the United States in 2008 of selected goods from a range of developing fertilizers toward manufacturing with moderate techno- countries, as well as Germany. Some products command logical content. Apparel was one such new industry as was an identical unit price (for example, dry or crushed cap- trade in parts and components related to automobiles. In sicum), suggesting that prices are dictated internationally terms of share of high-tech products in its overall exports and little room exists for within-product upgrading. Unit basket, Morocco’s ratio is less than 10 percent, but this values of some goods vary marginally (for example, basket- marks a significant improvement from a decade earlier. work, printing press parts, cutting blades for machines) whereas those of others vary widely (for example, frozen Unit Values tuna, locks and keys, motor car bodies). Summary of data needs Hwang (2006) suggests that because convergence of Indicators and sources unit values occurs unconditionally, low-income countries Cross-country comparison Unit values computed from need to produce goods within a category in which the of unit values and trade data in WITS; World Bank quality at the SITC International Trade Department global frontier of productivity is high and is possibly dom- five- or HS six-digit level database developed for EU inated by rich countries. Learning and catch-up is highest Quality ladders imports based on the COMEXT database from EUROSTAT; in those categories. If a country’s portfolio consists of a Co-mapping of quality and market share quality measured by unit prices small share of differentiated goods in which upgrading relative to 90th percentile of possibilities are limited, the need for diversification performance the unit value distribution across countries exporting the becomes more urgent. product to the market. Decomposing exports into value and volume contribu- tions can tell an important story about competitiveness. Goods in the same product category vary widely in For example, figure 1.18 illustrates that in Mongolia, the quality, proxied by unit values (nominal sales divided by rapid growth in minerals exports in recent years is quantity). When supply is competitive, higher prices are explained almost fully by rising world prices, a factor over generally associated with higher quality and greater prod- which the country has little control. By contrast, in many uct differentiation.14 One way to increase the absolute other key products, like meat and cashmere garments, in Table 1.5. Examples of Unit Values of Exports to the United States, 2008 SITC 5 Product China India Costa Rica Senegal Vietnam Pakistan Germany 07513 Capsicum dry and crushed 3.070 3.070 3.070 3.070 3.070 3.070 89971 Basketwork, wickerwork, etc. 4.698 4.736 4.868 4.468 4.570 4.852 4.716 72699 Printing press parts 57.020 57.020 57.025 57.016 57.044 57.020 69561 Cutting blades for machines 12.304 12.049 10.816 12.898 12.901 13.747 69911 Locks/keys/clasps/parts 9.227 18.305 133.196 5.846 42.371 26.477 03414 Tuna/skipjack/bonito 14.686 10.310 6.242 13.342 78421 Motor car bodies 495.27 170.997 123.23 10,522.75 Source: Computed using mirror data in Comtrade. 46 Module 1: Trade Outcomes Analysis Figure 1.18. Decomposition of Export Growth across Key Products, Mongolia, 2002–07 Module 1 0.6% 5.9% 0.7% 1.5% 41.6% 12.0% 50% 42% 40% 39% 30% 30% 30% 25% 23% share of exports 20% 15% 16% 10% 6% 1% 1% 2% 0% –1% –3% –10% –4% –12% –20% –22% –30% –29% meat cashmere cashmere textiles copper gold dehaired garments concentrate export value units value/unit Source: Authors. which prices are more dependent on producer competi- Figure 1.19. Analysis of Indonesia’s Unit Price Trends for Top tiveness, Mongolia has experienced substantial declines in Five Garment Exports to the European Union Relative to Main Competitor, 1988–2008 the unit value of production, suggesting poor quality com- petitiveness. 25 Analyzing data on unit prices of important export products against key competitors can provide a valuable 20 assessment of the trends in a country’s quality competitive- ness. We rely on the COMEXT database from EUROSTAT 15 to characterize the relative unit values of import in each 10 EU member country. As in Schott (2004), unit values were calculated simply as the quotient of general import values 5 and quantities. Within any product (eight-digit Combined Nomenclature code) for any given year, we then have a dis- 0 1988 1993 1998 2003 2008 tribution of unit values of imports from the different source countries. For each good i and exporting country c, Bangladesh China Indonesia in time year t, we generate a measure of relative quality R as Malaysia Thailand Vietnam follows: Source: Authors. uv Ritc = itc 90 (1.9) uv it lights the fact that Indonesia might be getting caught in the 90 Where uitc denotes the unit value of the good and uit middle in terms of competition in garment export denotes the value at the 90th percentile of the unit value markets—it struggles to compete on price with low-cost distribution across countries for that product. Ritc denotes producers like Bangladesh and China, but it is not yet able the relative quality of the country’s export of that good, to reach the quality levels of Malaysia and Thailand. that is, quality relative to other countries exporting the Using data on unit prices it is also possible to develop same good. Figure 1.19, for example, shows price per unit analyses of quality ladders, measuring the relative quality trends for Indonesia’s top five garment export products to of a country’s exports against all other countries that Europe, against its main competitors. In this case, it high- export a specific product (worldwide or to a specific Quality and Sophistication: The Quality Margin 47 Figure 1.20. Quality Ladder for Women’s Cotton Blouses analyze the growth of countries explicitly from the per- Module 1 and Shirts Imports to the European Union, 1998 and 2008 spective of actual goods produced. Instead of predetermin- ing the classification of products (for example, technology- 1998 2008 intensive or not), Hausmann, Hwang, and Rodrik (2006) 1.5 estimate the sophistication of products on the basis of the income levels of countries that produce them. If a product, say, internal combustion engine, is largely produced by rich 1 US PL countries, that product would be revealed to be “rich� and US sophisticated. This outcome-based measure of sophistica- PL tion for each product, called PRODY, is a weighted average MK RU .5 of the per capita GDP of countries producing that good, LK RU LK MK with weights derived from RCA. Similarly, PRODY of cof- fee beans would be much lower because the countries that 0 dominate its production are generally low income. Source: Authors. ⎛ x jk ⎞ ⎜ ⎜ Xj ⎟ ⎟ PRODYk = ∑ � ⎠ Y and ∑X x jk j (1.10) j market). As illustrated in figure 1.20, the plot of all coun- j j tries on the basis of their rank in quality and their relative ⎛ x ik ⎞ ∑⎜� X pricing creates a “ladder� or a long tail. Figure 1.20 high- lights the declining quality performance of Macedonia in EXPYi = ⎟ PRODYk k i ⎠ one of its most important export products—between 1998 and 2008, the quality of its exports declined and it was PRODY values of all products that a country exports are overtaken in quality by countries like Sri Lanka and Russia. then weighted by the product’s share in the country’s total The next step in the analysis is to look at the relation export basket and summed to derive a country’s level of between changes in the relative quality measure and GDP per capita as inferred from the sophistication of its changes in market shares—it is one thing to increase qual- export basket. Called EXPY, this measures the income con- ity; but if it comes at the expense of market share, it may be tent of a country’s export basket. It is regarded as a more a trade-off not worth having. Similarly, improving market inclusive measure of sophistication than intensity in tech- share in the context of declining quality may actually rep- nology or R&D. It captures the wages supported by pro- resent an increase in cost competitiveness rather than a duction of a good. Hausmann, Hwang, and Rodrik (2006) decline in quality per se. Figure 1.21 plots these results for show that countries with high EXPY tend to have higher three products (defined by an eight-digit Combined growth rates in the future. Countries “become� what they Nomenclature code) for Senegal in the European Union. export by converging to the income level implied by their The x-axis shows the growth rate of market share (log dif- export baskets. ference of market shares) between 1996–2008 and For each country in figure 1.22, one can ask whether the 2006–08. The y-axis represents the growth rate of the aver- products it is currently exporting are more sophisticated age quality measure between the same periods of time. The than would be suggested by that country’s level of income. size of each bubble is the importance of each product in This information can then inform an agenda aimed at Senegal’s export basket. gauging the urgency with which the country ought to be promoting or discovering new export activities. According Sophistication to Klinger (2010), for incumbent products, many of the Indicators Summary of data needs and sources conventional competitiveness variables matter (the broad- PRODY and EXPY Data obtained from Comtrade (WITS); est set is the 12 pillars covered by the World Economic PRODY and EXPY calculation plotted Forum’s Global Competitiveness Report). For “new prod- against gross domestic product per capita. ucts,� however, they may not be sufficient, as countries need to deal with distinct market failures related to infor- The foundational trade models like Hecksher-Ohlin or mational externality and coordination problems. On the Ricardo attribute trade to differences in factor endow- basis of the measure of export sophistication (EXPY), ments or technology across countries. Economists seldom countries like China, India, Indonesia, the Philippines, and 48 Module 1: Trade Outcomes Analysis Figure 1.21. Change in Senegal’s Market Shares and Relative Quality in the Food, Textiles and Clothing, and Footwear Products Module 1 in the European Union 16–24 food products 50–63 textiles and clothing Changes in market shares and relative quality Changes in market shares and relative quality (average 06–08/average 96–98) (average 06–08/average 96–98) 3 .5 2 log diff in relative quality log diff in relative quality 0 cotton (not carded or combed) 1 (HS = 520100) oil-cake, solid –.5 residues resulting from extraction of 0 ground-nut oil (HS = 230500) –1 preserved tuna, –1 skipjack and bonito cane molasses (HS = 160414) (HS = 170310) –1.5 –2 –6 –4 –2 0 2 –4 –2 0 2 log diff market shares log diff market shares 64–67 footwear Changes in market shares and relative quality (average 06–08/average 96–98) 1 wigs, false beards, eyebrows, of animal hair or other textile materials (HS = 670490) log diff in relative quality 0 –1 partial wigs, false beards, false eyebrows, of synthetic textile material (HS = 670419) –2 –8 –6 –4 –2 0 log diff market shares Source: Authors. Thailand are above the line, which implies that their export more sophisticated but not as fast as China’s. Vietnam basket is “richer� than they are. Developing new products is resembles the trajectory of India. Starting from a very low much more important for countries below the line, such as base around the time it began its reforms under Doi Moi in resource-rich countries like Qatar and Russia. Countries the late 1980s, it has since caught up with many low- above the line can expect to see growth from existing income countries like Pakistan, whose export sophistica- exports. tion has not undergone as stark an improvement as its As with many measures presented in this toolkit, EXPY Asian peers. From this figure alone, we cannot say whether has its drawbacks (see box 1.2). Despite this, measuring rising export sophistication pulled up per capita incomes EXPY or another indicator of sophistication over time can or whether countries moved into production of more give an important indication of the relative growth in sophisticated exports after average incomes rose. However, sophistication of the export basket and the degree to which Hausmann and Klinger (2007), using a large pool of coun- this is affecting growth of per capita income. As figure 1.23, tries, have shown that current export sophistication is a panel A, shows, over the past two decades, sophistication of good predictor of economic growth in the future. Felipe China’s export basket has increased every biennium (each (2010) estimates that a 10 percent increase in EXPY at the dot represents two years), and this has been associated with beginning of a period raises growth by about half a per- rising per capita income. India’s exports are also becoming centage point. Figure 1.23, panel B, provides an additional Quality and Sophistication: The Quality Margin 49 Figure 1.22. The Relationship between Income and Export If PRODY and EXPY reflect the income content of Module 1 Sophistication, 2003–05 exports, the revealed factor intensities of traded goods reflect the human and physical capital content of exports. Export sophistication 2003–05 They are computed in a similar manner to PRODY, but CHE 9.5 SGP they arguably have a stronger theoretical linkage to com- PHL USA THA MYS DEU CHN parative advantage derived from factor endowments. 9 ZAF BRA IND RUS ARE Goods that are predominantly exported by countries rich TUN BRN log of EXPY 8.5 NPL VNM QAT in human capital and physical capital are revealed to be LKA intensive in human capital and physical capital, respec- BGD tively. The indexes are computed by weighting the factor 8 endowments of all countries exporting a particular prod- 7.5 uct; weights are derived from a modified version of the RCA. Human capital is estimated by the average years of 7 schooling, and physical capital stock is estimated by the 6 7 8 9 10 11 perpetual inventory method, which reconstructs capital log of GDP per capita (PPP, 2003–05) stock estimates from investment flows by recursively Source: Authors. adding up current investments to a previous period’s capi- Note: ARE = United Arab Emirates; BGD = Bangladesh; BRA = Brazil; BRN = Brunei Darussalam; CHE = Switzerland; CHN = China; DEU = Germany; tal stock with appropriate depreciation. The database of IND = India; LKA = Sri Lanka; MYS = Malaysia; NPL = Nepal; factor intensities (human, physical, land, and natural PHL = Philippines; QAT = Qatar; RUS = Russian Federation; SGP = Singapore; THA = Thailand; TUN = Tunisia; USA = United States; resources) of all products at the SITC four-digit and HS VNM = Vietnam; ZAF = South Africa. six-digit level are made available by United Nations Con- ference on Trade and Development (UNCTAD).16 explanatory element by adding dates to each dot on the ⎛ x jk ⎞ graph—this helps us see more clearly the consistent trajec- ⎜ Xj ⎟ K ⎜ ⎟ tory of China (upward) and Russia (downward) and the RPCI k = ∑ � ⎠ * j and ∑ more ambiguous picture in Brazil. x jk L j j j Xj (1.11) Revealed Factor Intensity (RFI) ⎛ x jk ⎞ ⎜ ⎜ Xj ⎟ Indicators Summary of data needs and sources ⎟ Revealed Physical Capital Index (RPCI) Indexes available from UNCTAD (http://r0.unctad.org/ditc/tab/index RHCI k = ∑ � ⎠ *H ∑X j x jk and Revealed Human .shtm) and World Bank International j Capital Index (RHCI) Trade Department database. j j Figure 1.23. Evolution of Export Sophistication Panel A. Pakistan versus Peers, 1998–2006 Panel B. BRIC Change in export sophistication Change in export sophistication 1988–2006 2002–2008 EXPY PPP (constant 2000 US$) 08 12,000 9.6 06 07 02 04 05 03 03 06 02 04 07 05 log EXPY 9.5 08 8,000 05 07 04 9.4 03 06 08 05 06 07 02 04 03 02 08 4,000 9.3 100 800 1,500 7.5 8 8.5 9 9.5 real GDP per capita (constant 2000 US$) log GDP per capita China India Vietnam Pakistan Russia China Brazil India Source: Authors. 50 Module 1: Trade Outcomes Analysis Module 1 Box 1.2. The Drawbacks of PRODY and EXPY The concepts of PRODY and EXPY are not free of criticism. The PRODY of some products is counterintuitively high, suggesting sophistication in products merely because rich countries produce them: bacon and ham, for example, have a higher PRODY than internal combustion engines. Furthermore, the quality of products varies (even if they all have an identical code at the HS six-digit level)—cars from country X may not be the same quality as cars from country Y. When product quality is not taken into account, EXPY overestimates the importance of sophisticated products from low-income countries. Xu (2006) shows that once products at the HS six-digit level are further divided by relative unit values, the structure of China’s exports is consistent with its level of development. This has led authors like Lederman and Maloney (2009) to conclude that how a country produces an export matters more than what it produces. Seemingly high-tech products like computers can be produced in low-tech ways and vice versa. Furthermore, because of fragmentation of production, while the final export of a sophisticated product might be from a low-income country, its contribution might have just been in the final assembly of high-value intermediate inputs made elsewhere. One should not, therefore, lose sight of the entire value chain and explore which stage of production creates and captures the greatest value. Even if computers are deemed not to be sophisticated because the final assembled package is exported from a low-income country, the parts and components could be highly skill-intensive and possibly imported from richer countries. According to Dean, Fung, and Wang (2007), imported inputs accounted for 57 percent of Chinese computer exports in 2002. Koopman, Wang, and Wei (2008) estimate the foreign content in China’s exports to be about 50 percent overall, and 80 percent in sophisticated products like electronic devices. In the well-known example of the iPod, an overwhelming share of the final assembled value of an iPod exported from China is captured by the creators of intellectual property and not in the form of wages earned by the assemblers. Krugman (2008) discusses this issue in the context of a paradox that increased trade of the United States with developing countries appears to be in skill-intensive products, contrary to trade theory. Much of this increase is due to aggregation bias, where only the labor-intensive final stages of production could be from developing countries, yet they give the illusory impression that the entire production of the finished good occurred within the borders of that country. To the extent possible, total exports net of components imports could reveal a country’s place in global production sharing. For example, in 2006–07, nearly 75 percent of components imported for machinery and transport equipment (SITC 7) by China were from the rest of East Asia (Athukorala and Menon 2010). Source: Authors. Figure 1.24, panels A and B, plot the physical and human capital of Qatar’s exports. Despite the large number human capital content of exports on the same graph for of goods, the human capital content of the median export Pakistan and the Republic of Korea, with dots weighted by is almost identical (Singapore’s 7.7 to Qatar’s 7.8). The export value in 2003. The quadrants are formed by the human capital content and economies of scale of existing median human and physical capital contents of each coun- exports have implications for the human resources policies try’s exports that year. The Korean space appears more of Qatar if it seeks to diversify away from its reliance on dense, indicating that it exports many more goods (at the natural resource–based exports into knowledge-based HS six-digit level) than Pakistan. Most notable, however, is industries and services. the fact that some of the biggest-earning Pakistani exports (indicated by bubble size) embody human and physical Upgrading: Analyzing Product Space capital content that is below the median of its portfolio. In Indicators Summary of data needs and sources contrast, Korea’s big export earners embody capital content Proximity Tools like Product Space Explorer and that is above the median of its overall export portfolio. between Product Space Parser downloadable from products www.chidalgo.com; Cytoscape (open-source Pakistan’s most important exports in terms of value are and product bioinformatics software) downloadable from those that need few machines, little capital equipment, and densities www.cytoscape.com; revealed comparative advantage data to be computed from WITS. little schooling. Its exports that are capital intensive are yet to be scaled up. Figure 1.24, panels C and D, compare only the When structural transformation or economic growth is revealed human capital intensity of the exports of Qatar studied as being determined by broad aggregates, such as and Singapore. The quadrants in both graphs are formed human and physical capital, analysts and policy makers by the median of Qatar’s export earnings and human capi- risk underappreciating the complexity of sector-specific tal content of its exports in 2003. Singapore exports 20 ingredients needed for economies to adapt, experiment, times more products (it has a much bigger native popula- and evolve. Hausmann and Klinger (2007) argue that tion than Qatar’s, but the workforce is not more than five every product requires capabilities that are specific to that times larger). The human capital content of a large share of activity, from labor training and physical assets to regula- those exports are higher than the median content of tory requirements, property rights, and infrastructure. Quality and Sophistication: The Quality Margin 51 Figure 1.24. Revealed Factor Intensity Module 1 Panel A. Pakistan 2003 Panel B. Republic of Korea 2003 Revealed factor intensity indices and export value Revealed factor intensity indices and export value revealed human capital index 2003 revealed human capital index 2003 12 12 10 10 8 8 6 6 4 4 2 2 0 0 0 50,000 100,000 150,000 0 50,000 100,000 150,000 200,000 revealed physical cap. index 2003 revealed physical cap. index 2003 Panel C. Qatar 2003 Panel D. Singapore 2003 Revealed human capital intensity index Revealed human capital intensity index revealed human capital index 2003 revealed human capital index 2003 12 12 10 10 8 8 6 6 4 4 2 2 0 5 10 15 0 5 10 15 20 log of export value by product (HS6) 2003 log of export value by product (HS6) 2003 Source: Authors. Exporting mangoes requires different capabilities (such as exports a product given that it also exports another prod- a decent sanitary and phytosanitary regime) than produc- uct.17 Proximity between any two goods (m and n) is the ing synthetic apparel, but the capabilities for producing minimum of the pairwise conditional probabilities of hav- mangoes are likely to be similar to exporting vegetables. ing comparative advantage. {( ) (RCA RCA )} Similarly, gold mining or even extraction of forest prod- RCAm ϕm ,n = min P RCAn , P n ucts may require a higher level of property rights enforced (1.12) m than, say, assembly of electronic parts. The ease with which an economy can move to producing new exports In the product space map presented in figure 1.25, the depends on what its installed capability looks like. The southeast part of the map has a lot of products that are clus- hypothesis is that countries that build up competence in tered together, particularly related to industries such as producing a certain good can redeploy their human, phys- chemicals, machinery, and metals. Peripheral products ical, and institutional capital more easily if they seek to include petroleum, agriculture, cereals, and labor-intensive produce goods that are “nearby� those that they currently products. Whether a country’s exports in which it has com- are producing. parative advantage are located in the denser part of the prod- Proximity between products in the product space is uct space or in the periphery can predict the ease with which computed from the pairwise likelihood that a country that country transforms itself economically. Structural 52 Module 1: Trade Outcomes Analysis Figure 1.25. Product Space Maps of Pakistan—Overview Module 1 Panel A. 1993 Panel B. 2008 Source: Authors. transformations are not smooth movements along a contin- and chemical industries. The scattered industries on the uum but rather a messy process beset by market failures. upper half are largely agricultural and resource based. When such market failures are binding, it is harder for firms Countries that succeed in transforming themselves over to hop longer distances without government coordination time from producing unprocessed natural or agricultural and support. Because products do not evolve in sequence, goods and labor-intensive manufactures (such as footwear that is, having iron ore deposits does not necessarily make a and garments) to more sophisticated manufactured prod- country an efficient steel producer, lateral linkages are as or ucts like machinery and chemicals tend to see higher rates more important than forward linkages with downstream of economic growth. Over the past 40 years, countries like industries. China, Indonesia, the Republic of Korea, Malaysia, Singa- Using the tools pioneered by Hidalgo, Klinger, Barabasi, pore, Thailand, and Turkey have undergone the most dra- and Hausmann (2007), the product space maps indicate all matic transformation and have seen some of the fastest tradable products at the SITC four-digit level. The black rates of economic growth. dots are those with RCA. Other shades indicate the cate- In Figure 1.25, panels A and B, the product space maps gory of goods to which they belong, such as resource based, for Pakistan are shown. The cluster on the top where raw materials, labor- and capital-intensive manufactures, Pakistan had several products in both years with RCA and so on. In their analogy, the product dots are trees that (greater than 1) represents garments. It has also per- group themselves to form dense and sparse parts of a for- formed well in textiles, which incidentally is closer to est. Location of firms in the denser parts of the forest cre- industries that are more capital intensive and generally ates more opportunities for diversification and technologi- produced by rich countries. Between 1993 and 2008, cal upgrading because market failures are less binding during which time Pakistan increased the number of agri- when firms have to make smaller adjustments to move to cultural and labor-intensive products in which it had produce nearby goods that require similar capacities. comparative advantage, it had not had a major break- The center of the product space, for example, is quite through in more sophisticated products. dense with better connectedness among industries related Figure 1.26, panels A to D, classify Pakistan’s exports to metallurgy, vehicles, and machinery. To the bottom right (valued above US$10,000) into four categories. The first is of the product space lie the more sophisticated electronics a group of products in which Pakistan has consistently Quality and Sophistication: The Quality Margin 53 Figure 1.26. Pakistan’s Exports, Mapped in Product Space, 1993–2008 Module 1 Panel A: Competitive products Panel B: Emerging products goat leather bovine leather acyclic alcohol refined copper frozen fish base men’s knit coats metal ore made-up textile arts brown rice cement molasses jewelery mattresses and hosiery bedding bed, table woven cotton linens metal waste knotted carpets waste slag leather clothing Panel C: Marginal products Panel D: Declining products plastic boxes beverages vacuum pumps women woven coats artificial tractors filament/yarn food processing machines polycarboxylic acid synthetic filament nucleic acids telecom parts Source: Authors. been competitive. In 1993 and 2008, 103 products had an RCA of less than 1. There were more than 400 of such mar- RCA greater than 1. These products are mainly textiles and ginal exports. Figure 1.26, panel C, illustrates a few of these garment items, such as linen, cotton, curtains, carpets, with national export share in 2008 of at least 0.05 percent. men’s coats, and leather clothing. Figure 1.26, panel A, With external facilitation, some of these marginal products shows some of the top products from this category with at could be upgraded and made more competitive. They least 0.5 percent share in Pakistan’s total exports in 2008. include vacuum pumps, chemicals (acids), wheeled trac- On the product space map, the textile cluster comes closest tors, telecommunications parts, and food-processing to the denser, high-value manufacturing industries. No machines. These products indicate that Pakistan has Pakistani export (with RCA > 1) is firmly embedded in this installed capacity to move readily into fairly sophisticated part of the product space. manufacturing industries. Why it has not succeeded in Thirty-eight major products did not have an RCA becoming a major player in any of these products would be greater than 1 in 1993 but did in 2008. Figure 1.26, panel B, one major line of policy inquiry. shows some of these “emerging� products with at least 0.2 The fourth category includes goods that were competi- percent share of national exports in 2008.18 These products tive in 1993 but no longer in 2008. More than 20 major include potentially high-value exports like bedding and products were in the declining products category. In figure mattresses, frozen fish, jewelry, cement, and metal waste. 1.26, panel D, three of the products that had an export The shipping-dependent heavier products are likely to be share of at least 0.05 percent in 1993 are illustrated. These more competitive in regional markets. declining products include textile and garment products The third category includes “marginal� products that that were no longer able to withstand competition from Pakistan exported both in 1993 and 2008, but that had an countries producing similar items. 54 Module 1: Trade Outcomes Analysis Figure 1.27. Characteristics of Exporting Firms in Selected Indonesian Manufacturing Sectors, 2004 Module 1 Panel A. Export share of production Panel B. Export value Export share of production for exporting firms - 2004 Export value for exporting firms - 2004 100% 350,000 86% 90% 304,839 80% 82% 300,000 80% 250,000 60% 48% 200,000 40% 150,000 18% 100,000 20% 23,802 41,943 50,000 2,327 0% 0 apparel furniture automotive apparel furniture domestic foreign domestic foreign Source: Authors. Entry and Survival: The Sustainability Margin foreign markets but fail to sustain those flows can help explain the varying export performance across countries. Structure of the Export Sector Empirical exercises with firm-level data could shed light on Indicators Summary of data needs and sources whether firm characteristics such as age, size, and type of Number and nature Data from Enterprise, Manufacturing or ownership can influence export longevity. At a more of firms participating Industrial Census (country-specific), in trade or from Customs Transactions aggregate level, Brenton, Pierola, and von Uexkull (2009) Database find that the size of the initial export flow explains subse- quent duration of flows, as do search and information costs One important determinant of trade performance and and exchange rate volatility. sustainability is the structure of the trade sector itself— In figure 1.28, panels A and B, the survival rates of specifically, understanding the degree to which a signifi- Qatari and Singaporean exports at the SITC four-digit cant share of firms are participating in trade, the average level are assessed for the 10-year period from 1999 to and distribution of size of exporters, and the role of FDI in 2008. Qatar has 9,387 country-product pairs (excluding the export sector. Analyzing this performance requires sub- petroleum and gas). For many of these pairs, trade takes stantial firm-level data, which are not likely to be available place just once or for a single spurt of consecutive years. to the analyst in every country. Normally, the analysis will Some pairs die and are then revived. So, the total number rely on access to census data—for example, from a manu- of export spells is 22,534. The median duration of facturing, industrial, or establishment census. Figure 1.27, the export spell is only 1 year, and the mean duration is panel A, shows that the apparel and furniture sectors in 2.3 years. Indonesia are bifurcated—although most firms do not The first graph (Kaplan-Meier survival function) export, those that do export tend to export the large major- shows that the probability of a Qatari export relationship ity of their production. Figure 1.27, panel B, highlights the surviving until the second year is less than 50 percent, dramatic difference between domestic and FDI exporters and maintaining a relationship for more than two years in these sectors, with FDI firms producing and exporting is less than 25 percent. In comparison, the survival rate 15 to 20 times (on average) that of domestic exporters. of Singapore’s export relationships is much higher. It has Longevity of Export Episodes 76,429 export relationships. The probability of a Singa- Indicators Summary of data needs and sources porean export relationship surviving beyond the first Kaplan-Meier survival Trade data from WITS; regression run year is 70 percent. Singaporean exports also have a much function; Nelson- in Stata using commands designed higher probability of survival in countries with which it Aalen cumulative for survival analysis. shares a border (namely Malaysia, indicated by the red hazard function; extended mean graphs line). This is marginally true for Qatar’s exports to coun- tries with which it shares a border (Saudi Arabia and the Attempts by developing countries to introduce new United Arab Emirates), but the increased chance of sur- exports in new or incumbent markets are fraught with vival is not as stark as for Singapore.19 Geographic loca- challenges. Exploring why countries succeed in penetrating tion is not a trade policy variable, but for almost all Entry and Survival: The Sustainability Margin 55 Figure 1.28. 10-Year Export Survival Plots, 1998–2008 Module 1 Panel A. Qatar’s non-oil & gas relationships Panel B. Singapore’s export relationships Survival of Qatar’s non-oil & gas Survival of Singapore’s export relationships 1999–2008 1.00 relationships 1999–2008 1.00 0.75 0.75 0.50 0.50 0.25 0.25 0.00 0.00 0 5 10 0 5 10 analysis time analysis time contig = 0 contig = 1 contig = 0 contig = 1 Source: Authors. Figure 1.29. Export Relationships: Intensive and Extensive countries, proximity matters, highlighting the impor- Margins tance of logistics, business organization, and infrastruc- ture that reduce trading time and cost. old new Decomposition of Export Growth and Death market market Summary of data old intensive extensive Indicators needs and sources product margin margin Growth and survival rates of Trade data from WITS; new extensive extensive export relationships; breakdown computations in either Excel or Stata. product margin margin of the intensive and extensive margins into their constituents Source: Authors. This section complements the earlier discussion on the (5.8 percent). A modest 6 percent of export growth was intensive and extensive margins by looking at export rela- explained by existing products to new markets. Although tionships at the level of country-product pairs. This exercise the categories can be sensitive to the thresholds and cutoffs has the advantage of exposing better the relationships along used, overall, in poorer countries, growth at the extensive the intensive margin (existing exports to existing markets) margin can play a bigger role than it does in higher-income and extensive margin (new exports to existing markets, new countries, as can the decline and extinction of existing exports to new markets, and existing exports to new markets), flows (low survival rates). This is illustrated by the decom- as illustrated in figure 1.29. This can also reveal the scale of position of export growth for Senegal, which saw a bigger decline and death of major exports in specific markets. percentage increase in exports of existing products into For mature exporters, growth generally occurs at the existing markets (110 percent) as well as a bigger percent- intensive margin. The share of export growth contributed age decline in the same category (42 percent). Growth at by existing flows to existing markets is usually dominant. the extensive margin (both of new products to new makets This growth contribution can be tempered by the extinc- and of old products to new markets) was much higher for tion of products or decline in export value of existing Senegal than India.21 products in existing markets. On the extensive margin, Going further, one can analyze whether a pattern can be expansion of existing products to new markets is more identified in the death of exports. Are exports becoming commonplace.20 In figure 1.30, panels A and B, export extinct more frequently in particular markets? Do declin- growth is decomposed for India and Senegal between 2001 ing exports belong disproportionately to a particular and 2008. In India, existing flows to existing countries industry cluster like animal products or labor-intensive accounted for nearly 100 percent of the growth, but this industries? In the Senegal example, 305 export relation- growth was offset by exports that fell to existing markets ships (out of 9,720 country-product pairs) had at least one 56 Module 1: Trade Outcomes Analysis Figure 1.30. Decomposition of Export Growth Module 1 Panel A. India, 2001–08 99.74% intensive margin extensive margin 6.00% –5.78% –0.11% 0.00% 0.00% increase of old fall of old extinct increase of increase of increase of old products in products in new products new products products in old markets old markets in new in old markets new markets markets Panel B. Senegal, 2001–08 109.4% intensive margin extensive margin 27.1% –42.1% –3.5% 8.2% 0.9% increase of old fall of old extinct increase of increase of increase of old products in products in old new products new products products in old markets markets in new in old markets new markets markets Source: Authors. nonzero value between 2001 to 2006 but had a zero export versatile with the maximum number of goods reaching value in both 2007 and 2008 (see table 1.6). In terms of the most number of countries, covering half of all rela- markets, the maximum number as well as cumulative value tionships that could exist; (2) India exported three times (from 2001 to 2006) of export relationships that failed to more than Vietnam in 2008, but the average value of each survive were destined mainly to neighboring countries like relationship was similar, at US$3.8 million; (3) the annual The Gambia, Guinea, Guinea-Bissau, Mali, and Sierra growth rate of exports is many times higher than the Leone. The three notable non-African markets were annual growth rate of export relationships, indicating that France, India, and the Netherlands. In terms of products, it is easier to expand existing exports to existing markets the dominant industry groups to which export deaths than to connect new products with incumbent or new belonged were petroleum and cereals. For India, during the markets, or to expand old products to new markets; and same period, the major markets in which its exports disap- (4) if the intensive margin is defined as the export of old peared were Indonesia, Japan, Oman, and the Syrian Arab products to old markets (that is, defined as relationships Republic. As for products, the main ones that disappeared that existed at the beginning and the end of the five-year in 2007 and 2008; were all related to petroleum (motor sample period), most trade occurs at the intensive margin. spirit and light oil) (see table 1.7). In 2008, 99 percent of German exports were in products A related anlaysis is a more explicit accounting of that went to countries that already existed in 2004. This export relationships by product and country. In table 1.8, ratio was 98 percent for China, 94 percent for India, and for the period 2004–08: (1) German exports are the most 93 percent for Vietnam. Entry and Survival: The Sustainability Margin 57 Module 1 Table 1.6. Destinations of Declining Exports of Senegal Cumulative value Number of Code Country Region (US$ ‘000) 2001–06 relationships MLI Mali Sub-Saharan Africa 92,257 23 GMB Gambia, The Sub-Saharan Africa 19,066 21 GNB Guinea-Bissau Sub-Saharan Africa 16,764 18 GIN Guinea Sub-Saharan Africa 9,875 15 FRA France Western Europe 9,137 38 NLD Netherlands Western Europe 8,304 5 LBR Liberia Sub-Saharan Africa 5,780 2 SLE Sierra Leone Sub-Saharan Africa 4,931 5 TGO Togo Sub-Saharan Africa 4,795 5 IND India South Asia 4,385 3 CPV Cape Verde Sub-Saharan Africa 4,354 5 Source: Authors. Table 1.7. Declining Exports of Senegal Cumulative value Number of SITC Product name Industry (US$ ‘000), 2001–06 relationships 3330 Petroleum oil, crude Petroleum 246,743 15 3342 Kerosene/medium oils Petroleum 111,475 14 2634 Cotton, carded/combed Cereals 45,200 25 3345 Lubricants (high petroleum content) etc. Petroleum 9,077 20 3341 Motor spirit/light oils Petroleum 8,913 7 3344 Fuel oils, n.e.s. Petroleum 4,197 3 812 Fodder bran/by-products Cereals 2,395 2 422 Rice husked (brown) Cereals 2,329 3 2633 Cotton waste Cereals 2,142 8 Source: Authors. Exports Relative to Factor Endowment capital content of the export will be higher, reflecting the Indicators Summary of data needs and sources capital stock of all countries that produce those goods. Simi- Distance between Trade data from WITS; endowment data larly, for capital-rich countries, their exports are likely to be national endowment from United Nations Conference on to the southwest of their national endowment points. This and the factor Trade and Development. intensity of exports occurs when goods produced by capital-rich countries are also produced by countries with lower physical and human To explain why a country’s exports cannot be sustained, capital stock. Because of aggregation bias even at the HS six- one of several areas to investigate is whether the exports that digit level, this is a pervasive problem in trade data. The die represent attempts to produce goods that require a dif- insight, therefore, is obtained not by looking at the share of ferent mix of factor endowments than supported by the products that exceed the endowment point but by looking at economy. If a nation’s endowment point is represented by the share of products that are distant from the national the intersection of its average stock of physical and human endowment point regardless of whether the endowment capital, we can see how far or close to the average endow- point is on the lower or the higher ends of the axes. ment point are the factor intensities of exports. By construc- Take the example of Nepal. With no exception, the most tion, most low-capital countries will be seen to produce significant exports of Nepal in 1993 were in line with the exports that have capital content exceeding their endow- country’s factor endowments, with some embodying capi- ment point (to the northeast). If the goods they produce are tal greater than the national average. By 2003, Nepal’s also produced by capital-rich countries, then the average endowments had increased, and it produced an increasing 58 Module 1: Trade Outcomes Analysis Table 1.8. Export Performance across Products and Markets, 2004–08 Module 1 China India Vietnam Germany Tunisia Costa Rica No. of export relationships in 2004 82,186 50,825 15,770 99,307 4,715 6,455 Realized (global) potential 2004 (%) 41.09 25.41 7.89 49.65 2.36 3.23 Average value of a relationship (US$ million) 11.48 1.97 2.20 16.75 1.51 1.80 Export value in 2004 (US$ million) 943,852 100,310 34,668 1,663,440 7,135 11,683 No. of export relationships in 2008 82,992 53,820 21,123 10,1542 4,047 7,316 Realized (global) potential 2008 (%) 41.50 26.91 10.56 50.77 2.02 3.66 Average value of a relationship (US$ million) 22.94 3.82 3.85 26.09 2.29 2.32 Export value in 2008 (US$ million) 1,903,742 205,808 77,507 2,648,773 9,261 17,039 Annual growth in export (2004–08, %) 19.17 19.68 22.28 12.33 6.73 9.89 Annual growth in exp. relation (2004–08, %) 0.24 1.44 7.58 0.56 –3.75 3.18 No. of new exports, 2004–08, two-year cutoffa 3,389 2,316 1,149 2,328 244 1,249 No. of relationships from Year 1 through Year 5 60,027 31,938 9,592 76,552 936 2,160 Survival rate over 5 years (2004–08) 73.04 62.84 60.82 77.09 19.85 33.46 Export value of relationships existing in Year 1 and Year 5 (US$ million) 1,864,135 193,837 72,263 2,623,793 5,398 16,264 Intensive margin, 2004–08 97.92 94.18 93.23 99.06 58.29 95.45 Extensive margin, 2004–08 2.08 5.82 6.77 0.94 41.71 4.55 Source: Authors; Computed using data in Comtrade. Note: a. Judging a “new product� using a two-year cutoff means that the export relationship did not exist in years n – 2 and n – 1, but it did exist in years n, n + 1, and n + 2. share of exports with a higher level of physical and human exports that were active in 2003 (darkest dots), but not a factor requirements. The major exports, however, remained decade earlier, were moderately capital intensive. close to the endowment point (see figure 1.31). Success of exports depends on an array of factors, In figure 1.31, panel C, the darkest dots show exports including accumulated national capabilities, search and that existed in 1993 but not in 2003. The majority of such information costs related to the business of exporting, and exports were those that required a relatively high level of exchange rate volatility. Deviation from generalized com- physical and human capital. Of the 608 exports in 1993, parative advantage is neither necessary nor sufficient for 143 had disappeared by 2003. In the subsample of Nepal’s exports to die. In fact, many successful exporting countries exports with revealed physical capital index greater than in Asia used policies to push the limits posed by static com- 50,000, the death rate by 2003 was 37 percent (87 dead parative advantage to move into products exported by rich among 236 exports). In the subsample with revealed physi- countries. If a country suffers from high rates of export cal capital index less than 50,000, the death rate was 15 per- death, however, this metric ought to be examined. The cent (56 dead among 372 exports). It can be hypothesized analysis of comparative advantage may be more relevant that, all else equal, ambitious ventures that defy a country’s for smaller developing countries than large ones. The aver- comparative advantage probably have a higher rate of fail- age capital endowments of large developing countries like ure. At the same time, by 2003, export activity had Brazil and India may not be comparable to that of rich increased substantially (see figure 1.31, panel D). By that countries, but they are known to produce sophisticated, time, Nepal exported 1,510 products, of which only 465 capital-intensive products such as helicopters and light were also exported in 1993. The majority of these new aeroplanes. Annex A. Product Classifications 59 Figure 1.31. Export Flows and Factor Endowments, Nepal Module 1 Panel A. Nepal: Exports relative to endowment 1993 Panel B. Nepal: Exports relative to endowment 2003 12 12 revealed human capital index revealed human capital index 10 10 8 8 6 6 4 4 2 2 0 50,000 100,000 150,000 0 50,000 100,000 150,000 revealed physical capital index revealed physical capital index Panel C. Nepal: Death of exports 2003 Panel D. Nepal: New exports 2003 12 12 revealed human capital index revealed human capital index 10 10 8 8 6 6 4 4 2 2 0 50,000 100,000 150,000 0 50,000 100,000 150,000 revealed physical capital index revealed physical capital index Source: Authors. Annex A. Product Classifications 6. Iron, steel, and other metals (HS 26, 72–83): produc- tion of iron, steel, and other metals Classification of Products (HS two-digit) 7. Machinery, electronics, transportation equipment (Harmonized Commodity Description and Coding System) (HS 84–89): production of skill and capital-intensive These eight categories are adapted from Hanson (2010). machinery, electrical materials, electronics, and trans- 1. Agriculture, meat and dairy, seafood (HS 1–10, port equipment 12–14): land-intensive activities surrounding agricul- 8. Other industries (HS 37, 43, 49, 66–67, 90–97): collec- ture production tion of remaining manufacturing industries (photo- 2. Food, beverages, tobacco, wood, paper (HS 11, 15–24, graphic material and equipment, fur, printed material, 44–48): manufacturing activities that use agriculture, umbrellas, hats, musical instruments, arms, furniture, forestry, and other land-intensive inputs toys, and miscellaneous items) 3. Extractive industries (HS 25–27, 68–71): nonmetallic minerals, ores, petroleum, precious stones, precious Classification of Products (SITC two-digit) metals, and other industries based on subsoil resources (Standard International Trade Classification, Rev. 2) 4. Chemicals, plastics, rubber (HS 28–36, 38–40): manu- These 10 categories are adapted from Leamer (1984) facture of chemicals and other petroleum-based products and Felipe, Kumar, and Abdon (2010). 5. Textiles, apparel, leather, footwear (HS 41–42, 50–65): the production of labor-intensive clothing and 1. Petroleum: petroleum and petroleum products (33) apparel items and the inputs for these goods (textiles 2. Raw materials: crude fertilizers and crude minerals and leather) (27); metalliferous ores (28); coal, coke, briquettes 60 Module 1: Trade Outcomes Analysis (32); gas (34); electric energy (35); nonferrous ment services. They exclude compensation of employees and investment Module 1 income (formerly called factor services) and transfer payments. metals (68) 4. Hanson (2010) classifies products in the Harmonized Commodity 3. Forest products: wood, lumber, cork (24); pulp, waste Description and Coding System (HS). An alternative is suggested by paper (25); wood, cork, manufactures (63); paper Leamer (1984) for products following the Standard International Trade paperboard (64) Classification (SITC). See Annex A. 5. RCA of product k in country i is the export of product k relative to 4. Tropical agriculture: fruits, vegetables (05); sugar the country’s total exports divided by the world’s export of product k rel- (06); coffee, tea, cocoa, spices (07); beverages (11); ative to total world exports. crude rubber (23) 6. Athukorala and Menon (2010) also use these disaggregated data to debunk the so-called decoupling thesis that argues that East Asia can 5. Animal products: live animals (00); meat (01); dairy maintain its own economic dynamism: They show that China’s reliance (02); fish (03); hides, skins, furskins (21); crude animal on the import of components from other East Asian countries has grown and vegetable minerals (29); animal, vegetable oils at the same time its share of final exports of manufactured goods to this region has declined, suggesting that China links East Asia to the developed and fats (43); animal, live not otherwise specified markets of the European Union and the United States through global pro- (n.e.s.) (94) duction networks. 6. Cereals: cereals (04); feeds for animals (08); miscella- 7. Leung (2010) singles out Vietnam as a conspicuous laggard in East neous food preparations (09); tobacco (12); oil seeds, Asia in terms of both assembly and manufacturing of components, attrib- utes the slow entry of Vietnam into the global supply chain to the protec- oil nuts, oil kernels (22); textile fibers (26); animal oils, tion of the state sector in the 1990s, and notes the orientation of FDI to fats (41); fixed vegetable oils (42) joint ventures with state-owned enterprises in heavy industries. Only after 7. Labor intensive: nonmetallic mineral manufactures 2000 have reforms been undertaken to propel Vietnam into being a player in global production networks in light manufacturing. (66); furniture (82); travel goods, handbags (83); 8. Log value of 13.35, for example, is a US dollar amount equivalent clothing (84); footwear (85); miscellaneous manufac- to exp(13.35) * 1,000, which is approximately US$632 million. tured articles, n.e.s. (89); postal packages (91); special 9. Quadrants are formed by the global median values of log of export per capita (y-axis) and the share of manufacturing and services sectors in transactions (93); nongold coins (96) GDP (x-axis). 8. Capital intensive: leather (61); rubber (62); textile, 10. The US nominal GDP is nearly US$15 trillion. Even a 1 percent yarn, fabrics (65); iron and steel (67); manufactures of annual growth of this economy creates economic value of around US$150 metal (69), sanitary fixtures, fittings (81) billion, which is equivalent to a 10 percent growth in a US$1.5 trillion economy (such as Brazil, Canada, or Spain). All else equal, however, a sus- 9. Machinery: power generating (71); specialized for tained growth rate of 1 percent every year doubles present income every particular industries (72); metalworking (73); general 35 years, whereas a sustained growth rate of 10 percent doubles present industrial (74); office and data processing (75); income every seven years or so. It is this power of compound growth that has transformed China after its reforms and opening-up process (Gaige telecommunications (76); electrical (77); road vehicles Kaifang) began three decades ago. (78); other transport equipment (79); professional and 11. This index was initially developed to test the market power of scientific instruments (87); photographic equipment firms, but it has since had wider applicability. 12. These calculations are sensitive to the thresholds set for minimum (88); armored vehicles, firearms and ammunition (95) export values. If any export above US$0 is included in the sample, the cal- 10. Chemicals: organic (51); inorganic (52); dyeing and tan- culations are less informative than when a sharper cutoff of, say, ning (53); medicinal and pharmaceutical (54); oils and US$10,000, is used, below which exports are defined as insignificant or perfume (55); fertilizers (56); explosives (57); artificial equivalent to zero. 13. Classified by the World Bank’s Poverty Reduction and Economic resins and plastic (58); chemical materials, n.e.s. (59). Management (PREM) Network using data from Comtrade. Data available at http://info.worldbank.org/etools/prmed/. High-technology exports generally include products with high research and development intensity, such as in aerospace, computers, pharmaceuticals, scientific instruments, Notes and electrical machinery. 1. Population is the log of a country’s total population, averaged 14. There are caveats, as explained in Racine (2010), when (mirror) between 2006 and 2008. The cost of exporting is proxied by a subindicator export values are measured inclusive of cost, insurance, and freight, from the Doing Business indicators (see, for example, World Bank 2008), larger distances introduce larger biases. Products like oil, whose prices which measures fees levied on a 20-foot container for documents, cus- are set internationally, have a weaker association between unit values and toms clearance and broker fees, terminal handling charges, and inland quality. High unit values could reflect high costs or market power in spe- transport. The cost does not include customs tariffs and duties, costs cific locations. They may also vary with the processing stage of produc- related to ocean transport, or bribes. tion, with downstream industries typically having higher unit values 2. A country’s remoteness measure is a GDP-weighted average dis- than upstream. tance between a country and all its trading partners. Weights are calcu- 15. Rauch (1999) classifies commodities into the following cate- lated by dividing the GDP (current US dollars) of each partner by an gories: (1) those traded in organized exchanges (homogenous products), estimated World GDP of US$55 trillion, for the years 2006–08. (2) those with reference prices (for which the brand of producers is not 3. Exports of goods and services in the WDI database (World Bank important), and (3) differentiated products. Special links between coun- 2011c) represent the value of all merchandise, freight, insurance, trans- tries (common language and colonial ties) are found to be more impor- port, travel, royalties, license fees, and other services, such as communica- tant for trade in differentiated products because they lower search and tion, construction, financial, information, business, personal, and govern- matching costs between sellers and buyers. References 61 16. Cadot, Tumurchudur, and Shirotori (2009) describe the method- Felipe, J. 2010. Inclusive Growth, Full Employment, and Structural Change: Module 1 ology of the computation of the indexes; database available at http:// Implications and Policies for Developing Asia. London: Anthem Press. r0.unctad.org/ditc/tab/index.shtm. Golub, S. S., R. W. Jones, and H. Kierzkowski. 2007. “Globalization and 17. The minimum of the two probabilities is taken to avoid the prob- Country-Specific Service Links.� Journal of Economic Policy Reforms 10 lem that originates when the number of exporters of a product falls. If (2): 63-88. good A is produced only by one country, the conditional probability of all Hanson, G. 2010. “Sources of Export Growth in Developing Countries.� other products being produced given that A is produced by that country is University of California–San Diego. 1, reflecting the uniqueness of the country not the similarity between Hausmann, R., and B. Klinger. 2007. “The Structure of the Product Space goods. The reverse probability is not the same. See Hausmann and Klinger and the Evolution of Comparative Advantage.� CID Working Paper (2007) for methodological details. No. 146, Center for International Development, Harvard University, 18. The product space maps include 775 products, whereas medium- Cambridge, MA. to large-size countries typically export more than this number. Several Hausmann, R., J. Hwang, and D. Rodrik. 2006. “What You Export Mat- products that Pakistan exports cannot be mapped on the product space. ters.� CEPR Discussion Papers 5444, Centre for Economic Policy and 19. According to the log rank test, the difference between survival rates Research, London. to countries with and without a shared border is statistically insignificant. Helpman, E., M. Melitz, and Y. Rubinstein. 2008. “Estimating Trade Flows: 20. Brenton and Newfarmer (2009) find in their study of 99 developing Trading Partners and Trading Volumes.� Quarterly Journal of Econom- countries that the increase in exports of existing products to existing markets ics 123 (2): 441–487. accounted for 105 percent of total export growth between 1995 and 2005. C. A. Hidalgo, B. Klinger, A.-L. Barabási, R. Hausmann, 2007, “The Prod- 21. This analysis for the period 2001 to 2008 assumed the follow- uct Space Conditions the Development of Nations�, Science, 317: ing: (1) products that were exported to at least one country either in 482–487. 2001 or 2002 were classified as existing products, and those not Hummels, D., and P. Klenow. 2005. “The Variety and Quality of a Nation’s exported anywhere in 2001 and 2002 were new products; and (2) mar- Exports.� American Economic Review 95 (3): 704–723. kets that were reached with any product in either 2001 or 2002 or 2003 Hwang, J. 2006. “Introduction of New Goods, Convergence and Growth.� were classified as existing markets, and the rest were new markets. Job Market Paper, Department of Economics, Harvard University, Products that were not exported to any country in 2007 and 2008 were Cambridge, MA. deemed “dead.� Alternative time periods should be considered to check Imbs, J., and R. Wacziarg. 2003. “Stages of Diversification.� American Eco- for robustness. nomic Review. 93 (1): 63–86. Klinger, B. 2010. “(New) Export Competitiveness.� Center for Interna- tional Development, Harvard University, Cambridge, MA. References Klinger, B., and D. Lederman. 2004. “Discovery and Development: An Empirical Exploration of ‘New’ Products.� World Bank, Washington, DC. 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Module 2 Competitiveness Diagnostics Market Access Link with Competitiveness Challenges Identified in Trade Outcomes Competitiveness challenge areas General export Cost Product extension Main components of market access environment competitiveness and quality Market penetration Tariffs and quantitative restrictions ✓ ✓ ✓ Nontariff barriers (NTBs) ✓ ✓ ✓ ✓ Preferential trade arrangements ✓ ✓ (PTAs) Quantitative Analysis: Indicators and Data Sources Indicators Source General restrictions World Trade Indicators (WTIs, which draw on • ROW average applied tariff, MA-TTRI, MA-OTRI TRAINS, Comtrade, ITC MacMap); World Trade Organization (WTO) Trade Policy Reviews • Tariff escalation ratio Note that some of these data is now available via • Nontariff coverage ratio World Development Indicators. Zero or preferential tariff • MFNa zero-duty exports (percent of total) • Exports to PTA partners • Preferences utilization rate (percent) and actual value (percent of exports) in the United States and European Union Product-specific access • Applied tariffs and NTMs faced by the country’s key exports, compared with what peer exporters face in the world’s major markets in the North and South (matrix) • Number of major export products (HS six digit) that face tariff peaks (MFN > 15 percent) in the world’s top 10 major markets • Share of export value rejected from border in the past 12–18 months Descriptions of key indicators Tariff average, simple and weighted: The extent to which a foreign market restricts imports can be measured by the arithmetic average of tariffs on goods (at an appropriate level of classification, such as the Harmonized Commodity Description and Coding System [HS] at the six- or eight-digit level). A simple average includes statutory tariffs on goods in which trade flow is zero. The weighted average takes into account the tariff rate and the volume of imports. For very high rates of tariff, however, the weighted tariff underreports trade restrictiveness: A rate of zero and a prohibitively high tariff rate receive similar weights. Because no measure is perfect, it is common practice to report tariffs in all their forms: simple and weighted average, minimum, maximum, and standard deviation (UNCTAD 2009). Rest-of-the-world (ROW) applied tariff: Following above, the ROW applied tariff average are rates imposed by a country’s export partners at the HS six-digit level and can be reported either in simple or weighted form. Tariff escalation ratios: Are calculated as the percentage change between the applied tariff for fully processed goods and applied tariffs for raw materials (or primary products). If tariffs are higher on finished products than on raw materials, they implicitly encourage the export of primary products. Because tariff escalation acts as a tax on value addition, developing countries face reduced incentives for industrial upgrading required to produce processed goods. 63 64 Module 2: Competitiveness Diagnostics Market Access–Overall Tariff Restrictiveness Index (MA-OTRI): Although measures of simple and trade-weighted tariff averages, as well as tariff dispersion, are widely used, they are without theoretical foundation. Building on the work of Anderson and Neary (1994), World Bank economists have created indexes summarizing all forms of trade restrictions—tariffs, quotas, licenses, and so on—into a common metric by estimating the ad valorem equivalent of NTBs at the tariff-line level. They are then aggregated to produce a single tariff rate imposed by all trading partners on exports of a country in a manner that maintains the current level of exports. This uniform tariff is called MA-OTRI (Kee, Nicita, and Olarreaga 2008). Market Access–Trade Tariff Restrictiveness Index (MA-TTRI): This is computed in the same manner as the OTRI but only for tariffs (including preferences) imposed by trading partners on a country’s exports. Nontariff measure coverage ratio: Is calculated by coding products (with a zero or one) within a category that is affected by at least one NTB, then multiplying the binary variable with the share of imports or exports, and summing to produce a coverage ratio. This ratio is only indicative of the prevalence of NTBs and is silent on the restrictiveness. This weakness is similar to the one discussed for weighted average of tariffs in which case a highly restrictive barrier acquires a low weight by reducing trade flows (UNCTAD 2009). Antidumping and countervailing duties: In practice, antidumping duties are almost identical to tariffs, and are generally expressed ad valorem. As discussed, however, the process of determining these duties can be highly distortionary and interruptive. Active use of antidumping measures by a country can lower export of unconcerned products and aggregate exports to that country.b Ideally, all these effects should be accounted for, but there is no common technique available to do so. The tariff equivalent of a dumping duty is expected to be slightly larger on the domestic price of imports because part of the ordinary tariff is normally absorbed by exporters. With antidumping duties, however, exporters have no incentive to lower the price (Deardorff and Stern 1997). Countervailing duties are also levied like tariffs, but their purpose is to offset any subsidies given by foreign governments. Note: Vandenbussche and Zanardi (2010) found that in India and Mexico, both active users of antidumping measures, aggregate annual imports decreased by around 7 percent. a. MFN (most favored nation) refers to a nondiscriminatory trade policy commitment whereby countries agree to apply to each other the lowest level of import duties and quota restrictions which they apply on similar imports from other trade partners. Qualitative Analysis: Interview Targets and Issues for Discussion Senior policy makers at the Ministry • Do exporters make use of negotiated tariff preferences? Or, do they instead opt to pay for the Module 2 of Trade or Foreign Affairs MFN rate because the costs associated with meeting the rules of origin (ROO) or preparing official documents to qualify for reduced duties are onerous? • What explains the country’s low penetration in x market despite having a PTA? Are ROOs too restrictive to be eligible for preference; or are exports uncompetitive to the extent that the tariff margin does not compensate for higher productivity of competitors? • Is there correlation between recent surges in exports and increased stringency in the application of sanitary and phytosanitary (SPS) measures and technical barriers to trade (TBT), or in the number of antidumping and CVD investigations initiated against their exports? Is there also a correlation between recent cuts in the importing country’s tariffs, and its shift toward increased use of trade remedy laws? Chambers of commerce • What is the experience of major exporters in complying with NTBs, especially those related to sanitary and phytosanitary, technical, and security/terrorism standards? How much do these compliance costs typically add in terms of tariff equivalents? • How readily do policy makers or staff in embassies take up concerns in bilateral negotiations, or at the WTO on behalf of exporters? Major exporters • Are tariffs so high that they drive exporters out of competition despite enjoying lower input costs or higher productivity than in countries that enjoy tariff preferences? Are PTAs signed by the export destinations leading to trade diversion? • Have there been costly rejections of exports in the past 12–18 months? List products (for example, nuts, shrimp, honey) and countries that rejected them? What were the grounds? The SPS agreement requires that regulation be based on scientific principles and not maintained without sufficient scientific evidence except in cases of scientific uncertainty. Was this complied with or were they arbitrary, excessive, and a form of disguised protection? What was the cost incurred by the exporter? Could export tragedies be avoided with better information? Export promotion agencies • When the SPS and TBT concerns on the part of the importer are genuine, what kind of capacity building initiatives are needed for exporters? How is the service and capacity of domestic institutions to facilitate exports regarding testing standards, preshipment inspections, and so on? Analytical Approach Step 1: Understand the Structure of Tariffs Affecting Key Exports For a rapid Diagnostics aimed at understanding the major trade policy barriers a country’s exports face, fol- lowing is a simple two-stage analytical process that can be • High or peak tariffs. Is Country B a major export mar- followed. ket for County A in terms of existing size (for example, Market Access 65 Germany or the United States) or growth potential (for • Margin of preferences. Does one or more of the competi- example, Brazil, China, or India)? Does Country B have tors receive a preferential tariff either through a high tariffs (or peaks) on major exports from Country A? regional, bilateral, or unilateral arrangement from a Does it escalate tariffs to deter import of value-added major importing country? What is the margin of prefer- goods? Are there tariff-rate quotas (TRQs)? As an exam- ence? Does this margin received by competing countries ple, the United States has high MFN applied duties outweigh any cost and price advantage that Country A against the import of HS 240120 (tobacco, partly or enjoys? If Country A receives preferences itself, are they wholly stemmed/stripped). The average tariff for least negated by compliance criteria such as tight ROO? For developed countries (LDCs) is more than 77 percent. small LDCs, concessions on market access appear to be However, an African LDC like Malawi qualifies for a more important than for larger exporters that rely on zero tariff, but a non-African developing country can scale and cost advantages to be competitive despite face a specific tariff of US$5,480 per ton, or a tariff having to face negative preferential margins on tariff. equivalent of 158 percent. It would be highly difficult to compete in an identical product when a competitor has Step 2: Find Out about the Main Nontariff Barriers a substantial margin of tariff preference, which is the Faced by Exporters case in many agricultural and labor-intensive manufac- In addition to tariffs, several trade instruments can tured exports. potentially be invoked to restrict market access, includ- • Penetration of markets. Because the tariff rates faced by a ing quotas, antidumping and countervailing duties, and country as well as its competition determine the depth safeguards. Other provisions can also be applied with of one’s market access, it is crucial to know about other restrictive intent, such as technical safety and sanitary competing countries that export similar products as requirements, and compliance with intellectual property Country A. In the example in table 2.1, exports in 2008 rights (IPR). Major questions to ask regarding NTBs are Module 2 of product category HS 6204 (women’s suits, jackets, as follows: and so on) to the world’s four major importers are shown. China, Romania, Turkey, and Vietnam are large • Technical regulations. To what extent do SPS and TBT exporters of the product. In Bangladesh and Morocco, measures represent prominent restrictions to exports? both products were important, accounting for 8.8 and Are these measures perceived as justified or used to 4.6 percent of their total exports. In the United States, restrict trade? Is compliance difficult and expensive? Are Morocco’s exports are substantially less than that of procedures cumbersome? Is the information publicly Bangladesh, despite the fact that Morocco has a free available and accessible? Are the problems related to the trade agreement with the United States, and qualifies for measure itself or the inspection at the border? Are these reduced tariffs. In HS 6204, the MFN tariff that measures applied on an MFN basis? Are there any Bangladesh pays is 14 percent. Morocco is eligible for mutual recognition agreements for standards with key the preferential rate of 2.8 percent. Although its focus partners and at the regional level? on the EU market is understandable given the geo- • Incidences of trade remedy action. Is a particular export graphic proximity, the underpenetration of the US mar- part of an industry that is a frequent target for trade ket is worth exploring. Why are preferences being remedy actions? Has there been an antidumping underutilized in a lucrative market? Although the rate of investigation against the country’s export, in the past 18 utilization can be calculated quantitatively, the reasons months?1 By which country in which product and will have to be gathered through qualitative assessments industry? Did the investigation lead to an actual impo- and interviews. sition of duty? Has there been a CVD investigation, and Table 2.1. Market Shares of Major Exporters of HS 6204 (Women’s Suits) in 2008 in Selected Markets World (US$) Bangladesh China Morocco Romania Turkey Vietnam Canada 1,144,146 4.49 58.11 0.48 0.94 1.75 2.14 European Union 13,007,403 4.36 41.80 7.62 — 14.12 2.06 Japan 3,388,246 0.06 82.04 0.39 0.48 0.22 2.85 United States 12,411,131 4.73 38.63 0.32 0.25 0.49 7.84 Source: ITC 2011. Note: — = not relevant. 66 Module 2: Competitiveness Diagnostics was the duty imposed? Has there been a safeguard country’s products on preferential terms. Table 2.2 illus- measure applied? Were exports restricted? How did trates for a sample product (HS 610120) how tariffs can those actions affect exports? vary widely in the world’s three major economies—Japan, • Quotas and other NTMs. Do exporters face tariff-rate Europe, and the United States—depending on an array of quotas on some key export products? Are surtaxes, criteria, such as the following: developing countries; LDCs; beyond tariff, common? African, Caribbean, and Pacific Countries (ACPs); trade agreement partners; nonagricultural goods; agricultural Although tariff and nontariff barriers are explicit goods; and services. policy-induced barriers to foreign market access, several other factors affect market access, such as geographic dis- Developing Countries tance and cost of transport; colonial, linguistic, or cultural Since the 1960s, industrial economies like Japan, the Euro- affinity; exchange rate misalignment; and costs related to pean Union, and the United States and at least 10 other search and information as well as contract enforcement. countries have provided preferential access to exports from These are, however, not related to direct trade policy more than 100 developing countries unilaterally under the measures in the sense that they are hard to change through Generalized System of Preferences (GSP). National pro- unilateral action, or bilateral, regional, and multilateral grams vary, however. The United States, for example, does negotiations. not include textiles and clothing exports in its GSP pro- gram. Developing countries like China, Pakistan, and Sri Lanka pay the MFN tariff rate on their apparel exports to Tailoring the Diagnostics to Country the United States (see table 2.2). The European Union, and Sector Characteristics however, includes textiles and clothing in its GSP scheme Access to foreign markets is either granted on concessional from which countries like Pakistan benefit. Chinese Module 2 terms to specific partners, or negotiated multilaterally, exports were disqualified for tariff preferences in the Euro- regionally, and bilaterally. Generally, preferential schemes pean Union after 2004. The European Union also offers applying to developing countries depend on the stage of duty-free access to a distinct subgroup of developing coun- development, geographic or cultural proximity, and any tries: under its GSP-plus program, beneficiary countries specific terms and conditions negotiated between govern- have to demonstrate that their economies are vulnerable ments. All country Diagnostics need to know the condi- and have to have ratified and implemented the 16 core con- tions under which foreign markets are accessible to a ventions of human and labor rights and at least 7 out of the Table 2.2. How Tariffs Differ across Trade Partners Illustration of HS 610120 (Men’s or boys’ overcoats, cloaks, anoraks) Kenya Sri Lanka Lesotho Bangladesh Pakistan China UNITED STATES: 0 15.9 0 15.9 15.9 15.9 Gives zero tariffs AGOA preference Not an LDC; and AGOA preference An LDC, but Full applied MFN Applied MFN to SSA, NAFTA, apparel not receives no duty; bill duty Central included in preference proposed in American, and U.S. GSP for U.S. Congress Caribbean, and developing to grant Andean countries preference to countries. Pakistan EUROPEAN UNION: 0 0 0 0 9.6 12 Gives zero tariffs Preference Neither an LDC Preference Preference Preference Applied MFN to LDCs, EPA, received as a nor an EPA received as an received as an received as duty and GSP+ trade partner partner, but LDC, but also LDC, but not part of GSP countries. (EPA), but not receives as a trade an EPA partner an LDC preference as partner (EPA) an incentive for sustainable development JAPAN: 10.9 10.9 0 0 10.9 10.9 Gives zero tariffs Applied MFN Applied MFN LDC preference LDC preference Applied MFN Applied MFN only to LDCs. duty duty duty duty Source: Compiled from ITC MacMap (2010). Market Access 67 11 conventions on good governance and protection of the African, Caribbean, and Pacific Countries environment. Sri Lanka was among such countries benefit- The group of ACP countries, now numbering 77 (exclud- ing from GSP-plus, until it was suspended in 2010 for ing South Africa), has traditionally received more generous governance-related issues. In general, ROOs under the EU tariff preferences on a broad range of products than those GSP require two significant value-adding processes (often covered under the EU GSP (Staritz 2011). Kenya, for exam- referred to as “double transformation�) to be performed ple, benefits from this scheme (see table 2.2). The United within the beneficiary country. States does not have a specific program for LDCs, but it provides duty-free treatment on approximately 83 percent Least Developed Countries of tariff lines from 15 Asian LDCs, 88 percent of tariff The acronym LDC is often used generically to refer to lines from selected Caribbean and Andean countries, and any less developed country. In the United Nations as well 98 percent of tariff lines for several low-income countries as the WTO agreements, however, LDC refers to a dis- under the African Growth and Opportunity Act (AGOA). tinct group of low-income countries classified by the Kenya and Lesotho benefit from AGOA preferences in the United Nation to include those with (1) gross national United States, but LDCs from elsewhere (like Bangladesh) income (GNI) per capita under US$905; (2) poor do not benefit on apparel-related exports, and they pay the Human Assets Index (HAI) based on indicators of nutri- same MFN tariff as larger developing countries like China tion, infant mortality rate, education, and the literacy (see table 2.2). Under AGOA, however, ROOs required at rate; and (3) economic vulnerability in terms of popula- least 35 percent value addition, which many potential ben- tion size, remoteness, export concentration, homeless- eficiary countries found hard to meet, resulting in very low ness from natural disasters, and so on. There are 48 LDCs utilization of the preferences. These rules were later relaxed as of November 2011. for apparel exports, giving the option to source inputs The most favorable arrangement under the EU GSP is from third countries. Module 2 reserved for LDCs. The Everything But Arms (EBA) amendment, which became effective in March 2001, Trade Agreement Partners extended duty- and quota-free access to all products origi- The third type of countries that benefit from preferential nating in LDCs, except arms and ammunition. Lesotho market access are those that have signed BTAs or RTAs with and Bangladesh benefit from zero tariffs in the European the major importing countries. This includes the EU’s Eco- Union as LDCs (see table 2.2). nomic Partnership Agreement (EPA)—a web of BTAs. To The Japanese and Canadian programs are simpler and qualify for preferences, exporters have to satisfy ROOs, cover almost all products except, for example, eggs, poul- such as minimum value addition or change of tariff head- try, and dairy in Canada, and rice and sugar in Japan. To ing. The latter requires that the value addition should be qualify for preferences in textiles and clothing, exporters sufficient to change the tariff classification of a product generally have to satisfy double transformation ROOs either at the HS four- or six-digit level. The United States (for example, fabric and clothing). In recent years, large also grants favorable market access to partners in its RTAs developing countries like China and India have also like the North American Free Trade Agreement (NAFTA), unilaterally begun to grant preferences to LDCs on a and nearly 20 other agreements with specific countries. To negotiated list of products. The preferences granted by qualify for preferences in textiles and clothing, exporters China, for example, include both natural resources like generally have to satisfy triple transformation ROO (yarn, minerals and agricultural products as well as manufac- fabric, and clothing); however, less developed countries tured goods, including some processed foods, light man- from Africa may source inputs (yarn and fabric) from third ufactures, and textiles. countries and undergo a single transformation. Importantly, one of the pending items in the unfin- China is the only exporter that receives no tariff pref- ished Doha Development Agenda is the pledge by WTO erence in any of the markets. Yet, in 2008, it was the members in 2005 to make it compulsory for industrial largest exporter of the above product (HS 610120) in all countries, and voluntary for developing countries, to give three markets (Japan, the European Union, and the duty- and quota-free market access to all exports from United States). This suggests that it is able to offset the LDCs. The flipside of this pledge was that 3 percent of tar- higher tariff with productivity that results in either lower iff lines could be exempted from receiving zero tariff rates. cost or higher quality of the product. But tariff prefer- Because LDC exports tend to cover a narrow range of ences are important to many exporters. Lesotho has no products, this clause could negate any meaningful access market presence in Japan and almost none in the Euro- the LDCs could receive. pean Union, but for a country of its size, it is a major 68 Module 2: Competitiveness Diagnostics exporter to the United States, taking advantage of the Tariffs aside, nonagricultural goods are less susceptible to AGOA preference and lenient ROO requirements. Both in sanitary and technical barriers,2 but these goods are per- Japan and in the European Union, Lesotho enjoys prefer- haps more vulnerable to antidumping petitions and other ences, but the ROOs are harder to comply with, which contingent measures. explains its negligible presence. Market access in terms of tariffs and NTBs varies widely Agricultural Goods by sector. In particular, there are significant differences in In contrast to restrictions in industrial goods, the richest tariff levels, dispersion, and in the nature and importance of countries of the world continue to maintain high levels of NTBs between agricultural and nonagricultural (or manu- tariff and nontariff restrictions in agriculture. In Japan factured) goods. The Diagnostics should therefore analyze and the European Union, the OTRI for agricultural goods market access issues separately by sector, bearing in mind is more than 50 percent. In the United States, it is nearly that, within sectors, specific products can be subject to dis- 20 percent. Developing countries like China and India tinctly high measures of tariff and nontariff restrictions. also restrict agricultural goods, primarily to safeguard the interests of small farmers. Agricultural goods are also Nonagricultural Goods more sensitive to sanitary and phytosanitary conditions, In high-income countries, tariffs and NTBs against imports increasing their vulnerability to rejections and other costly are generally low. The Overall Trade Restrictiveness Index precautionary non-tariff measures. (OTRI), which summarizes the trade restrictiveness of tar- iffs as well as nontariff measures in Japan, the European Services Union, and the United States ranged between 5 and 6.1 The WTO’s General Agreement on Trade in Services percent in 2006–09, according to the WTIs. This is histori- (GATS) envisions four modes through which trade in ser- cally very low, even though the average does conceal tariff vices occurs: Module 2 peaks in specific items, such as labor-intensive manufactur- ing goods like footwear and apparel, as shown in table 2.2. 1. Mode 1: Cross-border supply—a user in one country The emerging developing countries like India, who argue receives service from a provider abroad (for example, that they are still in the process of industrialization, main- financial, accounting and other professional services, tain higher trade restrictions in nonagricultural goods. information technology (IT)-enabled medical diagnos- As seen in figure 2.1, the OTRI of India is 17 percent. tics and advice, online energy trading) China’s restrictions came down substantially during the 2. Mode 2: Consumption abroad—a user moves abroad to course of its negotiated accession to the WTO in 2001. consume a service (for example, tourists, health patients) Figure 2.1. Overall Trade Restrictiveness Index, 2006–09 (Applied MFN tariffs and nontariff measures in selected countries) 70 58.48 60 52.95 50 39 40 30 19.85 18.66 20 17 9.45 10 5.03 5.86 6.15 0 EU Japan India United States China agriculture non-ag Source: Authors. Market Access 69 3. Mode 3: Commercial presence—a user is offered service visit the country for long periods and take advantage of by entities owned by foreign providers (for example, diverse care packages. Because portability of insurance is foreign-owned subsidiary in insurance, telecom, or important, it requested Japan to allow health insurance electricity) coverage for treatment of Japanese patients in Thailand. 4. Mode 4: Movement of natural persons—a service provider Countries could, in fact, specialize in different segments of moves abroad to supply a service (for example, doctors, health care. While the United States offers highly sophisti- construction workers) cated services that are costly, other countries have devel- oped capacities to provide different services at affordable Market access in services overwhelmingly focuses on prices. Health care can also be provided through other modes 3 and 4. Mode 3 is essentially FDI in services (for modes, for example, telemedicine (mode 1), hospitals example, South African telecom services based in other established overseas (mode 3), and doctors and nurses African countries). An importing country could restrict moving to provide services overseas (mode 4). this form of trade by imposing screening requirements, Beyond infrastructure and human resources, evolu- limiting the number of service suppliers, limiting the tion and coordination of new regulations is critical to value of transactions, restricting the number of persons facilitate market access for services trade through modes employed, and so on. The most common restriction, 1 and 2. These issues include privacy and protection of however, is to cap the ownership of equity in firms by for- data, recognition and harmonization of regulatory stan- eigners.3 Mode 4 is even more contentious. Although it is dards across borders, jurisdictions regarding taxation about temporary movement of service suppliers, it is eas- and indemnity, and rules governing government pro- ily tied to threats of permanent movement or immigra- curement (Chanda 2006). tion if managed ineffectively. This is why most countries have liberalized more the movement of skilled and corpo- Module 2 Background Reading: Relationship Between rate personnel than low-skilled labor, in which poor Market Access and Trade Competitiveness countries have an export interest. Remittance sent by temporary service suppliers (for example, Bangladeshi or Trade policies adopted by trading partners, as well as those Nepali construction or factory workers in Gulf countries) implemented at home, affect how competitive a country’s has become a major source of national income in devel- exports are in world markets. In commercial diplomacy, oping countries. “market access� is a broad concept referring to all measures In modes 1 and 2, market access is much more in the that restrict a country’s exports in foreign markets. These control of exporting countries, as their competitiveness is restrictions are a subset of overall trade costs. All else equal, highly dependent on domestic regulations and capacity. access to a foreign market can be hindered by a partner’s use For mode 1, the presence of a technical or professional tal- of tariffs (taxes on imports) and nontariff measures, such as ent pool and decent infrastructure (especially telecom and quantitative restrictions (quotas, licenses, voluntary export Internet connectivity) are prerequisites. Take IT services: In restraints), contingent protection (antidumping measures, 2008, the global market for outsourced IT services was val- countervailing duties, safeguards), and technical barriers ued at US$250 billion and expected to grow by up to 9 per- involving safety and sanitary standards. cent per year until 2013; India and Israel were the top two Increased market access is important to realize the developing country exporters with US$23.1 billion (Eng- gains from trade. Access to world markets allows firms to man 2010). Other countries like Argentina, Costa Rica, exploit scale economies, reduce unit costs, and specialize. Malaysia, the Russian Federation, and Sri Lanka are seeing Some measures act as an absolute barrier to access (for rising exports. In addition to IT, professional services such example, quotas, technical bans), but in general, the main as medical diagnosis, architectural design and consultancy, channels through which barriers in foreign markets hurt accounting, and distance learning can also be traded export competitiveness are (1) by increasing the fixed costs through mode 1. of entry—that is by raising prices of goods in the import- For mode 2, infrastructure is key, not only for tourism, ing country through increased cost of compliance and but especially for health care. In 2008, more than 400,000 add-on taxes (and if the tariff-imposing country is partic- nonresidents purchased health services in the United ularly large in terms of its share of the global market, the States, 450,000 in India, 300,000 in Malaysia, 410,000 in world price of the affected good could fall, hurting Singapore, and 1.2 million in Thailand (Cattaneo 2010). exports even in third markets); and (2) raising risk— Thailand, in fact, established the Long-stay Management while tariffs are at least predictable, technical barriers Corporation in 2002 to encourage elderly foreigners to raise significant risks for exporters, who may invest in 70 Module 2: Competitiveness Diagnostics product development, production, and transport only to Tariffs find their goods rejected at the border. Box 2.1 summa- Tariffs are taxes levied on imports mainly with the dual rizes some of the important current issues and debates objective of protecting domestically produced goods from around market access. foreign competition, and raising revenue to finance public Figure 2.2 illustrates the main component factors that expenditure. They can be expressed either ad valorem, that shape market access from a policy perspective. Each of is, a fixed percentage of the declared import value, or as a these components is then discussed in the remainder of specific tax, which is a fixed amount per specified quantity, this section. size, or weight. Some tariffs can be expressed in both a Box 2.1. Key Issues and Debates—External Market Access Are LDCs taking advantage of market access? Although market access has long been a concern on the trade agenda for developing countries, and it remains so in key areas like agriculture, most LDCs now have preferential market access to industrial countries for an extensive range of manufactured products as well as many important commodities. But many developing countries struggle to take advantage of this market access. This not only is a function of nontariff measures (particularly around technical standards) but also more broadly reflects behind-the-border constraints in home markets that continue to render producers uncompetitive. South-South trade and market access: With the growing importance of South-South trade, market access among developing countries is becoming an increasing priority. Yet, tariff barriers among developing countries remain much higher than between industrial and developing countries. Moreover, evidence from the recent global crisis suggests that developing countries are quicker to raise barriers against each other. On the other hand, technical standards tend to be less of a barrier to South-South trade. Implementation of RTAs: Perhaps because of the failure of multilateralism in Doha, the number of regional preferential agreements is growing rapidly. More new RTA agreements were concluded in 2009 than in any previous year. But implementation Module 2 of RTAs has been slow. In fact, only 313 of the 505 RTAs notified to the WTO as of November 2011 are actually in force. Source: Authors. Figure 2.2. The Main Components of Market Access Difficulty accessing foreign markets Tariff barrier Direct Policy Barriers Nontariff barrier Antidumping (AD), Countervailing Indirect Most Favored Duties (CVD) Barriers Preferential tariff Nation tariff Emergency Safeguards (ES) Regional or Autonomous Tariff peaks Bilateral PTA (GSP, AGOA) Sanitary and Transport cost; Phytosanitary (SPS) search and information Admin and documentation; cost; language and constraints posed by rules cultural hurdle; use of Tariff escalation of origin different currencies; Technical Barriers contract enforcement (TBT) and other hurdles Need multilateral (WTO) negotiations, or Bilateral and Regional PTAs Need domestic capacity building, and international disciplines Source: Authors. Market Access 71 specific and ad valorem form. The level of tariff a country’s prohibitions, nontariff charges, licenses, SPS and TBTs, goods are charged by its trading partner may well depend and contingent measures are among the most prominent on whether the two countries have a PTA, are members of NTMs. Exporters should identify whether their export the WTO, or neither. Tariffs that are levied in a nondis- products face any of these barriers and analyze the impact criminatory manner on goods irrespective of their country on their competitiveness, in particular, compared with of origin are called MFN tariffs. Tariffs that have been competitors. negotiated bilaterally or regionally to be less than the MFN level are known as preferential tariffs. To qualify for prefer- Quotas, Prohibitions, Licenses, ential tariff rates, countries normally have to meet ROO and Nontariff Surcharges criteria (see box 2.2). An import quota is a type of protectionist trade restriction that sets a physical limit on the quantity of a good that can Nontariff Measures be imported into a country in a given period of time. As import tariffs have been reduced worldwide, NTMs Above a certain quantitative threshold, no imports are per- have risen in prominence and have become a major trade mitted into the country. Through negotiations at the WTO, policy tool with important implications for exporters most quotas have now been converted to tariffs, or have and importers. NTMs include a wide category of instru- taken the form of tariff-rate quotas (TRQs),4 in particular, ments such as SPS, TBT, quotas, subsidies, anticompetitive for agricultural products. In a competitive setting, quotas measures, import or export licenses, export restrictions, and tariffs are alike in that just like a quota truncates excess custom surcharges, financial measures, and contingent demand for an imported good, an equivalent level of tariff measures. It is, however, necessary to make a distinction can be found that reduces imports by the same amount between NTMs and NTBs. Although NTMs may have a with identical effect on domestic prices. Although tariff clear domestic goal of preventing unfair trade or protecting revenues accrue to the government, rents from quotas can Module 2 the health of citizens, they become NTBs when used with be captured by either domestic license holders, the govern- clear protectionist intent to stop imports. NTMs are there- ment if it auctions off quotas, or foreign suppliers in the fore considered NTBs when they restrict trade. Quotas, case of a voluntary export restraint (VER). Box 2.2. Tariffs, Preferences, and ROOs When Country X applies a tariff of 19.7 percent, say, on men’s or boys’ cotton shirt not knitted or crocheted (HS 62052020) from Country Y, but exempts a tariff on the same import from Country Z with which it has a PTA, all else equal, exporters from Country Z have a substantial price advantage over exporters from Country Y. If domestic firms in Country X also produce such items, they benefit too by making imports from Country Y less competitive. Even if exporters from Country Y are the world’s most efficient, they may still not be able to compete on price when tariffs are high. For exports from Country Z to qualify to enter Country X duty-free, it may need to fulfill agreed criteria on ROOs and other NTMs, which can present a cost disadvantage in a manner that negates partly its positive margin on tariff. As explained in Staritz (2011), in the early 2000s, Bangladesh was the top supplier of cotton t-shirts in the European Union, but it did not figure among the top t-shirt suppliers in the United States. One of the reasons for this is that the European Union grants Bangladeshi clothing exports duty-free entry as an LDC and Bangladesh is able to meet the EU’s double transformation ROO. In the United States, by contrast, Honduras was the top supplier of t-shirts followed by Mexico, El Salvador, and the Dominican Republic— all countries that have preferential access to the United States. Similarly, until 2000, nearly three-quarters of clothing exports from Sub-Saharan Africa (SSA) were directed to the European Union where SSA countries enjoyed duty- and quota-free access under the Lomé Convention. Only South Africa and Mauritius were important exporters, however, because preferential market access required fulfilling double transformation ROO. These export patterns have changed dramatically since 2000–01 when the United States introduced AGOA. Exports to the United States more than doubled, whereas those to the European Union stagnated. Kenya, Lesotho, Madagascar, and Swaziland became large clothing exporters to the United States because AGOA allowed quota- and duty- free access by requiring only single transformation ROO. A tight ROO regime favors countries with an “integrated� industry (such as manufacture of fabric and sewing of apparel). Those that only seek to add value mostly through labor fail to meet this requirement. Therefore, preferences programs that relax ROO, by requiring less value addition to qualify, or permit the sourcing of inputs from abroad are utilized more. At the same time, the rules ought not be relaxed too much so that it encourages transshipment from third-country exporters who merely use the preference- receiving country as a port and contribute little to the economy. The debate continues on what constitutes an appropriate balance between the goal of preventing transshipment to encourage integrated production structure in poor countries, on the one hand, and the goal of offering preferential market access conditions on terms that can be fulfilled and used by poor countries, on the other. Source: Authors. 72 Module 2: Competitiveness Diagnostics When the domestic industry is not perfectly competi- exceptional circumstances (see, for example, box 2.3 on tive, however, quotas and tariffs that permit the same vol- the Multi-Fibre Arrangement), the WTO prohibits the use ume of imports into a country can have different effects on of quantitative restrictions. With the gradual elimination domestic prices. Prices that consumers pay under a quota of quantitative restrictions, and cuts in tariff, the focus of are higher than with a tariff because a quota caps imports trade negotiations has increasingly turned to the reduc- and leaves the monopolist facing an imperfectly elastic tion of NTMs. NTMs in Country A affect exports from the demand curve. With tariffs, if the domestic monopolist rest of the world. But these could also hurt the competi- raises its price, imports can increase. Quotas choke off a tiveness of Country A firms by limiting their options to supply response, and restore a monopolist’s market power source the cheapest inputs. in a way tariffs do not. This is illustrated in figure 2.3. Export markets may also prohibit the import of some From the perspective of export competitiveness, quotas products. Moreover, both quotas and bans are usually sub- are more burdensome because irrespective of the price ject to licenses that may be granted automatically or that competitiveness of an export, or quality, goods may not be may be given more restrictively on a nonautomatic basis. permitted to enter a foreign market after a certain thresh- Charges, taxes, and other paratariffs may also increase the old is reached. This is one of the reasons why, barring cost of the exported product and hurt its competitiveness Figure 2.3. Quotas and Tariffs under Different Market Conditions Quota and tariff equivalent under Quota and tariff not equivalent under perfect competition imperfect competition Module 2 Residual Price demand Excess supply Marginal cost Price with quota Quota Price with tariff t rent or tariff Tariff Quota rev World price Excess demand Marginal revenue Q Source: Authors. Box 2.3. Quotas in Textiles and Clothing The global trade in textiles and clothing (T&C) was distorted by an elaborate system of quotas for more than 40 years until they were removed on December 31, 2004. The Multi-Fibre Arrangement (MFA), in violation of the fundamental GATT principle of nondiscrimination, enabled industrial importing countries to impose quotas, applied as negotiated “voluntary� export restraints against those imports from individual countries (“low-cost suppliers�) deemed to cause or threaten market disruption in the importing country. The MFA, renewed several times between 1974 and 1994, continued and expanded the product and country coverage of two earlier regimes of protection: the 1962 Long Term Arrangement Regarding International Trade in Cotton Textiles and the 1961 Short Term Arrangement. These were ended by the Agreement on Textiles and Clothing (ATC), an outcome of the GATT Uruguay Round. The ATC froze the number of quotas in place in 1994 and set an irrevocable schedule for their elimination over a 10-year transitional period (1995–2004). Although the purpose of the MFA was to restrain trade, it did result in some “benign� outcomes. As manufacturers/and exporters shifted production from countries that faced a binding quota restraint to those that were less restrained by bilateral quotas, T&C industries sprung up in poor countries like Bangladesh and Sri Lanka that have remained competitive even in the postquota era (Waglé 2005a). Source: Authors. Market Access 73 on the export market. These may include customs sur- The process of establishing antidumping and counter- charge and services charges. vailing duties is also an important cause of distortion of behavior and export flows. Antidumping petitions are Contingent Protection particularly disruptive, because in certain sectors such as Contingent protection measures are applied as temporary textiles and clothing that are frequently targeted, back-to- deviations from a normal import policy and include back investigations could be initiated over many years antidumping measures, countervailing duties, or emer- (see box 2.4). By the time a verdict is reached, trade flows gency safeguards.5 Antidumping duties are levied against could be severely curtailed. Often the exporters affected imports that are believed to be sold at prices below those in are SMEs in poorer countries, whose ability to “dump� the good’s country of origin or other countries. Such prac- products is questionable in the first place. For example, a tices on the part of foreign exporters could be sporadic, series of antidumping actions were imposed by the Euro- persistent, or predatory, the last of which provides the pean Union against bed linen exports from India, Pakistan, strongest economic justification for antidumping duties. Thailand, and Turkey in the 1990s. By the time the imposi- Countervailing duties are levied on imports from countries tion by the European Union of antidumping duties on that subsidize exports. Safeguard measures are applied Indian bed linen imports was settled at the WTO in when surges in imports temporarily disrupt a domestic India’s favor in 2001, the disruption was such that exports industry. Antidumping and countervailing duties are nor- had fallen from US$127 million in 1998 to US$91 mil- mally an issue that affects only large developing countries, lion. This led to job losses for 1,000 workers in the south- like Brazil, China, and India. Smaller countries seldom ern city of Pondicherry, where one of the targeted firms have the scale of production to actually engage in dumping was based. Even after the WTO verdict of 2001, the terms or to do it on sufficient scale to affect the domestic markets of the complaint were altered slightly, and new antidump- of trading partners. ing duties were applied. This illustrates that trade remedy Module 2 Contingent protection may be used as a disguised pro- measures can take a long time to resolve and the cost of tectionist measure. Although antidumping duties were arbitration is high (Oxfam 2004). almost exclusively levied by industrial countries in the 1990s, developing countries are now active users. In the last Sanitary and Phytosanitary Requirements quarter of 2009, 26 WTO members initiated 26 product- and Technical Barriers to Trade level investigations under national trade remedy laws. SPS measures are applied by governments to protect More than three-fourths of the cases were brought by human, animal, or plant life or health from risks arising developing countries, of which 71 percent targeted exports from the entry or spread of pests, from plant- or animal- from China. In the same quarter, 30 measures were borne pests or diseases, or from additives, contaminants, imposed following prior investigations, of which 25 were toxins, or disease-causing organisms in foods, beverages, initiated by developing countries and only five by indus- or foodstuffs.6 This includes checking for pesticide residue trial countries (Bown 2010). in food, or subjecting animals to veterinary examination. Box 2.4. Catfish and the Politics of Antidumping In the late 1990s, the United States became a major export market for Vietnamese exporters of catfish. Their inroads hurt the domestic producers, represented by the Catfish Farmers of America (CFA). The CFA argued that the Vietnamese catfish were not catfish and lobbied the US Congress to include language in the 2002 Agriculture Appropriations Act that barred Vietnamese exporters from labeling their fish as catfish. The Act stipulated that only catfish of the species Ictalurus Punctatus can accurately be labeled catfish; the Vietnamese fish is of the family Pangasius. The Vietnamese complied by renaming their fish “basa� or “tra.� The change in name, however, had little effect on Vietnamese catfish sales in the United States. The CFA then filed an antidumping petition alleging that the Vietnamese fish were being sold in US markets at unfair prices. The CFA petitioned for the low prices to be redressed with a dumping margin (tax) of 191 percent. The Vietnamese argued that their export prices were competitive because of the attributes of the Mekong River, low labor and feed costs, and traditional knowledge, as well as the fact that state subsidies were not involved. During the investigation, the United States treated Vietnam as a “nonmarket economy� and used prices from surrogate markets (Bangladesh and India). In January 2003, the US Department of Commerce announced a preliminary determination that imports of frozen basa and tra fish fillets were indeed being dumped and that the margins against their imports had to be levied in the range of 38 to 62 percent. Duties on catfish before this investigation were less than 5 percent. Source: Waglé 2003. 74 Module 2: Competitiveness Diagnostics For example, the United States mandates Hazard Analysis designing and adopting its SPS measures. Trade regula- and Critical Control Point (HACCP) certification (which tions can be WTO compatible and still be discriminatory requires processes to reduce the risk of contamination in or even create obstacles to trade because of their imple- food production) for imports of juice and meat, and the mentation. European Union has adopted a suite of standards govern- Under the SPS Agreement, countries may depart from ing the “farm-to-table� chain, targeting a series of linked international standards if there is a scientific justification product and process standards governing food safety, ani- or if a member determines that a higher level of protection mal health, animal welfare, and plant health. Similarly, is appropriate after conducting a risk assessment. Although TBTs refer to all technical regulations and standards the SPS Agreement obliges countries to accept the SPS applied to industrial products and aimed at ensuring con- measures of other WTO members as equivalent if the sumers’ health and safety. exporting country can demonstrate that its measures are Although both measures aim to achieve legitimate adequate, the TBT agreement is softer in that countries policy objectives, they may be used to restrict trade and can give a “positive consideration� to accepting as equiva- serve as an NTB (see box 2.5). The WTO SPS Agreement lent the technical regulations of other countries, but they contains a number of provisions to ensure that adopted are not obliged to accept them. As Staiger and Sykes SPS measures are not a camouflage for protectionism, (2009) argue, it is these kinds of provisions that give coun- such as, among other things, the obligation of any coun- tries freedom to select their own level of risk without try wishing to introduce an SPS measure to conduct a much regard for the costs of achieving the regulatory tar- scientific risk assessment, to demonstrate consistency in get or the incidence of those costs on exporters or its SPS actions, and to reduce negative trade effects, when importers (see box 2.6) Module 2 Box 2.5. The Increasing Importance of Standards As tariffs are being lowered, a new family of potential barriers has become prominent—standards over products and processes. The ability to meet these standards has become central for market access, particularly in high-income markets. Standards create both a threat and an opportunity for producers: generally the process is costly and can act as a barrier to enter, particularly for small-scale producers; alternatively, they provide the potential to enter high-margin markets and improve capabilities of producers. Three characteristics of standards as a barrier to global trade differentiate them from tariffs and quotas: (1) standards are not just established by governments but also involve a range of private actors, particularly firms, international industry bodies, and civil society organizations; (2) unlike tariffs and quotas, which are publicly codified, standards that producers have to meet often are not widely publicized or stable and consistent; (3) unlike tariffs and quotas for which there are established mechanisms to resolve conflicts (for example, the dispute resolution procedures under the WTO), the determination of performance with respect to standards is generally an asymmetric process, determined solely by the buying party or country, with the producer having little capacity to challenge decisions on conformance. A detailed discussion on standards and certification is included in the section “Trade-Promotion Infrastructure: Standards and Certification� in this module. Source: Kaplinsky 2010. Box 2.6. Sanitary and Environmental Concerns as an NTB Sanitary and environmental issues that appear alternately as food-safety and eco-labeling requirements have acted as NTBs. The European Union, for example, has adopted a policy of “zero tolerance� to fish products containing the residual antibiotic chloramphenicol. The standards have led to a plunge in shrimp imports from major Asian exporters. Advances in the technology of seafood analyses have been made to the point that pesticide and pharmaceutical residues can be detected at the parts per billion (ppb), and in some cases, at the parts per trillion (ppt) levels. When zero tolerances are established on the basis of the ability of a test to detect ppm, the increase in sensitivity to ppb or ppt can turn a “safe� product into an “unsafe� one. Regulations that draw on HACCP have made fish inspection programs tough; absence of such food-safety guidelines at home means that standards of the richest importing markets are applied to imports from poorer exporters. In cases in which sanitary requirements are scientifically justifiable, the appropriate course is not to lower those standards but to help exporting countries meet the standards. Source: Mathew 2003. Incentive Framework: Trade and Investment Policy 75 Incentive Framework: Trade and Investment Policy Note to the Practitioner: Many of the issues for analysis and the quantitative measures with regard to trade policy in this section are much the same as in the section “Market Access.� In this section, the emphasis is on the import side—understanding how trade policy facilitates or creates barriers to accessing quality and cost-effective inputs. In “Market Access,� the emphasis is on the export side—how these same trade policies, imposed by current or potential trade partners, affects the competitiveness of exporters. Link with Competitiveness Challenges Identified in Trade Outcomes Competitiveness challenge areas Main components of trade and General export Cost Product extension investment policy environment competitiveness and quality Market penetration Trade policy ✓ ✓ ✓ Export restrictions ✓ ✓ Investment policy ✓ ✓ Exchange rates ✓ ✓ ✓ Quantitative Analysis: Indicators and Data Sources Indicator Source Import restrictions: MFN tariff all products, manufactures, and primary goods—simple, weighted, WDI/WITS-TRAINS Tariffs and NTMs maximum, dispersion Module 2 MFN zero-duty imports (percent of imports) Share of MFN tariff lines with international peaks, all products, manufactures, and WDI/WITS-TRAINS primary goods (percent) Share of MFN tariff lines with domestic tariff peaks all products, manufactures, and WDI/WITS-TRAINS primary goods (percent) Share of MFN tariff lines with specific rates, total, manufactures, and primary products WDI (percent) Applied tariff rate, all products, manufactures, and primary goods—simple and WDI weighted average Tariff rate with key PTA partners, all products, manufactures and primary goods– WITS-TRAINS simple and weighted average Customs and other import duties, total and in key products (percent imports) WDI Customs and other import duties (percent tax revenues) WDI NTMs frequency ratio WITS-TRAINS/WTI Export restrictions Export taxes, total, and in key products (percent total exports) WDI Export taxes, total, and in key products (percent tax revenues) WDI Export subsidies and presence of export processing zones (EPZs) Export surrender requirements, Yes/No WTI Export repatriation requirements, Yes/No WTI Requirement for licenses, Yes/No WTI Exchange rate Nominal exchange rate volatility (standard deviation) WDI Real effective exchange rate (percent change) WDI FDI policy Foreign equity ownership index Investing across Borders Foreign equity ownership index—sector specific Investing across Borders Starting a foreign business—ease of establishment index Investing across Borders Qualitative Analysis: Interview Targets existing research is likely to have been conducted in and Issues for Discussion recent years by the World Bank and other development partners such as the WTO (for example, see the WTO’s The analysis outlined in this section can be mostly under- Trade Policy Review series of country reports). The analy- taken as desk research. For most countries, data on tariffs and sis could be completed in a couple of days. Issues that exchange rate are quickly available. Moreover, significant 76 Module 2: Competitiveness Diagnostics may be covered during interviews are outlined in this sec- valued exchange rate, (3) burdensome trade-related tion. Depending on the size of the economy, fieldwork measures, (4) export taxes, or (5) other? The challenge could be conducted in 10 to 14 days. is to interview exporters that may offer different views depending on their sector and size. The sample should • Policy makers: Interviews with director-level or higher include large firms and SMEs, successful exporters official staff is important to understand the vision and and some of their competitors, and if possible unsuc- policy objectives the government has been pursuing, cessful exporters. To identify these players, first locate including some background on past policies and new market leaders and ask them about their competition. directions. For example, the discussion should help shed Business groups, sectoral chambers, and export promo- light on the political-economic forces explaining the tion agencies could provide information on potential country’s existing structure of trade protection, mar- candidates, including producers that face difficulties to kets, and choice of exchange rate regime. export. • Exporters and business groups: How do major export- • Academia: In many countries, local scholars have stud- oriented firms rate their experience of sourcing inputs ied development and could offer insightful views on from abroad? Which of the factors do they find most the role of the domestic trade policy on export compet- constraining: (1) tariff on intermediate inputs, (2) over- itiveness. Interviews with Government Interview targets Key issues for discussion Tariffs • Ministry of Trade • Government trade policy objectives (for example, export growth, export Module 2 • Ministry of Industry diversification, domestic protection, regional integration, industrial policy, and so on) • Ministry of Finance • Applied MFN tariff structure: tariff bands and peaks; publication and frequency of • Customs tariff changes • Export and investment • Preferential trade agreements promotion agencies • Export restrictions NTMs • Ministry of Trade • Find out which ministries and agencies set up trade-related regulations • Ministry of Industry • Potential overlap/coordination among ministries and agencies • Ministry of Agriculture • Barriers to export • Other agencies responsible for • Simplification of procedures and Single Window issuing permits and licenses • Use of risk management by customs and other border agencies • Customs/Single Window Exchange rate • Central Bank • Government policy on exchange rate • Ministry of Trade • Role of exchange rate to promote exports or protect industries FDI policy • Ministry of Trade • Overall strategy with respect to FDI—sector-specific targets • Ministry of Industry • Sectors restricting foreign ownership • Ministry of Finance • Other specific requirements for FDI over and above what is required for domestic • Investment promotion agency investors • Incentives available for foreign investors—terms, requirements (for example, only in special economic zones) Interviews with Private Sector and Other Institutions General Issues • How do they perceive the government’s trade policy (for example, supporting an open trade regime and exports or protecting domestic production)? • Do they perceive the government’s trade policy as business friendly, transparent, and predictable? • How do they perceive the government’s preferential trade policy (for example, did they materialize in important market access)? • What are the most binding domestic policies for their export competitiveness? • Have they benefited or are they benefiting from any specific incentives? • Discuss specific issues relative to the firm size (in particular small versus large). • Discuss the top-three recommended actions the government should take to help them improve their export competitiveness. Incentive Framework: Trade and Investment Policy 77 Tariffs • Do they pay tariffs on their imports (which goods and what rates)? • Do they feel that import tariffs are a burden for their export competitiveness? • Can they provide an estimate of the share of import duties in their cost structure? • Are PTA tariff schedules implemented effectively? • Is access to information on tariffs transparent? • Do they face obstacles at customs with identification of the right tariff schedule? • Is corruption prevalent at customs and is it hindering their competitiveness? NTMs • Are NTMs implemented by their own country perceived as hurting their competitiveness? • Is compliance with NTMs perceived as an obstacle in terms of number of requirements, bureaucracy, overlap and lack of coordination among agencies? • Are associated fees moderate or high, and what is their approximate share in cost structure? • What is the time to clear goods (specify import and export regime)? • Are there procedures to challenge decisions made by customs and other border agencies not to clear imported merchandise? • Is risk management used by customs and other border agencies? • What is the impact from state-trading enterprises on their business? Exchange rate • How is the exchange rate seem to be helping or hurting their exports? • How does the exchange rate affect their use of imported inputs/and integration into global and regional value chains? • Is the government’s exchange rate policy transparent and predictable? • Are there any issues they have with accessing foreign exchange? • What is the availability of hedging markets and instruments? • What are the requirements for hedging due to volatility? • Discuss links with access to finance and availability of loans in local currency versus the US dollar or other Module 2 international currencies. FDI policy • Is the government open to foreign investment in key input sectors (transport, ICT, energy)? • Are there any restrictions put on foreign investors outside what is clear in the law (for example, through limited licenses, capping the number of transactions, and so on)? • Are there any restrictions on foreign exchange availability? • What incentives are available to foreign investors? Interviews • Address the questions asked above but at the sectoral and industry level. with business • Are there initiatives to alert the government about binding constraints and the government’s groups responsiveness/actions? (across all issues) • Is the government open and responsive to their concerns and suggestions? • Discuss examples of failures (for example, lost export opportunities, nonsurvival of new exporters). • Discuss key factors for success (in general and sectoral). • Discuss specific issues relevant to some firms by size or new firms. Analytical Approach: Key Issues to Understand Component Main issues TRADE POLICY: TARIFFS, NTMs, EXPORT RESTRICTIONS MFN tariff regime 1. Complexity of import tariff regime • Trend in the simple and weighted average level • Summary statistics: Minimum, maximum, tariff dispersion (coefficient of variation in tariff rates, computed as 100 times the ratio of the standard deviation to the mean), tariff bands, frequency distribution of tariff rates • International comparison 2. Sectoral differences in import tariff regime • Distribution of tariff rates across products, sectors, and industries • Tariff escalation (imposing higher tariffs with each stage of processing) by product: for example, look at tariffs imposed on first stage, semifinished, and fully processed light manufacturing) as an indication in effective protection Preferential tariff 1. Complexity of PTAs rates • Number of PTAs, their coverage, and implementation phase 2. Wedges between preferential and nonpreferential trade partners 78 Module 2: Competitiveness Diagnostics Customs duties 1. Revenue impact of import tariffs • Implicit tariff rates, that is, the rates implied by actual tariff collections: (a) customs duties collected as a percentage share of the total value of imports and; (b) custom duties collected as a share of only dutiable imports • Implicit tariff rates by industry and by processing stage (first stage, semifinished, and final) to see whether customs exemptions attenuate the escalation of statutory tariff rates • Specific tariffs (duties levied on the monetary value of imports): identify tariff lines with specific duties; infer ad valorem duties by calculating implicit tariff rates (duties actually collected as a share of import values) • Tariff revenues as a share of government revenues 2. Export taxes NTMs 1. Existence of quantitative import restrictions 2. Complexity and transparency of trade-related regulations • Number of import licenses and permits • TBTs and SPS 3. Import and export customs procedures • Differences between general and export regimes, if any 4. Identify any state-trading enterprises and collect information on their import and export practices EXCHANGE RATE Exchange rate 1. Nominal exchange rate policy • Volatility 2. Real effective exchange rate • Trend • Any misalignment with long-run equilibrium exchange rate • International comparison with comparators and competitors Module 2 INVESTMENT POLICY FDI policy 1. Foreign equity ownership restrictions • Local ownership requirements • Other barriers (licensing, concessioning) 2. Other practical restrictions on FDI • Setting up a foreign business • Arbitration procedures 3. Incentives to promote FDI • General incentives—for example, tax breaks • Sector-specific issues Tailoring the Diagnostics to Country and Sector Characteristics Summary of Specific Considerations by Country Type Country type Relative priorities and issues for consideration Small (population) and • Likely to be heavily dependent on imports—pressure to use trade policy for import substitution, but remote/landlocked import restriction would be a significant barrier to upgrading Resource rich • Exchange rate policies will be critical—potential for overvalued exchange rate and volatility • Issue of export restrictions may arise from policies that discourage commodity exports and increase value addition from domestic producers • State trading may be an issue • FDI policy with respect to resources sectors (for example, the Mining Code) will be critical Low income, labor abundant • Likely to be reliant on imported inputs in light-manufacturing sectors—focus on effective rates of protection and any policies that protect local monopolies • Check on use of FDI incentives in export sectors (for example, light manufacturing) versus input sectors (which are often more protected) Middle income • NTBs often are a bigger issue • Protection of the services sector (mainly through investment policies) is an issue to check Incentive Framework: Trade and Investment Policy 79 Summary of Specific Considerations by Sector Sector Relative priorities Other issues for consideration Light manufacturing • High reliance on imported inputs and intermediates in • Many sectors will have special import regimes for most light-manufacturing sectors requiring a focus on imported inputs designed for export manufacture import tariffs and effective rate of protection (ERP) (for example, textiles and clothing) • TBTs can become a disguised way to restrict imports • Countries may extend preferential access in some • State trading may arise as a by-product of the sectors through PTAs nationalization of an ailing industry or as a means to • Trade facilitation pursue government policies on products or industries • Cost and efficiency of key services considered to have strategic importance Agriculture • Heavily protected sector with a prominent use of high • Countries may extend preferential access in some tariffs and quotas goods through PTAs • SPS can become a masked way to restrict imports • State trading is common in many economies in which agriculture is an important sector of trade, in industrial countries as well as in agriculturally based developing countries, to provide price support for important agricultural products or to ensure food security • Export duties are mostly used for agricultural products Services • Investment restrictions are critical given that many • Regulatory barriers to entry services are nontradable in a traditional sense • Competition • Export services such as transportation, tourism, professional services, and IT Module 2 Background Reading: Relationship Between Trade restricted (through high tariffs or other barriers), mak- and Investment Policy and Trade Competitiveness ing it more difficult for such exports to compete with similar products from other countries. Trade policy bar- Countries raise barriers against imports for a number of riers against imports hurt the export competitiveness of reasons. On the one hand, tariffs are a revenue source for domestically produced goods and deter private sector governments (increasingly less so in most countries but incentives to increase productivity, innovate, and enhance still important in many developing countries with limited export potential. Potential efficiency losses are greater alternative sources of revenue). At the other end of the when the domestic market is small and in industries inten- spectrum, NTMs, particularly technical restrictions, often sive in intermediate products, such as light manufacturing. are raised at least nominally to protect the health and safety From a policy point of view, reducing import barriers of consumers. But perhaps most important, tariffs, quotas, would serve as an export-promotion strategy. and NTMs, as well as exchange rate policies, all are Trade policy has for a long time been designed with a employed as part of industrial policies designed at best to mercantilist worldview, in which exports are good, imports support domestic “infant industries� and at worst to pro- are bad, and the protection of domestic producers is a prior- tect long-entrenched special interests. In an environment ity. Governments put in place import-substitution policies of increasingly integrated global production, trade in to develop and support a domestic industry and provide inputs and components plays a critical role in the competi- jobs. But with the emergence and proliferation of disaggre- tiveness of most exporters. A country’s barriers against gated production processes, transnational supply chains, imports to support the development and growth of domes- and cross-border investment, trade policy is playing an tic economy can deter its own export competitiveness, increasingly greater role in supporting a competitive mainly by increasing the cost of inputs and final goods and export sector and cross-border integration. In addition to by reducing the availability of imports. reducing tariffs, developing countries’ development pro- Trade barriers distort production and consumption grams aim to minimize trade-related regulations and prices and choices, which often translates into the misallo- administrative frictions and to facilitate the movement of cation of resources and protection of inefficient local goods. Services trade liberalization has become a pillar of industries. As such, import protection acts as a tax on a countries’ export competitiveness agenda. Governments’ country’s export sector, and export-tax equivalents of strategy is not only to increase services exports but also to import tariffs can be large for some developing countries make services, as input to the industry, more efficient and (Tokarick 2006). An anti-export bias arises, for example, cost effective. when imported inputs that are used in production are 80 Module 2: Competitiveness Diagnostics Many developing countries have used trade and invest- industry, while supporting exporting firms through tax ment openness, together with sound domestic policies, as privileges and subsidies to grant duty-free access to a key driver for their development and have seen signifi- imported inputs, thus removing or reducing price distor- cant reductions in poverty and increases in welfare. The tions and correcting the anti-export bias. Exporters often literature provides strong evidence that an increase in the also benefit from other measures that remove or reduce import of intermediate goods boosts productivity and high transactions costs through efficient streamlined economic growth (Lee 1995; Eaton and Kortum 2001; admissions of imports and customs clearance. Miroudot, Lanz, and Ragoussis 2009) (see figure 2.4). Export restriction measures penalize exporters of Empirical analyses also indicate that exporting firms are restricted products. By affecting the price and quantity of the most productive (Wagner 2005; Park et al. 2009). This trade, export restrictions produce trade-distorting effects growth in productivity is a direct consequence of the rise in the same way as import restrictions. Export duties raise in the number of varieties of imported inputs through the cost of exported products, resulting in decreased export better complementarity with domestic varieties and the volumes, which may then divert some supply to the domes- learning effect of foreign technology. The increased diver- tic market, leading to a downward pressure on domestic sification in imported inputs also entails an increase in the prices and reducing incentives for the suppliers to increase number of domestic varieties produced and exported their production and investment. Moreover, price volatility (Carrère, Cadot, and Strauss-Kahn 2011). and unstable supplies contribute to an insecure business Services also can be intermediate inputs when they are environment. used to produce goods. Given the domestic regulatory Governments may apply different types of export nature of barriers to trade in services and the lack of infor- restrictions (for example, export bans, taxes, quotas, or mation on these restrictions (for example, in the form of restrictive licensing) in pursuit of various public policy databases, as in the case of tariffs), services trade policy objectives (such as security, social, health, and safety) or to Module 2 deserves special attention and differentiated treatment. control inflationary pressures and maintain adequate sup- The analysis of these barriers to trade must be undertaken ply of essential goods. The relative ease of implementing on a sector-by-sector basis, relying on government docu- tax regulations through customs procedures makes export ments and the expertise of sector specialists. Global inte- duties an attractive option for governments, especially gration of the world economy is calling for increasingly when international prices are high (see box 2.7). Globally, efficient services sectors, from the development of trans- export controls are more frequently imposed on primary port and telecommunication sectors and efficient bank- commodities or scarce agricultural goods to control their ing and insurance to professional business services to help domestic price, and are mostly imposed by developing exporters better compete in international markets. With countries. low trade costs and efficient services, countries may gain a Export restrictions also can act as an implicit subsidy comparative advantage for services-intensive manufac- when they promote downstream industries by providing tured goods, an advantage that is enhanced if the country them with an artificial competitive advantage. Such meas- also produces intermediate services more effectively or has ures create a differential between the price available to lower barriers to entry for services suppliers. domestic processors and the price charged to foreign buy- Some countries seek to benefit from international trade ers, and thus these measures provide domestic-processing by promoting a dual economy, protecting a domestic industries using the concerned products with an advantage. Figure 2.4. The Trade-TFP Relationship Competitive pressure Selection Imports Higher firm-level TFP Exports Absorptive Better inputs Learning capacity Source: Carrère, Cadot, and Strauss-Kahn 2011. Note: TFP = total factor productivity. Incentive Framework: Trade and Investment Policy 81 Box 2.7. Use of Export Restrictions by Developing Countries In recent years, export restrictions have continued to attract the attention of trade policy makers, both as a perceived means to achieve certain objectives (for example, value addition) and because of perceived gaps in international disciplines on their use. For example, following the peso devaluation in 2002, Argentina applied export duties to all exports to cushion the effects of exchange rate fluctuations on domestic products and to counter the sharp fall in tax revenue. After successive increases in rates, the applicable duties were 5, 20, 15, 20, 25, and 45 percent (depending on products) as of mid-2006. In 2007, China eliminated value-added tax (VAT) rebates on exports for 553 items to restrain the export of products regarded as highly energy consuming, highly polluting, and consuming large amount of raw materials. Since 1999, Cameroon has gradually prohibited exports of logs to promote the processing industry. From 1999 until the prohibition of log exports in 2004, a certificate of registration had to be obtained to export timber; this was intended to ensure that 70 percent of production is processed locally and only 30 percent of the annual harvest exported as logs. In 2007–08, the world experienced a period of high food prices, which was aggravated by export controls being imposed by some food-exporting countries on major food exports. Such controls were undertaken to mitigate the impact on domestic prices; however, by reducing international supply, they exacerbated the increase of international prices. A study based on data for Argentina, a country with a long record of substantial export taxes and quantitative restrictions on food exports, showed that that such policies have in fact harmed the competitiveness of Argentina’s agricultural sector more than tariff and nontariff barriers imposed by its trading partners. Elimination of export restrictions prevailing in mid-2007 in Argentina would increase production and employment levels of primary agriculture. To increase value added, Mongolia imposed an export ban on raw cashmere between 1994 and 1996 and then imposed an export tax from 1997 to 2009. Experience shows, however, that unless a country has market power (which is clearly not the case in Mongolia, where neighboring China is also a major producer), the impact of export restrictions is to reduce domestic prices received by local producers encourage inefficient value addition, and promote the use of substitute inputs. In Mongolia, 15 years of export restrictions had no impact on industry value addition but instead shifted more of the power and profits in the industry from the herders to the processers. Sources: World Bank 2003; Nogués 2008; Jeonghoi 2010. Module 2 Production distortions result from the fact that too much is currency terms through two potential channels. On the produced in the exporting country’s downstream industry, one hand, if the real exchange rate is overvalued whereas too little is produced in the importing country’s because of a nominal appreciation, the foreign currency downstream industry. This production efficiency loss is price of exports is excessively high, thus reducing for- sometimes justified by the “infant industry� argument. It eign demand for exports. On the other hand, if the over- is not clear, however, whether this infant industry strategy valuation is due to excessively high domestic inflation leads to successful results. relative to global inflation, then domestic costs of pro- The real exchange rate also plays an important role in duction would be artificially high, thus reducing profits countries’ export competitiveness. The emphasis should be from exporting, or firms would be forced to raise their on the real exchange rate rather than the nominal rate prices, thus reducing foreign demand. because what matters for private-sector profitability is • Second, although an overvalued exchange rate makes the ratio of unit price over unit costs. In general, exchange imports cheaper, political economic pressures build up rate policy should target the (hypothetical) equilibrium to increase trade protectionism to support import- real exchange rate, which should reflect long-run fundamen- competing firms that find it more difficult to compete tals of the country, in terms of relative prices in domestic against cheaper imports, hurting the export competi- markets. Directed policies to support either an overvalued or tiveness of export-oriented industries. An overvalued undervalued exchange rate can affect relative competitive- exchange rate can divert government resources to less ness. Both can be detrimental over the long term. efficient production in the domestic market. An overvalued real exchange rate, defined as the ratio of global prices expressed in domestic currency over the According to this analysis, exchange rate depreciation domestic prices and often defined as the ratio of tradable to bring the real exchange rate closer to equilibrium (dri- goods prices over nontradable prices, can hurt export ven by the relative productivity of the economy) would competitiveness in several ways: stimulate exports and curtail imports, whereas exchange rate appreciation would be detrimental to exports and • First, an overvaluation of the real exchange rate makes encourage imports. In the presence of high import con- exporters’ goods expensive in foreign markets by rais- tent or in countries that are substantial net oil importers, ing the prices of exported goods and services in foreign however, exports are less adversely affected by currency 82 Module 2: Competitiveness Diagnostics appreciation. The lower import prices due to apprecia- In addition, volatility of exchange rates raises uncer- tion reduce the cost of export production and generate tainty and may force exporters to shift to less risky activi- productivity improvements. Service exports, neverthe- ties (products or markets), which could raise costs through less, with very low import content, tend to suffer from adjustment as well as contribute to a suboptimal allocation currency real appreciation. of resources. The negative impact, however, depends on Undervaluation cannot be an optimal or long-term pol- access to information, attitudes toward risk, and market icy. Although undervalued exchange rates, subsidies, and structures. These impacts will be most acute in financially suppressed wages can boost exports in the short term, this underdeveloped countries and economies that do not pro- is not the same as securing competitiveness through vide hedging instruments and opportunities that enable productivity growth. According to Porter, Ketels, and firms to guard against this risk (Eichengreen 2008). Delgado-Garcia (2006), competitiveness has to enhance Finally, investment policy—specifically policy with an economy’s productivity measured by the value of goods respect to FDI—can support competitiveness of a coun- and services produced per unit of a nation’s human, capi- try’s exporters. This role is important because foreign tal, and natural resources. Indeed, a number of countries— investors tend to be overrepresented in the export sector, including Austria and more recently the former Yugoslav particularly in countries with relatively limited home mar- Republic of Macedonia—have used a rigid exchange rate to kets. Research on FDI shows not only that they tend to be force exporters to improve competitiveness rather than rely more productive than firms in the domestic market but on devaluation. Evidence from both countries suggests it also, and most important, that they generate spillovers to can be highly effective over the medium term. domestic firms in the backward-linked supplying indus- Furthermore, the maintenance of an undervalued real tries (Javorcik 2004), thus contributing to wider productiv- exchange rate can be costly and unsustainable over long ity growth. Foreign investors can play a critical role in periods of time because it requires sterilized intervention introducing greater competition in local markets and Module 2 in foreign exchange markets, usually by the monetary pol- breaking down the local monopolies that can be a source of icy authority. As capital flows in, the monetary authority poor input competitiveness and anti-export bias. buys foreign exchange with domestic currency, which can be inflationary. To reduce inflationary pressures from the Main Components of Trade growth of the monetary base, the monetary authority usu- and Investment Policy Analysis ally engages in open market transactions by issuing public Trade policy is more conducive to economic growth and bonds (either central bank or federal government paper) in business friendly when it is open, transparent, and pre- exchange for domestic currency, which is withdrawn from dictable. Governments may use various instruments to the market. As the supply of domestic bonds increases, control trade flows, generate revenues, and protect domes- however, domestic interest rates must rise for market tic production and employment. Analyzing a country’s agents to hold the additional bonds denominated in trade policy and its implications for competitiveness domestic currency. Consequently, capital inflows tend to requires an assessment of several instruments, including rise as domestic interest rates rise, thus requiring another (1) tariff policy, (2) NTMs, (3) restrictions on exports, (4) round of sterilized intervention. In some instances, the exchange rate policy, and (5) investment policy. These government can force domestic economic agents to hold instruments are outlined in figure 2.5. additional domestic bonds at a constant interest rate, but this requires an additional distortion. For instance, in some Tariff Policy countries, state-owned banks can be forced to accept addi- Several trade and competitiveness issues are related to tional bonds at an artificially low interest rate. This import tariffs: requirement would imply that depositors are forced to accept artificially low deposit interest rates. Other policy • Import tariffs increase the cost of inputs and intermedi- instruments, such as financial transactions or capital ate goods, increasing the domestic production cost. inflow taxes, could be implemented to reduce pressures on They tend to restrict the variety of goods affordable to the real exchange rate while also raising public revenues. producers that seek to be competitive in international Finally, a fiscal contraction (for example, a reduction of the markets. primary fiscal deficit or an increase of a surplus) could • Relatively high average tariffs introduce an anti- reduce real exchange rate appreciation by reducing domes- export bias into the trade regime because they make it tic interest rates (thus reducing incentives for capital more attractive for companies to produce for the pro- inflows) and reducing domestic inflationary pressures. tected domestic market rather than to sell overseas. Incentive Framework: Trade and Investment Policy 83 Figure 2.5. Framework on the Relationship between Trade Policy and Competitiveness Trade Business High import cost/anti-export bias facilitation environment Nontariff Export Investment Tariffs Exchange rate measures restrictions policy Quantitative Management (over/ MFN tariffs Export taxes FDI regulations restrictions undervaluation) Effective rate of Bans and quantitative Exchange rate Mergers and Permits and licenses protection restrictions volatility acquisitions laws State trading Real effective Foreign exchange Preferential tariffs Permits and licenses enterprises exchange rate laws and regulations Export taxes FDI incentives Source: Authors. Module 2 Duty-drawback and import-under-bond systems only overlapping commitments may complicate business partially offset this anti-export bias, while at the same operations and access to information. Although time introducing additional administrative burdens on PTAs often lead to trade expansion among members, by enterprises. Reducing prohibitively high tariffs also making imports from other PTA members cheaper, provides benefits in the form of increased tariff rev- these agreements may hurt export competitiveness, enues and reduced incentives for fraud, corruption, particularly when countries keep high MFN import and smuggling. tariffs with the rest of the world. In that case, PTAs • High levels of tariff dispersion—the degree to which may lead to trade diversion away from more compet- different sectors or products within a sector face differ- itive nonmember countries, and hence hurt firms’ ent tariff levels—can introduce significant distortions. efficiency and competitiveness. Dispersion often results from the use of excessive exemptions and tariff escalations. Countries with signif- Economists and policy makers might not agree on the icant tariff dispersion often show a large number of tar- optimal level for tariffs, but establishing a uniform tariff iff bands, with certain sectors being protected through presents several advantages, including the fact that (1) particularly high rates of protection. This protection has effective protection is the same for all sectors and equals a distorting effect on resource allocation within the the nominal protection rate; (2) it is simple, clear, and economy. transparent, and therefore reduces business costs; (3) it • Higher tariffs on final products than on inputs increase reduces the cost of the customs administration; and (4) it the ERP. By taking into account protection on both out- reduces discretion (corruption). Moreover the manner in puts and inputs, ERPs provide a better representation of which countries reduce tariffs has important implications tariff-generated transfers to producers than nominal in terms of export incentives. Tariff-reduction schemes rates of protection, which only protect outputs. High that exempt high tariffs or sensitive sectors could leave effective rates of protection shield inefficient producers countries out by creating more distortions (see box 2.8). A from adjusting to changing needs. strategy to reduce all tariffs—in which high tariffs are cut • Although tariff reduction through PTAs has become more than low ones—would do the most to improve widespread, lack of implementation of PTAs and export incentives and real income (Tokarick 2006). 84 Module 2: Competitiveness Diagnostics Box 2.8. Avenues to Reduce Tariffs The WTO multilateral trade rounds have helped reduce bound tariffs on goods, which are the maximum tariff rates WTO member countries can apply to imports from other WTO members. Autonomous or unilateral liberalization of trade barriers has accounted for most of the trade liberalization in developing countries over the past two decades. Hence, applied tariff rates globally are well below their bound rates. Countries may reduce their tariffs through PTAs or RTAs. This option could lead to deeper integration, including some traditionally sensitive sectors such as agriculture and services. Regional trade liberalization may be even more central for trade in intermediates, which are more sensitive to trade barriers and have an important regional dimension. Trade liberalization can go further, and investment and trade in services are also likely to be liberalized. Liberalization toward selected partners, while maintaining MFN rates at high levels, can lead to large wedges between the levels of protection provided by preferential tariffs and those levied on imports from the rest of the world. These discrepancies may generate distortions across sectors in the economy and losses of tariff revenue as importers switch from third-country suppliers to partner producers to take advantage of tariff preferences. Source: Authors. Nontariff Measures • Licenses, quotas, prohibitions, and other quantity control As import tariffs have been reduced worldwide and locked measures in under the twin pressures of multilateral rounds and • Charges, taxes, and other paratariff measures preferential agreements, NTMs have grown significantly • Finance measures and now represent one of the most important areas of con- • Anticompetitive measures cern in trade policy. Between one-third and two-thirds of • Trade-related investment measures Module 2 traded goods are affected by one or more NTMs, with tech- • Distribution restrictions nical standards being the most prevalent. Unlike tariffs that • Restrictions on postsales service directly increase the price of imports and indirectly • Subsidies (excluding certain export subsidies included increase import quantities, NTMs tend to directly limit under export-related measures) import quantities and indirectly limit the cost of imports. • Government procurement restrictions NTMs tend to have a significant trade-reducing affect that • Rules of origin is on par with tariffs. Estimates by Hoekman and Nicita • Export-related measures (2008) suggest that cutting the ad valorem equivalent of NTMs in half (from around 10 to 5 percent) would boost When poorly designed and adopted with little consulta- trade by 2 to 3 percent. Some NTMs intentionally restrict tion with the private sector, NTMs may hurt competitive- trade, such as import quotas that limit the quantity of ness by constraining the ability of companies to outsource some goods that may be imported, however the WTO for- key inputs, putting them at a competitive disadvantage on bids such quantitative restrictions. NTMs are typically international markets. NTMs often complicate day-to-day trade-related regulations, such as TBTs (for example, prod- business and distract managerial attention. Firm surveys uct standards or labeling requirements) that may be highlight private-sector demands for more transparency in imposed for legitimate purposes, such as protecting public the adoption and application of NTMs across countries. In health or the environment, but that may restrict trade many countries, the need to streamline cost-raising NTMs either intentionally or unnecessarily. Governments may is now recognized as a key component of national compet- twist normal health and safety standards or custom proce- itiveness agendas. dures to place additional costs on foreign exporters, With the prominence of NTMs and their relatively thereby limiting imports. UNCTAD developed the follow- opaque impact on imports (and hence on exports that rely ing standard nomenclature for the categories of NTMs, on imported inputs), streamlining NTMs has become an which provides perhaps the most comprehensive defini- important component of any competitiveness agenda. tion of NTMs: Because governments can use NTMs to pursue different policy objectives and may be implemented by various • SPS (sanitary and phytosanitary) measures government agencies, it is crucial that they be transparent, • TBT (technical barriers to trade) consistent, efficient, nondiscriminatory, and the least trade- • Preshipment inspection and other formalities distorting. In reality, NTMs habitually lead to excessive, • Price control measures complex, costly, and redundant procedures that dampen the Incentive Framework: Trade and Investment Policy 85 competitiveness of importers and exporters, even when forms, such as prominently export duties, but also include implemented for legitimate public policy objectives. Below quantitative restrictions and licensing requirements. are key principles required by the WTO for regulations: Although quantitative export restrictions are, in principle, prohibited by WTO rules, there is no substantive disci- • Measures should not discriminate between countries pline on export duties, only efforts to revise this at the and between domestic and foreign producers. multilateral and bilateral levels. A recent OECD study • Measures should be transparent so that all parties have shows that the number of countries applying export duties access to the information. over the period of 2003–09 has increased compared with • Measures should be formed on a scientific basis in the previous years and that such duties were introduced pri- case of SPS measures. marily by middle-income developing countries and LDCs • There is no less trade-impeding alternative. Govern- (Jeonghoi 2010). ments should use regulations that are not more trade When designing export restrictions, several factors and investment restrictive than necessary to fulfill legit- should be carefully considered: (1) whether the measures imate public policy objectives. Creating such regula- are effective in achieving intended policy objectives; (2) tions requires careful assessment of their impact to whether the benefit of the measures outweighs the cost ensure that in both design and implementation they do (not only in the target sector but also on other sectors in not create unjustified difficulties for the free flow of the economy); and (3) whether the measures achieve the goods, services, and investment. objectives in the least trade-distorting ways. Some govern- ments responded to high food prices in 2007–08 with an State-trading enterprises (STEs) may be used to increase in the international price of a commodity to limit implement a number of trade policy measures that are inflationary pressures. An export restriction, by increasing not consistent with WTO provisions. The most common domestic supply, reduces the domestic price of the prod- Module 2 is a violation of market access obligations. For example, uct, thus partially offsetting the inflationary pressures an STE might be used to provide protection for the coming from higher prices abroad. Such measures, how- domestic market in a given product by setting resale ever, prevent exporters from benefiting from high interna- prices of imports at very high levels, thus negating tariff tional prices. Also, when applied by large countries that can concessions bound in WTO schedules. The provision of influence world prices, these measures can have a negative subsidies to STEs which mainly are involved in exporting impact on the welfare of trading partners, especially those may run afoul of export subsidy disciplines. Even in cases of small countries, by reducing the supply to the world mar- in which the objective of the government acting through ket and thus amplifying the negative aspects of the initial the STE does not intentionally distort trade, the STE oper- high price. To address inflation in food prices, some govern- ations nevertheless may do so. For example, the protection ments have responded with more trade-friendly policy of public health, which is a frequently stated rationale for options, such as reducing or suspending import tariffs on the maintenance of monopolies on alcohol and alcoholic food products. Another response has been to provide beverages, may seriously distort trade in those products. It targeted cash transfers to vulnerable groups. To promote is only when the activities of the STE are examined and value addition, some governments have included positive their impact on trade is analyzed that more effective rules incentives—for example, measures to promote targeted can be developed. WTO provisions seek to make the STEs investment, including subsidized credit and accelerated behave as private competitive traders and thus remove depreciation—for investment in downstream sectors. the potential for trade distortion offered by government involvement in an enterprise’s decisions and activities. Exchange Rate The nominal exchange rate is the price of one currency Export Restrictions expressed in terms of another, and it is crucial to exporters. Some governments impose export taxes on exported When the exchange rate rises, goods priced in local cur- goods. These taxes most commonly are imposed with rency become more expensive in foreign currency—so unprocessed products, with one or both of the following demand for these dearer exports drops, reducing overall objectives: (1) to maintain a large supply of a product (par- demand. Imports become cheaper in local currency, put- ticularly a staple food crop) in the country to control price ting downward pressure on inflation and interest rates. escalation, and (2) to promote increased value addition Conversely, a lower exchange rate typically boosts export within the country (for example, for food products, wood, demand and increases the cost of imports, putting upward minerals, and so on). Export restrictions take various pressure on inflation and interest rates. 86 Module 2: Competitiveness Diagnostics The real exchange rate can be expressed as the nominal also hurt both domestic consumption and export-oriented exchange rate relative to the price of nontradables. Being industries with high import content. the relative price of nontraded goods, it cannot be con- trolled by policy makers directly. Rather, it is the outcome Foreign Investment Policy Investment policy includes of other policies and processes influencing supply and the various laws and regulations that determine whether demand. and how a foreign entity may invest in firms, infrastruc- Some researchers have advocated for consciously ture, or other economic activities in a country. At the maintaining undervalued exchange rates in developing heart of FDI policy is the existence of restrictions or regu- countries intent on boosting exports. Rodrik (2008) lations on the nature or level of investment in certain sec- articulates two stories in which real exchange deprecia- tors or in certain types of firms—this might include, for tions expanded the tradable sector. In one, tradables are example, the requirement for some local shareholding or special because they suffer disproportionately from the even majority local holding in any investment (or it institutional weakness and contracting incompleteness might bar FDI completely in certain sectors). Beyond that characterize low-income environments. In the other, this, foreign investors can face restrictions to investment tradables are special because they suffer disproportionately through the following: from the market failures (information and coordination externalities) that block structural transformation and economic diversification. In both cases, an increase in the • Limitations or caps on the availability of licenses or relative price of tradables acts as a second-best mecha- concessions in certain sectors nism. Indeed, Rodrik (2008) shows that growth over the • Laws related to mergers and acquisitions medium term is much higher in countries with more • Foreign exchange laws, which may make it practically undervalued exchange rates. This result is confirmed by difficult to operate Module 2 Miao and Berg (2010) and implicitly suggested by • Regulations and processes involved in company regis- Freund and Pierola (2008), who find that a change in rel- tration ative prices due to a real exchange rate depreciation leads • Other industry-specific regulations to entry in new export industries and the discovery of new markets. FDI openness varies considerably across sectors, with An important caveat regarding the use of the exchange services sectors—particularly the critical input services like rate as a policy instrument to boost exports and growth is telecommunications, energy, and transport—often most that it suffers from a fallacy of composition—that is, the restrictive in terms of FDI access. Box 2.9 provides a sum- tool would be ineffective if many developing countries were mary of good practices with respect to various aspects of to employ it because of competition among them. It would cross-border investment policy. Box 2.9. Investing Across Borders—Reviewing Good Practices Most research and empirical evidence finds that, on balance, FDI helps foster development in recipient economies (Nair-Reichert and Weinhold 2001). These benefits are particularly increased in countries with good governance, well-functioning institutions, and a transparent, predicable legal environment. Foreign investors and governments concerned about the competitiveness of their economy’s business environment have a broad range of resources at their disposal. The most recent resource is the World Bank’s Investing across Borders 2010, which includes up-to-date indicators that measure FDI regulation in four specific policy areas: (1) investing across sectors, (2) starting a foreign business, (3) accessing industrial land, and (4) arbitrating commercial disputes. Countries can improve their FDI competitiveness by looking for lessons and good practices of other countries that scored well on Investing across Borders indicators, summarized as follows: Investing Across Sectors • Allowing foreign ownership in the primary, manufacturing, and services sectors. The global trend has been to liberalize a growing range of economic sectors. In many countries, the benefits of openness to foreign capital participation have overcome the reasons for restricting certain sectors from foreign ownership. (continued on next page) Incentive Framework: Trade and Investment Policy 87 Box 2.9. (continued) Starting a Foreign Business • Equal treatment of foreign and domestic investors. The start-up process should be governed by the same rules for all companies regardless of their ownership. Any differences in treatment should be due to companies’ size, legal form, or commercial activity, and not the nationality of its shareholders. • Simple and transparent establishment process. Countries should consolidate start-up procedures and abolish unnecessary ones (that is, investment approvals for small projects). In addition, countries can enable investors to register business online. Fast- track alternatives, even if they entail higher processing fees, are usually valuable to foreign investors. Countries should not require foreign companies to go through a local third party (lawyer, notary, public entity). Accessing Industrial Landa • Clear laws providing fair and equal treatment for foreign and domestic companies. Laws should provide security to investors—foreign and domestic—so that they feel comfortable operating and expanding their businesses and should not limit their ability to develop, renew, transfer, mortgage, or sublease land. • Accessible land information and efficient acquisition procedures. Law records should be current, centralized, integrated, and easily accessible, and should provide information useful to investors and the general public. There should be clear rules for acquiring private and public land, avoiding unnecessary and cumbersome procedures. Arbitrating Commercial Disputes • Strong arbitration laws in line with arbitration practice. Ideally, arbitration laws should be consolidated in one law or a chapter in civil code; these laws should be coherent, current, and easily accessible. A strong legal framework should be associated with effective arbitration practices and greater awareness of the benefits of arbitration. • Autonomy to tailor arbitration proceedings. Good arbitration regimes provide a flexible choice for commercial dispute resolution. • Supportive local courts. There should be strong support from local courts for arbitration proceedings and consistent, efficient enforcement of arbitration awards. • Adherence to international conventions. Adherence to and implementation of international and regional conventions on Module 2 arbitration, such as the New York Convention and the International Center for Settlement of Investment Disputes Convention, signal a government’s commitment to the rule of law and the protection of investor rights. Source: World Bank, Investment Climate Advisory Services 2010. Note: a. This is addressed in the section “Intermediate Inputs and Backbone Services� in this module. 88 Module 2: Competitiveness Diagnostics Incentive Framework: Domestic Policies and Institutions (Competition, Business Environment, and Governance) Note to the Practitioner: Business environment and governance issues have a fundamental impact on competitiveness well beyond export markets. These issues are also covered in quite significant detail in many other analytical products from the World Bank (for example, Doing Business reports and Investment Climate Assessments. As such, an in-depth analysis of the business environment and governance should not be required as part of the Trade Competitiveness Diagnostic. Rather, a summary of key issues can be drawn from existing research in most countries. There may be some need to qualify specific impacts in some key sectors and to understand how these factors affect the decisions of exporters, but only limited field research should be required. Link with Competitiveness Challenges Identified in Trade Outcomes Competitiveness challenge areas Main components of domestic policies General export Cost Product extension Market and institutions environment competitiveness and quality penetration Competition ✓ ✓ ✓ Business environment and governance ✓ ✓ ✓ Quantitative Analysis: Indicators and Data Sources Module 2 Measures Sources Business Starting a Business Number of procedures to start a business Doing Business (DB) regulatory Cost of complying with procedures DB environment Time (number of days) to complete the procedures DB Closing a Business Time (number of days) to complete a bankruptcy DB Cost of bankruptcy proceedings as percentage of estate’s value DB Recovery rate for claimants through bankruptcy proceedings DB Dealing with Licenses Number of procedures to build a standardized warehouse DB Median duration (number of days) to complete a procedure DB Cost to complete procedure as a percent of the country’s income DB per capita Registering Property Number of procedures to transfer the property title from a seller DB to a buyer Time (number of days) to complete the procedures DB Cost as a percent of the property value DB Protecting Investors Transparency of transactions (extent of disclosure index) DB Liability for self-dealing (extent of director liability index) DB Shareholder’s ability to sue officers and directors for misconduct DB (ease of shareholder suits index) Degree of protection of property rights and intellectual property Global Competitiveness Index (GCI) Enforcing Contracts Number of procedures to resolve a commercial dispute DB Time (number of days) to resolve a commercial dispute DB Cost (as percentage of the claim) to resolve a commercial dispute DB Lack of confidence courts to uphold property rights World Bank (percent of firms) Enterprise Surveys Taxation Paying Taxes Effective corporate tax rate WDI Total tax rate (percent) WDI Administrative burden of paying taxes (number of taxes, agencies DB involved, methods for payment, frequency) Time (in hours per year) to prepare, file, and pay taxes DB Management time dealing with officials (percent of management ICS time) Incentive Framework: Domestic Policies and Institutions (Competition, Business Environment, and Governance) 89 Competition Competition Intensity of domestic market competition GCI Extent of market dominance (rating) GCI Effectiveness of antimonopoly policy (rating) GCI Services and FDI Investing across Borders (IAB) IAB Starting a foreign business (time and procedures) IAB Accessing industrial land (time to lease, strength of legal rights, IAB availability of and access to information) Arbitrating commercial disputes (strength of laws, ease of process, IAB extent of judicial assistance) Governance Governance Number of firms paying bribes World Bank Enterprise Surveys Average bribe as percentage of total sales ICS Irregular payments in exports and imports GCI Losses due to crime and violence Enterprise Surveys; GCI Losses due to security issues Enterprise Surveys; GCI Unpredictable interpretation of regulations Enterprise Surveys Corruption perception Index Transparency International Degree of undue influence in the judicial system and among GCI government officials Government efficiency GCI Module 2 Sources for Cross-Country Indicators of the Business Environment World Competitiveness Yearbook • Published by the Institute for Management Development in Lausanne. Until 1996, a joint publication with the World Economic Forum (WEF). Analyzes the international competitiveness of 49 countries, on the basis of hard data from international organizations and perception surveys of enterprise managers. • Hard data cover economic performance, international trade and investment, public finance and fiscal policy, education, productivity, and infrastructure quality. Survey questions cover institutional framework (government efficiency, justice, and security), business legislation (openness, competition regulations, labor regulations, and capital market regulations) and management practices. Source: http://www.imd.ch. Global Competitiveness Report • The Global Competitiveness Index, published annually by the World Economic Forum since 1996, is another good example of benchmarking. Analyzes the international competitiveness of more than 100 countries, on the basis of hard data from international organizations and perception surveys of enterprise managers. • Survey questions cover access to credit, public institutions for contract and law enforcement, corruption, domestic competition, labor regulations, corporate governance, environmental policy, and cluster development. Hard data cover economic performance, international trade and investment, public finance and fiscal policy, education, technological innovation, information and communications technology, and infrastructure quality. Starting in 2003, the analysis includes six Doing Business indicators on starting a business and enforcing a contract. Source: www.weforum.org. Global Enabling Trade Report • Measures and analyzes institutions, policies, and services enabling trade in national economies around the world. Includes the most current data and recent analysis of the factors enabling trade in industrial and emerging economies, as well as the latest thinking and research from trade experts and industry practitioners. Source: www.weforum.org. Index of Economic Freedom • Published since 1995 by the Heritage Foundation and the Wall Street Journal. Analyzes economic freedom in 161 countries and is based on assessments by in-house experts, drawing on many public and private sources. • The index covers 10 areas: trade policy, fiscal burden, government intervention, monetary policy, foreign investment, banking and finance, wages and prices, property rights, business regulation, and black markets. Source: www.heritage.org. 90 Module 2: Competitiveness Diagnostics Economic Freedom of the World • Published since 1997 by the Fraser Institute. Analyzes economic freedom in 123 countries on the basis of assessments by in-house experts, drawing on many public and private sources. The ratings on the business environment are derived from the Global Competitiveness Report. • The index covers eight areas: size of government, legal structure, security of property rights, access to sound money, freedom to exchange with foreigners, regulation of credit, regulation of labor, and other business regulation. Source: www.freetheworld.com. World Markets Research Center • Published since 1996 by the World Markets Research Center in London. Analyzes the investment climate in 186 countries and is based on assessments by 180 in-house experts, drawing on many public and private sources. Source: www.worldmarketsanalysis.com. Country Risk Service • Published quarterly since 1997 by the Economist Intelligence Unit. Provides international investors with risk ratings for 100 countries on the basis of assessments by in-house experts, drawing on previous ratings. • The index covers seven areas of country risk: political, economic policy, economic structure, liquidity, currency, sovereign debt, and banking sector. Source: www.eiu.com. Business Environment Risk Intelligence • Published by Business Environment Risk Intelligence three times a year since 1966, in Geneva, Switzerland. • Provides international investors with risk ratings for 50 countries on the basis of assessments by in-house experts, drawing on previous ratings and outside experts. Their assessments are evaluated by a panel of about 100 external experts. • The index covers two areas of country risk: political and operational. Operational risk covers the enforceability of contracts, labor costs, bureaucratic delays, short-term credit, and long-term loans. Source: www.beri.com. FDI Confidence Index Module 2 • Published since 1997 by A.T. Kearney. Provides subjective views on the attractiveness of 60 countries for foreign investment. Based on assessments by executive managers of 1,000 global companies. Only the aggregate index is published. Source: www.atkearney.com. Source: World Bank 2008. Qualitative Analysis: Interview Targets and Issues for Discussion Interview targets Key issues for discussion Business • Ministry of Trade • Main constraints faced by firms regulatory • Ministry of Industry • Constraints to set-up versus day-to-day operations environment • Ministry of Finance • Which issues affect importing and exporting directly? • Ministry of Labor • Reform policies/programs in place or planned • Local government • Company registrar • Other agencies responsible for issuing permits and licenses • Commercial banks • Investment promotion agency • Customs Taxation • Ministry of Finance • Structure of tax regime • Local government • Any taxes or administrative issues (for example, audits) that • Agencies responsible for tax audit and collection keep firms informal or create anti-export bias • Tax incentives/subsidies linked to exporting Competition • Ministry of Trade • Current competition law • Ministry of Industry • Nature of existing anticompetitive behavior • Competition Authority • Existence of state-owned enterprises or state-trading • Academia monopolies • Structure of ownership of major input industries • Cost and service implications • Quality of local suppliers Incentive Framework: Domestic Policies and Institutions (Competition, Business Environment, and Governance) 91 Governance • Ministry of Trade • Incidence of corruption and nature (for example, large-scale • Ministry of Industry corruption linked to securing government contracts versus petty corruption linked to licensing, customs, and other • Ministry of Finance regulatory processes) • Local government • Other governance issues affecting investment and exporting • Academia (linked to judicial system, political processes, and so on) Private sector • Domestic investors • How do individual firms respond to these issues in terms of (relevant for • Private investors investment? in terms of importing and exporting? all issues • How do responses differ by nature and size of firms? • Informal firms above) • Law and accounting firms • Chambers of Commerce Tailoring the Diagnostics to Country and Sector Characteristics Summary of Specific Considerations by Country Type Country type Relative priorities and issues for consideration Small (population) • Competition issues may arise due to limited scale of domestic market—greater likelihood of strong links and remote/ between business and government elite, which contributes to competition and wider governance issues landlocked • FDI policy and business regulations likely to be critical—these countries are less able to afford weaknesses in the business and investment climate • May have limited tax base and so there may be pressure on tax instruments • May have more limited institutional capacity Resource rich • Historically, many resource-rich economies face particular problems with governance issues—this may manifest itself in business regulatory issues as well as in high- and low-level governance problems (for example, Module 2 corruption) • Assess how the tax and competition environment affects the resources sector versus the nonresources sector (potential for an environment that creates barriers to competitiveness and adjustment toward nonresources sectors) Low income, labor • Important to understand how the tax and regulatory environment affects labor markets abundant • Low-income countries typically face greater problems with regulatory capacity Middle income • Competition policy is an important issue to assess, as many middle-income countries have well-established national champions in key industries • Business environment and governance issues likely to vary widely across countries Summary of Specific Considerations by Sector Sector Relative priorities and issues for consideration Light manufacturing • Check on competition issues related to key inputs • Many light-manufacturing sectors are targeted with special tax treatment through industrial policies—this may include lower corporate taxes for FDI (through SEZs or otherwise) • Major issues to check on business regulatory environment include procedures for establishing a business, accessing land and property, obtaining permits for construction, and setting up utilities (obtaining electrical and water connections) Agriculture • Check on competition issues, including price controls and monopolies in certain parts of the value chains (especially processing and marketing) • Business regulatory issues should focus on land access, zoning, titling, registration, and other processes related to land purchase and lease; issues related to Environmental Impact Assessments (EIA) should be considered Services • Competition issues are critical, particularly in key input sectors (energy, transport, telecommunications) • Regulatory restrictions regarding licensing as well as professional and educational credentials can be an important barrier In spite of the significant impact that business regulation providing regulation and contract enforcement, than has on overall export competitiveness, the services sector trade in goods for which markets may be more transpar- may be one of the most affected by inefficient, unnecessary, ent. A sound regulatory framework is the main pillar for and restrictive regulations. Trade in services tends to be business in the services sector, especially when it comes to more reliant on institutions, with clear and simple rules subsectors in which large initial investments are required, 92 Module 2: Competitiveness Diagnostics such as telecommunications, transportation, and Business regulation may constitute an obstacle to financial services. Managing reforms of services markets improving firms’ competitiveness at the micro level, requires integrating trade openings with a careful combi- reducing the options for companies to compete success- nation of competition and regulation. Governments have fully in international markets. Businesses in less developed an important role to play in generating the preconditions countries normally face heavier administrative costs, more for an efficient set of service industries, giving special regulatory procedures, and longer processing times. The reg- importance to the institutional infrastructure. Regulation ulatory burden is often more costly as the size of the com- is generally motivated by a mix of efficiency and equity con- pany decreases, constituting a major impediment to start a siderations. The challenge for policy makers is to strengthen new business. Although the effect of ineffective business such regulation without making it inefficiently strong and, regulation on business is a decreased ability to assert legal when needed, introducing complementary policies to or economic rights, the effect on the government side is a ensure that the benefits of competition are widely distrib- structural obstacle for expanding the tax base and generat- uted (Hoekman and Mattoo 2008). ing greater revenue. A dynamic private sector—with companies engaging in investments, creating jobs, and improving productivity— Background Reading: Relationship Between Domestic promotes growth and expands opportunities for interna- Policies and Institutions and Trade Competitiveness tional trade. The process by which an productivity grows The business environment plays an important role in firm- and economy upgrades works through a series of enablers, level competitiveness in the international context and may which also serve as intermediate indicators of competitive- act as an enabler or obstacle for their growth. Factors affect- ness. True competitiveness is measured by productivity. Pro- ing the business environment are diverse and complex. They ductivity ultimately depends on the microeconomic capabil- include a variety of transactions-related costs,7 the fiscal ity of the economy, rooted in the sophistication of Module 2 environment in which firms operate, and institutional qual- companies (both local and foreign), the quality of the ity as well as government effectiveness. An effective business national business environment, and the externalities arising environment should promote firm behavior that is alloca- from the presence of related clusters and supporting indus- tively efficient on a macro basis over the long term (that is, tries (Porter 1998). In a study conducted to investigate the sustainable). This requires (1) a regulatory regime that is linkages between business regulation and macro- and adequate to fulfill the task of essential controls of the private microeconomic outcomes, Loayza and Servén (2010) find sector without creating unnecessary obstacles to running a evidence that some types of regulations have negative effects business, (2) a nondistortionary tax environment, (3) a legal on labor productivity growth, whereas others have a positive framework that promotes market competition, and (4) impact. Product market regulations and labor regulations sound governance and capable institutions that minimize fall under the first group of regulations. The primary con- the wedge between policy (de jure) and practice (de facto). necting link that explains this adverse effect is firm turnover: The main channels through which the domestic business In countries in which labor and product market regulations environment affects export competitiveness are as follows: are more burdensome, turnover rates are lower on average. (1) by introducing distortions to the microeconomic incen- The authors found, however, that a third type of regula- tives of companies, which ultimately affect their decisions tion—level of taxation—has a positive effect on productivity on producing and exporting; and (2) by raising both fixed growth, a result explained as being associated with the and variable costs for firms. Although there is no doubt that higher supply of productive public services permitted by macro policies are important, consensus is growing that the higher taxation. Conversely, an inefficient business environ- quality of business regulations and the institutions that ment and burdensome regulations create distortions and enforce it are major determinants of prosperity. Macro- discourage firms from competing in the market. Thus, incentives that contribute to the soundness and stability of improvements to the existing business regulation can con- an economy create opportunities for prosperity, but actual tribute to firms’ competitiveness by facilitating procedures wealth creation occurs through the productivity of firms and diminishing associated costs (WEF 2007). that combine available resources in the production process. Constraints to entry and exit a business, the regulatory bur- Main Components of Business Environment den, the time and cost of getting licenses and permits, the and Governance Analysis costs of enforcing contracts, and other factors shape firm- Governance Countries are not endowed with the institu- level competitiveness by influencing the microeconomic tions that make up their economic environments, but flexibility of a country (Porter 1998; WEF 2007). rather this is determined endogenously. Policy makers Incentive Framework: Domestic Policies and Institutions (Competition, Business Environment, and Governance) 93 play an important role in shaping future developments on and more corruption but is not associated with better qual- competitiveness. One important component of under- ity of private or public goods. Frequently, countries that standing the microincentives in the business environment regulate the most have the least enforcement capacity that shape firm decision making is the role of the govern- and the fewest checks and balances to ensure that regula- ment in protecting against private diversion, including tory discretion is not used for private gains. Bad institu- such factors as the rule of law, bureaucratic quality, cor- tions—for example, those involving cumbersome entry ruption, the risk of expropriation by the state, and the procedures, rigid employment laws, weak creditor rights, enforcement of contracts (Hall and Jones 1999). These inefficient courts, and overly complex bankruptcy laws— meta-institutions are considered fundamental not only simply do not get used. for the export sector but also more broadly for a country’s A large part of the business environment is determined overall competitiveness and economic growth. The institu- by business regulations that affect a company through its tional framework provides the fundamental preconditions different stages of development—that is, from starting the for private companies, government, and individuals to business and hiring and firing workers to paying taxes, interact to produce goods and services in the economy. dealing with customs, and complying with licenses and Owners of land, other physical assets, and intellectual permits requirements. property will invest in the improvement and upkeep of their property only if their rights as owners are not guaran- Taxation Although taxation is clearly necessary in all teed. In the same sense, if property cannot be bought and countries, it can have a negative impact on export compet- sold with the confidence that the authorities will uphold itiveness by effectively raising the costs at which firms must and enforce the transaction, the market will lack incentives sell in export markets. Excessive tax rates (for example, for growth. The result will be an increase in the perceived Sweden’s notorious former 98 percent marginal tax risk premium of investment, and thus restricted firm entry bracket) create clear disincentives for individuals and Module 2 and reduced investment in innovative activities. This out- firms, but in most cases, the issue is not the rate of the tax come will be particularly evident in smaller markets and in per se but rather the way in which it is applied and the dis- sectors in which the potential rent earnings are limited (for torting effects it may have on firm behavior. For example, example governance is likely to affect trade and investment excessive tax rates can create a disincentive to invest8 or an more in places like Mongolia and Swaziland than in China incentive to invest in capital over labor (or vice versa). For and Russia). Analysis of the impact of institutions and gov- large multinationals, the corporate tax rates—which are ernance on export competitiveness may focus on observ- often the headline figure used in discussions over the able channels through which it may affect firm behavior, for competitiveness of tax regimes—matter little, as multina- example, through a greater understanding of FDI percep- tionals make use of transfer pricing, double taxation tions. At a micro level, governance impacts on trade com- treaties, and other instruments to reduce their tax burden petitiveness can be analyzed through firm perceptions of in any one country. Conversely, Loayza and Servén (2010) corruption and trade-related transactions (for example, find that the level of taxation (what they call fiscal regula- licensing, importing, and exporting). tion) is positively correlated with GDP growth. Perhaps more important than the level of taxes is the Business Regulations In terms of export competitive- administrative process involved in enforcing the tax ness, extensive compliance requirements associated with regime. This process may include excessive red tape as government regulatory procedures, such as paying taxes, well as, more onerous, inspection regimes that can be getting licenses, or dealing with custom procedures for bureaucratic at best and corrupt at worst. Understanding trading across borders, can be detrimental to firms’ com- the basic statutory requirements, procedures, and trans- petitiveness in international markets. In the services sec- parency with which the tax regime is administered is tor, more sophisticated regulations on financial and important to analyzing the business environment in which banking services, and specialized delivery services such as firms operate. telecommunications and transportation, as well as special provisions on FDI and professional licensing and qualifi- Competition Uncompetitive business practices constrain cation requirements, may constitute significant obstacles domestic firms’ export competitiveness as well, in particular for growth and competitiveness. through practices affecting market access for imports such as Excess regulations may add extra costs for regular firms domestic import cartels or monopolies, exclusionary abuses in terms of time and money. Heavier regulation is generally of a dominant position, control over importation facilities, associated with greater inefficiency of public institutions vertical market restraints that foreclose markets to foreign 94 Module 2: Competitiveness Diagnostics competitors, certain private standard-setting activities, and competition policy, maximizes the benefits of such invest- other anticompetitive practices of industry associations. By ment to host countries, by encouraging participating contrast, robust competition in the home market contributes firms to construct state-of-the-art production facilities, positively to the international competitiveness of firms by (1) to transfer up-to-date technology into host countries, driving prices toward marginal costs, (2) ensuring that firms and to undertake appropriate training programs. FDI produce at the lowest attainable costs, and (3) providing liberalization can enhance the contestability of markets, incentives for firms to innovate and introduce new products which can provide an important stimulus for greater effi- and production methods into the marketplace. ciency; it is not a sufficient condition to achieve this A transparent and effective competition policy can be result. Rather, effective competition laws, policies, and an important factor both in enhancing the attractiveness enforcement machinery are necessary to ensure that preex- of an economy to foreign investment and in maximizing isting statutory obstacles to contestability are not replaced the benefits of such investment. More specifically, compe- by anticompetitive practices of firms, thus negating the tition policy can enhance the attractiveness of an economy benefits that could arise from liberalization. for foreign investment by providing a transparent and Box 2.10 summarizes some of the key benefits of regula- principles-based mechanism for the resolution of disputes tory reform and the main factors for success. Box 2.11 reviews that is consistent with international norms that are widely the benefits and drawbacks of two of the main sources of accepted internationally. This transparency and consis- comparative data on the business environment—the World tency increases investor confidence and the propensity to Bank’s Doing Business indicators and the World Bank’s invest. Vigorous competition in markets, reinforced by Enterprise Surveys. Module 2 Box 2.10. Maximizing the Benefits of Regulatory Reform—Factors for Success Benefits International evidence shows that efficient and transparent regulations have a positive impact at macro and micro levels: • Economic growth. Regulatory reform has been estimated to increase the level of real GDP in several OECD countries, ranging from 1 percent in the United States to between 5 and 5.5 percent in France, Germany, and Japan. • Export competitiveness. Supported by efficient trade liberalization reform, export competitiveness transformed Hungary and Mexico from inward-looking to successful export-oriented economies. • Investment. Both domestic and foreign investment responds positively to an effective regulatory framework that provides credibility and certainty to the private sector. The Republic of Korea’s FDI inflow increase resulting from regulatory reform was estimated at US$36.5 billion between 1999 and 2003. Trade growth in Hungary was accompanied by a dramatic increase in FDI—during the reform decade, Hungary attracted more than one-third of all FDI in Central and Eastern Europe. • Expansion of private-sector activities. The contribution of the Mexican and Hungarian private sector to the GDP reached nearly 90 percent and 85 percent, respectively, by the end of the 1990s, higher than the ratio for many OECD countries. • Increased labor productivity. A study concludes that economic deregulation in five sectors increased labor productivity in OECD countries, ranging from 0.5 percent in the US to 3.5 percent in Germany. • Enhanced competition. The opening of port operations to multiple parties in Uruguay increased firm productivity by 300 percent. In Chile, deregulation of entry into the long-distance telephone market cut rates by 50 percent. • Reduced business costs. Inefficient regulation in port operations contributed to implicit tariffs of 5 to 15 percent on all Latin America exports. A survey highlights that managers spent between 10 and 30 percent of their time managing process regulation, incurring costs in the range of 5 to 15 percent. • Public goals. Goals such as consumer protection and environmental quality can be reached through efficient reform. Costs Regulatory reform can be associated with short-term job losses and reduced government revenues, although evidence shows mixed results: • Short-term employment losses. Can occur in sectors with low levels of productivity and efficiency. However, there is evidence that early job losses can be compensated in the longer run as reforms breed entrepreneurialism and formal employment. In the Republic of Korea, the 1998 deregulation was estimated to create more than 1 million new jobs between 1999 and 2003. • Reduced government revenues. Can occur when reform targets regulations created for revenue purposes (for example, some business licenses). Yet evidence shows that reforms to streamline licenses and eliminate those that are unnecessary or redundant can have a pull effect on potential new users—for example, informal firms—hence increasing the coverage of the revenue base. (continued on next page) Incentive Framework: Domestic Policies and Institutions (Competition, Business Environment, and Governance) 95 Box 2.10. (continued) Factors for successful reform Countries have taken different approaches to regulatory reform based on their intrinsic economic, social, and institutional structures. Underlying factors, however, have contributed to reform success in most countries: • A supportive macroeconomic environment. In an unstable economic environment, it is unlikely that the government will prioritize regulatory reform over macroeconomic stability. Political will has been vital to the success of regulatory reform in Hungary and Mexico. • Adapting best practices to local conditions. In Hungary, international models were adapted using the existing legal and administrative frameworks to implement change. • Creating an independent dedicated reform agency. Ideally composed of influential, skilled technocrats with direct access to the highest levels of policy making, this agency should have the authority to promote regulatory reform, to monitor progress, and to assess the quality and quantity of regulations using cost-benefit and cost-effectiveness principles. In the Republic of Korea, the Regulatory Reform Commission (RRC) was created to maintain a consistent set of principles to control regulatory quality. In Mexico, the government created executive units in key ministries to overcome entrenched resistance to reform. • Designing and implementing compensation mechanisms. Getting the support of interest groups opposed to reform may require a good mix of mechanisms, such as compensatory resources for short-term losses, training for rapid relocation in the marketplace, and prior involvement of labor groups in the design of the reform process. Mexico is a good example of the efficient use of specific adjustment programs during privatization and trade liberalization, although it also highlights that these programs are fiscally expensive. • Building effective regulatory structures. Regulations can be changed in a relatively short period of time, but strengthening the regulatory institutions that implement reform and monitor the quality of regulations needs more time and the government’s continuous support. • Cost-benefit analysis and monitoring. As each individual regulation has a cost-benefit balance, a government should be able to know the expected outcomes of its actions on different stakeholders. Source: World Bank 2009d. Module 2 Box 2.11. Doing Business Data and Enterprise Surveys—Facts and Shortcomings Doing Businessa Benchmarking exercises provide a useful and straightforward way to address competitiveness issues. Examples of these exercises are provided by the World Bank Group’s Doing Business indicators, which benchmark and rank the cost and quality of business regulations for key cross-cutting investment climate issues. The Doing Business indicators use available information on 175 countries and measure the cost of doing business for a hypothetical firm on an annual basis. The two types of indicators in Doing Business focus on government regulations and its effect on business—especially on small and medium-size domestic businesses. The information contains measures of actual regulation, for example, the number of procedures to register a business or an index of employment law rigidity, and measures on regulatory outcomes, for example, time and cost to register a business, enforce a contract, or go through bankruptcy. Frequent observations based on a standard firm description can be extremely useful for monitoring progress in the areas covered under the indicators (that is, costs of starting and closing a business, employing workers, trading across borders, registering property and getting credit, dealing with licenses, and paying taxes; investor protection issues; and contract enforcement) as well as for making cross-country comparisons. The Doing Business data do not allow the productivity effects of the cross-firm, within-country variation in investment climate conditions to be studied (Fajnzylber, Guasch, and López 2009). The main shortcoming with this approach is that it is not enough to know a country’s ranking. Rankings are no substitute for a careful evaluation of impact and may be misleading sometimes, as they tend to give equal importance to factors that may influence performance and growth quite differently. For this reason, benchmarking exercises should be seen as complementary to other approaches that try to assess the relative importance of reforms to the selected outcome, be it growth or competitiveness. Enterprise Surveys The World Bank Enterprise Surveys (also known as Investment Climate Surveys) collect hard data and perceptions at the firm level. Firm-level data allow for the measurement of some dimensions of the business and investment climate for which limited data sources exist at the aggregate level—notably for indicators of the quality of governance and institutions and, in particular, for measures of the incidence of corruption or regulatory burdens. In addition, microeconomic data allow for the possibility of comparing the different effects and constraints that investment climate conditions have within countries among different type of firms. The idea of directly asking firms about the various aspects of the business environment that affect their performance is the underlying premise of the Enterprise Surveys prepared by the World Bank. The latter cover 105 countries, more than 76,000 firms and dozens of indicators on the quality of the business environment. The surveys capture entrepreneurs’ perceptions about the different obstacles affecting firm competitiveness and allow for comparison of these perceptions with hard data on the business environment and firm performance. (continued on next page) 96 Module 2: Competitiveness Diagnostics Box 2.11. (continued) Business surveys are a direct way of identifying competitiveness constraints. The World Bank Enterprise Surveys include a standard question on the main obstacles for growth of firms. Business professionals are asked to evaluate the severity of some 20 potential obstacles to the growth of their businesses. A five-point scale is used, ranging from extremely severe to not important. These results can be compared across more than 100 countries and can be compared over time as well. This approach provides valuable information on the priorities that entrepreneurs would adopt if faced with the task of designing policies to improve the investment climate. In many countries, business associations also survey firms frequently. This approach has three main limitations. First, perceptions of the entrepreneurs are volatile and may be biased by recent events reported in the media, and they may also reflect their specific cultural and socioeconomic background. For instance, managers of firms that concentrate on local as opposed to national or international markets may lack the necessary benchmarks to judge the severity of the problems existing in their cities or provinces, and compare them with national or international best practices. Second, the questions tend to focus on obstacles and problems, giving less attention to factors that enable growth, such as technology and innovation. Third, they tend to overestimate the impact of factors whose costs are borne privately and benefits for the economy are more diffused—taxes are perhaps the best example of this.b Sources: Authors. Note: a. The Doing Business methodology, surveys, and data can be found in http://www.doingbusiness.org. b. Another often-cited shortcoming is the fact that these surveys do not cover firms that have not entered the market. This limits their effectiveness to identify barriers to competition. This can be addressed, in principle, by the survey sample design. Module 2 Factor Conditions: Access to Finance 97 Factor Conditions: Access to Finance Link with Competitiveness Challenges Identified in Trade Outcomes Competitiveness challenge areas General export Cost Product extension Main components of access to finance environment competitiveness and quality Market penetration Access to investment capital ✓ ✓ Access to working capital ✓ Trade finance services ✓ ✓ Quantitative Analysis: Indicators and Data Sources Measures Sources General and Cost of capital (average of last five years) IMF International Financial Statistics (IFS) investment database capital Percent of firms indicating access to finance as a major constraint World Bank Enterprise Surveys Percent of firms obtaining bank credit World Bank Enterprise Surveys Average interest on bank loan and credit line World Bank Enterprise Surveys Average collateral requirement (as percent of loan) World Bank Enterprise Surveys Working capital Average interest on working capital loans National sources Module 2 Availability of factoring services National sources Trade finance Average cost of confirmed letter of credit (L/C) (percent rate) National sources Average cost of export credit insurance (percent rate) National sources Total export value (US dollars per capita) that can be supported National sources by Export Credit Guarantee Agency (ECGA) fund Share of commercial risk covered by ECGA National sources Qualitative Analysis: Interview Targets and Issues for Discussion Interview targets Key issues for discussion Government • Main sources of finance for exporters • Ministry of Trade and Industry • Relative availability and terms of investment capital versus working • Ministry of Finance capital? • Development Banks • What restrictions are there on access to capital? What are the main reasons that firms do not take out bank loans? • Export finance institutions (for example, Export Credit Guarantee Agency) • Cost of loans, terms, and collateral requirements • Export promotion agency • Are there any restrictions that prevent firms from collateralizing certain assets? Private sector • What trade finance support is provided to exporters—L/C? Guarantees? • Individual exporters (small; new and established) across Subsidized insurance? Subsidized loans for export-related projects? traditional and emerging sectors Factoring? • Export councils or industry associations • Is there any specific support related to smaller/new exporters? • Banks and other financial institutions • What are the main areas for which additional support would facilitate • Legal/accounting firms (or professional associations) exports? • Do most exporters make use of bank financing for exporters? • Do exporters make use of the above services? What are the barriers to greater take-up? 98 Module 2: Competitiveness Diagnostics Tailoring the Diagnostics to Country and Sector Characteristics Summary of Specific Considerations by Country Type Country type Relative priorities and issues for consideration Small (population) and remote/landlocked • No specific issues inherent to being small and remote Resource rich • Dutch disease effects may raise the nominal and relative cost of capital for many nonresource export activities Low income, labor abundant • Cost of finance often high and collateral requirements excessive • Working capital a major constraint for export entry and survival Middle income • Trade finance likely to be a particularly important factor determining export entry and survival • More sophisticated products like factoring and insurance likely to be well established Summary of Specific Considerations by Sector Sector Priorities and issues for consideration Light manufacturing • Working capital and trade finance more important for SMEs and firms operating outside global value chains (otherwise should be able to access credit within the supply chain) Agriculture • High-volume, low-margin commodity agricultural trade reliant on trade finance • Some countries will have specific programs for agricultural exports Tourism • Access to finance, particularly for local and smaller-scale tourist sectors Business and IT services • Firms tend to have few tangible assets to use as collateral • Most firms in these sectors are SMEs Module 2 Background Reading: Relationship Between Access to (for example, often only short-term credit is made avail- Finance and Trade Competitiveness able) and the cost of loans. Two main issues related to cost are most important: (1) the actual interest rate charged and One of the most important inputs to the production (2) the collateral requirements. On the former, high inter- process is capital—that is, access and cost of finance to fund est rates mean that only prospective investments with par- investments and working capital. As is well documented ticularly high return expectations and relatively limited through many ICAs, access to finance is almost always riskiness will be considered “feasible.� On the latter, high identified as one of the biggest barriers facing firms. collateral requirements make it virtually impossible for Access to finance is a bigger constraint for certain types of smaller firms to qualify for credit. firms. Small firms tend to be most constrained in access- The implication of lack of access or high cost of finance ing finance, but access to finance is also a particular on export competitiveness is significant. First, lack of challenge to firms (of all sizes) that have low levels of access to finance to fund working capital may be a barrier asset tangibility (Rajan and Zingales 1998)—that is, firms to participation in export markets, particularly given the that have limited physical assets that can be used as a basis greater risks and often longer payment terms involved in of collateral. This is a problem for firms in the services exporting. Second, lack of access to affordable finance will sector as well as for manufacturing exporters in the mean that producers fail to undertake investments that will apparel sector, for instance, who tend to have relatively improve productivity or that they substitute variable costs few assets relative to the size of their working capital (like labor) for capital, resulting in nonoptimal production requirements. Finally, exporters operating within global structures. value chains tend to have better access to finance than Trade finance mechanisms exist to support two funda- firms that are disconnected from such global networks, as mental aspects of the trading process: risk mitigation (that credit is typically extended across the supply chain. The is, insuring against the risk of nondelivery or nonpayment downside for these exporters is that liquidity shocks such by one party) and liquidity (that is, bridging the gap as in the recent global financial crisis can transmit quickly between incurring liabilities for export-oriented produc- across these production networks, drying up exporters’ tion and receiving payment from the customer). Some 80 sources of trade credit. to 90 percent of all international trade transactions are Although many firms face challenges accessing capital, said to be financed by some form of trade credit (Auboin in most cases, it is not access itself that creates these chal- 2009). The provision of trade finance support lowers lenges but rather the terms of the loans that are available risks for exporters and so is particularly important Factor Conditions: Access to Finance 99 during initial stages of exporting (at the extensive mar- play a central role in facilitating trade, both through the gin, new products and new markets) as well as during provision of finance and bonding facilities and through periods of macroeconomic uncertainty. Lower risk over- the establishment and management of payment mecha- comes barriers to entering and sustaining exports nisms such as telegraphic transfers and documentary (increasing export survival) as well as lowering trade cost L/Cs. Among the intermediated trade finance products, (through financing costs). the most commonly used for financing transactions are The case for government intervention in the provision L/Cs, whereby the importer and exporter essentially or support of trade finance stems from unique aspects of entrust the exchange process (that is, payment against trade finance that may imply greater potential risk. The agreed delivery) to their respective banks to mitigate most obvious is its exclusively international context, counterparty risk. Complementing the activities of the which tends to increase both macrolevel risks (for exam- banks are export credit agencies (ECAs), which guarantee ple, exchange rate fluctuations, changes to policy, con- and insure domestic exporters; private insurers, which flict, political upheaval) and counterparty risk, linked to provide trade credit insurance, political risk insurance, the greater difficulty of enforcement across borders and bonding facilities; and multilateral development (Menichini 2009). Weak cross-border enforcement raises banks (MDBs), which operate formal trade facilitation the risk of strategic default on the part of suppliers, programs designed to support banks by mitigating risks in which, combined with information asymmetries, creates new or challenging markets for which trade lines may be a problem of “credible commitment� across borders constrained. (Ellingsen and Vlachos 2009). Finally, the cross-border Assessing the effectiveness of trade finance support in nature of trade financing means that data on which to developing countries relies in part on understanding the assess counterparty credit risk are often limited or non- provision of credit, in general, or key trade finance prod- existent (for example, limited public credit registry cov- ucts, in particular, those offered through commercial Module 2 erage or public access to accounts or court proceedings). banks. A number of surveys have been conducted in recent The vast majority of trade finance involves credit years (cf. ICC 2009; Malouche 2009) to assess the perceived extended bilaterally between firms in a supply chain or constraints in the provision of trade credit during and fol- between different units of individual firms.9 Banks also lowing the global economic crisis of 2009 (see box 2.12) Box 2.12. Financing Trade in a Postcrisis World By providing liquidity and security to facilitate the movement of goods and services, trade finance lies at the heart of the global trading system. Indeed, as Auboin (2009) notes, trade finance has become ever more critical as global supply chains have increasingly integrated in recent years. During the recent global crisis, the availability trade finance was seen to have been substantially reduced, particularly for SMEs and in developing countries. This acted as a further constraint to trade and became yet another source of contagion that reverberated down supply chains to exacerbate the crisis. Although governments and multilateral institutions responded aggressively to stave off the trade finance “gap�—involving the provision of up to US$250 billion in support—evidence from past crises indicates that trade finance may continue to be a problem long after the crisis ends. For example, in a study of the Asian Financial Crisis, Love, Preve, and Sarria-Allende (2005) find that the total amount of credit provided collapses in the aftermath of a crisis and continues to contract for several years. This is because trade credit is generally a complement rather than an alternative to bank credit. When firms are constrained in their access to bank credit, they tend to reduce the amount of credit they extend in the supply chain; when they are flush with bank credit, they extend more trade. This highlights the potential vulnerability of trade finance. If banks continue to limit lending (exacerbated by regulatory requirements like Basel II), the integrated nature of global production networks means these credit constraints are likely to amplify across supply chains. Proactive responses by governments to promote not only the provision of trade finance but also wider credit facilities, particularly for SMEs, will be critical to supporting the competitiveness of the export sector. Source: Farole and Reis 2010. 100 Module 2: Competitiveness Diagnostics Factor Conditions: Labor Markets, Skills, and Technical Efficiency Link with Competitiveness Challenges Identified in Trade Outcomes Competitiveness challenge areas Main components of labor markets, General export Cost Product extension skills, and technical efficiency environment competitiveness and quality Market penetration Labor regulations and skills ✓ ✓ Firm-level technical efficiency ✓ ✓ Quantitative Analysis: Indicators and Data Sources Indicators Sources Productivity— Total factor productivity (TFP) Derived from Enterprise Surveys; national top line sources derived from Labor Force Surveys measures and Enterprise Census Labor productivity Conference Board database, ILO Key Indicators of the Labor Market (KILM) database; national sources (as above) Unit labor cost Derived from Enterprise Surveys; national sources (as above) Labor markets Average wages per category of employee Country-specific data Wages and earnings ILO KILM; CEIC Dataa Firing costs Doing Business, Enterprise Surveys Module 2 Hiring costs Doing Business, Enterprise Surveys Payroll taxes ILO KILM Rigidity Index Doing Business Percent of workers unionized ILO KILM, World Bank Enterprise Surveys Strikes and work stoppages (annual average) ILO KILM Share of workers in the informal sector ILO KILM Labor skills Percent skilled labor World Bank Enterprise Surveys Educational attainment of workers ILO KILM Percent of firms offering formal training World Bank Enterprise Surveys Average percent of workforce receiving formal training World Bank Enterprise Surveys Firm-level Capacity utilization World Bank Enterprise Surveys technical Share of firms having introduced new technologies World Bank Enterprise Surveys efficiency Share of firms using technology licensed from a foreign company World Bank Enterprise Surveys Share of firms with ISO certification World Bank Enterprise Surveys Share of firms outsourcing a major activity World Bank Enterprise Surveys Share of firms with process or product innovations in past year World Bank Enterprise Surveys Average/median highest level of education of managers World Bank Enterprise Surveys Average/median years of experience managers have in the sector World Bank Enterprise Surveys Percent of skilled technicians in the workforce (industry specific) World Bank Enterprise Surveys a. Commercial database provided by CEIC Data: http://www.ceicdata.com/. Qualitative Analysis: Interview Targets and Issues for Discussion Interview Targets Government agencies and ministries Private sector and other institutions Labor markets and skills • Ministry of Trade and Industry • Individual exporters • Ministry of Labor/Employment • Export councils or industry associations • Ministry of Education • Universities, other schools, training institutions Firm-level technical efficiency • Ministry of Trade and Industry • Individual exporters • Ministry of Labor/Employment • Export councils or industry associations • Ministry of Education • Universities, other schools, training institutions • Quality certification bodies Factor Conditions: Labor Markets, Skills, and Technical Efficiency 101 Key Issues for Discussion in Interviews Labor markets and skills • Trends in labor productivity and main drivers • Trends in labor market: supply- and demand-side issues • Trends in wages—skilled versus unskilled labor • Labor relations issues • Major concerns raised by private sector over labor market issues: wages, hiring/firing costs, regulations, and so on • Any recent labor legislation • Main skills challenges and how they are being addressed • What is government doing to address it • What is the private sector doing • Situation with vocational training/higher education Firm-level technical efficiency • General perceptions on the quality of management/factors behind this • Level of education and experience of most managers • Role of local versus foreign management • Educational and training institutions—availability and quality of management training • Any specific programs/efforts to improve managerial technical capacity Tailoring the Diagnostics to Country and Sector Characteristics Summary of Specific Considerations by Country Type Country type Relative priorities and issues for consideration Small (population) and • May be limited pool of skilled and managerial talent remote/landlocked • General worker skills and labor productivity likely to be critical, which suggests importance of tight Module 2 focus on sectors of comparative advantage Resource rich • Wages and other input costs may be high resulting from currency impacts of commodity exports (Dutch disease effects) • Depending on market size, access to skilled workers and managers may be limited, as the best may be lured toward the dominant resources sector; understanding the dynamics of this will be important Low income, labor abundant • Wage rates should be an important source of comparative advantage—if they are not (for example, in many parts of Africa) understanding the reasons behind this (including labor market issues but also wider transactions costs) is critical • Local managerial skills may be limited—importance of openness to FDI but also in having policies to ensure spillovers of knowledge Middle income • Avoiding the middle-income trap—identifying skills and other inputs that will facilitate upgrading to services and knowledge-intensive sectors Summary of Specific Considerations by Sector Sector Priorities and issues for consideration Light manufacturing • Most issues will be critical—labor market regulations, wages, skills, and technical efficiency often are the most important determinants of competitiveness Agriculture • Technical efficiency critical—important to understand capacity/quality of extension services Tourism • Wages and skills an important issue, particularly given location of tourism facilities in relation to labor markets • Important to assess training and skills development programs Business and IT Services • Labor force scale can be an issue in some outsourcing sectors • Skills are the most important issue—important to understand number and quality of graduates from technical universities and availability and quality of vocational training programs Background Reading: Relationship Between office gate).10 Indeed, productivity (specifically, TFP) is Labor Markets, Skills, Technical Efficiency, often equated to competitiveness—according to Porter and Trade Competitiveness (1990), productivity is “the only meaningful concept of Productivity and Competitiveness competitiveness at the national level.� There are compelling At the heart of competitiveness is the productivity of firms theoretical arguments and mounting empirical evidence in producing goods or services (at the factory, farm, or of the importance of productivity for the prosperity of 102 Module 2: Competitiveness Diagnostics nations. Although macroeconomic factors play an impor- exporting. Similar results are found by Bernard and tant role in creating opportunities to create wealth, the Jensen (2004) for the United States, and by Bernard and process of wealth creation in an economy is actually tied Wagner (2001) for Germany. In general, there is some to the increase in the productivity with which a nation uti- reason to believe that in low-income countries, where lizes its resources to produce goods and services (Porter exporters can benefit from technology absorption and et al. 2008). adaptation, exporting can have significant positive Recent years have seen resurgence in interest in the spillovers to productivity. In countries in which exporters role of productivity. At the same time, a sharp debate has are already operating at the technology frontier, however, focused on the links between productivity and trade. the stronger causality probably runs the other way—from Trade can affect a country’s productivity by affecting productivity to exporting. firm-level productivity directly, or by distorting the allo- Abundant empirical evidence suggests that productiv- cation of resources across the economy (see box 2.13). ity is strongly associated with both the propensity to The causality, however, can run in the other direction, export as well as with volumes of exports (see Escribano, from productivity to exporting. Considerable research, Pena, and Reis 2010). The same can be said about factor both at the theoretical and empirical level, shows that costs and availability, although labor skills can be consid- exporters are more productive than nonexporters and ered a particularly important ingredient for export that this productivity difference predates any entry into diversification in products and markets. In particular, exporting (Pavcnik 2002). Firm-level productivity can endowments of human capital seem to be one of the key change with trade because of many reasons: (1) import determinants of comparative advantage in services, an competition, (2) outsourcing, (3) FDI, and (4) integra- area of trade presenting continuous expansion in recent tion and access to research and development (R&D) years (cf. Mattoo 2009). inputs. In this strand of research Roberts and Tybout Module 2 (1997) develop a model of exporting with sunk costs of Main Components of Analysis of Productivity A firm’s entry and test it on a sample of Colombian firms. In the productivity depends on a wide range of factors—the two presence of these entry costs, only the relatively produc- most important proximate determinants are (1) the costs tive firms will choose to pay the costs and enter into the and quality of the inputs employed in the production, espe- foreign market. The implied relationship between export- cially labor and capital, and delivering processes11; and (2) ing and productivity is positive in a cross-section of firms the efficiency with which the firm employs its resources. In or industries, but the causality runs from productivity to addition, structural features such as the potential for Box 2.13. Channels Linking Trade and Productivity Bloom, Sadun, and Van Reenen (2009) document that Chinese import competition in the European Union led to both within-firm technology upgrading and between-firm reallocation of employment toward more technologically intensive plants. In this strand of research, Cusolito (2009) shows that a reduction in trade barriers shifts firms’ incentives away from horizontal innovations and toward the introduction of vertically superior goods. The theory underlying these results is that import competition encourages firms to improve the quality of existing products and to create more efficient production techniques to escape from foreign competition. Arm’s-length trade in intermediate inputs is another source of productivity gains. Offshoring enables a firm to relocate its relatively inefficient production process to external providers with cheaper and more efficient production capabilities. This allows the firm to turn its focus to areas where it has a comparative advantage and to expand output with the existing capacity. Evidence on this effect has been recently provided by Criscuolo and Leaver (2005) who show that there is a positive and robust impact of offshoring on productivity, both in the manufacturing and services sectors. The effect comes mainly from firms that are domestic and nonglobally engaged, that is, do not export and are not parts of a multinational firm. Another channel between trade and productivity relates to FDI. Plant productivity could rise through the spillovers and linkages between foreign and local firms. The international exchange of goods and services opens channels of communication that facilitate the transmission of technical information. Firms in each country learn not only from the R&D projects undertaken locally but also from the novel experiments that are carried out abroad (Grossman and Helpman 1991). Integration also enlarges the markets in which firms operate, and by itself this effect increases the profit opportunity available from innovating. Finally, trade allows domestic firms to have access to a larger and highly qualified set of inputs needed to conduct R&D.a Source: Authors. Note: a. The evidence on the impact of trade on productivity is not conclusive. A growing body of work has suggested that exporting confers little or no benefit in the form of faster productivity growth at the plant level (Clerides, Lach, and Tybout 1998; Bernard and Jensen 1999; Delgado, Farinas, and Ruano 2002). Factor Conditions: Labor Markets, Skills, and Technical Efficiency 103 achieving scale economies will also impact productivity. employing workers (figure 2.7, arrow 1)—through mini- Figure 2.6 illustrates these main factors. This figure is fol- mum wages, payroll taxes, worker benefits—thus con- lowed by a discussion of labor-related issues and technical straining firm labor force decisions, including hiring and efficiency scale; the discussion of intermediate inputs and firing, work shifts and the skill level of a firm’s workforce backbone services is covered in the next section of this (arrow 3). These effects on the size and composition of a module. firm’s labor force will have implications for firm labor pro- ductivity directly (arrow 5) and indirectly through reduced Labor Markets and Skills level of R&D (arrows 6 and 7). On the supply side, labor One of the main determinants of the costs of producing a legislation may create incentives for workers to maintain good is labor, including both costs and skills. Labor costs or sever employment contracts (arrow 2), which in turn are a function of the labor legislation and the structure of will affect firm labor force investment decisions (arrow 8), the market. The theory underlying government interven- with implications for the composition of a firm’s labor tions in the labor market is based on the fact that free labor force (arrow 4) or firm human capital investment and markets are imperfect, and as a consequence, there are search budgets (arrow 8), again affecting the labor pro- rents in the employment relationship, which lead to both ductivity and profits of firms directly (arrow 5) and indi- unfair and inefficient situations. The system of civil rights rectly (arrows 6 and 7). Notably, arrow 6 points in both protections that applies to workers encompasses three bod- directions. ies of law: Labor skills have an equally important role in the deter- mination of productivity at both the firm and economy 1. Employment laws govern the individual employment levels.12 As discussed by Syverson (2010), much of the work contract. in labor economics has focused on wages as the outcome of 2. Collective or industrial relations laws regulate the bargain- interest, whereas only a smaller set of work has looked at Module 2 ing, adoption, and enforcement of collective agreements, human capital’s impact on productivity at the firm level. the organization of trade unions, and the industrial Recent work, however, using matched employer-employee action by workers and employers. data sets offered evidence on the importance of labor qual- 3. Social security laws govern the social response to needs ity for a firm’s productivity.13 and conditions that have a significant impact on the quality of life, such as old age, disability, death, sickness, Firm-Level Technical Efficiency and unemployment. Controlling for external factors, the productivity of any firm is ultimately a function of the effectiveness with Labor legislation may work through various channels to which its management makes use of the inputs available to affect firm labor productivity and eventual profits. On the it. This is captured in the concept of firm-level technical demand side, labor legislation may change the cost of efficiency. Although TFP is classically obtained under the Figure 2.6. The Main Determinants of Productivity at the Factory or Farm Gate Productivity Intermediate inputs Scale Labor Technical efficiency and backbone services Labor markets Skills and regulation Land and Intermediate Capital Business Utilities Finance infrastructure inputs equipment services Source: Authors. 104 Module 2: Competitiveness Diagnostics Figure 2.7. The Channels of Impact of Labor Legislation on Firm Productivity and Profits Innovation & Hiring/firing decisions technological (labor demand) adoption 1 6 Labor 3 Labor force regulation size & 7 and skill level institutions 4 2 5 Frequency of job Productivity leaving, tenure & (labor supply) profits 8 Inadequate training Source: Authors. assumption that firms optimally allocate their inputs, the management practices could be improved in badly man- Module 2 reality is that some producers may be systematically more aged firms and how much difference would result from successful in optimizing than others. Technical efficiency management improvements. Early results suggested that takes this fact into account and reflects the ability of a management practices can be improved and that improve- firm to minimize input use in the production of a given ments in management practices may lead to large increases output level with no guarantee of achieving optimal allo- in performance—productivity levels rose by about 15 per- cation.14 One can thus say that technical efficiency is anal- cent and profits by about 24 percent in the treatment firms ogous for firm-level analysis to TFP in macroeconomic compared with control firms.15 In addition to management and sectoral studies. skills and experience, many firms (especially SMEs) suffer Among the most important determinants of technical from lack of access to information on new technologies efficiency is the level of education, training, and experi- and methods of organizing production. ence of its management. Indeed, ICAs have consistently The average capacity utilization of a firm, which is the highlighted the importance of management education amount of output actually produced relative to the maxi- and experience in firm-level outcomes. More recently, mum amount that the firm could produce with the exist- Bloom, Sadun, and Van Reenen (2009) developed a ran- ing machinery and equipment, is often indicative of the domized experiment in India designed to measure whether efficiency with which the firm employs its fixed assets. Factor Conditions: Intermediate Inputs and Backbone Services 105 Factor Conditions: Intermediate Inputs and Backbone Services Link with Competitiveness Challenges Identified in Trade Outcomes Competitiveness challenge areas Main components in intermediate inputs General export Cost Product extension Market and backbone services environment competitiveness and quality penetration Scale economies ✓ ✓ Intermediate inputs ✓ ✓ ✓ Land and infrastructure ✓ ✓ Services inputs ✓ ✓ Quantitative Analysis: Indicators and Data Sources Measures Sources Scale Median firm size (output, workers, exports, and so on); Enterprise Surveys, national sources overall and exporters Number of firms in the sector; number exporting Enterprise Surveys, national sources Level of intraindustry trade—domestic and regional Comtrade (regional); national sources (input-output [I-O] Module 2 tables) Intermediates Comparative regional/global prices of key production Country-specific analysis and capital inputs equipment Tariffs on key inputs and capital equipment WITS-TRAINS Domestic resources costs (DRC) of producing inputs in Requires data on domestic and world prices and value local market added of inputsa “Machinery and equipment� price index International Price Comparisons database Share of material inputs and machinery inputs sourced National sources (I-O tables) from domestic versus foreign markets Land and “Housing and utilities� price index International Price Comparisons database infrastructure “Construction� price index Industrial land rent (per square mile) in main National sources commercial city Factory rent (per square mile) in main commercial city National sources Office rent (per square mile) in main commercial city National sources Backbone See “housing and utilities� above International Price Comparisons database services, Electricity cost National sources utilities Electricity quality (value lost due to power outages) World Bank Enterprise Surveys Water cost National sources Water quality (value lost due to water shortages) World Bank Enterprise Surveys ICT price basket International Telecommunications Union (ITU) International internet bandwidth (bits/person) WDI Fixed broadband Internet connection charge and ITU monthly subscription “Communications� price index International Price Comparisons database Business services Local supplier quantity and quality ratings Global Competitiveness Index (WEF) a. For a discussion and training presentation on calculating DRC, see http://www.fiscalreform.net/index.php?option=com_content&task=view&id= 966&Itemid=1. 106 Module 2: Competitiveness Diagnostics Qualitative Analysis: Interview Targets and Issues for Discussion Interview Targets Government agencies and ministries Private sector and other institutions Scale and • Ministry of Trade and Industry • Individual exporters (small/new and established) across traditional and structural • Competition Agency emerging sectors features • Export councils or industry associations Inputs and • Ministry of Trade and Industry • Individual exporters backbone • Ministry of Finance • Export councils or industry associations services • Ministry of Energy/Communications • Private utilities providers: electricity, water, telecommunications, IT • Utilities regulators • Industrial property developers • Customs Authority • Banks and other financial institutions • State-operated industrial parks • Legal/accounting firms (or professional association) Key Issues for Discussion in Interviews Scale and structural • General trends in productivity in the economy/specific sectors features • Trends in terms of capacity utilization in the economy/specific sectors • Has there been any significant merger activity/consolidations? Why or why not? • What is the participation of firms from outside the country in the value chain of key sectors? Is there any evidence of mergers or value chain integration on a regional basis? • What are the impediments to integration into global and regional values chains? • To what degree are external economies being exploited in industry agglomerations/clusters? What are the barriers to exploiting these opportunities? Module 2 Intermediate inputs and • Any major restrictions to imports of key raw materials? capital equipment • Do existing programs allow for duty-free access or duty drawback on key raw materials? If so, how effective? What barriers to take-up? • Availability and cost of key inputs in the domestic market. • Any factors constraining availability of quality local inputs: scale, competition, protection, and so on? • What are the implications on competitiveness (cost, time, quality) of using imports versus local supply of key inputs? • Local or regional market access to capital equipment and main intermediates (industry-specific). • Any protection of local suppliers? • Any border restrictions on importing capital equipment or important inputs (tariffs, quotas, technical barriers)? If so, what is behind this? • Any restrictions imposed by exporters of capital equipment (collateral, terms, and so on)? • Availability of capital to finance equipment imports. • Any special programs for duty-free imports of capital equipment and/or intermediates? How effectively does it work? Land and facilities • To what degree is access to serviced land (or agricultural land) a problem? Is it an issue of space, titling, or regulation? • Any issues related to zoning, regulations, requirements to pay compensation, and so on? • Any issues around security of property rights? • Where are export-oriented sectors based and what is the land availability for them? • What reforms have taken place/are planned to address any legal and regulatory constraints to land access? • Are any special facilities available for FDI or export-oriented investors, including location, types of facilities, flexibility, and so on? Backbone services— • General situation with cost, access, and reliability of utilities—what are the main factors contributing to poor Utilities reliability? • Structure of the utilities sectors—who are the providers and what is the general state of competition? • What is the degree to which foreign investment is restricted in these sectors? • Role and effectiveness of the regulator. • Is there existing or planned PPP for delivery of power generation/distribution, water distribution, ICT, and so on? • Recent or future changes to regulatory structure. Business services • Access to quality business services in local market. • Services provided by local versus foreign firms. • Are there areas where no quality local services are provided? Factor Conditions: Intermediate Inputs and Backbone Services 107 Tailoring the Diagnostics to Country and Sector Characteristics Summary of Specific Considerations by Country Type Country type Relative priorities and issues for consideration Small (population) • Scale issues may limit productivity potential in some sectors and remote/ • Access to quality business services likely to be limited landlocked • Likely to be reliant on imports of many intermediates and capital equipment; therefore, importance on understanding trade policy and other barriers to this Resource rich • May have access to certain raw material inputs at advantageous cost—this may offer source of competitive advantage but may also act as a bias toward activities in which the country may not have comparative advantage • Depending on the resources available (coal, oil) energy costs could be a source of competitive advantage—is this in fact the case or are the rents being taken by a monopoly? Low income, labor • Industry structure usually characterized by SMEs, so scale economies are a problem abundant • Input costs (intermediates, utilities, capital equipment) often major barriers, but these are often policy induced and are not inherent Middle income • Achieving greater scale economies in production often a major opportunity • Focus on input markets (especially utilities) and moving toward greater competition and PPPs; trade barriers may remain for key inputs • Focus on inputs that will facilitate upgrading to services and knowledge-intensive sectors, particularly ICT (regulatory, rather than infrastructure, issues are probably most important) Summary of Specific Considerations by Sector Module 2 Sector Priorities and issues for consideration Light manufacturing • Access to cost-effective, quality raw materials is critical • Access to utilities also is critical in some subsectors • The importance of scale economies will vary significantly by subsector (for example, very important for textiles, but less so for garments) Agriculture • Scale issues often critical—both in terms of production (in many low-income countries, average farm sizes decline from generation to generation; many middle-income transition countries have shifted from large collectives to highly fragmented ownership structures) and also postharvest processes • Access to cost-effective inputs critical—important to understand government policies on tariffs and technical barriers to key inputs and capacity/quality of extension services • Land access issues (both for FDI and domestic investors) obviously fundamental as is core inputs infrastructure (for example, irrigation, power) Tourism • Land and infrastructure issues obviously important—policies on FDI can be important for land issues and PPP possibilities for infrastructure Business and IT • ICT infrastructure and pricing critical—regulatory and competition are the most important to understand Services Background Reading: Relationship Between Inputs and (for example, China) are often in a better position to have Backbone Services and Trade Competitiveness firms operating on a large scale than in smaller countries. Ultimately, factors like market access, openness to FDI, and Scale Economies the degree of openness to cross-border trade mediate the The potential to produce at an economically efficient scale potential for reaping scale economies, as it is frictions in can play an important role in determining productivity. trade and investment that prevent achieving scale through While scale almost always plays some role, its influence firm mergers and consolidation of value chains across or varies significantly by sector. For example, producing at within countries. scale in textiles matters much more for competitiveness In considering the role of scale economies, it is also than in the manufacture of garments. Generally, the capital important to recognize that scale economies can be real- intensity of the sector will be closely related with the rel- ized externally as well as internally. This tends to be par- ative importance of scale. The potential to operate at ticularly important in sectors closer to the technology scale may vary significantly across countries, both for frontier, where requirements for specialization and other structural and policy reasons. In general, larger countries 108 Module 2: Competitiveness Diagnostics market uncertainties make the consolidation of activities countries have schemes whereby producers can access within single firms less economically efficient (although it capital equipment on a duty-free or reduced basis). can also happen in traditional craft-linked sectors like cloth- ing and footwear, for reasons linked to design, skills, and Land and Facilities Access to land, and especially to serv- labor market factors). In this case, the emergence of proxi- iced industrial land, is a major barrier to competitiveness in mate industry clusters (agglomerations) may offer the many countries. The challenge is often particularly acute for potential for reaping the benefits of scale externally, through FDI, but it can affect local investors equally (or in some cases access to deep pools of specialized labor and suppliers and even more acutely, as foreign investors may have access to through access to industry-specific public goods (for exam- certain preferential arrangements for accessing facilities, for ple, testing facilities, logistics platforms, and so on). example, through SEZs). In addition to the simple availabil- ity of land and facilities, key issues that determine the impact Production Inputs and Backbone Services In addition on firm-level productivity include the following: to labor, firm productivity is also a function of the physical capital that it employs in the production process. This • Location where serviced land and facilities are available, includes the cost and quality of land and facilities, capital in relation to labor markets and major transport infra- equipment, intermediate inputs, and utilities.16 It also structure; includes the financing costs involved in employing these • Time and cost of acquiring and registering the property, resources. Access to high-quality, efficiently priced inputs including obtaining titles, if necessary; and backbone services can strengthen the export response • Land costs, including taxation; to market access opportunities by lowering the costs of • Zoning/regulatory issues, including the process of production and export. For almost all of these issues, obtaining environmental and other permits; analysis should focus on understanding the regulatory • Flexibility of lease terms—in many sectors, investors Module 2 structure of the market and the degree of competition. seek to limit risk by taking on relatively short-term leases of factory “shells� or other units (for example, on Intermediate Inputs and Capital Equipment Local leases as short as five years); market availability (or availability of competitive local sup- • Quality may be an issue in some locations and particu- ply) and the impact of trade policy measures affect the larly in some industries—this relates particularly to degree to which firms can access materials and especially industrial buildings and facilities for services activities intermediate inputs cost effectively. In cases in which trade (for example, high-end ICTES); and policy places tariffs or restrictions on imports, production • Security of property rights. costs rise; in cases in which local producers of these inputs are protected from international and domestic competi- Utilities Having access to relatively cost competitive and tion, quality eventually declines and productivity down the (most important) reliable power, water, and ICT services value chain faces knock-on effects. is a critical determinant of firm-level productivity. Because most developing countries lack market scale Indeed, evidence from ICA reports suggests that inade- and in many cases technical capacity, most of the capital quate supply of electricity is one of the top two or three equipment for production tends to be imported from biggest constraints facing firms in most low-income abroad. This puts these countries at a competitive disad- countries. The key utilities that need to be considered vantage from the start because of the higher transport include the following: costs involved in acquiring the equipment from abroad. In addition, in many developing countries, maintenance • Power: This may include gas, but in most cases the costs of equipment also rise significantly because of the biggest issue is electricity. The relative importance of need to bring in not only parts but also technicians from power costs and reliability will vary significantly by abroad (because of the lack of skills or proprietary sector, with capital-intensive sectors (for example, alu- knowledge of the equipment). The alternative in other minum) being extremely reliant on power costs as are firms is to not maintain or operate the equipment many light-manufacturing sectors (like textiles and properly, shortening its usable life or lowering its day-to- garments). ICT and other professional services sectors day productivity. These disadvantages are compounded are also reliant on adequate power supply. The biggest in many countries by factors like currency fluctuations, issue for firms in many low-income countries is the lack high costs of capital, and—most problematic—high of reliability of power supply, which results in many firms tariffs and duties on capital equipment (although many having to rely on generators (usually diesel-powered and Factor Conditions: Intermediate Inputs and Backbone Services 109 often doubling or tripling the cost of power) or face market structure, including the degree of private sector long periods of production downtime. participation and the level of competition in the market. In • Water: Although not as critical across all sectors, access addition, the regulatory and tax regime will have an impact to quality, efficiently priced water is fundamental in on cost structures. most agricultural sectors as well as some manufacturing sectors (including iron, steel, and other metals as well as Business Services The available and quality of local sup- some agriprocessing activities like cocoa processing). ply of business services can have an important impact on Again, although cost is important, the issue of reliable firm-level productivity. Specialized business services access is usually paramount. tend to agglomerate in larger markets and in larger cities • Telecommunications: This includes fixed line and (increas- (within markets) and so the level of choice and quality of ingly more important) mobile telephony, and broadband such services may be limited in smaller, developing Internet access. This is obviously most critical in the countries. Among such input services are accounting, services sectors, particularly ICTES and other business legal, marketing, business strategy, printing and publish- services. Again, reliability issues are critical here, although ing, ICT, and industry-specific technical services (for access (especially to Internet bandwidth) is also an issue example, research, testing, certification, and so on). In rela- in many developing countries. Even more so than with tively unsophisticated sectors and those in which a country electricity, price is often the biggest determinant of the has been operating for some time, access to these business degree to which telecommunications backbone services services inputs is likely to have only limited impact on facilitate or hinder competitiveness. competitiveness. These services, however, play a bigger role in the establishment and development of new firms and In assessing the impact of utilities, the biggest issues tend to particularly in new sectors. relate to infrastructure investments and (related to this) Module 2 110 Module 2: Competitiveness Diagnostics Factor Conditions: Trade Facilitation and Logistics Note to the Practitioner: This section addresses issues related to trade facilitation and logistics. Analysts looking to conduct a comprehensive analysis of the transport and trade facilitation environment should consult “Trade and Transport Facilitation Assessment: A Practical Toolkit for Country Implementation� (TTFA; World Bank 2010d). This document (available in hard copy and CD-ROM from the World Bank International Trade Department) provides a detailed, step-by-step program for analyzing the trade facilitation and logistics environment in any country. This section draws heavily from the TTFA, but the information presented here is less detailed. The analyst will be guided to various parts of the TTFA, where appropriate. Link with Competitiveness Challenges Identified in Trade Outcomes Competitiveness challenge areas Main components in trade General export Cost Product extension facilitation and logistics environment competitiveness and quality Market penetration Distance ✓ ✓ ✓ ✓ Inbound trade facilitation ✓ ✓ and logistics Outbound trade facilitation ✓ ✓ ✓ ✓ and logistics Quantitative Analysis: Indicators and Data Sources Indicators Sources Cost • Export cost (by land and sea/air) Logistics Performance Index (LPI) Module 2 • Import cost (by land and sea/air) • Cost to export and import • Cost per kilogram (kg) for a 500 kg shipment by air Doing Business (benchmark to key markets) Freight forwarders Time and reliability • Export time (by land and sea/air) LPI, Doing Business • Import time (by land and sea/air) • LPI score (overall) • Doing Business; Trading Across Borders(overall; time to export and import) • Percent of value lost in transit because of breakage or theft World Bank Enterprise Surveys Distance • Distance to markets by sea and road LPI, websites of shipping lines, other shipping related websites (for example, portworld.com; e-ships.net; distances.com) Connectivity • Liner shipping connectivity index UNCTAD • Air traffic statistics International Air Transport Association (IATA) Physical infrastructure • Infrastructure score LPI Customs and trade • Customs score LPI facilitation • Clearance time: with and without inspection; LPI; World Bank Enterprise Surveys import and export LPI • Physical inspection rate Transport and logistics • Logistics quality and competence score LPI services • Tracking and tracing score • International shipments score Note that in large countries, national metrics on costs, and (making use of World Bank Enterprise Surveys or time, and reliability performance may have little rele- national manufacturing census) to get an indication on vance for some producers, particularly those in more relative shipping costs, customs clearance times, and peripheral regions. As such, it may be necessary to collect other performance criteria at a subnational level. For some data at the subnational level. Although comparative additional sources of data on a wide range of transport data may be limited, it may be possible in some countries and logistics related factors that may be included in the to map out market access to and from nearby ports and Diagnostic, please refer to the World Bank’s TTFA Toolkit airports, to get performance statistics on specific ports, (World Bank 2010d). Factor Conditions: Trade Facilitation and Logistics 111 Qualitative Analysis: Interview Targets and Issues for Discussion Interview Targets Export manufacturers Importers and exporters and other producers Importers: manufacturers, wholesalers, retailers, traders Transport service providers Road transport Railways Ocean shipping Air freight Container terminal operator Logistics service providers Customs—land border Customs—international gateway Clearing and forwarding agent Integrated third-party logistics (3PLs) Consolidator, storage Bonded warehouse operator Free zone operator Banks Government ministries Commerce and trade and agencies Finance Transport Agriculture Health Module 2 Export promotion agencies Preshipment inspection Issues to be covered during the interviews will being studied, as well as on country and region-specific necessarily depend somewhat on the supply chains factors. Key Issues for Discussion in Interviews Exporters and • Type of commodities exported, volumes shipped, and how this has been changing importers • Role of logistics in improving competitiveness of exports • Integration of outbound supply chain for principal exports • Regulatory procedures significantly increasing documentation, cost, and time for shipments • Role of ICT in simplifying transactions, including managing orders, expediting regulatory procedures, and coordinating logistics shipments • Problems caused by quality of transport infrastructure and operations, including ports and border crossings • Opportunities for mitigating these problems Road transport • Principal trades (commodities and routes) handled and volumes shipped • Value added services offered • Description of typical supply chain for shippers • Fleet size and truck types • Vehicle annual productivity • Typical shipping times and rates • Mechanisms for increasing load factors and reducing empty backhauls • Use of information and computer technology for contracting trucking services and managing fleets • Impact of other government regulation on quality and competitiveness of services • Effect of taxes, tolls, and formal and informal road checks on intrastate movements • Impact of quality and capacity of the road network on transport time, cost, and reliability • Problems with security on primary routes and impact on time and cost • Other impediments to improving trucking services • Existing programs or proposals to overcome these impediments 112 Module 2: Competitiveness Diagnostics Railways • Principal foreign trades (commodities and routes) handled and volumes shipped • Unit train operations: scheduled and on-demand • Value added services offered • Description of typical supply chain for shippers using rail service • Contractual arrangements and performance standards included in agreements • Typical shipping times and rates • Procedures for pricing services including backhauls • Use of information and computer technology for arranging shipments and scheduling movements • Impact of condition and utilization of the rail network on transport time, cost, and reliability • Other impediments to improving rail services • Existing programs or proposals to overcome these impediments Ocean shipping • Principal trades (commodities routes and TEUsa) • Vessel size by route • Complementary services offered • Description of supply chains for typical consignees and shippers • Primary direction for loaded containers and efforts to improve balance • Typical shipping times and rates • Typical dwell time for containers inbound and outbound • Difficulties with clearing containers • Electronic transfer of ship manifests, load plans, and other information to expedite movement of cargo and vessels • Other government regulatory procedures affecting efficiency of shipping services • Impact of quality and capacity of the port facilities and services on transport time, cost, and reliability • Other impediments to improving shipping services Module 2 • Existing programs or proposals to overcome these impediments Air freight (only when • Principal trades (commodities and routes) handled and volumes shipped the country has a • Value added services offered sector that makes • Aircraft capacity and frequency significant use of air freight) • Primary direction for cargo and efforts to improve balance • Description of typical supply chains for shippers and consignees • Typical dwell time for inbound cargo • Typical shipping times and rates • Information and computer technology used for arranging shipments and submitting shipping documents • Impact of other government regulation on quality and competitiveness of services • Impact of quality and capacity of the airport on efficiency and cost • Other impediments to improving airfreight services • Existing programs or proposals to overcome these impediments Container terminal • Principal shipping lines served and trades operator • Traffic volume (vessels and TEU) • Vessel size by route • Berth and crane productivity • Value added services offered • Description of typical landside and waterside logistics • Terminal handling charge • Typical dwell time for containers inbound and outbound • Difficulties with clearing containers • Congestion in land access to the terminal • Impact of other port infrastructure on efficiency • Use of information technology for managing storage and berth, scheduling container movements, and notifying shippers and consignees • Other impediments to improving shipping services • Existing programs or proposals to overcome these impediments Customs • Type and volume of activity • Principal enforcement responsibility and performance targets • Primary source of violations • Procedures for clearing inbound and outbound cargo Factor Conditions: Trade Facilitation and Logistics 113 • Impact of complex regulations on efficiency and effectiveness • Efforts to modernize processes and increase transparency, including automation and risk management • Efforts to move clearance activities off the border and to allow movement of goods in transit • Other problems preventing more efficient and transparent activities • Opportunities for mitigating these problems. Clearing and • Principal trades (commodities and routes) handled and volumes shipped forwarding agents; • Range of logistics services provided including value added integrators and • Priorities of clients in term of time, cost and reliability 3PLs; consolidator; warehouse • Ways to establish competitive advantage operator; free • Responsibilities for clearing cargo, typical clearance times and problems with clearance procedures zone operator • Government regulation that limit type of services and markets served • Use of computerization and modern communications for contracting, scheduling, and coordinating services • Impediments to improving the quality of services • Existing programs or proposals to overcome these impediments Ministry of Trade • Role of trade in economy and Ministry of • Reduction of regulation of trade, import, and export Finance • Use of revenue targets for customs • Efforts to simplify customs procedures Ministry of • Plans to improve quality of transport infrastructure serving foreign trade, including ports and airports Transport • Procedures and effectiveness of regulations of road safety, security, overloading, and vehicle roadworthiness • Efforts to improve quality and utilization of long distance trucking services • Commercialization and privatization of cargo-handling facilities at ports and airports • Efforts to simplify regulation of truck operators, licensing, rates, and area of operation Module 2 Ministry of • Principal regulatory responsibilities Agriculture; • Most important commodities that require regulation Ministry of Health • Source of greatest threats • Authority responsible for notification of arrival of controlled goods • What are the sources of alerts • Use of risk profiling to determine whether to inspect and test the cargo Ministry of • Proportion of the shipments physically inspected and typical time required Agriculture; • Efforts to develop secure supply chains Ministry of Health • Proportion of controlled shipments subjected to laboratory tests and time required • Efforts to simplify regulations • Efforts to improve efficiency and transparency of regulatory procedures • Efforts to improve exchange of information regarding alerts among agencies and with shippers • Other impediments to increasing the efficiency of regulatory function • Existing programs or proposals to overcome these impediments a. Twenty-foot Equivalent Units—these are intermodal shipping containers. Analytical Approach the institutions and regulations that govern the trade facili- tation environment or wanting to understand supply- Assessing a country’s trade facilitation and logistics envi- chain-related issues in a specific sector), the analyst may ronment requires looking at a wide range of issues—includ- wish to widen the scope of the analysis. In this case, the ana- ing trade-related infrastructure, transport, and logistics lyst is directed to the TTFA Toolkit (World Bank 2010d), services—and at several border and behind-the-border pro- where additional details on policy issues can be found— cedures. Table 2.3 summarizes the main components of the specifically, see Table C1 and Box C1 of the TTFA Toolkit. trade facilitation and logistics environment that should be The approach outlined in this section is based on a covered in a basic assessment. Table 2.3 is based on the scaled-down version of the Phase 1 assessment developed TTFA framework but is presented here in a reduced form in the TTFA (World Bank 2010d). with the aim of conducting a high-level assessment on a Once the objectives of the assessment are defined, the countrywide basis. If the analyst requires a more in-depth key starting point is to identify a limited set of commodities assessment, for example, wanting to explore in more detail 114 Module 2: Competitiveness Diagnostics Table 2.3. Summary of Main Components of Trade Facilitation and Logistics Assessment Components Policy areas and main issues Trade logistics performance Tools and institutions to measure and assess logistics a. Trade logistics patterns performance 1. Availability of statistics, sources a. Statistical instruments for trade in volume 2. Volume by routes, modes, and gateway b. Logistics performance on main routes and at gateway in terms of cost, time, and reliability 3. Main commodities in volume b. Logistics performance: cost, time, reliability on the main routes; arbitrage costs reliability by exporter and importers, specific commodities c. Other issues: economies of scale, backload Availability, quality, and performance of services Regulation of transport and logistics services a. Logistics competence: practices and skills with consignees a. Licensing of transport—equipment and operations b. Trucking market structure b. Effectiveness of freight regulations (e.g., axle load) c. Trucking operational performance c. Domestic and regional regulation of long-distance transport d. Freight-forwarding and integration Quality, reliability of logistics services e. Customs brokers a. Foreign participation in logistics services f. Railways services b. Availability of value added logistics services, and conducive g. Express regulations h. Banking and insurance c. Access to information on available services i. Warehousing, 3PLs (3rd party logistics) j. Others: air cargo, river services Trade and customs facilitation Customs modernization a. Coordination, transparency, security and IT a. Transparency and consistency of customs clearance procedures Module 2 b. Customs clearance b. Improvement of clearance and border facilities (physical and IT). c. Customs regimes c. Introduction of modern practices conducive of professionalism d. Import and export chains, main steps, and structure of delays (risk management, authorized operators) d. Coordination among border agencies and procedural consistency with customs International connectivity and transit systems Transit regime a. Transit systems a. Transit systems applicable on international road and rail corridors b. Port/shipping connectivity b. Reduction of controls at the border and en route c. Customs performance c. Domestic and regional regulation of entry of transit operators d. Facilitation of multimodal transportation Air and sea connectivity and liberalization of services a. Air transport services, passenger, and cargo b. Shipping services, impact of feeder services Trade supporting infrastructure Public infrastructure a. Roads a. Adequacy of maintenance funding and policies b. Ports b. Port development c. Railroad c. Improvement in service delivery (price and quality) and private d. Airports participation. e. Other backbone infrastructure d. Development of logistics hubs, such as logistics centers (in or not in free zones), inland clearance facilities, and dry ports/inland container depots e. Addressing congestion problems in rural areas f. IT infrastructure Source: World Bank 2010d. and products and trade relationships on which to focus. flowers vary dramatically from those facing an exporter of This is necessary because the structure of the supply chain, coal or of consumer electronics. It will be critical to address the nature of transport, and the regulations and procedures the import side of supply chains, as this is where many of involved will vary significantly across products—for exam- the biggest performance gaps are found. Selection of the ple, the trade logistics issues facing an exporter of fresh-cut supply chains to study should focus on those supply chains Factor Conditions: Trade Facilitation and Logistics 115 that represent particularly important export sectors or suggests that customs and infrastructure are major con- potential new opportunities. Decisions on selection should straints that should be assessed. balance the needs of comprehensiveness and strategic Institutions and regulations play a major underlying importance with potential implications of time, cost, and role in establishing the trade facilitation environment, and complexity. so they are likely to be at least part of the problem, wher- Following this, desk research can be undertaken—in ever constraints exist. For the purposes of the Diagnostic, most countries, significant existing research is likely to however, the framework does not focus on understanding have been conducted in recent years by the World Bank institutions and regulations in detail. Rather, the emphasis and other development partners. This can provide valuable is in trying to identify broadly the observable areas in background input before undertaking field interviews. the trade facilitation environment in which the binding In conducting the analysis, it is valuable to try to constraints exist. A second stage of work could then drill understand the degree to which the constraints are down into understanding the institutional and regulatory related to the transport environment or the border and factors behind this. For analysts who wish to address these trade facilitation environment. Experience shows that in issues in more depth, the TTFA Toolkit (World Bank many countries in which problems exist in the transport 2010d) provides a guide to assessing institutional and reg- environment, the border environment is also poor. ulatory issues. Indeed, in many cases some links will exist between the Finally, the analytical framework described here is two. In cases in which it is possible to isolate the main designed to analyze a country’s overall trade and transport sources of constraint, however, identifying the policy facilitation environment. In many countries, the analyst may levers to address it will be a much easier task. One way to wish to assess specific export sectors. Although the above begin to focus the direction of the analysis is through the framework may still be adopted for a sector-specific analysis, first stage of comparing performance through bench- the analyst may want to consider making use of value chain Module 2 marking key quantitative metrics (see next section). For analysis, to study the sector in greater depth, including example, if analyzing Rwanda, a quick look at its relative understanding the impact of the inbound trade logistics performance across the LPI measures (see figure 2.8) environment in shaping access to competitive inputs. Figure 2.8. Comparison of Rwanda LPI Performance 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0 s e ts e ng s om es ur c en en ci in ct pm st tra t el ru pe Cu m st hi & m Ti ra ls co g f In na in s k tio ic ac ist na Tr g r Lo te In Rwanda Peer avg (Tanzania, Kenya, Uganda) Hungary Source: World Bank 2010a. 116 Module 2: Competitiveness Diagnostics Tailoring the Diagnostics to Country and Sector Characteristics Summary of Specific Considerations by Country Type Country type Relative priorities Other issues for consideration Landlocked • May need to emphasize role of air transport • Likely to be necessary to extend analysis to cover (depending on export sectors) regulations, processes, and agencies in bordering • Greater emphasis on border-related issues (including (especially those where the main regional port is customs and other border processes) as well as transit based) regimes and cross-border trade regulation • Corridor analysis may be a useful approach • Cost and time comparisons should include benchmarks against other landlocked countries • Landlocked countries may have potential to develop logistics sector as important regional transit hubs Small (population) • Greater emphasis on speed and efficiency of logistics • Small and remote countries often also landlocked and remote environment • Explore the implications of scale in logistics costs and • Greater emphasis on role of air transport the potential for improving consolidation in supply • Exporters tend to be more dependent on imported chains inputs—so emphasis on efficiency of inbound supply • Lack of scale increases importance of ensuring local chains logistics market is open to foreign service providers Resource rich • Existing infrastructure and supply chains often designed for resource extraction; focus on understanding effectiveness of supply chains (for example, rail and ports systems as well as customs and trade facilitation) to support export diversification Low income, labor • No specific focus inherent to these countries—often abundant face challenges across the board Module 2 Middle income • Emphasis on processes, institutions, and supply chain issues Summary of Specific Considerations by Sector Sector Relative priorities Other issues for consideration Light manufacturing • High reliance on imported inputs in most light- • Many sectors will have special customs regimes manufacturing sectors requires a focus on inbound for imported inputs designed for export logistics processes manufacture • Clearance speed and processes often critical (outbound and inbound) • Air transport will also be a important channel for some subsectors Agriculture • Perishability of many agricultural products means that • Individual agricultural sectors often have quite cold chain networks (including infrastructure and customized logistics networks that will need to transport/logistics services) should be a priority be analyzed closely • For bulk commodities, rail and even river-based transport infrastructure and services tends to be more important than it is in other sectors • Border-related issues are critical, linked to both tariff and nontariff barriers (health and safety) Tourism • Traditional logistics issues are relevant for supply • Quantitative and qualitative analysis should side of the sector, but otherwise focus is on the focus on connectivity, which may require passenger transport network—especially road and assessment not only of focus country but also air transport of its main tourism source markets • Primary emphasis on connectivity and cost (internal • Assessment of public transport systems and of and to key source markets)—infrastructure and safety and security may also need to be services are critical, as are institutions and regulatory included in the analysis issues (for example, air transport liberalization) Business and IT services • As with tourism, the traditional logistics issues are • Note that the logistics services sector may itself less relevant for this sector—primary focus will be be a focus of assessment, in which case all on the passenger transport network and issues of aspects of the logistics environment in the connectivity country will be important in the assessment. Factor Conditions: Trade Facilitation and Logistics 117 Background Reading: Relationship Between Trade corruption, and lack of competitive logistics markets—that Facilitation and Logistics and Trade Competitiveness contribute to high cost and unpredictable trade logistics environments (see box 2.14) For exporters in many developing countries, comparative Trade facilitation and logistics affects export competi- advantage is eroded step by step across the miles between tiveness through several channels. Although structural production and markets. Distance alone will, in many sec- factors like distance may act as an absolute barrier to par- tors, determine the potential to compete in international ticipation in exports markets (in certain sectors), the main markets. But more controllable factors, such as transport and channels through which trade facilitation impacts export communications infrastructure, border-related processes, competitiveness are through transactions costs and risk and local logistics markets, will play a critical role in shaping (which is a function of time and reliability). These are exporters’ competitiveness through their impact on cost, summarized briefly in the remainder of this section. time, and supply chain reliability. Indeed, in recent decades, the role of trade facilitation and logistics as a source of trade competitiveness has increased Direct Costs of Exporting and Importing The direct cost substantially. This is for two main reasons. First, with of exporting includes, among other things the cost of trans- increased trade liberalization, the transactions costs imposed port, insurance, fees to logistics service providers (for exam- by trade facilitation environment have become, in most cases, ple, freight forwarders), and administrative fees for customs more significant than tariffs. Second, the emergence of highly and other border procedures. The largest component of integrated global production networks and the shortening of these costs is transport and, in this regard, two of the biggest product life cycles has raised the importance of timely and determinants are distance to market and the transport mode cost-effective logistics. Thus, the cost and quality of the logis- required. Indeed, landlocked countries—which tend to be tics environment often play an important role in determining located far from markets but, most important, are forced to Module 2 firm-level decisions about where to locate production, where ship much greater distances by ground transport rather to source supplies, and how to serve consumer markets. than sea transport—tend to face much greater direct costs Data from the LPI (World Bank 2010a) show a clear rela- of exporting. For exporters with products that are particu- tionship between logistics performance and exports (see larly time sensitive (for example, because they are physically figure 2.9). Empirical literature tracing the effect of trade perishable), reliance on air transport raises costs dramati- facilitation constraints on trade flows, while limited by the cally—the cost for air freight is typically four to five times difficulties of properly measuring these barriers, shows that of road transport and 12 to 16 times that of sea trans- unequivocal impacts of time and costs on developing port (World Bank 2009a). Cut flower exports, for example, country exports and particularly perishable agricultural often incur air transport costs of up to 50 percent of cost, products (Djankov, Freund, and Pham 2006) and on the insurance, freight (CIF) value. composition of trade (Li and Wilson 2009). Scale economies also affect transport costs. In small Developing countries tend to suffer from myriad economies, the costs of maintaining trade-related infra- issues—including poor infrastructure, inefficient systems, structure (both public and private sector) raise the costs Figure 2.9. Relationship Between Logistics Performance and Exports, 2008 4.5 4.0 LPI score 3.5 3.0 2.5 2.0 4 5 6 7 8 9 10 Log exports Sources: World Bank 2010a; COMTRADE (US$ exports, 2008). 118 Module 2: Competitiveness Diagnostics Box 2.14. The Gap Between Industrial and Developing Countries in Trade Logistics High logistics costs and low levels of service are a barrier to trade and FDI and thus to economic growth. Countries with higher overall logistics costs are more likely to miss the opportunities of globalization. Take landlocked Chad. Importing a 20-foot container from Shanghai to its capital N’djamena takes about 10 weeks at a cost of $6,500. Importing the same container to a landlocked country in western or central Europe would take about four weeks and cost less than $3,000. The shipping costs and delays from Shanghai to Douala, the gateway for Chad, and to West European ports are essentially the same. And the same international freight forwarding company would handle the container from Douala to N’djamena and within Europe. But what accounts for the large difference in time and cost? The answer lies in better processes, higher-quality services, and the operating environment. The forwarder in Europe would use a seamless, paperless system to manage the inland shipment from its eight-hectare campus in the gateway port of Le Havre. The transport inside Europe would take less than three days. And to add value for its client and generate more business, the forwarder would provide additional services, such as improving the client’s internal distribution practices. In Chad, the process would be different. Although only five days should be needed to move the container from Douala to N’djamena, the actual time likely would be as long as five weeks. In a difficult governance and security environment, the freight- forwarding company would be trying simply to avoid a breakdown in its client’s supply chain. It would maintain company staff along the trade corridor to physically track the goods and trade documents. And it would have to be ready to mediate with the trucking syndicate, the security forces, and myriad government agencies. Source: World Bank 2010a. for exporters. Moreover, exporters are often unable to checkpoint—combine to make round-trip times for a take advantage of less-than-truckload or shared con- 2,000 km journey as much as 40 days in the region (that is, tainer shipments, and the lack of two-way traffic means an average of only 50 km per day). This has significant Module 2 they must often bear the cost of shipping empty contain- implications on the capital utilization of the transport ers or trucks. fleet in the region and subsequently on the cost of trade. Beyond mode, distance, and scale, however, other Although the average monthly mileage for trucks in factors—which are in theory more controllable—shape the Southern African regional transport is 8,000–9,000 km, in transactions costs involved in exporting. One of the most countries like Mali and Niger, it is no more than 2,500 km important of these is the level of competition in local trans- (Egis BCEOM International 2008). port and logistics markets. In many markets, transport and The most important issue is the predictability and relia- logistics services operate as oligopolies or engage in collu- bility of the supply chain. The absence of predictability and sion (for example, tour de role) to maintain high prices reliability raises risks for firms, forcing them to hedge, for (and usually poor service). Regulations that often restrict example, by carrying greater inventory of supplies and end the provision of services from foreign transport providers products, to source from alternative suppliers, or to shift to contribute to uncompetitive local markets in many coun- air transport or other more expensive modes to meet deliv- tries. On top of competition, other factors include high ery schedules. According to the World Bank’s LPI, suppliers fees for customs and other documentation, high port and to the same automobile manufacturer will carry seven handling charges, the need to hire agents to facilitate clear- days of inventory in Italy, but 35 days in Morocco; and ance, and the need to pay bribes to facilitate the movement garment exporters in Bangladesh have to export, on aver- of goods. age, 10 percent of production by air to be certain to meet the schedules of European buyers. Induced Costs: Time, Risk, and Reliability Perhaps even Finally, most exporters (particularly those operating in more important than the direct costs are the induced these global value chains) also rely on importing critical costs that firms must bear related to timeliness, and par- raw materials and intermediate inputs from international ticularly, reliability of the trade and transport facilitation suppliers. As such, all the direct and indirect costs dis- environment. Time in itself raises costs, in terms of cussed in this section also raise production and inventory financing, insurance, and warehousing. Research by Hum- costs for exporters. The impact of poor reliability in the mels (2001) finds that each day saved in shipping time is trade and logistics environment imposes a significant worth 0.8 percent ad valorem for manufactured goods. In opportunity cost on exporters, restricting their ability to West Africa, for example, additional delays from other diversify into higher value added production and to inte- sources—including goods being held in customs at the grate into global value chains, both of which rely on pre- port, border crossing delays, and formal and informal road dictable, just-in-time production and delivery. Trade Promotion Infrastructure: Export and Investment Promotion 119 Trade Promotion Infrastructure: Export and Investment Promotion Link with Competitiveness Challenges Identified in Trade Outcomes Competitiveness challenge areas Main components in export and General export Product extension investment promotion environment Cost competitiveness and quality Market penetration Export promotion ✓ ✓ ✓ ✓ Investment promotion ✓ ✓ Note: Trade Finance is covered in the section “Access to Finance.� Quantitative Analysis: Indicators and Data Sources Indicators Sources Export-promotion Exports per US$ EPA budget World Bank EPA survey agencies (EPA) EPA budget (percent GDP or per capita) Share of EPA expenditure: market research/information; training/tech support; marketing/other Share of EPA expenditure by main sector Share of EPA expenditure: new versus established exporters Investment-promotion FDI flows and stock (share of GDP; per capita) UNCTAD agencies (IPA) FDI flows and stock per US$ IPA budget National sources; IMF IPA performance score: overall World Bank Global Investment Promotion IPA performance score: website Benchmarking (GIPB) IPA performance score: enquiry handling Module 2 Qualitative Analysis: Interview Targets and Issues for Discussion Government agencies and ministries Private sector and other institutions EPA • EPA (national and, if relevant regional) • Individual exporters (small/new and established) across traditional • Ministry of Trade and Industry or other ministry with and emerging sectors responsibility for export promotion • Training institutions • Export councils or associations • Consultants/service providers IPA • IPA (national and, if relevant, regional) • Existing investors—across traditional and emerging markets and • Ministry of Trade and Industry or other ministry with sectors responsibility for investment promotion • Potential new investors (or investors considering the country) • Agencies responsible for company registration, land • Chambers of commerce purchase, and registration • Industry associations • Embassies of major investors Key Issues for Discussion in Interviews with Government Agencies and Ministries EPA • Structure of the EPA: Single or multiple agencies? Links to government ministries? Structure of executive board and level of private-sector participation on the board? • Management structure: Is it operated by the private sector? • Structure of budget and sources of funding? • Is there a broad sector focus to export promotion support activities? • Is there a focus on nontraditional exports? • Is there a focus on new exporters versus established? Also small versus large firms? • What is the focus on breaking into new markets versus survival of existing exporters? • What efforts are made to track support on an ongoing basis? • What is the focus of information provision? • What is the focus on marketing and trade fairs? • What is the focus of training and capacity building—regulatory compliance, documentation, accessing trade finance, logistics and customs, packaging, pricing, and so on? • What is the focus on regional markets versus major global markets? For the latter, on the European Union versus the United States, Japan, China, and/or other markets? 120 Module 2: Competitiveness Diagnostics IPA • Structure of the IPA: Links to government ministries? Structure of executive board and level of private sector participation on the board? • Structure of budget and sources of funding? • What is the emphasis of efforts between image building, investment attraction, aftercare, and policy advocacy? • What are the main targets in terms of sectors and markets? • What explicit links are made between the IPA and the EPA? • What incentives are offered and how important are these in the overall offering to potential investors? Key Issues for Discussion in Interviews with the Private Sector and Other Institutions EPA • What are the main challenges in terms of entering and staying in export markets? • Are there specific markets (product or geographic) that are seen as high opportunity or a particular challenge? • How effective is the EPA and other government support agencies? What are the main strengths and weaknesses? • To what degree are the main challenges related to marketing? Building contacts/networks in export markets? Meeting technical/regulatory requirements? Other? IPA • What are the main requirements for investors in terms of infrastructure, regulatory framework, transport, incentives, and so on? • To what degree have they invested in Country X to access local markets or to establish a base for exporting? • How do they view Country X as a location for investment? Across sectors and relative to alternatives in the region? • What are the main advantages and disadvantages of the country as an export platform? Tailoring the Diagnostics to Country and Sector Characteristics Summary of Specific Considerations by Country Type Country type Relative priorities and issues for consideration Module 2 Small (population) and • Strategic prioritization across all aspects of trade promotion will be critical given limited resources remote/landlocked • Importance of targeted and efficient EPAs and IPAs Resource rich • Emphasis on use of trade-promotion tools to support diversification—EPA and IPA roles likely to be priorities • Does the program of trade promotion effectively leverage the existing natural resources sectors (by facilitating development of supply and services sectors/clusters)? Low income, labor abundant • Strategic prioritization across all aspects of trade promotion will be critical given limited resources • Importance of targeted and efficient EPAs and IPAs Middle income • Often the main issues will focus on adjustment processes and moving to higher value added activities—how does the incentive system, and the wider programs of trade promotion, support facilitate efficient adjustment (toward sources of comparative advantage) versus support traditional sectors? • Analysis of EPA and trade promotion may focus more on survival and effectiveness in reaching nontraditional markets Summary of Specific Considerations by Sector Sector Relative priorities and issues for consideration Light manufacturing • The need to move beyond traditional promotion activities to training, market information, and other enterprise support • For any sector-specific analysis, check on IPAs expertise in the sector and their links with sector bodies • Importance of link between EPA and IPA with regard to attracting investment in export-oriented activities/global production networks Agriculture • Many EPAs and IPAs have limited expertise in this area • Role of state trading firms or marketing monopolies in export promotion Tourism • Focus analysis beyond EPA/IPA to tourist board or related agency, which may control all investment and export promotion in the sector Business and IT services • Assess capacity of EPA for addressing services sector needs Background Reading: Relationship Between Export and investment is channeled to the firms and sectors that are Investment Promotion and Trade Competitiveness most able to exploit sources of comparative advantage, but also addressing market and information failures, providing Establishing and maintaining competitiveness in export public goods, and improving coordination and the diffu- markets requires not only getting the microeconomic sion of knowledge and best practices. Governments play an environment right to support exporters and ensuring Trade Promotion Infrastructure: Export and Investment Promotion 121 important role—through EPAs and IPAs—in the provision Olarreaga, and Payton 2009) finds that they have a posi- of a broad range of instruments designed to support tive and statistically significant impact on national exporters and to attract investment in export-oriented exports, with important heterogeneity. First, returns to activities. Table 2.4 provides a summary for each, including EPAs increase in line with GDP per capita—that is, their purpose, the reasons for government intervention, and richer countries have more effective EPAs (or EPAs can how these interventions might support competitiveness of be more effective in richer countries). Second, they find firms or the export sector more widely. Trade and invest- decreasing returns to EPA spending, with negative mar- ment support focuses largely on the extensive margin— ginal returns after US$1 per capita. Finally, the return on on new products and new markets—although many investment in EPAs was highest in Eastern Europe and measures listed in in the table will affect the intensive Asia, with agencies in the Middle East and North Africa margin, particularly in terms of addressing export survival lagging furthest behind. and facilitating quality upgrading within existing products. The impact of trade-promotion support on competi- Although these interventions can all be defended as tiveness comes by supporting “discovery� as well as by addressing some form of market, information, or coordi- improving exporters’ technical capabilities to participate nation failure, it is by no means certain that they represent in export markets. Essentially, trade promotion reduces efficient or effective mechanisms to promote trade com- start-up costs and lowers risk, and it potentially facilitates petitiveness. It can be argued that, in many cases, some of higher-quality and lower-cost exports. In terms of discov- these interventions are in fact distortions to competitive- ery, trade-promotion support can help exporters find and ness that not only may harm trading partners by artificially access product-market combinations that they otherwise changing the terms of trade but also undermine competi- might not be able to exploit. This means there may be a tiveness in the long term. Conversely, some interventions potential for economy-wide efficiency impacts from by EPAs and IPAs are designed to address problems of export promotion, in terms of helping deepen specializa- Module 2 information and coordination failure that can be particu- tion in areas of comparative advantage. Export-promotion larly acute in export markets. support also lowers market entry costs, providing a direct cost advantage to exporters. An indirect cost advantage Export Promotion (Agencies) may subsequently follow, if this facilitates greater scale of Trade-promotion support is designed to help existing exports—for example, by lowering the cost of transport and potential exporters to understand the requirements and compliance. Finally, through the provision of techni- of export markets (tastes, standards, regulatory require- cal support, capacity building, and informational sup- ments) and to identify and exploit markets for their port, EPAs can help ensure compliance to standards, thus products. In most cases, this support is delivered through lowering risk and potentially increasing quality of an EPA. The case for government intervention to support exports. exporters is usually made on the basis of the (mostly nonrival) entry barriers to exporting (for example, high Investment Promotion (Agencies) fixed costs of making contacts, establishing distribution Attracting FDI is an important component of export networks, learning about compliance, obtaining licenses), development strategies in most countries. FDI not only which in particular would deter “pioneer� exporters (Haus- contributes to economic growth through the provision of mann and Rodrik 2002). capital and employment, but most important, in the There has been limited empirical analysis of the medium and long term, through its dynamic effects. It effectiveness of EPAs, but recent evidence (Lederman, is a source of significant positive externalities through Table 2.4. Summary of Key Trade and Investment Support Measures Potential impact on Purpose Reason for government provision competitiveness EPAs • Enable existing and new exporters to access • Information failures (mostly nonrival) • Reduces entry costs information, establish contacts, and initiate • Entry costs as barriers to exporting • Reduces risk/improves survival trade in export markets IPAs • Attract investment (mainly FDI) • Information failures • Diversifies export base • Spillover benefits • Improves aggregate productivity • Technology/knowledge spillovers 122 Module 2: Competitiveness Diagnostics knowledge spillovers, the introduction of new technolo- Export Promotion (Agencies) gies, and demonstration effects (Carkovic and Levine Assessment of an EPA and its contribution to export 2005). It is these externalities, along with the market failure competitiveness should cover the main activities that inherent in the provision of information on the potential are traditionally carried out by an EPA, including the returns in alternative investment destinations, that is the following: basis for government provision of investment promotion through the establishment of IPAs. • Country image building: advertising, promotion, and The literature on FDI defines two broad types of advocacy (lobbying) investment (Helpman 1984; Markusen 1984): (1) invest- • Targeted marketing: trade fairs and missions, and services ment seeking to access a local market (often referred to as provided to cultivate contacts in foreign markets “horizontal� or “market-seeking� FDI); and (2) invest- • Export support services: training, technical assistance, ment designed to take advantage of the cost or quality of capacity building, including regulatory compliance, certain factors of production (often referred to as “verti- information on trade finance, logistics, customs, pack- cal� or “efficiency-seeking� FDI) to establish a platform aging, and pricing for regional or global exports. For horizontal FDI, the • Market research and sector analysis: general, sector, and attractiveness of a local market in some cases might be firm-level information, such as market surveys, online strong enough to obviate the need for significant promo- information on export markets, publications encourag- tion efforts. Countries like China, Brazil, and Russia are ing firms to export, and importer and exporter contact examples of this. For most vertical FDI,17 however, databases investors are somewhat footloose between alternative locations. For small countries, especially, the role of pro- Although some recent empirical research suggests motion may be critical to getting the attention of poten- that EPAs do have a positive impact on export flows, Module 2 tial FDI. Singapore and Ireland are two well-known there are many examples of organizations that have examples of small countries that have been effective in failed to meet their objectives and have done little to their efforts to attract export-oriented FDI. Empirical support the competitiveness of exporters. Drawing on a evidence (Harding and Javorcik 2007) confirms the posi- note by de Wulf (2001), following are some broad princi- tive role of investment-promotion efforts in increasing ples that determine the effectiveness of EPAs: FDI flows to developing countries. Investment promotion supports trade competitiveness • Incentives that promote exports/avoid anti-export bias: primarily by attracting competitive investors. If these are EPAs can be effective only if the macro-incentive struc- exporters, they may contribute to diversifying a host ture does not create an inbuilt bias against exporting. country’s export profile. They are likely to increase the • Autonomous structure: EPAs need to be a policy advocate aggregate competitiveness of the country’s exporters, as and also be able to garner and mobilize resources foreign investors—like exporters in general—are on aver- quickly from both the public and private sector. As such, age more productive than domestic producers (Melitz they tend to operate more effectively when they are 2003). Finally, FDI may contribute the competitiveness established as an autonomous agency with strong of exporters, whether or not the foreign investors are private-sector participation on the board as well as top- exporters, through the provision of competitive inputs level political support. and through the spillovers of the knowledge and technol- • Demand-driven services: This requires strong private ogy they bring into the host market. sector involvement. • Sufficient focus on supply-side/competitiveness: Too many Main Components of Trade and Investment EPAs focus their resources almost solely on promoting Promotion Support Analysis exporters in new markets (for example, trade fairs). In analyzing a country’s program of trade and investment However, ensuring the export sector is competitiveness promotion support, it is necessary to assess the specific should be a first and fundamental priority. components and activities involved in each instrument of • Sustainable budget: EPAs must have sources of consis- support. This assessment allows for an understanding of tent and sustainable funding. This is likely to include the scope of the support and the areas in which support some degree of charging for services, but in many cases may be missing or performance lacking. there are limits to this. Trade Promotion Infrastructure: Export and Investment Promotion 123 Investment Promotion (Agencies) 4) Policy advocacy, in particular working with government Following the conceptual framework outlined by Wells and to improve the investment climate for FDI Wint (2001), IPAs have four basic functions: The relative emphasis across these roles will depend 1) National image-building somewhat on countries, resources, and government pri- 2) Specific investment generation, including proactive tar- orities. In most cases, there is a bias toward investment geting of investors and selling generation. The effectiveness of IPAs is dependent on 3) Servicing investment, including converting invest- many of the same issues as for EPAs, most important the ment commitments to on-the-ground realization and broader investment climate, access to a sustainable and retaining investment through effective aftercare (facil- sufficient budget, and institutional design that ensures itating licensing, access to infrastructure/facilities, high-level political commitment and strong private- and so on) sector representation. Module 2 124 Module 2: Competitiveness Diagnostics Trade Promotion Infrastructure: Standards and Certification Link with Competitiveness Challenges Identified in Trade Outcomes Competitiveness challenge areas Main components in standards General export Product extension and certification environment Cost competitiveness and quality Market penetration Standards ✓ ✓ ✓ ✓ Quantitative Analysis: Indicators and Data Sources result, the Diagnostic on standards will focus primarily on qualitative assessment, including both desk- and field- Quantitative measures of standards performance are lim- work. Following is a summary of a few quantitative metrics ited; and what measures are relevant are seldom tracked that can be included in the analysis. in most low- and many middle-income countries. As a Indicators Sources Nonagricultural ISO certification rates ISO 2008 Survey of Certificates, WDI Budget of national quality body and share of budget focused on exporters Country specific Agricultural Measure of border rejections as a share of exports Product Risk Indexa Share of exporters with HACCP, ISO 22000 or Eurepgap certification Country specific a. Cadot, Jaud, and Suwa-Eisenmann 2009. Module 2 Qualitative Analysis: Interview Targets and Issues for Discussion Interview Targets Government • Bureau of Standards: It understands the public quality infrastructure and works with private industry to address quality issues. Capacity varies greatly. • Line ministries (for example, Ministry of Health, Ministry of Industry, Ministry of Agriculture): They have legal responsibility and understand the public system. • Border authorities: Customs, Bureau of Standards, and line ministries are represented at the border. Interviews with border post personnel provide insight into the export process. Private sector • Exporters: Exporters are the prime source of information. Larger exporters are often readily accessible, but representative information requires interviews with smaller exporters as well. • Exporter/business associations: Many associations exist, often organized by industry. Be aware that the associations often speak mainly for selected larger members. In some countries, government influence over associations may be considerable. Associations may have been set up by donors for specific purposes. Information must be supplemented by exporter interviews. • Private quality service providers: Societe Generale de Surveillance (SGS) and Bureau Veritas are examples of private service providers. They have a local office in many countries. They have good knowledge of the supply and demand situation for the commercial services they supply, such as testing and certification. • Shipping companies/transporters: They are always involved in the export process and will help the analyst to understand the process. They are aware of delays and red tape and of project rejections resulting from quality problems. • International buyers: Interviews with exporters should be supplemented with interviews with their buyers. Occasionally, buyers will be represented locally, but phone interviews can be used as buyers may be spread out across the globe. Other stakeholders • Local academics and consultants: In countries with ongoing capacity-building projects, local specialists are knowledgeable about both technical and economic aspects as well as the local political economy. • Bilateral donors: Donors support capacity building in quality infrastructure and may have local experts working in capacity building projects. • International organizations: UN technical agencies such as the Food and Agricultural Organization and UNIDO often have projects on quality infrastructure and may have experts based locally. The experts tend to be technical specialists rather than economists. • Civil society: Local nongovernmental organizations (NGOs) or international NGOs with local presence are often involved in quality issues. The US NGO TechnoServe, for instance, is often involved in trade and commercialization projects. Key Issues for Discussion Sources of information Exporters and exporter/ Private service Shipping companies Stage industry associations providers and transporters International buyers Bureau of standards Line ministries Border authorities 1 Create inventory of Understand Understand export Create Understand Bureau Understand foreign Understand export requirements by requirements of the requirements: Can inventory of role: In which demands for public requirements: Can export customers: For which you make a list of requirements by industries is the certification: Is public you make a list of product:Which requirements do you quality related export product: Bureau active? What activity a prerequisite documents needed for quality demands do provide compliance documents that the Which standards and is the role of the in the export process export? Which of you meet? From services? For which exporter need? technical requirements Bureau in these (for example, these relate to where do you learn markets are these do you follow? What industries? Are the phytosanitary quality? about standards and services relevant? are the consequences standards of the licenses)? For which technical regulations? Which industries do of noncompliance? Do Bureau relevant for markets and How do quality you serve? Are there you work with your exporting? Is the products? Is this due demands vary across industries that you suppliers to ensure Bureau aware of to domestic or foreign your target markets? normally serve in compliance? export requirements? demands? How important is it to other countries but know the exact not in this one? quality? 2 Understand the Understand the Understand the export Understand the Understand Bureau role Understand Understand the export compliance process portfolio of process: Can you compliance process in compliance government role in process: Can you and the use of compliance services draw a flow chart and the use of process: Could you compliance process: draw a flow chart of quality services: How offered: Which showing the range of quality services: draw a flow chart of Could you draw a the export process? do you demonstrate services do you offer? activities needed for What is required to the compliance flow chart of the Which steps are compliance? Could Do you work on export? Where do demonstrate process and indicate compliance process relevant for quality you provide a flow behalf of domestic quality issues fit in? compliance? Do you where the Bureau and indicate where issues? Can you chart of activities companies or their Can you provide a list specify use of specific plays a role? Which government plays a provide a list of necessary to ensure international buyers? of documents needed? service providers services does the role? documents needed? compliance? Which Why have you chosen What are the Could you provide a Bureau offer What are the services do you use? the portfolio you consequences of flow chart of activities exporters? consequences of How do you access have? Will you expand missing documents? necessary to ensure missing documents? services? What is the services in the future? compliance? source of services? Have you shifted suppliers of services in the past? 125 Module 2 Module 2 126 Key Issues for Discussion Sources of information Exporters and exporter/ Private service Shipping companies Stage industry associations providers and transporters International buyers Bureau of standards Line ministries Border authorities 3 Understand use of Understand the Understand interaction Understand use of Understand Bureau Understand Understand red tape public services: Do competition they with government public services: Do operations: Compare government at the border: What you use national face: Do you compete agencies: Could you your suppliers use Bureau operations to operations: Compare is the fee structure? standards and public with government or specify the role of public services? Do international best government How much time does compliance services? donor subsidized government agencies you regard practice! What is the operations to it take to complete the Costs of public services? What are the in the export process? government activity fee structure? How is international best export process? How services? Do you face regulations that you Do you regard as helpful? the Bureau funded? practice! What is the much of that is unnecessary high follow to operate? government agencies Use of mandatory fee structure? How is related to quality costs and red tape Does the government as helpful or standards? government activity issues? due to public activity fulfill or exceed its constraining? funded? Role of in quality? Is the role? mandatory government helpful? standards? 4 Views on supply Understand their Not relevant Views on supply Understand public Understand public Understand border situation: Do you find supply: Why have you situation: What is the quality infrastructure: quality organization: Which an adequate supply of chosen the service supply situation Could you explain the infrastructure: Could agencies are services? How do portfolio you offer? Do compared with other organization of the you explain the represented at the domestic, imported, you produce all countries? Would you national organization of the border? How much of public and private services in country or prefer upgrades to the infrastructure? How national the paperwork needs services compare? do you use affiliates existing situation? Do does the Bureau infrastructure? How to be completed at What are your abroad? What is the you specify use of interact with public does your agency the border and how preferred suppliers of state of the local services from specific and private facilities? interact with public much must be done services? Do you miss compliance service sources? and private facilities? elsewhere? export opportunities? industry? Usefulness of public services? 5 Understand alternatives Not relevant Not relevant Understand alternatives Not relevant Not relevant Not relevant to compliance: What to compliance: What are the costs of happens in cases of noncompliance? What noncompliance? Are are the costs of you able to shift non- services? Can you shift compliant products to to alternative other markets? At markets? What will what costs? you gain by improved services? 6 Consultations Not relevant Not relevant Consultations Consultations Consultations Not relevant Trade Promotion Infrastructure: Standards and Certification 127 Analytical Approach argue that high costs hurt their competitiveness. Whether this is true in a social sense depends on the cost structure Product standards have the potential to impact exporters (see figure 2.10). Imagine that certification costs are high in both existing products and markets (as standards and because of a government monopoly. Private companies certification requirements change/become more strin- may be legally bound to use the laboratory of the local gent) as well as in new markets or product ranges, which bureau of standards. The bureau operates inefficiently and may require meeting new sets of standards. They affect the costs of testing and certification are excessive. A reform firms in diverse ways as well, raising transactions costs, of the legal framework for testing and certification will and either restricting or facilitating investment in innova- remove the deadweight loss to the economy represented by tion (depending on risk perception and thus the willingness excessively high testing costs. In this case, high certification of firms to invest in meeting new standards). costs are a constraint to competitiveness. Imagine a second Many international organizations, bilateral donors, scenario. The country in question is a small low-income and agencies working in the quality field have produced country located far from the target market. The industry material on how to assess a country’s quality system (see that complains about high certification costs is much box 2.15). Quality is a multidimensional issue, so contri- smaller than similar industries elsewhere. In this case, high butions often specialize in particular aspects. Gap analysis certification costs are the result of low economies of scale. is the most common technique used to assess standards The size of the local industry precludes investments in test- systems. In gap analysis, a desirable configuration of a ing facilities, and the local industry will have to use high- quality system is defined and the analysis then assesses cost imported services. The industry calls for subsidized the current state of a country’s system against this ideal. domestic testing facilities to remove the claimed constraint Gap analysis suffers from the drawback that the ideal sys- to competitiveness. But subsidizing testing facilities, in tem is not defined according to observed demand. Most this case, are only likely to improve competitiveness and Module 2 commonly, the ideal system is a description of an indus- national income in the long run. In the case of an industry trial country system that is beyond the means of most that is in the early stages of exploiting comparative advan- developing countries, and therefore maybe inappropriate tage this often will not be the case. to the needs of the particular country. It is often difficult to diagnose competitiveness prob- The main task of the analyst is to identify the con- lems without a social cost-benefit perspective in mind. straints to the exploitation of the full potential of the qual- The analysts, however, rarely will have the time and ity system. In doing so, it is critical to distinguish between resources to generate the data for a formal analysis of this private and social constraints. For example, companies kind. The methodological problems of quantifying the may complain about the high costs of certification and Box 2.15. Examples of Existing Handbooks, Manuals, and Diagnostic Tools for Standards Assessment Guasch, J. L., J.-L. Racine, I. Sánchez, and M. Diop. (2007). Quality Systems and Standards for a Competitive Edge. Washington DC: World Bank. ISO/UNIDO. (2010). Building Trust—The Conformity Assessment Toolbox. Geneva/Vienna: International Organization for Standardization/United Nations Industrial Development Organization. ISO/UNIDO. (2008). Fast Forward—National Standards Bodies in Developing Countries. Geneva/Vienna: International Organization for Standardization/United Nations Industrial Development Organization. ITC. (2005a). Innovations in Export Strategy—A Strategic Approach to the Quality Assurance Challenge. Geneva: International Trade Centre. ITC. (2005b). Building Corresponding Technical Infrastructure to Support Sustainable Development and Trade. Geneva: International Trade Centre. IPPC. (2010). Building National Phytosanitary Capacity (Strategic Framework). Draft of February 2010. Rome: International Plant Protection Convention. OIE. (2006). Performance, Vision and Strategy: A Tool For Governance of Veterinary Services. Paris: World Organisation for Animal Health. Sanetra, C., and R. Marbán. (2007). The Answer to the Global Quality Challenge: A National Quality Infrastructure. Berlin: Physikalisch Technische Bundesanstalt. UNIDO. (2006). Product Quality—A Guide for Small and Medium-Sized Enterprises. Vienna: United Nations Industrial Development Organization. Source: Authors. 128 Module 2: Competitiveness Diagnostics Figure 2.10. Distinguishing between Factors Influencing Competitiveness Factors influencing productivity Constraints to private competitiveness Costs of certification Cost of certification Constraints Climate due to low due to government to social economies monopoly competitiveness of scale Source: Authors. Module 2 costs and benefits of quality are also substantial even with technical experts. The desk analysis will rely on existing access to ample resources. Yet, it is important to keep the published material possibly supplemented by phone inter- cost-benefit perspective as a guiding principle even for a views with key stakeholders to verify key assumptions made rapid assessment. on the basis of the available material before the fieldwork is The individual stages of the analysis are presented begun. The fieldwork will mainly consist of interviews with table 2.5 and are discussed in detail below. The sources of stakeholders. Often stakeholders will be able to identify information and the individual stages are linked to the written material such as project and company reports that interview discussion guide shown at the start of this sec- the analyst has overlooked during the deskwork phase. tion, which identifies some of the key issues to cover and The following outline of the individual stages discusses provides examples of typical questions that the analyst the focus of each stage and explains how the standards link will seek to answer. Naturally, as quality issues are highly with competitiveness: complex and often country specific, the sources indicated should be understood as typical sources and the ques- Stage 1. What Is the Foreign Demand for Quality? tions as prototype questions; it is up to the analyst to The first task is to identify current and potential future adapt the list of sources and questions to the specific areas export markets. Only by understanding the quality of investigation. requirements in these markets may the analyst be able to The stages presented here necessitate deskwork as well grasp the demand for quality infrastructure. This stage as rapid fieldwork, the latter including two to three weeks requires a desk analysis of export trade data as well as a lit- of on-the-ground fieldwork. The rapid assessment tech- erature study on export performance and strategies in the nique is designed to identify specific areas of focus, which country in question. Many developing countries have for- would then most likely be analyzed in greater depth as part mal trade strategies and donors have assisted in the elabo- of a program of reform. ration of detailed studies of the potential of specific value The area of quality is broad and technically complex. chains. The Diagnostic Trade Integration Studies elabo- Teams assembled to assess a country’s quality system will rated under the Integrated Framework, for instance, have have to reflect the technical complexities. Representative been produced for many low-income countries after a industries often can be selected during deskwork rather careful process of stakeholder consultation. The identifica- than attempting to cover the entire export sector. This tion of export products and target markets will allow the sector-level approach will allow for the selection of the right analyst to use industry literature to identify quality issues. Trade Promotion Infrastructure: Standards and Certification 129 Table 2.5. Assessing the Quality System Stage 1 What is the foreign demand for quality? During deskwork, stage 1 analyzes the composition of current exports and the likely quality demands for future exports to get a first impression of the challenges. Does the country export high-value foods or basic commodities? Is the country linked up with global supply chains for manufacturers requiring inputs with exact quality attributes? During fieldwork interviews with private companies and public authorities, the nature of foreign demand should be explored in greater detail. Stage 2 What is the derived demand for quality services? Does the demand for quality lead to a derived demand for quality services? During deskwork, the analyst may become familiar with common ways of ensuring compliance for present and future exports. During fieldwork interviews, the analyst may identify which quality services are in demand and how they are supplied by the quality system. Which quality services (including standards and technical regulations) are demanded by business or national regulatory authorities? Stage 3 Which constraints emerge from the quality system itself? The quality system provides both opportunities and constraints. Standards and technical regulations often are used as barriers to trade and as vehicles for rent-seeking by public and private actors. Badly designed quality policies may produce constraints rather than facilitate trade. The analyst must use fieldwork interviews to listen to the perceptions of the private sector toward government policy and to assess how well the public parts of the quality system operate as compared with international best practice in standard setting and organization. Stage 4 What is the current capacity for quality service delivery? During deskwork, the analyst may become familiar with the basic outline of the quality system. Fieldwork interviews may be used to understand the current system and its limitation in detail. The analysis must include all potential sources, including public, domestic private, and imported services. Stage 5 What are the costs and benefits of improved quality services? A formal cost-benefit analysis will not be possible because of resource constraints and methodological problems, yet a cost-benefit perspective must be used to discuss which issues are truly social competitiveness constraints. Stage 6 Make a prioritized list of competitiveness constraints. Module 2 The analyst should create a prioritized list of competitiveness constraints. Priorities may be set with the help of stakeholder consultations. Source: Authors. The desk analysis must be supplemented by the field- Stage 1 has laid out the export opportunities and the work. Private-sector interviews and interviews with other potential constraints with respect to quality. Stage 2 will knowledgeable stakeholders will reveal the quality require- link these opportunities and constraints with demand ments with which exports must comply. The analyst must for specific services. The experienced analyst will get a be aware that compliance is often a relative term. Some good impression of the range of relevant issues during buyers may require strict compliance, that is, noncompli- the deskwork. Exports to specific markets are often ance will have grave consequences like lost markets, linked with the use of the same quality services. Consid- whereas others may work with their suppliers to improve erable variation exists across quality services, however, quality if problems arise. Given the often-complex even for seemingly identical products. Thus, the fieldwork requirements that exporters meet, especially in high-end is the primary source of information. Industry interviews segments, many exports will only comply with parts of with both buyers and sellers will provide specific informa- the requirements. Industry interviews will reveal the tion. As an illustration of the degree of precision needed, nature of the compliance process. Both private- and consider the export of fresh produce to the European public-sector actors should be consulted during the Union. The exact nature of the end market targeted is fieldwork, but the analyst should recognize that the important. Fresh produce produced for bulk markets in degree to which public representatives are aware of pri- southern Europe is radically different quality-wise from vate export markets varies considerably. produce destined for UK supermarkets. Table 2.6 gives an example of specific quality services and how they fulfill Stage 2. What Is the Derived Demand for demands. The analyst must know which quality services Quality Services? are in demand to understand the constraints to competi- The demand for quality services is specific. The services that tiveness. will prove compliance with the requirements in an emerg- The analyst involved in stage 2 will face the difficult ing electronics industry are totally different from what is problem that the product- and market-specific knowledge needed to comply with seafood quality specifications. necessary to understand quality constraints very often 130 Module 2: Competitiveness Diagnostics Table 2.6. Examples of Specific Quality Services Compliance Area Needs of the exporter Necessary services Product standards/technical regulations, Access to standards/technical regulations Reference center in standards body including packaging and labeling Product testing Conformity assessment recognized by the Testing laboratory upgrading toward (international) client internationally recognized accreditation Accuracy of measurement Internationally recognized equipment Metrology laboratory upgrading toward calibration, measurement traceability to internationally recognized accreditation, SI (measurement) standard intercalibration schemes Consistent product characteristics Enterprise Quality Management System Certification capacity and internationally and quality Certification (ISO 9000) recognized certifiers Management of environmental Enterprise Environmental Management Certification capacity and internationally impact System Certification (ISO 14000) recognized certifiers Food safety Management system to control food Certification capacity and internationally contamination (HACCP) recognized certifiers; laboratory/testing capability Social accountability Insurance of consumer concerns relating to Certification capacity and internationally child labor, worker exploitation, and so recognized certifiers on (for example, SA 8000, the Base Code) Examinations of shipment content to Product inspection Development of cross-border inspection order services Traceability of products and inputs from Traceability system Development of consultancy capacity and farm to fork internationally recognized certifiers Module 2 Source: Henson et al. forthcoming. requires specific technical expertise. The deskwork accom- Stage 3. Which Constraints Emerge from plished during stage 1 must identify the types of expertise the Quality System? needed early on. It may be necessary to include technical Standards are a double-edged sword. Benefits like coordi- experts in the fieldwork. It also may be necessary to con- nation and market access are enjoyed by those who comply, centrate on only a few representative export products but those who do not comply are excluded or at the least rather than attempting to cover all exports to get the depth burdened by additional costs. The quality system provides of analysis required. opportunities for improving social efficiency but also The sources for stage 2 work is value chain and market induces rent-seeking by both private and public actors. specific literature as well as interviews with key stakeholders, Parts of the quality system are likely to hinder rather than notably private-sector exporters in the country in question promote trade facilitation. The analyst should seek to and their buyers in the importing countries. The analyst may identify these parts of the system as competitiveness find phone discussions with buyers enlightening as part of constraints. the preparation for this fieldwork. A large body of business An example is the practices of the Tanzania Bureau of literature on supply chains is available for consultation. The Standards (TBS). TBS is a provider of various testing most important source of information remains the private services and extensive laboratory capacity has been estab- operators in developing countries. lished with the help of foreign donors. TBS has the power Some quality demands may be highly codified like the to make otherwise voluntary standards mandatory by private quality assurance schemes of retailers and branded recommending that the Minister of Industry make them product producers, such as Marks & Spencer, Nestle, Nike, a requirement. The opportunity to force exporters to and so on. Often the quality requirements are set out in comply with Tanzanian standards for which they see little great detail in readily available codes of practice and qual- use is of great concern to the business community. Inter- ity management manuals. The analyst should be aware that national best practice in standard setting and conformity although such material is detailed, an insightful view on service provision recommends that the roles of the stan- how it is interpreted is necessary to identify potential qual- dard setter, regulatory authority, and service provider be ity constraints. kept separate. The analyst should assess the degree to Trade Promotion Infrastructure: Standards and Certification 131 which such international best practices are applied in the The assessment of the supply of quality services is made target country and whether the existing practices open difficult by the absence of good indicators that may be up the possibility for rent-seeking. Practitioners in the accessed during deskwork. There are no reliable quantita- quality field are increasingly concerned that the recent tive indicators for quality issues. This is an areas in which surge in donor investment in quality infrastructure under the trade analysis of quality differs from traditional trade the pretext of trade facilitation may hinder rather than analysis for which trade regulations such as tariffs are avail- facilitate trade. The establishment of laboratories, for able from international databases. The analyst will have to instance, creates a potential for the generation of fees that be creative during deskwork and try use the existing but would sustain the income of agencies. Such investments scarce material before beginning fieldwork. Some informa- therefore create a risk that revenue generation takes tion may be available depending on the export industries precedence over service provision. Comparisons with and countries under scrutiny. international best practice and industry interviews about For example, ISO publishes a yearly report on the num- the usefulness of government and donor activity will help ber of certificates issued by members of the International identify such concerns. Accreditation Forum (IAF). The standards covered are The analyst may look at whether some quality-related mainly ISO 9001, 14001, and 22000, which gives the tasks are duplicated by various agencies. The export requirements for, respectively, quality management, envi- process may require documentation of quality issues that ronmental management, and food safety management are either unnecessary or demanded by multiple agencies. systems. The ISO survey for 2010 is the 18th survey. The The standard-setting process and the degree to which standards counts may be used as an early indicator of the private-sector representation takes place are important. state of the quality infrastructure in manufacturing, but The fee structure for quality services may explain agency the data are not flawless. The survey covers the number of behavior, as such agencies often are financially strained. certificates not the number of sites certified. Many compa- Module 2 Regulations may be assessed for their transparency. The nies have multiple sites under one certificate. The survey export process at the border requires special attention, as only covers certificates issued by IAF members; however, the understanding of the documentation required will certificates are also issued by other certification bodies and inform the efficiency of the process. an organization may choose to implement the standards for their own internal and external benefit without seeking Stage 4. What Is the Current Capacity certification. for Quality Service Delivery? Information available about other standards may be Stage 4 is the point at which many studies begin. The accessed during deskwork to learn about the state of por- capacity can often be analyzed using tools produced by tions of the quality infrastructure. High numbers of specialized agencies as presented in box 2.15. Most tools, advanced food management certificates, such as Global however, focus on the national public quality infrastructure Partnership for Good Agricultural Practice (GLOBAL- and ignore domestic private and imported services. The GAP) and Safe Quality Food (SQF), would indicate a rela- analyst should describe how quality services are produced tively advanced agribusiness sector with export interests in by both public and private actors. The mode of delivery is high-end markets. important, too. These services can be delivered within value Regulatory authorities may produce useful evidence. chains, purchased from third parties, produced internally in The analyst interested in the state of animal products some cases, and produced domestically or imported. Very exports to the European Union, for example, should con- often an exporter will use a combination of these channels sult publically available reports from the EU’s Food and of delivery. Veterinary Office (FVO). The FVO regularly monitors and The use of imported services is often an area of con- publishes reports on developing country regulatory sys- flict with authorities that prefer to see a national system. tems as any country exporting animal products to the Imports are often less costly in nearby countries that have European Union must have food management systems that a more developed quality infrastructure. Tanzania, for are equivalent to EU systems. Many regions and countries, instance, may access the Kenyan infrastructure, and like the European Union and the United States, also regis- Mozambique may access the South African infrastruc- ter quality problems at the point of import. Such data are ture. In today’s highly global economy, quality services often confidential and may be difficult to access, except for are generally a traded service, and even OECD countries in the United States. Media stories on product recalls are frequently use service imports rather than opting for another source of information about potential quality domestic production. problems. Most information tends to be anecdotal, and the 132 Module 2: Competitiveness Diagnostics nature and extent of any problems must be confirmed dur- Stage 6. Make a Prioritized List ing fieldwork. of Competitiveness Constraints. The work of the analyst will be most useful if it includes a Stage 5. What Are the Costs and Benefits good discussion of priorities rather than enumerating a of Improved Quality Services? “laundry list� of constraints. The analyst should aim for The time and resources for desk- and fieldwork are unlikely a rough categorization of urgent, important, and minor to allow for any rigorous cost-benefit analysis. The analyst constraints. Because quantitative methodologies can be should take care that all costs and benefits have been prop- applied given the constraints in time and other resources, erly identified and discussed, even though exact quantifica- setting priorities will be a normative exercise. tion may not be feasible. Keeping a cost-benefit perspective Stakeholder consultations ensure that the industry and is more important that quantification. Without a cost- government share the conclusions of the analyst to the benefit perspective, many competitiveness analyses degrade extent possible. This consultation also provides an oppor- into mercantilist statements. The analyst should distinguish tunity for error correction as a list of priorities often stim- clearly between private and social costs and benefits. ulates discussion and provokes reactions. Stakeholders are During deskwork, the analyst will identify export unlikely to react to abstract and unbinding discussions. industries. The analyst may use comparable case studies When the analyst presents a draft of priorities, extra from similar industries in other countries to identify the resources are often mobilized by stakeholders who fear that range of costs and benefits to be addressed during field- their concerns are being ignored. The analyst may organize work. Technical specialists with insight into specific a stakeholder meeting by the end of the fieldwork period; industries and quality issues often can assist in the iden- however, sensitive issue might be better discussed during tification of costs and benefits at the company level. one-on-one meetings. Box 2.16 summarizes some of the Social analysis at a higher level often is conducted by an main analytical challenges in assessing the relationship Module 2 economist. between quality infrastructure and competitiveness. Box 2.16. Analytical Challenges and Issues for Consideration The area of quality and competitiveness is prone to misunderstandings about how quality infrastructure may improve competitiveness. It is therefore useful to discuss some common misperceptions, including the following: • Contributing to competitiveness through standards is not about lowering the private costs of business by subsidized public quality services. It follows that competitiveness is not associated with picking specific value chains as “winners� and subsidizing their access to quality services. • Competitiveness is not necessarily (but it may be) about raising product quality. Increased quality is one approach to supporting export industries that may or may not be successful given the social cost-benefit ratio of the necessary interventions. Sometimes it pays to invest in quality, but sometimes it does not pay. There is a risk of overinvesting in quality services if the market is unwilling to pay for extra quality. The use of quality infrastructure is mostly not about raising (or lowering) quality. It is about knowing the quality. • Competitiveness is not necessarily achieved by building government quality systems. The government is a major player in quality services in many countries, but it is far from the only one. The role of the government is determined as much by historical tradition and ideology as by income levels. Low-income countries tend to have little government intervention in quality systems (mainly because of public finance constraints), but major differences exist even among high-income countries. In the United States, for instance, the government only provides knowledge to standard-setting organizations, whereas in the European Union, national governments have a much more hands-on approach. Government activities must be carefully designed to complement private activities. This is particularly important in low-income countries, where the social loss associated with the crowding out of private activity is particularly costly. • Competitiveness is not necessarily about building national quality systems. Many services may be imported either through buyer relationships or as third-party services. Often these imports are costly, but so is the establishment of national systems. Low- income countries are at a disadvantage simply because of the small size of their economies and often because of their isolation. • A quality infrastructure is not a necessary condition to achieve competitiveness. Quality infrastructure often is discussed in absolute terms like “The use of standards is increasingly becoming a prerequisite to worldwide trade.� This may be correct, but not all standards are the same. Some are simple and easy to meet, some are complex and require support infrastructure in the form of technological hardware (for example, laboratories) and software (for example, a cost-efficient value chain such as vertically coordinated chains). Only some developing country exports are of the latter variety. The choice of which type of market to aim for is a social cost-benefit consideration. Exports generally follow the principle of comparative advantage. Each country will end up exporting what it does relatively best. Part of the basis for a country’s export performance is the nature of its quality system. If the country performs badly in this regard, it will end up exporting goods and services that rely little on quality services. (continued on next page) Trade Promotion Infrastructure: Standards and Certification 133 Box 2.16. (continued) • Competitiveness in quality is not necessarily about harmonizing with international standards. The WTO SPS and TBT agreements have caused some confusion about the appropriate role of international standards. Compliance with these two trade agreements is made easier if a national standard is based on an international standard. Yet, achieving harmonization does not warrant the blind import of international standards. Countries are free to choose whichever standards they feel fit their situation as long as the standards are supported by a risk assessment. The use of international standards only makes the risk-assessment process a little easier. The choice of appropriate standards is a cost-benefit consideration. If a country deviates significantly from the countries for which an international standard has been developed, the import of the international standard is likely to lead to an economically inefficient situation. Furthermore, international standards abound. Many institutions develop international standards and the choice of one particular international standard therefore does not necessarily guarantee a perfect match with the demand of the customer. Only the customer can formulate the need for a standard, not an international trade agreement. The trade agreement sets some parameters for the use of standards; commercial relationships determine the standard. • Standards (and quality infrastructures) are not the same as quality. The instruments of standards, technical regulation, and the supporting quality infrastructure are often mistaken for quality itself. Quality is a much broader concept. It distinguishes between producing quality and proving quality. Quality infrastructure is mainly about the latter. Producing quality takes basic capacity building in the value chains through such means as training programs, extension, and advisory services, new technology, and so on. If a first investigation demonstrates a low quality level of the exports of a given country, the reason is often a lack of capacity to produce quality in the supply chain. Source: Authors. Tailoring the Diagnostics to Country products), governments (for health and safety protection), Module 2 and Sector Characteristics and civil society organizations (on ethical and environ- mental issues) has contributed to a steady increase in the Standards tend to be driven by requirements in end range and stringency of standards to which exporters must markets—as such, the assessment of standards needs to take comply. When selling into low-income markets, however, into account the markets being targeted by exporters. Indeed, the demand for standards tends to be less clear but often any diagnostic assessment of how a country’s quality stan- less rigorous. Recent research (Kaplinsky and Farooki 2010; dards system contributes to trade competitiveness must take Kaplinsky, Terheggen, and Tijaja 2010) suggests that stan- into account not only the supply side but also the demand dards play a much less important role in exports bound for side of quality standards. In high-income end markets, pres- low-income markets (see box 2.17). sures from consumers (for high-quality differentiated Summary of Specific Considerations by Sector Sector Priorities and issues for consideration Light manufacturing • Focus on product safety and consistency • Standards will be strongly driven by end markets or lead firms in global value chains; however, they can be strongly influenced by in-country quality systems • Standards will be highly sector specific • Both process and product-related standards should be included • Emphasis on testing facilities, role of local bureau of standards, overall certification costs Agriculture • Main emphasis on health (food safety) and environmental issues • Focus on SPS standards as well as process-related hygiene standards (for example, HACCP) • For some agricultural products, issues of certification (organics) and traceability (for example, Eurepgap) will require significant technical capacity and considerations of compliance costs • Key government agencies will be linked with Ministries of Health and Agriculture/Environment Tourism • Standards and certification usually include both government and private processes • Safety standards are of primary concern (from government regulatory perspective), but quality and consistency of service offerings tend to be the main focus of private initiatives Business and IT Services • Importance of ISO (9000) but also many industry-specific standards (ICT; business process outsourcing [BPO] services) • Importance of professional certification schemes—for example, Software Engineering Institute 134 Module 2: Competitiveness Diagnostics Box 2.17. Standards in South-South Trade Thailand’s Cassava Exports Thailand’s exporters of cassava pellets to the European Union are required to meet two demanding sets of standards: GMP (Good Manufacturing Practice) covering sanitary and processing procedures, and HACCP as cassava pellets are an input into animal feeds. By contrast, their exports of dried cassava to China are not subject to either GMP or HACCP certification, but only require a minimum level of starch content (Tijaja 2010). Gabon’s Timber Exports Gabonese timber exporters selling into the European Union and China face different markets in terms of standards (Terheggen 2010). Entry into Europe is covered by much more intense standards, both private standards specified by global buyers and mandatory standards set by governments and international bodies. These differences are illustrated in the figure: Private Legality certification International Formaldehyde requirements emissions 5.0 5.0 4.0 4.0 3.0 3.0 2.0 2.0 1.0 1.0 Phytosanitary ISO standards 0.0 GPP Building codes 0.0 requirements Module 2 Sustainability certification Product testing requirements requirements EU CN Source: Kaplinsky, Terheggen, and Tijaja 2010. Background Reading: Relationship Between use of compliance infrastructure are purely private matters Standards and Trade Competitiveness and all exchange of information about the nature of the product takes place efficiently on the basis of private trans- Standards are essentially descriptions of the quality param- actions. Many activities are part of the quality infrastruc- eters of a product. New public safety threats, such as food ture. Standards and their regulatory counterpart (technical safety hazards, and the emergence of ever more complex regulations) set out the specifications, but a range of qual- global supply chains with an associated increased demand ity services are part of the picture too. Box 2.18 provides for the interoperability of inputs create a strong push for basic definitions of key terms related to quality standards. knowing the exact quality of traded products. For instance, For low-income countries, in particular, the emergence the consumer wants to know the content of cancer-causing of standards as a form of governance in global trade raises aflatoxins in peanuts, and the power companies need to some threats, most important, the risk of being excluded know the strength of cables produced abroad. In short, from profitable markets. Three distinct but related charac- standards are used to transfer product information from teristics of standards act as a barrier to global trade (versus seller to buyer. This is not easy. The standard is simply a traditional barriers like tariffs and quotas): document outlining the desired characteristics. For the standard to be credible, a compliance infrastructure is needed. For some issues, such as food safety, the public has a • Unlike tariffs and quotas, standards are not established key interest and the government is often involved. In that just by governments but also involve a range of private case, standards are often included in legislation, and the actors. resulting document stipulating quality is known as a techni- • Unlike tariffs and quotas, which are publicly codified, cal regulation. But for many other issues, standards and the many standards are opaque. The rules and regulations Trade Promotion Infrastructure: Standards and Certification 135 Box 2.18. Definitions Quality—the value of a set of parameters that describe the nature of a product, service, or management system. An apple, for instance, is a fruit with edible flesh, certain sugar content, a given color, and so on. There are many apple qualities differentiated by, for instance, sweetness or color. Some qualities may be ranked on a low-to-high quality scale; others cannot be ranked but are fit for different purposes. An economic understanding of quality should not talk about low and high quality but rather efficient quality that is the quality that produces the highest benefit-cost ratio. Quality services—all services relevant to establish the values of the parameters that describe the quality of a product, service, or management system. These are the instruments of standards and technical regulations and conformity services. Quality infrastructure—the institutions and technologies used to provide quality services. The term relates to all the fields of metrology, standardization and testing, quality management, and conformity assessment, including certification and accreditation. Often the term MSTQ (Metrology, Standardization, Testing, and Quality) assurance is used interchangeably with quality infrastructure. Standard—a formal description of the desired quality of a product. Standards are voluntary and many standards often compete. Technical regulation—a mandatory formal description of the desired quality of a product. Technical regulations are often created by referring to a standard, thereby making it mandatory. Conformity assessment—activities concerned with determining that requirements laid out in a standard or technical regulation are fulfilled. Conformity assessment includes the areas of testing, surveillance, inspection, auditing, certification, registration, and accreditation. Conformity assessment services—services used to ensure conformity with a standard or technical regulation. Source: Authors. that producers have to meet are often neither widely Market Access publicized nor stable and consistent. Standards help create market access by ensuring that the Module 2 • Unlike tariffs and quotas for which there are established product specifications are aligned with foreign demands, mechanisms to resolve conflicts (for example, the dis- which may be public regulatory requirements or private mar- pute resolution procedures under the WTO), the deter- ket demands. The EU seafood regulations, for instance, are mination of performance with respect to standards is highly demanding both in terms of product standards and generally an asymmetric process, determined solely by management practices, as are US regulations. Vietnamese the buying party or country, with the producer having seafood exporters frequently export to both markets. The little capacity to challenge decisions on conformance. Vietnamese authorities with the assistance of Danida, the Danish development agency, have designed national stan- Standards also offer an opportunity for producers to dards that combine the EU and US demands, ensuring that access high-margin markets. Indeed, standards have the complying with the Vietnamese standards simultaneously potential to shape a number of aspects of export competi- ensures compliance with EU and US demands. tiveness. The channels through which standards shape In some cases, standards help shape and develop mar- competitiveness are summarized in the remainder of this kets. The competitiveness of a country or industry is then section. influenced by the ability to participate in the standard- setting process. The rapidly developing biofuel market is an Product Compatibility example. Quality issues include chemical composition to A well-functioning quality system improves market coor- ensure compatibility with the existing stock of combustion dination by ensuring product compatibility. This is a key engines, environmental parameters to ensure a positive issue behind the rapid growth in global trade. Standardiza- effect on climate change, and social parameters to guaran- tion ensures that inputs produced in distant locations fit tee ethical behavior of biofuel producers. Environmental together when assembled in the final product. This often is and social parameters are important to ensure market achieved by referring to voluntary standards and using pri- access into markets like the United States and the European vate conformity assessment services, such as testing and Union. The ability to follow and, if possible, influence the certification. Occasionally, the government intervenes to standard-setting process may be a key factor when a coun- direct the choice of product variety toward a social opti- try wants to ensure that its emerging industry complies mum that market participants are unwilling to reach with regulation. Rules on forest clearance, for example, themselves. In an export context, the drive for product may exclude countries that have recently converted forests compatibility often translates into complying with stan- into agricultural lands as opposed to most developing dards set up by global buyers. countries where this conversion took place centuries ago. 136 Module 2: Competitiveness Diagnostics For exporters, compliance with international product common regulations on pesticide use will allow extension and process standards can open doors to important mar- agencies to advise on the pesticides that are acceptable in kets. The flip side, of course, is that firms that fail to comply export markets. This is less costly than having to fine-tune risk being excluded from global value chains. crop protection management to individual market demands. Meeting standards is generally a costly process, and this Quality Signaling and Value Addition can act as a barrier to entry for small-scale and informal The market access aspect of standards is linked to the wide- producers (see further discussion in the section “The Costs spread use of standards as the basis for technical regula- of Achieving Standards�). On the other hand, in many tions. The right product specifications (formulated as cases, firms adopting the various sets of standards required either voluntary standards or mandatory technical regula- to access global markets have experienced considerable tions) safeguard human, animal, and plant life and protect improvements in both process and product upgrading. the environment. The gap in regulations is widening Meeting the needs of demanding corporate value chain between industrial countries and many developing coun- leaders to enhance quality, cost, and delivery has invariably tries, specifically regarding environmental and social issues meant that firms have had to change their practices on such as labor practices. Private operators expect produc- inventories (reducing working capital costs), to restructure tion and trading practices to comply with various codes of their plant layouts, to move from quality at the end of the practice in many markets. The quality system must be able line to quality at the source, and to introduce new equip- to understand new requirements and prove compliance in ment that boosts productivity and enhances product qual- a cost-effective way if industries are to remain competitive. ity (Womack and Jones 1996). Similarly, firms participating Developing countries are most often standards takers in global value chains that require conformance to civil- rather than setters. That is, their exports must be compati- society driven standards on health, safety, work practices, ble with quality demands determined elsewhere. For exam- and the environment generally are able to participate in Module 2 ple, following emerging international standards on the high-margin niche markets. chemical composition of biofuels, ensures Mozambican There is an important caveat here, however, because, as exporters a market because their product is compatible in the case of ISO standards, the adoption of process stan- with car engines in export markets. The biofuel standard dards may provide the capability to enhance productivity creates a network effect. The value of Mozambican biofuel and reduce costs, but this capability may or may not be uti- increases with the number of people using compatible lized to achieve these ends. Firms may be able to monitor technologies. Awareness of emerging standards therefore quality performance at each stage of the production cycle becomes a key factor in a competitive industry, as market through the use of ISO 9000 procedures, but unless participants must lock into the right technologies as soon these performance indicators are actually used to stretch as possible. efficiency—through setting and meeting a series of targets Standards can identify specific product attributes and for systematic improvement—the achievement of stan- add value to exports by allowing producers to be rewarded dards accreditation will have little impact on a firm’s for their efforts when producing them. In this way, stan- capacity to upgrade. dards allow exporters to tap into their willingness to pay for specific product attributes by ensuring them of the Innovation nature of the product that is traded. For example, most The right standards are codified specifications of state-of- African agricultural export is de facto organic as chemicals the-art technology and best practices in meeting consumer are little used because of their high costs. The average con- expectations. Standards are platforms on which to add new sumer does not know this, however. Organic labeling com- insights. As the world changes, new standards are intro- municates the information to the consumer. duced to reflect the latest technologies, innovations, and community needs, and redundant standards are discarded. Cost—Scale Economies and Efficiencies The role in innovation in developing countries is often to Standards affect firm cost structures, and therefore product diffuse cutting-edge practices as these countries catch up prices, in a variety of ways. Product compatibility makes with industrial countries. Often, the knowledge built into long-distance trade and the inherent specialization possi- standards is transferred through the global supply chains ble, which leads to national and global gains of economies that link distant markets. In Kenya, knowledge about food of scale. In an emerging industry, many product configura- safety management has been transferred through the coun- tions may exist, but agreeing on one configuration will try’s successful fresh produce exports. New innovations such allow private operators to mass produce compatible inputs, as prepacked vegetables and ready-to-eat salads have been thereby reaping greater economies of scale. For example, created using food safety management standards as the Trade Promotion Infrastructure: Standards and Certification 137 underlying basis. These standards ensured that final prod- the European Union as the costs of achieving GMP and ucts were acceptable in end markets and concentrated HACCP accreditation are too high. These firms reported innovation efforts. that it was not just the cost of accreditation but also the fact that HACCP implementation requires trained staff and the The Costs of Achieving Standards maintenance of records (Kaplinsky 2010). Small-scale, and Although there may be a payback to the firm in effectively especially informal sector, firms also may be excluded from implementing standards arising from higher product participating in global value chains because they lack the prices, lower costs, and larger volumes (due to selling to capacity and culture to systematically record and store the large-scale buyers), the achievement of standards will not information required to achieve and maintain standards be costless. The financial costs of accreditation may be accreditation. Therefore, because of this combination of low, but there will be resource costs in acquiring, and acquisition costs, costs of maintaining accreditation, and then maintaining, accreditation—for example, managerial the lack of capabilities to implement and sustain accredita- time, training, new procedures, and new equipment. tion, the advance of standards in global value chains Moreover, there may also be significant lock-in costs when excludes many small-scale and informal sector producers suppliers invest heavily in meeting the specific standards from global markets. of a particular firm (as in traceability in horticulture, in which different retail firms have different types of paper Main Components of Standards Analysis Two main trails), and suppliers may find it costly to make the switch types of standards can be defined—product and process: to a different lead buyer’s standards and procedures. These costs will necessarily vary across industries. • Product standards: Product standards address the char- Achieving the standards required to sell into the defense acteristics of the output from production. They are rel- sector will be orders of magnitude more costly than those atively unambiguous and are defined by the quality Module 2 involved in the certification of organic coffee. See box 2.19 requirements set by particular standards setters. For for an example of compliance cost differences across example, in the case of standards set by lead firms seek- industries. ing to reduce costs and increase flexibility, this may The key issue in considering the costs of standards involve the definition of minimum levels of permitted accreditation is thus best seen in relation to the size and defects. Thus, in the auto sector, permissible levels of financial viability of the suppliers involved. Although defects that suppliers must achieve have been progres- these levels of expenditure may be affordable to MNCs or sively reduced from 10,000 parts per million to less large locally owned suppliers, they often exclude small-scale than 400 parts per million. In the food-retailing sector, suppliers. One reason for this exclusion is the financial the product standards that are tested include pesticide cost. Therefore, in the Thai cassava value chain, a number residues. In a relatively new development, Walmart is of smaller plants have had to withdraw from exporting to increasingly focusing on green standards, including on Box 2.19. Sectoral Differences in Compliance Costs Gabonese Timber Industry In the Gabonese timber industry, one large forest-holding reported the cost of acquiring initial Forestry Stewardship Council (FSC) certification (which requires action through the chain of production) at €4 million, with an annual cost of maintaining accreditation of around €100,000. A second Gabonese firm estimated its environmental compliance cost at €2.10 per hectare, in the context of an estimated minimum economic forest-holding of 50,000 hectares. A third large forest-holding company estimated the cost of achieving the CFAD (Sustainably Managed Forest Concessions) accreditation to be in excess of €1.5 million. Source: Terheggen 2010. Malaysian Electronics Industry By comparison, the cost of compliance to health and safety and the ISO 14001 environmental standard in the Malaysian electronics industry was considerably lower. A large multinational company estimated the annual costs of maintaining its ISO14001 certification and the international occupational health and safety management system standard (Occupational Health and Safety Accreditation Standard [OHSAS] 18001) certification to be around US$4,600. A second multinational reported the cost of OHSAS certification to be $278 per year. Two second-tier suppliers estimated the costs of maintaining ISO14001 accreditation at between $4,600 and $9,275 per year. Most of these cost estimates, however, are based on previous investments by the firms in setting in place the processes and procedures for certification, and these relatively low cost estimates relate only to the annual costs of maintaining registration. Source: Kaplinsky 2010. 138 Module 2: Competitiveness Diagnostics the carbon content of products that it sources from its the chain if producers are to meet the demanding supply chain. In general, these product standards are pesticide-residue requirements of global retailers, unambiguous and require single-point verification at who demand that a defaulting shipment can be the end of the production process. traced all the way to the individual plot of land in • Process standards: Process standards are more complex which a particular leaf in a salad was grown. and more varied than product standards: ° They are more complex because they typically involve It is not always possible to separate product from the documentation of procedures involved through- process standards. For example, is organic food a product out the production process rather than measuring a standard (whose characteristics can be measured) or a single outcome (as in the case of a product). For process standard (the documentation throughout the example, the ISO quality and environment standards chain that inorganic materials are not entering the chain)? (respectively the ISO 9000 and ISO 14000 series) In most cases, therefore, particular product standard out- require the documentation of practices and out- comes require the application of particular process stan- comes at various stages of the production process. dards. But the obverse is not always the case—that is, given Unlike product standards, they do not set the levels process standards do not necessarily produce the targeted that must be achieved but require only that these lev- product standards. For example, the ISO quality and envi- els be checked and documented. ronmental standards specify only that pertinent informa- ° They are more varied because, in some cases, they tion is systematically collected, which will make it easier to include both the documentation of procedures and achieve given product standards. But it is entirely possi- the achievement of clearly defined and measured ble—and indeed often the case—that producers have outcomes. This may involve indicators, such as the achieved the required process certification but that this is level of the minimum wage, the age of workers, and not used systematically to improve quality and environ- Module 2 the rights of workers to engage in collective bargain- mental performance. ing, as well as the introduction of processes to reduce Four major sets of actors are involved in setting hazardous work practices. standards—private sector actors, governments, civil society ° They are more systemic than product standards organizations, and international industry bodies. These because they typically involve the documentation or actors, and their roles, are outlined in table 2.7. achievement of standards throughout the chain. For The other key actors in the standards process are the example, the FSC certification that addresses sustain- providers of quality services. Conformity assessment and ability in the timber and wood products value chain other quality services may be provided from both public involves a chain of custody that follows the timber and private actors. Many exporters conduct some of their from its forestry cultivation, through the sawmills, to own tests and quality control (first-party assessment), are the manufacture of processed wood, and its transfor- tested or audited by their buyers (second-party assess- mation into furniture and other final products. A ment), and buy services from neutral actors (third-party similar process of verification is required throughout assessment). When quality is regulated by mandatory Table 2.7. Actors in Standards Setting Actor Role Private sector Individual lead firms have developed standards to determine the efficiency of their value chain operations. Initially these corporate standards largely defined the nature of the product and were generally unique to the firm. But, in some cases, firms began to cooperate to widen the pool of suppliers on which they could draw. GLOBALGAP is one such example. GLOBALGAP is a private sector body that sets stringent standards for the certification of production processes of agricultural products primarily for food safety purposes. The standards are voluntary in principle, but the fact that some large buyers such as British supermarkets use them have made them de facto mandatory in some markets. Another example is in the automotive industry, where ISO-TS16949 has now been adopted globally, replacing country-specific standards. In addition to focusing on flexibility, inventories, quality, and cost and focusing on product standards, lead firms increasingly have needed to respond to civil society pressures on labor standards and the environment. One example is the Marine Stewardship Council (MSC), which sets standards for environmentally sustainable fishing. The electronics industry adopted the Electronic Industry Code of Conduct (EICC), based on the HP Supply Chain Social and Environmental Responsibility Code of Conduct, to replace company-specific codes, following a campaign by civil society organizations that exposed poor working conditions in the industry’s global supply chains. (continued on next page) Trade Promotion Infrastructure: Standards and Certification 139 Table 2.7. (continued) Actor Role Government Unlike corporate sector standards for which suppliers can perform at differential levels (and for which they may be rewarded or punished for over- or underperformance) government-legislated standards are mandatory, are transparent, and provide little leeway to producers. Government standards also can vary in their sectoral purview. For example, the United States mandates HACCP certification (which requires processes to reduce the risk of contamination in food production) for imports of juice and meat, but for other foodstuffs, conformance is voluntary. With growing international cooperation, particularly in Europe, many legislated standards are no longer set by individual governments, but rather by groups of governments, as in the case of standards set by the EU Commission. For example, the European Union has adopted a suite of standards governing the farm-to-table chain, targeting a series of linked product and process standards governing food safety, animal health, animal welfare, and plant health. These cover both domestic firms selling into the European Union and exporters to the European Union. In addition, governments agree to multilateral standards—for example, WTO SPS agreements. Member states are encouraged to base their technical regulations on international standards, although they may choose to deviate from such standards, if they find that they are inappropriate in the local context. The SPS agreement defines international standards for food safety, animal health, and plant health as the standards set by, respectively, the Codex Alimentarius, the International Office of Epizootics, and the International Plant Protection Convention. Civil society Unlike either the standards that pertain in corporate-governed value chains or those standards set by organizations national and international governmental bodies, civil society standards are voluntary. This does not make these standards less important, particularly if producers are seeking to sell into high-margin niche markets. Many of these standards fall under the fair trade umbrella, covering items such as foodstuffs (for example, coffee, where the emphasis is on ensuring minimum incomes for producers), intermediate products (such as organic cotton and FSC timber, covering environmental issues), and final consumer goods (such as apparel, addressing labor standards). Although still a small segment of the global market for these items, the pressures leading to the adoption of fair trade–type certification are forcing many value chains to adopt their own or analogous standards in their value chains. One example of this is Starbucks, which has Module 2 adopted a non–fair trade scheme to regulate its supply chain (the Rainforest Alliance). Unlike fair trade, which explicitly targets minimum prices paid to farmers and other socioeconomic standards, the Rainforest Scheme focuses on environmental and sustainability issues. Similarly, Walmart, which, under pressure, has tried to resist labor standards, has struck out against criticism by pushing through a series of greening standards to its supply chain, involving second- and third-tier suppliers (with chain-of-custody type accreditation) as well as first-tier suppliers. One of the major difficulties associated with the standards driven by civil society organizations is the plethora of confusing and overlapping standards that confront producers. This difficulty arises as a direct consequence of the multiplicity of civil society organizations that are involved. Thus, in the apparel industry, many producers in low-income economies are involved in a costly and often bewildering process of multiple audits of their labor standards as each of the lead buyers bows to pressures from particular civil society organizations in their different final markets. Therefore, in some cases, large global branding firms have approached neutral bodies like the ILO to develop a single globally recognized and transparent labor standard that they can apply to their value chains and meet the demands of civil society organizations across their final markets International industry International industry bodies are involved in both general and industry-specific standards setting. For bodies example, the IS0 9000 quality standards grew out of the British Standards BS 5750 certification scheme to address an international audience of participating firms. ISO standards generally cover a range of sectors, as they target internal processes; hence, ISO 9000 certification has been adopted in manufacturing as well as services and marketing companies. In other cases, these international standard-setting bodies are industry specific. For example, the International Maritime Organisation (IMO) has grown into the major body regulating practices and safety in the shipping industry. Its explicit purpose is to safeguard transport and to prevent unfair competition from low-cost and less scrupulous shipping lines. In cooperation with governments and civil society organizations, the IMO has developed in a series of standards, some of which have been enacted into law by most governments, and others that are considered to be beneficial and that are advisory. Source: Authors. technical regulations, government agencies in the import- assessment services. The global quality system is marked by ing country and occasionally in the exporting country competition between service providers who offer standards often get involved. A myriad of private actors offer qual- and the associated conformity services and attempts to ity services, ranging from global quality service giants harmonize these standards and compliance procedures. like SGS and Bureau Veritas with offices in many coun- The trade-off between competition and the specialization tries, to small companies specialized in particular serv- of services and harmonization is difficult to achieve, yet the ices. Many national bureaus of standards offer conformity right balance is often crucial for trade concerns. 140 Module 2: Competitiveness Diagnostics Trade Promotion Infrastructure: Special Customs Regimes and Special Economic Zones Link with Competitiveness Challenges Identified in Trade Outcomes Competitiveness challenge areas Main components in special customs General export Cost Product extension Market regimes and SEZs environment competitiveness and quality penetration Duty drawback and manufacturing-in-bond ✓ ✓ EPZs and SEZs ✓ ✓ Quantitative Analysis: Indicators and Data Sources Indicators Sources Duty drawback and manufacturing Share of exporters making use of duty relief regimes National sources under bond (MUB) EPZs/SEZs Share of exports from SEZ National sources; World Bank International Trade Department (PRMTR) database SEZ exports per capita National sources; PRMTR database Number of SEZs National sources; PRMTR database Number of companies operating in SEZs National sources; PRMTR database Clusters and collective action Existence of national cluster programs National sources Subsidies and incentives to Existence of subsidy programs National sources sectors and exporters Share of exporters benefiting from subsidies National sources Module 2 Cost of subsidies (actual and percent of export value) National sources WTO actions over past X years WTI Qualitative Analysis: Interview Targets and Issues for Discussion Interview Targets Government agencies and ministries Private sector and other institutions Duty drawback and MUB • Customs and excise • Individual exporters (small/new and established) • Other border agencies (police, health, across traditional and emerging sectors and so on) • Export councils or associations • Ministry of Trade and Industry or other • Private sector administrators or service providers ministry with responsibility for scheme to drawback schemes EPZs/SEZs • SEZ regulatory authority • Private SEZ operators • Ministry of Trade and Industry or other • Investors operating in SEZs ministry with responsibility for SEZ program • Customs and other border authorities • Port operators Key Issues for Discussion in Interviews with Government Agencies and Ministries Duty drawback • What duty relief regimes are offered and why? and MUB • Do exporters (of all sizes) make appropriate use of the regimes? • What is their approach on the balance-of-trade facilitation and risk management? • What are the main challenges they face and how are they addressing them? EPZs/SEZs • How effective have SEZs been in attracting export-oriented investment? • Structure of the SEZ regulatory authority: links to government ministries? Structure of executive board and level of private-sector participation on the board? • Are the SEZs operated publicly, privately, or both? What is the strategy for this? • What are the challenges in delivering infrastructure, “one-stop� registration, efficient customs, and so on? What are they doing to address these? • Is there any evidence of the SEZs linking effectively with local producers—for example, accessing supplies from local markets, contributing to indirect exports? Trade Promotion Infrastructure: Special Customs Regimes and Special Economic Zones 141 Key Issues for Discussion in Interviews with the Private Sector and Other Institutions Duty drawback and MUB • What duty relief regimes do they make use of and why? • How effective are the regimes in terms of registration, paperwork requirements, financial commitments, and repayment times? • What are the main problems that arise with the regime and how could they be improved? EPZs/SEZs • How does the investment environment for exporters compare with what would be available outside the zones—in infrastructure, transport access, regulatory burdens, set-up, and so on? • Are incentives offered within the SEZs? How important are they? • What are the main issues that still constrain exporters on a day-to-day basis? • Do investors make significant purchases from local suppliers? What restricts greater links with local suppliers? Tailoring the Diagnostics to Country and Sector Characteristics Summary of Specific Considerations by Country Type Country type Relative priorities and issues for consideration Small (population) and • SEZs may be difficult to make work due to lack of scale remote/landlocked • Logistics or border-oriented zones may be worth consideration Resource rich • How can zones support diversification and value addition? Low income, labor abundant • Traditional processing zones may be relevant Middle income • Greater emphasis on science parks, IT parks, and services-oriented zones Module 2 Summary of Specific Considerations by Sector Sector Priorities and issues for consideration Light manufacturing • Duty drawback particularly relevant for sectors with substantial imported inputs (for example, garments, electronics, automotive) • SEZs may be a critical issue to explore; in many countries and sectors, the majority of exports will be based in zones • Infrastructure, regulatory frameworks, and incentive policies of SEZs must be understood Agriculture • SEZs are a possible area of interest for consolidating agricultural value chains, particularly when land is scarce Tourism • Increasingly being integrated into SEZ projects but unlikely to be a major area of focus Business and IT services • Assess effectiveness of IT and science parks infrastructure and services; location (nearness to skilled labor) is often a critical issue Background Reading: Relationship Between Special Duty Drawback and Manufacturing Under Bond Customs Regimes and SEZs and Trade Competitiveness Most countries have established duty relief or exemption schemes designed to promote competitive exports by reduc- A majority of countries provide support to exporters ing or removing taxes on imported inputs for use in further through duty deferral and drawback or through a spatial export-oriented manufacturing, through either duty draw- program like EPZs or SEZs. Although these interventions back or MUB regimes. The rationale for specific exemption can all be defended as addressing some form of market, or duty relief for exporters is that the imposition of a tariff information, or coordination failure, it is by no means cer- on imported inputs acts as a tax on exporters, which may tain they represent efficient or effective mechanisms to reduce the competitiveness of exporters in world markets. promote trade competitiveness. It can be argued that some Fundamentally, duty drawback and MUB regimes pro- of these interventions are in fact distortions to competi- vide the potential for exporters to improve competitive- tiveness, which may harm trading partners or create an ness through both cost (access to lower-cost inputs) and unlevel playing field within the country. Conversely, they quality. To the degree that they facilitate imports of higher address constraints that hinder investment and trade. technology inputs than might be available in the domestic Table 2.8 provides a brief summary of the purposes, market, they offer the potential to improve aggregate pro- rationale, and potential impact on competitiveness of ductivity through knowledge and technology spillovers. these interventions. 142 Module 2: Competitiveness Diagnostics Table 2.8. Summary of Special Customs Regimes and Economic Zones Reason for Potential impact Purpose government provision on competitiveness Duty drawback and MUB • Allows exporters to access • Reduce anti-export bias • Lowers production costs for exporters imported inputs for exports of tariff regime • Allows for access to high-quality inputs on duty-free basis EPZs/SEZs • Provides exporters with an • As above and overcomes • As above environment of high-quality poor investment climate • Improves quality and flexibility (speed) infrastructure, more liberal more generally of production and distribution environment, improved administration, and possibly fiscal incentives Source: Authors. The administration of such schemes is sometimes problem- Duty Drawback and Manufacturing Under Bond19 atic, however, and so their existence alone does not necessar- Exporters have a wide range of possible approaches to duty ily contribute to competitiveness. Indeed, it is recommended and tax relief on imported inputs; however, two main that duty and tax exemptions for exporters be kept to a min- mechanisms are of most interest: imum to reduce the burden on customs administrations. • Duty drawback: Under a duty-drawback regime, the Export Processing Zones and Special Economic Zones exporter pays full duty upon importing the relevant SEZs18 are demarcated geographic areas within a country’s good but then can claim a refund on the basis of specific national boundaries inside which the rules of business are information on the content of its exports. different—generally more liberal—from those that prevail • MUB: This mechanism is particularly relevant for Module 2 in the national territory. SEZs act as a tool of trade and exporters who make substantial use of imported inputs. investment policy, aiming to overcome barriers that hinder MUB is similar to a duty drawback, but in this case, the investment in the wider economy, including restrictive imported input remains under bond until it is policies, poor governance, inadequate infrastructure, and processed and reexported. Thus, the exporter is not problematic access to land. required to pay the duty for each individual importa- Specifically, SEZs tend to offer export-oriented investors tion, although exporters are usually required to main- three main advantages relative to the domestic investment tain a credit with customs as financial security against environment. First, they generally offer a special customs the value against the tax liabilities that otherwise would environment, including efficient customs administration be payable for the imported raw materials. An MUB and (usually) access to imported inputs free of tariffs and scheme requires that the raw materials be kept within a duties. Second, historically at least, zones have offered a specific bonded warehouse or factory that has been range of fiscal incentives, including tax holidays, exemp- licensed by customs. Box 2.20 provides an example of tions, and reductions, as well as unrestricted movements of an MUB program. capital and repatriation of profits. Finally, SEZs offer a high-quality investment climate that is a marked improve- Assessment of a duty and tax relief regime should con- ment over what is available in the country overall. By con- sider the nature of the program and how it is administered. centrating on a relatively narrowly defined area, SEZs make Specifically, it comes down to a balance between meeting it more feasible to deliver a high-quality investment the needs of exporters for limited bureaucracy and cash- environment—from the perspective of financial invest- flow commitments and the needs of government to mini- ment, governance, and delivery capacity—than otherwise mize the risk of diversion. Exporters prefer mechanisms may be possible across the economy as whole. whereby duties are exempted, whereas governments prefer some financial guarantees, either through exporters put- ting up a bond or paying and reclaiming duties. For Main Components of Interventions exporters, particularly small exporters, the burden of In analyzing a country’s program of sectorally and spa- drawback mechanisms in some countries often under- tially targeted support to the export sector, it is necessary mines its potential value as a source of competitiveness. to assess the specific components and activities involved in This is because extremely detailed paperwork require- each instrument of support—a summary of these compo- ments may make it costly or difficult for the exporter nents follows. to prove its right to the refund, and because in many Trade Promotion Infrastructure: Special Customs Regimes and Special Economic Zones 143 Box 2.20. Kenya’s MUB Program Kenya maintains an MUB program that is designed to encourage manufacturing for export by exempting approved applicants from import duties and VAT on the raw materials and other inputs that they import and also providing a 100 percent investment allowance on plant, machinery, equipment, and buildings. If the goods that are produced from the raw materials and other inputs are not exported, the scheme’s participant is subject to a surcharge of 2.5 percent and the imported inputs used in their production are subject to all other duties. Under this scheme “manufacture� includes any process by which a commodity is finally produced. This includes assembling, packing, bottling, repacking, mixing, blending, grinding, cutting, bending, twisting, and joining or any other similar activity. The remission, however, is not available for the importation of plant, machinery, equipment, fuel, and lubricants, or for suspended duty or dumping duty. The scheme can be used by both direct exporters (that is, manufacturers who import raw materials, manufacture, and then export the finished product) and indirect exporters (that is, a manufacturer/producer who imports goods for use in the production of goods for supply to another manufacturer for use in the production of goods for export). Application for participation in the scheme must be supported by a bona fide export order or contract for specified export goods or a letter of credit; a detailed production plan; a list of imported goods, including their description; and the tariff classification, quantity, value, and amount of duty/VAT to be waived. Furthermore, the value of the imported goods must exceed K Sh 1 million (approximately US$10,000). Source: World Bank 2009a. countries, exporters face extraordinarily long delays in • Third, another important component of the administra- receiving their refunds. It is, therefore, critical to have the tive services offered in zones is a privileged and expedited right legal and regulatory environment to manage the customs administration. Such services often involve the schemes effectively and efficiently. Customs needs to have stationing of customs officers inside or at the gate of the Module 2 processes in place to ensure that claims for duty relief are free zone to offer on-site clearance to speed up import legitimate and can be audited, but it needs to be able to do and export procedures. It is usually also combined with a this in an efficient way. range of other advantages, including the ability to move and hold goods in bond as well as the removal of finan- Export Processing Zones and Special Economic Zones cial requirements for bonded and duty-free inputs. Several specific aspects of the investment climate are usu- ally targeted for improvement inside SEZs. Recent research (Farole 2011) suggests that the follow- ing factors are important determinants of the potential • First, SEZs are designed to overcome land and infra- success of SEZs as a tool to promote exports: structure constraints that may hinder investment in the national economy by providing investors access to long- • Infrastructure quality: The quality and cost of electricity term leases, prebuilt factory shells, and reliable utilities is the most important determinant of competitiveness (electricity, water, telecommunications). for manufacturing-related exporters (for services • Second, SEZs normally improve the overall administra- exporters, telecommunications infrastructure tends to tive environment, particularly with regard to the proce- be equally important). In too many SEZs, infrastructure dures required to register a business, acquire the provision remains of relatively poor quality. licenses required to operate, obtain visas and work • Trade and transport facilitation: Efficient on-site cus- permits, and access key services like utilities and toms clearance, effective transport links to key trade construction. This is often facilitated through the gateways, and (perhaps most important) efficient port establishment of “single-window� or “one-stop shop� operations are critical determinants of SEZ success. services, whereby the SEZ authority will be a single • Investor servicing (one-stop shops): Although less critical point of contact to arrange the delivery of these admin- in the long run, access to an effective one-stop service is istrative services through coordination with the rele- often important for attracting and converting initial vant government agencies. investors. 144 Module 2: Competitiveness Diagnostics Trade Promotion Infrastructure: Industry Coordination and Sector Support Link with Competitiveness Challenges Identified in Trade Outcomes Competitiveness challenge areas Main components in industry General export Cost Product Market coordination and sector support environment Competitiveness extension and quality penetration Industry associations and bodies ✓ Clusters ✓ ✓ ✓ ✓ Subsidies and incentives to ✓ ✓ sectors and exporters Quantitative Analysis: Indicators and Data Sources Indicators Sources Industry associations Share of firms/exporters that are members of industry bodies (taking into account National sources only those that are dues-paying members) Clusters Existence of national cluster programs National sources Subsidies and incentives Existence of subsidy programs National sources to sectors and exporters Share of exporters benefiting from subsidies National sources Cost of subsidies (actual and percent of export value) National sources WTO actions over past X years WTI Module 2 Qualitative Analysis: Interview Targets and Issues for Discussion Interview Targets Government agencies and ministries Private sector and other institutions Clusters and • Ministry of Trade and Industry or other ministry • Individual exporters (small/new and established) across industry bodies with responsibility for clusters, sectors, and traditional and emerging sectors industrial policy • Established cluster and industry representative bodies • Any relevant local or regional government • Universities and training institutions • National Competitiveness Council (if established) • Relevant research institutions Subsidies and • Ministry of Trade and Industry or other ministry • Individual exporters (small/new and established) across incentives to with responsibility for administering incentive traditional and emerging sectors sectors and regimes • Established cluster and industry representative bodies exporters • Export promotion agency Key Issues for Discussion in Interviews with Government Agencies and Ministries Industry bodies • What is the nature of interaction between industry bodies and government? • Does the government provide financial or other support to facilitate the creation and sustainability of industry associations? What are constraints to more collective action on part of industry/exporters? • What role do they see for industry bodies going forward? Clusters • Do they take a sectoral or cluster approach? • What sectors/clusters are officially being supported with policy? How are these chosen? • How are they organized to deliver support? • What public goods are they focused on delivering? Subsidies and incentives • What subsidy and incentive programs do they offer to exporters? to sectors and exporters • What is the take-up rate on these? What constraints are there to higher take-up (awareness, administrative burdens, and so on)? • Are they monitoring the cost and impact of these programs? What are the results? Trade Promotion Infrastructure: Industry Coordination and Sector Support 145 Key Issues for Discussion in Interviews with the Private Sector and Other Institutions Industry bodies • What is the level and nature of membership? • What share of members are exporters? • What are the main services they offer? • What specific services for exporters? • What is the nature of interaction between industry bodies and government? • What are constraints to more collective action on part of industry/exporters? Clusters • How are the clusters organized? What is the role of private and public sector and other institutions? • How are they funded? Is it sustainable? • How effective is public-private dialogue? • What public goods are being delivered through the cluster or provided by government? • To what degree does the cluster actually contribute to greater competitiveness for individual exporters? Subsidies and incentives • What subsidy and incentive programs are available? to sectors and exporters • Do exporters take advantage of these? What constraints are there to higher take-up (awareness, administrative burdens, and so on)? Tailoring the Diagnostics to Country and Sector Characteristics Summary of Specific Considerations by Country Type Country type Relative priorities and issues for consideration Module 2 Small (population) and • May have limited scale through which to support clusters in many industries; it is critical that remote/landlocked sectoral support be tightly matched with comparative advantage • Industry bodies likely to be dominated by a small group (elite) Resource rich • May be strong industry bodies from natural resources sectors (potentially dominated by FDI) with effective lobbying • Role of subsidies and incentives may be important to probe; how effective is the incentive structure in facilitating investment in sectors in which the country has comparative advantage? Low income, labor abundant • Building capacity of industry bodies and clusters should be a priority Middle income • May have well-established, strong industry bodies • Emphasis on cluster support to facilitate innovation and upgrading Industry representation, cluster, and sector support will and associated institutions operating in the same broad vary tremendously across sector and country. In this respect, field, and usually is located within a relatively narrow geo- there are no specific considerations inherent to the sector. graphic area (World Bank 2009b). Cluster support differs fundamentally from traditional industrial-policy-inspired sectoral approaches principally in their focus on related Background Reading: Relationship Between Industry and supporting institutions, their preoccupation with Coordination and Sector Support and Trade competitiveness, and their openness to imports and Competitiveness foreign investment. Governments provide a range of support targeted to indi- Clusters contribute to competitiveness by offering a rich vidual sectors, which may be specifically targeted to promote environment for realizing externalities, including access to export competitiveness or may do so implicitly. In the past, specialized labor, specialized suppliers, and knowledge such support normally came under the banner of “industrial spillovers. This allows individual firms to realize the bene- policy� and targeted specific sectors according to their tra- fits of scale economies, contributing to greater productivity ditional importance to the economy or their potential to act and innovation (for example, the ICT clusters in Silicon as a catalyst for diversification and upgrading. Although Valley in the United States and Bangalore in India). As clus- such targeted sector policy remains popular in many coun- ters rely on external scale economies, however, they face a tries, more recently, government intervention has focused challenge of collective action. Thus, the government often on a comprehensive cluster approach. A cluster is an has an important role to play in facilitating clusters, partic- agglomeration of companies, suppliers, service providers, ularly in cases in which the cluster remains latent and in 146 Module 2: Competitiveness Diagnostics countries and regions in which cooperation is lacking. as such, are important to consider when evaluating a coun- Governments support clusters in various ways, including try’s performance in global trade, particularly within facilitation of dialogue to overcome coordination chal- specific sectors. lenges, and support for the provision of public goods to It is beyond the scope of this Diagnostic to assess enable clusters to realize opportunities for scale or quality the performance of individual clusters and of sectors upgrading (see box 2.21). Because many clusters in their more broadly. The more relevant issue is to understand initial stages are composed of companies that may compete the nature of government policy support to clusters and aggressively in domestic markets, facilitating clusters to the degree to which it is playing a positive role in sup- address export market opportunities can be a valuable first porting competitiveness. Components of support that step to cluster development. can be assessed include the following: Many governments around the world offer a range of subsidies and incentives to promote exports—in many • The degree to which cluster support is targeted to indus- cases, linked with some of the instruments discussed thus tries with comparative advantage: Too often, cluster far. Such incentives may include direct subsidies, low-cost strategies target areas beyond what is reasonable for a loans, or tax relief. Export subsidies are most commonly country to become competitive in, even in the medium applied in the agricultural sector, in which the establish- term (for example, biotech and nanotech). Good prac- ment of price floors (as part of income support programs tice cluster approaches focus on sectors in which the for farmers) encourages overproduction.20 It is also country or region has already shown some success or in common in other sectors in which governments want to which it has a clear source of comparative advantage. encourage production for export rather than domestic • The institutional structure for delivery of sector and clus- markets, or in which export sectors are seen as particularly ter support: Good practice would call for participation important to protect (for example, the automotive indus- of both national and local or regional government as Module 2 try in South Africa and elsewhere, the textile and garments well the private sector and other institutions such as sector in India, and so on). universities, training centers, and so on. Within gov- Several arguments have been raised to support govern- ernment, interministerial coordination is critical to ment intervention to subsidize exports, most notably, the success. case of “infant industries�—that learning by doing and • The role of the private sector in driving the initiatives: external scale, in combination with imperfect capital mar- Although the government has a clear role, the most suc- kets (information asymmetries), justify temporary indus- cessful cluster initiatives are, at least in time, strongly try protection through such schemes as export incentives private sector driven with active commitment from the and subsidies. Many such schemes create significant mar- leading companies, both domestic and foreign-owned. ket distortions and may not be compatible with WTO agreements. Although subsidies may not affect underlying A wide range of incentives and subsidy regimes have firm competitiveness (and may be harmful to competitive- been developed to support exporters. Among the most ness in the long run), they do alter the terms of trade and, common are the following: Box 2.21. Upgrading Quality for Competitiveness in Pakistan’s Sialkot Surgical Instruments Cluster Of Pakistan’s clusters, the one with most success in exporting has been Sialkot’s surgical instrument cluster. The city hosts around 300 producer firms, supported by more than 2,000 subcontracted supplier firms. Together, the firms produce more than 2,000 different types of surgical instruments, most of which are exported to the United States (59 percent) and Europe (27 percent), making Pakistan the world’s second-largest exporter of surgical instruments (Nadvi 1997). The vast majority of firms in Sialkot’s surgical instrument cluster are composed of SMEs with less than 20 employees, mostly family run. These firms share a defining characteristic—that is, a vast social network between firms at all levels. The industry faced a serious crisis in the mid-1990s when the US Food and Drug Administration revealed that Sialkot surgical instruments failed to meet quality standards (under the Good Manufacturing Practice System) and thus prohibited import of its products. The industry had no choice but to adapt. Under the effective guidance of two existing local institutions, the Surgical Instrument Manufacturers Association and Sialkot’s chamber of commerce, the cluster achieved rapid quality upgrades, resulting in the US embargo being dropped. By 1996, the industry more than recovered its market, exporting 10 percent more than in previous years. The cluster has been able to respond successfully to subsequent quality challenges, and a number of firms in the cluster have adopted the ISO 9000 quality standard. The surgical instruments sector is now Pakistan’s second in numbers of quality-certified firms, with the textile sector in first place. Source: UNIDO 2006. Trade Promotion Infrastructure: Industry Coordination and Sector Support 147 Box 2.22. WTO Prohibitions against Export Subsidies—the SCM Agreement Article 3 of the Agreement on Subsidies and Countervailing Measures (SCM) identifies export subsidies as prohibited and provides clear examples of interventions that constitute export subsidies. The SCM Agreement defines export subsidies as subsidies that are contingent in law or in fact upon export performance. Examples of prohibited export subsidies include (but are not limited to) the following: • A direct subsidy contingent on export performance • Currency-retention schemes involving a bonus on exports • Preferential transport and freight charges for export shipments • Provision of domestic products and services for exports at terms more favorable than those for domestic goods • Exemption, remission, or deferral of direct taxes or social welfare charges if contingent on exports • Allowance of special direct tax deductions for exports above those granted on goods for domestic consumption • Exemption or remission of indirect taxes on exports in excess of those on goods sold for domestic consumption • Exemption, remission, or deferral of prior-stage cumulative taxes on goods or services used in the production of exported products in excess of products sold for domestic consumption (except for the exemption, remission, or deferral of such taxes on “inputs consumed� in the production process) • Provision of export credit guarantees or insurance programs at premium rates inadequate to cover long-term costs • Grants of export credits at rates below those that they pay for the funds, or at below market rates, or payment of all or part of the costs of obtaining credit. Source: Creskoff and Walkenhorst 2009. • Direct subsidization of exports: This may be on a nomi- • R&D or training subsidies: These tend to be less directly nal or an ad valorem basis. linked with exports. Module 2 • Transport subsidies: This involves cost reduction or refund • Tax incentives: These include tax holidays or reductions on transport or customs-related costs for exporters; it is linked to export participation or export volumes. most commonly used when transport costs rise substan- tially (for example, to mitigate the impact of petroleum Many of these incentives, however, are not compliant price increases on exporters reliant on air cargo). with WTO agreements, as outlined in box 2.22. 148 Module 2: Competitiveness Diagnostics Trade Promotion Infrastructure: Innovation Link with Competitiveness Challenges Identified in Trade Outcomes Competitiveness challenge areas General export Cost- Product extension Market Main components in innovation environment Competitiveness and quality penetration Product Innovation ✓ Process Innovation ✓ ✓ Quantitative Analysis: Indicators and Data Sources Stage of development Indicator Sector relevance relevance Measure/Description Source A. Absorption and Innovation Local Capacity A1. Scientific/Design Capabilities Patent applications, all most science all but mostly Worldwide patent applications filed through World Intellectual Property nonresidents based and scale middle the Patent Cooperation Treaty procedure or Organization (WIPO), intensive income with a national patent office for exclusive WIPO Patent Report: Module 2 rights for an invention—provides Statistics on Worldwide protection for the invention to the owner Patent Activity of the patent for a limited period, generally 20 years. Patent applications, residents Patents in the Number of patents filed in the United States US Patent and Trademark United States by residents of a country. Office Patents in Europe Number of patents filed in the European European Patent Office Union by residents of a country. Trademark all but mostly all Trademark applications filed are applications WIPO, WIPO Patent applications, supplier to register a trademark with a national or Report: Statistics on direct nonresident dominated and regional Intellectual Property (IP) office. A Worldwide Patent specialized trademark is a distinctive sign that identifies Activity suppliers certain goods or services as those produced or provided by a specific person or enterprise. A trademark provides protection to the owner by ensuring the exclusive right to use it to identify goods or services or to authorize another to use it in return for payment. Trademark applications, direct resident Royalty and license all but mostly all but mostly Royalty and license fees are payments and International Monetary fees, receipts science based also middle receipts between residents and Fund, BoP Statistics (balance of nature based income nonresidents for the authorized use of Yearbook and data files payments [BoP], intangible, nonproduced, nonfinancial current US$) assets and proprietary rights (such as patents, copyrights, trademarks, industrial processes, and franchises) and for the use, through licensing agreements, of produced originals of prototypes (such as films and manuscripts). Data are in current US dollars. Licenses Percent of establishments in the World Bank Enterprise country/sector that have purchased either a Surveys foreign or local license. Trade Promotion Infrastructure: Innovation 149 Researchers in R&D all but mostly Researchers in R&D are professionals engaged WDI (per million science based in the conception or creation of new people) knowledge, products, processes, methods, or systems and in the management of the projects concerned. Postgraduate doctoral students engaged in R&D are included. Research and Expenditures for research and development development are current and capital expenditures (both expenditure public and private) on creative work (percent of GDP) undertaken systematically to increase knowledge, including knowledge of humanity, culture, and society, and the use of knowledge for new applications. R&D covers basic research, applied research, and experimental development. Scientific and Scientific and technical journal articles refer to National Science technical journal the number of scientific and engineering Foundation, Science and articles articles published in the following fields: Engineering Indicators physics, biology, chemistry, mathematics, clinical medicine, biomedical research, engineering and technology, and earth and space sciences Quality of scientific all all but mostly “To what extent do you agree that your World Economic Forum research middle country has adequate scientific research Global Competitiveness institutions income institutions available? 1 = Disagree strongly, Index (GCI) 5 = Agree strongly. A2. IPR/Certification Module 2 Intellectual property all all “How would you rate intellectual property GCI protection protection, including anticounterfeiting measures, in your country?� 1 = Very weak, 7 = Very strong, International all but mostly Percent of establishments in the Enterprise Surveys Certifications exporters country/sector that have an (ISO) ISO certification, A3. Human Capital Technicians in R&D all all but mostly Technicians in R&D and equivalent staff are WDI (per million middle people whose main tasks require technical people) income knowledge and experience in engineering, physical and life sciences (technicians), or social sciences and humanities (equivalent staff). They participate in R&D by performing scientific and technical tasks involving the application of concepts and operational methods, normally under the supervision of researchers. Availability of all mostly science “To what extent do you agree that scientists GCI scientists and based and engineers in your country are widely engineers available?� 1 = Disagree strongly, 5 = Agree strongly. Enrollment in all Registered students in STEM. Country statistics Science, Technology, Engineering, Mathematics (STEM) disciplines School enrollment, Gross enrollment ratio is the ratio of total United Nations tertiary (percent enrollment, regardless of age, to the Educational, Scientific, gross) population of the age-group that officially and Cultural corresponds to the level of education Organization (UNESCO) shown. Tertiary education, whether or not Institute for Statistics to an advanced research qualification, normally requires, as a minimum condition of admission, the successful completion of education at the secondary level. 150 Module 2: Competitiveness Diagnostics Share of population all but less supplier Economic Growth Center speaking English dominated at Yale University Percent of tertiary- Docquier and Marfouk educated (2004) individuals in OECD countries A4. Production Capabilities State of cluster all, mostly supplier all, mostly low “In your country, how extensive is GCI development dominated and income collaboration among firms, suppliers, specialized partners, and associated institutions within suppliers clusters?� 1 = Collaboration is nonexistent, 7 = Collaboration is extensive. Local availability of all all “In your country, to what extent are high- specialized quality specialized training services research and available?� 1= not available, 7= widely training services available. University-industry “To what extent do business and universities collaboration collaborate on research and development (R&D) in your country?� 1 = Do not collaborate at all, 7 = Collaborate extensively. Production process “In your country, how sophisticated are sophistication production processes?� 1 = Not at all— labor-intensive methods or previous generations of process technology prevail, Module 2 7 = Highly—the world’s best and most efficient process technology prevails. A5. Finance Domestic credit all all Domestic credit provided by the banking WDI provided by sector includes all credit to various sectors banking sector on a gross basis, with the exception of credit (percent of GDP) to the central government, which is net. Access to finance all all “Is there sufficient access to financing, which Enterprise Surveys includes availability and cost [interest rates, fees, and collateral requirements]?� Measures share of firms that identify it as a major obstacle to doing business. B. Exposure to External Technology FDI net inflows all all percent of GDP WDI FDI in all all percent of total FDI Country investment manufacturing statistics Inward FDI potential all all 0–1 UNCTAD index FDI and technology all all “To what extent does FDI bring new GCI transfer technology into your country?� 1 = Not at all, 7 = FDI is a key source of new technology. Royalty and license all all but mostly BoP, current US dollars IMF, BoP Statistics fees, payments middle Yearbook and data files. income Imports of high-tech all all percent of GDP CEPII BACI (Base pour goods l’Analyse du Commerce) Imports of high-tech all all percent of GDP database capital goods Imports of all all percent of GDP intermediary goods Foreign all all percent of all inputs that are foreign by World Bank ES intermediate country/sector inputs Trade Promotion Infrastructure: Innovation 151 C. Penetration of Older Technologies Electrical power all all kilowatt-hours/capita WDI consumption International all all minutes outgoing telephone traffic Air transport, all all registered carrier departures worldwide Agricultural all all per 100 hectares of arable land machinery: tractors Main lines all all per 100 inhabitants D. Penetration of Recent Technologies Internet users all all per 1,000 inhabitants WDI Personal computers all all per 1,000 inhabitants Cellular subscribers all all per 100 inhabitants Percentage of digital all all per 100 inhabitants mainlines Qualitative Analysis: Interview Targets and Issues for Discussion Module 2 Interview Targets for Field Research on Innovation Innovation issue Government agencies and ministries Private sector and other institutions A.1/A3. Skills (scientific, design • Education Ministry • Universities capabilities/human capital) • Science and Technology Ministry • Training Institutions • NGOs A.2. IPR/Certification • Standards and Norms Agency • NGOs or donor-funded agencies that promote • Patent and Trademark Agency certification and standards adoption A4. Production Capabilities • Ministry of Industry • Chambers of commerce • Business/cluster associations • Incubator associations A5. Finance • Science and Technology Ministry • Banks • Ministry of Finance/Economy • Microfinance institutions • Venture capital associations B. Exposure to External Technology • Ministry of Industry • Universities’ tech transfer offices • Investment promotion agencies Key Issues for Discussion in Interviews with Government Agencies and Ministries Education Ministry • Promotion of STEM careers? • Funding of doctoral studies in local and foreign universities • Percentage of return of foreign-trained doctors Science and Technology • What is the amount of government funds to R&D? Ministry • Which type of R&D (basic applied) is funded? • What are the mechanisms to fund R&D: through public R&D labs, higher education institutions, or the private sector? • Who keeps the IP of inventions discovered with government-funded R&D? Standards and Norms Agency • Type of certification more demanded by firms • Sectors with highest demand • Are standards usually adopted by large firms? By SMEs? 152 Module 2: Competitiveness Diagnostics Patent and Trademark Agency • Extent of use of IPR in its different modalities: local patents, utility models and industrial designs • Does the local IPR agency also provide guidance in international patenting (for example, the United States and Europe)? Ministry of Industry • Is there a strategy/policy for innovation? What are the main components? • Is there a special tax treatment for R&D investments? • What are the policies related to cluster development? Ministry of Finance/Economy • Is there a special tax treatment for R&D investments? • What is the amount devoted for government-funded R&D? Investment Promotion Agencies • FDI legal regime: do foreign investors have the same legal rights as local investors? • What are the incentives that MNCs receive for installing plants in the host country? For technology licensing? • Do the incentives differ by sector? Key Issues for Discussion in Interviews with Private Sector and other Institutions Universities • Are there tech transfer offices in the university? • What about spin-off companies initiated by professors? • Structure of the R&D funding: own funds, government-funded R&D, private sector–funded R&D • Joint applications with firms to government-funded R&D Training institutions • Are there tech transfer offices in the institution? • What about spin-off companies initiated by professors? • Structure of the R&D funding: own funds, government-funded R&D, private sector–funded R&D Module 2 • Joint applications with firms to government-funded R&D NGOs and donor-funded • What programs exist to promote standards adoption? agencies • What are the main shortcomings in the current standards and certification regime? Chambers of commerce • What is the role of public and private sectors on the organization and structure of production clusters? • Issues with access to government funding and programs • Linkages between local firms and FDI • Schemes to link firms with universities Business associations • Use of government-funded R&D • Use of financial institutions funding for R&D • Schemes to link producers with input suppliers Banks • Funds for R&D—basic • Funds for R&D—applied • Funding for early stage research • Is any sector(s) prioritized? Microfinance institutions • Funds for R&D—basic • Funds for R&D—applied • Funding for early stage research • Is any sector(s) prioritized? Venture capital associations • Funds for R&D—basic • Funds for R&D—applied • Funding for early stage research • Is any sector(s) prioritized? Analytical Approach hand. First, the speed with which a country absorbs and adopts technology depends on many factors, including the The analytical framework distinguishes between the factors extent to which a country has a technologically literate that dictate the efficiency with which an economy absorbs workforce and a highly skilled elite; promotes production and creates technology, on the one hand, and the extent to capabilities that encourage investment and the creation which it is exposed to external technologies, on the other Trade Promotion Infrastructure: Innovation 153 and expansion of firms using high-technology processes; trade competitiveness, taking into account the importance permits access to capital; and has adequate public sector of innovation dimensions for each innovation pattern, in institutions to promote the diffusion of critical technolo- terms of (1) whether these measures are likely to have an gies for which private demand or market forces are inade- impact on export diversity or export sophistication— quate. Second, among the most important channels specifically, in terms of new products for the former and through which low- and middle-income countries are quality upgrading for the latter; (2) how these measures exposed to foreign technologies are trade, FDI, and con- affect the cost-competitiveness of exporters. For example, if tacts with highly skilled diaspora members (nationals traditional manufacturing is important in an economy and working abroad) and with other information networks, therefore supplier dominated is the prevalent innovation including those of academia and the media. pattern, design capabilities and certification compliance are The framework considers four key dimensions: A. likely to be vital for both introducing new products and Absorption and Innovation Local Capacity, B. Exposure to upgrading existing products. As explained, the nature of External Technology, C. Penetration of Older Technologies, innovation in supplier-dominated sectors is not based on and D. Penetration of Recent Technologies. The assessment developing new technologies but rather on improving will collect its data from two components: (1) a quantita- designs and branding. This innovation pattern relies on tive part that uses secondary sources to capture innovation technology embodied in foreign capital goods; therefore, metrics; and (2) a qualitative section to be formulated to exposure to external technology is paramount. A big oppor- key actors in the innovation ecosystem, both in the public tunity to innovate resides in improving production and private spheres as well as the nonprofit. processes using embodied new technology and human cap- Previous sections have stressed the particularities of dif- ital held by technicians and engineers. The funding needed ferent innovation patterns. Table 2.9 provides a summary of in traditional industries to enter the market is usually low the degree of influence of each innovation dimension on compared with higher entry barriers in all other sectors. Module 2 Table 2.9. Framework for Analysis of Innovation Characteristics and Trade Competitiveness Diversification: New Sophistication: Product Cost saving: New products upgrading processes A. Absorption and Innovation Local Capacity A1. Scientific/Design Capabilities SD *** design SD *** design Not determinant SI *** both SI *** both SS *** both SS *** both SB ***scientific SB ***scientific A2. IPR/Certification SD ** certification SD * certification Not relevant might SI * **IPR SI *IP even increase costs SS *** IPR SS * IPR SB ***IPR SB *IPR A3. Human Capital SD * SD * SD ** SI ** SI ** SI ** SS ** SS ** SS ** SB *** SB *** SB ** A4. Production Capabilities All*** All*** All*** A5. Finance SD * SD * SD * SI ** SI ** SI * SS *** SS *** SS * SB ** SB ** SB * B. Exposure to External Technology All *** All *** All *** C. Penetration of Older Technologies All *** All *** All *** D. Penetration of Recent Technologies SD ** SD ** SD * SI *** SI *** SI ** SS *** SS *** SS ** SB *** SB *** SB ** Source: Authors. Note: SD = supplier dominated; SI = scale Intensive; SS = specialized suppliers; SB = science based. *important, **more important, ***very important. 154 Module 2: Competitiveness Diagnostics Tailoring the Diagnostics to Country and Sector Characteristics Summary of Specific Considerations by Country Type Country type Relative priorities and issues for consideration Small (population) and • May have limited scale and market access to support leading-edge innovation remote/landlocked • However, obtaining knowledge through suppliers may be restricted because of difficulties in access • Certification and standards-related issues may be important barriers Resource rich • May have strong technical skills linked to the resource sector that could be applied to support upgrading and diversification • Important to understand whether linkages with local firms (or lack of them) are supporting (restricting) knowledge spillovers Low income, labor • Focus on technology absorption and generating spillovers from FDI abundant • Certification and standards-related issues may be important barriers • Technology transfer policies and institutions may be critical to assess Middle income • Main challenges will be in developing scientific and design capabilities • Access to recent technologies likely to be a critical issue • IPR and patenting issues likely to be important to attracting science-based activity • Skills development, particularly tertiary education critical • Assess role of industry-university linkages and government research institutions To better understand a country’s innovative capabilities, it increase the diversity and sophistication of the products Module 2 is necessary to map the country’s economic and export they produce and export (UNIDO 2009). Diversification structures to understand specific sectoral patterns. Using tends to be more important for countries climbing the table 2.10, we can classify specific industries according to stages of development. Imbs and Wacziarg (2003) find an the innovation patterns and export propensity. Table 2.10 inverse U-shaped relationship between specialization in provides a guideline to match innovation patterns with production and exports and per capita income. As incomes International Standard Industrial Classification (ISIC) and rise, countries diversify their production and export struc- the OECD classification of industries using sectoral tech- tures. New product lines are introduced and new activities nological content. are taken up within existing sectors until countries reach The reclassification exercise provides a tool for identify- high levels of income. They also find that poor countries ing main innovation patterns in a country’s economy. Nev- and—to a lesser degree—rich countries tend to specialize ertheless, not all manufacturing or services sectors show the in the production of a fairly narrow range of activities. same degree of tradability in external markets nor the same Across a wide range of incomes, however, the diversity of potential for product differentiation (a proxy of production what a country produces increases with the level of per and export diversification). We can link then the economic capita income. sector structure with its tradability and its potential diversi- In most cases, when diversification and sophisti- fication using table 2.11. Manufacturing products are the cation are coupled, they are an outcome of “moving up most tradable, especially in R&D-intensive manufacturing the production ladder� from relatively simple mass- and manufacturing (see table note to table 2.11 for detailed manufacturing activities, such as textiles or footwear, to industry list). Services are not highly tradable. Product dif- increasingly more complex production processes, such as ferentiation varies within services subsectors as well as in metal-mechanical, chemical, or electronics industries. manufacturing subsectors. Indeed, although successful low-income countries tend to expand their export market share of unskilled labor- intensive products, success for middle-income countries Background Reading: Relationship Between typically involves moving vigorously up the ladder of prod- Innovation and Trade Competitiveness uct sophistication. Diversification is fostered through a Diversification and sophistication are important dimen- strong network of linkages generated across economic sec- sions of trade performance. Recent research suggests that tors. Linkages to other sectors of the economy are related the developing countries that have been more successful in with trade because industrial diversification appears to terms of growth of both exports and output have tended to lead to export diversification. More diverse economies may Trade Promotion Infrastructure: Innovation 155 Table 2.10. Comparative Industrial Classification OECD Technology Intensity Index Index R&D/Production Aggregate Median ISIC Rev. 31 Innovation Patterns intensity 2 Intensity High-technology industries Aircraft and spacecraft 353 Science based/scale intensive 10.3 10.4 Pharmaceuticals 2423 Science based 10.5 10.1 Office, accounting, and computing machinery 30 Science based/scale intensive 7.2 4.6 Radio, television, and communications equipment 32 Science based/scale intensive 7.4 7.6 Medical, precision, and optical instruments 33 Specialized suppliers 9.7 5.6 Medium-high-technology industries Electrical machinery and apparatus, n.e.s. 31 Scale intensive 3.6 2.3 Motor vehicles, trailers, and semitrailers 34 Scale intensive 3.5 2.8 Chemicals excluding pharmaceuticals 24 excl. 2423 Science based 2.9 2.2 Railroad equipment and transport equipment, n.e.s. 352 + 359 Scale intensive 3.1 2.8 Machinery and equipment, n.e.s. 29 Specialized suppliers 2.2 2.1 Medium-low-technology industries Building and repairing of ships and boats 351 Specialized suppliers 1 1 Rubber and plastics products 25 Scale intensive 1 1.1 Coke, refined petroleum products, and nuclear fuel 23 Scale intensive 0.4 0.3 Other nonmetallic mineral products 26 Scale intensive 0.8 0.6 Basic metals and fabricated metal products 27–28 Scale intensive 0.6 0.5 Module 2 Low-technology industries Manufacturing, n.e.s.; recycling 36–37 N/A 0.5 0.5 Wood, pulp, paper, paper products, printing, and publishing 20–22 Supplier dominated 0.4 0.1 Food products, beverages, and tobacco 15–16 Scale intensive 0.3 0.3 Textiles, textile products, leather, and footwear 17–19 Supplier dominated 0.3 0.4 Total manufacturing 15–37 2.6 2.2 Sources: Author’s elaboration using OECD (2003), Pavitt (1984), and UN ISIC. Note: n.e.s. = not otherwise specified; N/A = not applicable; Technology Intensity Index calculated as R&D expenditure as a share of production value. Table 2.11. Sectoral Groups According to Degrees of Tradability and Differentiation Sectors Tradabilitya Product differentiation 1. Infrastructure services Low Low 2. Local services Low Medium 3. Business services Low/medium High 4. R&D-intensive manufacturing High High 5. Manufacturing High Low 6. Resource-intensive industries Medium Medium Source: Author’s adaptation from McKinsey Global Institute (2010a). Note: SD = supplier dominated; SI = scale Intensive; SS = specialized suppliers; SB = science based. 1 = Infrastructure services: electricity, construction, hotels and restaurants, land transport; 2 = Local services: real state, post, telecommunications, wholesale and retail, finance and insurance; 3 = Business services: R&D, computers and related activities; 4 = R&D-intensive manufacturing: pharmaceuticals, radio, television, communication equipment, chemicals, aircraft and spacecraft, medical instruments. (Comment: Mostly SB, SI, SS); 5 = Manufacturing: motor vehicles, machinery, and equipment. (Comment: Mostly SI, SS); 6 = Resource-intensive manufacturing: pulp, paper, printing, publishing, wood products, rubber and plastics, basic metals, fabricated metals, agriculture, forestry and fishing. (Comment: Mostly SI, SD). a. Tradability is calculated by (M + X)/sector GDP. be better able to take advantage of export opportunities in As a major driver of economic growth and productivity, global markets. Finland’s wood industry and its movement innovation21 has an obvious impact on exports and trade up the production ladder provides an example of indus- competitiveness. First, innovation in the form of new trial and export diversification and sophistication through products increases diversification, whereas sophistication linkages with other sectors (see box 2.23). is fostered by quality upgrading. Recent research in the 156 Module 2: Competitiveness Diagnostics Box 2.23. Moving up the Production Ladder in Finland—Sector Linkages, Diversification, Sophistication, and Exports Finland’s exports 1900–1996 5000 Chemicals Exports MUS$ 4000 Machinery 3000 2000 Cellulose and paper 1000 Wood, wood products, and furniture 1900 1920 1950 1970 1996 Year Source: Hernesniemi, Lammi, and Ylä-Anttila 1996. Finland is an example where linkages to domestic suppliers sprout diversification and sophistication from the wood and paper industry. During the first development phase (approximately from the early 1900s to the mid-1950s), native wood was only minimally processed before being exported, and the majority of required capital goods and production inputs were imported. During a second phase, which lasted until 1970, industries that processed wood into cellulose, paper, and cardboard were established. All the engineering services required in the value chains were provided by local companies and the first local technology-intensive suppliers came into being and developed rapidly. The development after 1970 is characterized by increasing exports of high-valued wood, paper, and chemical products as well as machinery and equipment (Hernesniemi et al. 1996). In Module 2 2005, instruments, electro machinery, processing machinery, and transport equipment were already important export products of the Finnish economy representing 21 percent of all exports. Source: Torres-Fuchslocher 2010. manufacturing sector has found an influence from product (2008) support this idea by showing the link between innovation to productivity and then to exporting, which exporting to process innovation and subsequently from may explain how a firm’s decision to invest in R&D and process innovation to productivity growth using panel data make product innovations drives its productivity and from Slovenian firms between 1996 and 2002. triggers the decision to start exporting (Cassiman and Martìnez-Ros 2007). Additionally, participation in global Main Components of Innovation Analysis—Understanding production through exports provides firms with access to Patterns of Innovation knowledge to meet requirements of product quality; deliv- ery time; process efficiency; and environmental, labor, and There are a number of sources by which firms acquire social standards. Mastering the requirements of global pro- knowledge and innovate. Certain innovation patterns are duction (“learning by exporting�) builds a platform for more relevant for certain economic structures, and their local innovations in more sophisticated products (Gereffi, importance varies by country. Within each pattern, firms Humphrey, and Sturgeon 2005). tend to have a predominant learning and innovation Second, exporting may imply the reduction of ineffi- behavior regarding main sources of technical change, ciencies through the renewal of production processes with dependence on basic or applied research, modes of R&D resulting cost savings. Process innovations may have labor, (in-house or extramural R&D), use of tacitness or codified capital, and inputs saving effects and therefore are expected nature of knowledge, scale and relevance of R&D activity, to result in significant productivity growth (Hall, Lotti, and and degree of appropriability of the innovations. Mairesse 2007; Harrison et al. 2005). Through persistently Table 2.12 provides the taxonomy of the different inno- performing an activity over time, a firm may accumulate vation patterns, the economic sectors that make up each skills and knowledge as well as learn how to organize and pattern, their main components of innovation, and typical manage the activity in an effective manner (Andersson and firm size. It is influenced heavily by Pavitt’s (1994) work Lööf 2009). For example, Damijan, Kostevc, and Polanec on sectoral innovation patterns in manufacturing as well Trade Promotion Infrastructure: Innovation 157 Table 2.12. Sector Innovation Patterns and the Main Components of Learning and Innovation Typical Broad sector Industries firm size Learning Innovation components and characteristics Traditional Textiles and apparel, SME Mainly supplier Most new techniques originate from machinery manufacturing footwear, furniture, driven and chemical industries tiles Opportunity for technological accumulation is focused on improvements and modifications in production methods and associated inputs, and on product design Most technology is transferred internationally, embodied in capital goods Low appropriability, low entry barriers Innovation takes the form of new designs and branding; trademarks would be the ideal way to appropriate innovation efforts Natural Sugar, tobacco, wine, Large Supplier driven, Importance of basic and applied research led by resource based fruit, milk, mining science based public research institutes due to low appropriability industry of knowledge Innovation is also spurred by suppliers (machinery, seeds, chemicals, and so on) Increasing importance of international sanitary and quality standards, and of patents Low appropriability of knowledge, but high for input suppliers Complex Automobile and auto Large Scale intensive Technological accumulation is generated by the Module 2 products components, aircraft, and also design, building, and operation of complex consumer electronics, science-based production systems or products pharmaceuticals firms In-house R&D is critical for innovation Process and product technologies develop incrementally In consumer electronics, technological accumulation emerges mainly from corporate R&D laboratories and universities; there is a skill entry barrier Appropriability is medium, high Specialized Software, precision SME Specialized Important user-producer interactions; learning from suppliers equipment suppliers advanced users Low barriers to entry and low appropriability High in-house R&D for development of cutting-edge technologies Sources: Author’s elaboration based on Pavitt (1984) and Giulani, Pietrobelli, and Rabellotti (2005). as by recent developments (Giuliani, Pietrobelli, and in competitiveness. Scale economies and barriers to entry Rabellotti 2005) and the inclusion of the services sectors are generally low. The final market grows slowly, with (Castellacci 2008). income elasticities below unity. There are exceptions Traditional manufacturing includes labor-intensive and to these features, however,. There are particular low- mature technology industries, such as textiles, footwear, technology products in high-quality segments for which tiles, and furniture. This group of industries tends to have brand names, skills, design, and technological sophistica- stable, well-diffused technologies. SMEs dominate the tra- tion carry large value added, even if technology intensity ditional manufacturing sectors. These sectors are defined does not reach the levels of other innovation patterns as supplier dominated because producers of inputs (Lall 2000). (machinery, materials, and the like) introduce major Firms in traditional manufacturing can upgrade their process innovations (Pavitt 1984). The technologies are products (and processes) by developing or imitating new primarily embodied in the capital equipment; the low end products’ designs, and by interacting with large buyers of the range has relatively simple skill requirements. Many who are increasingly playing a role in shaping the design traded products are undifferentiated and compete on of final products and the production process (time, qual- price: Thus, labor costs tend to be a major element of cost ity standards, and costs). The production of traditional 158 Module 2: Competitiveness Diagnostics manufactures has undergone massive relocation from rich firms that take advantage of the economies of scale intrinsic to poor countries, with assembly operations shifting to to the sector’s technologies. Complex product industries low-wage sites and complex design and manufacturing can be separated further using Pavitt’s (1984) categories of functions retained in industrial countries. This relocation science-based industries and scale-intensive sectors. has been the engine of export growth in this industry, First, science-based industries have an innovation pattern though the precise location of export sites in textiles, and that is closest to the traditional linear model of innovation, clothing has been influenced strongly by trade quotas and for which in-house R&D is critical for innovation (see trade agreements (Gereffi, Humphrey, and Sturgeon 2005). box 2.24). Science-based innovation has five stages: funda- Other exports that have benefited from active relocation in mental research, applied research, engineering development, this group are toys, sports and travel goods, and footwear production engineering, and service engineering (Balconi, (Lall 2000). Brusoni, and Orsenigo 2008). Innovations are appropri- The natural resource-based sector activities imply the ated by the inventor and take the form of a large number of direct exploitation of natural resources, for example, patents. Their products have advanced and fast-changing copper, marble, or fresh fruit. The output of extractive technologies. The most advanced technologies require industries is the internationally standardized product. For sophisticated technology infrastructures, high levels of spe- example, copper produced by a mine in Latin America is cialized technical skills, and close interactions among firms likely to be identical to copper produced in Zambia. An and between firms and universities or research institutions. implication is that downstream integration from commod- Some products like electronics have labor-intensive final ity extraction often fails because buyers can choose any assembly, and their high value-to-weight ratios make it producer of such standardized goods. To date, however, economical to place this stage in low-wage areas. These such downstream activities have often been the main focus tend to be lead products in international integrated pro- of government attempts to broaden the economy from its duction systems for which different processes are separated Module 2 extractive industries base (UNIDO 2009). Traditional and located by MNCs according to fine differences in pro- manufacturing and natural resource-based sectors are, by duction costs. far, the most common in developing countries. Second, scale-intensive industries are the heartland of The complex products group includes automobiles, auto industrial activity in mature economies. They tend to have components, aircraft, ICT, and consumer electronics, complex technologies, with moderately high levels of R&D, among others. These industries are dominated by large advanced skill needs, and lengthy learning periods. Those in Box 2.24. Linear Model of Innovation The linear model of innovation is associated with V. Bush, who claimed that scientific progress is essential to technological innovation and economic development. This thesis was laid out in a policy paper meant to raise support for public funding of basic research (Bush 1945). Basic research is performed without thought of practical ends. It results in general knowledge and an understanding of nature and its laws. The scientist doing basic research may not be interested in the practical applications of his work, yet the further progress of industrial development eventually would stagnate if basic scientific research were long neglected. In general, science does remain an important condition and component of technological progress, and one that is fundamental in science-based industries (for example, consumer electronics, pharmaceuticals, aircraft and spacecraft, and so on). See tables 2.10 and 2.11 for a list of science-based sectors. The linear model of innovation conceptualized the steps involved in transforming a new concept to a practical reality in the form of a new product. The sequence is as follows: Basic Research ‡ Applied Research ‡ Development ‡ Production Applied research is nurtured by the results of fundamental (basic) research, and it emphasizes new products and processes. Development includes the improvement, testing, and evaluation of a process, material, or device resulting from applied research. In the linear model of innovation, to sustain basic scientific research, it is necessary to train a large pool of scientists and to strengthen the centers of basic research, which are colleges, universities, and research institutes. Nevertheless, there is a clear division of labor along the sequence among different types of agents who specialize in the various relevant stages. Typically, basic research is conducted in universities and public laboratories, whereas applied research and technological development are carried out by firms, especially large ones, that can afford expensive R&D investments. Source: Balconi, Brusoni, and Orsenigo 2008. Notes 159 the engineering and automotive subgroups are linkage 2. An exception to this is fisheries. At the WTO, tariffs on fish prod- ucts fall under the Non-Agricultural Market Access (NAMA) negotia- intensive and need considerable interaction between firms tions. to reach best practice technical efficiency. Automotive prod- 3. See the World Bank Group’s Investing Across Borders 2010 (World ucts have been of particular export interest to newly indus- Bank, Investment Climate Advisory Services 2010) report on FDI regula- trializing countries, particularly in East Asia (for example, tion in 87 economies. 4. A lower tariff is charged until a certain quantitative threshold, after China and the Republic of Korea) and Latin America (for which a higher rate kicks in. example, Argentina, Brazil, and Mexico) (Lall 2000). 5. See http://go.worldbank.org/C8SJJ4GW50. The specialized suppliers group is composed of makers 6. SPS Agreement Annex A. 7. This includes costs related to setting up a business and remaining of machinery, equipment, and precision instruments. in compliance with legal and regulatory frameworks (discussed in this In this group, innovation benefits greatly from user- section) but also infrastructure, transport, and trade facilitation costs producer interactions. A machinery precision instruments (covered separately in the section “Factor Conditions: Trade Facilitation and Logistics�). industry that serves traditional manufacturing was crucial 8. For example, if reinvested profits are taxed in the same way as prof- for the development of the economies of Finland, Ger- its distributed as dividends. many, and Sweden. Empirical studies show that the 9. According to messaging data from SWIFT, approximately 90 per- strength of local technology-intensive suppliers and the cent of trade finance occurs through interfirm, open-account exchange. Estimates from BAFT (2009) suggest that 10-20 percent of trade finance is specialized knowledge-intensive services represents a com- composed of cash-in-advance payments (these mainly involve SME buy- mon characteristic of the development path of these coun- ers, and inordinately in developing countries); 45-80 percent is on open tries (Torres-Fuchslocher 2010). account (of which 30-40 percent is intrafirm), and 10-35 percent is bank intermediated. Specialized suppliers have an important role to play in 10. Roughly half of cross-country differences in per capita income the enhancement of national technological capabilities. and growth are driven by differences in TFP, generally attributed to tech- Some types of knowledge creation depend on a close rela- nological development and innovative capacity (Dollar and Wolff 1988; Hall and Jones 1999). tionship between suppliers and customers and the implicit Module 2 11. Actually, the productive effects of inputs like labor and capital can exchange of information. Internationally successful export affect productivity, if there are input quality differences that standard industries, including natural resources–based sectors, can input measures do not capture (see Syverson 2010). help local suppliers to internationalize. Clustered indus- 12. Human capital is a broad topic (Schultz 1961) that encompasses “investments� in health, knowledge, and education at different ages. tries attract the attention of foreign demand more effec- 13. See, in addition to Syverson (2010), Abowd et al. (2005), Fox and tively than an isolated firm. Consequently, specialized Smeets (2009), and Galindo-Rueda and Haskel (2005). suppliers have more chances to follow the industry in the 14. Technically, technical efficiency (TE) is a (one-sided) deviation from a production frontier described by some common production func- process of internationalization. In Denmark, for example, tion and is estimated simultaneously with the latter. In a stochastic pro- the export-oriented dairy and fishing sectors have stimu- duction frontier model, TE may, roughly, be viewed as a “systematic� com- lated dozens of supporting industries in such areas as food- ponent of TFP, as TFP includes random shocks that are beyond managerial control. processing machinery, fishing boats, varnish for boats, and 15. Bloom and Van Reenen (2007) offer a comprehensive study relat- telecommunications equipment. A number of these indus- ing management practices to productivity. tries are internationally competitive. 16. Another critical backbone service is, of course, transport and Location is important in cases such as small-scale special- logistics. This is addressed as a separate issue in the section “Factor Condi- tions: Trade Facilitation and Logistics� of this module. ized supplier firms. Proximity confers an advantage in com- 17. One exception may be where FDI is targeted at a natural resource municating with each other and their customers, and hence or other endowment that is not widely available or earns particularly high the opportunity to respond quickly to the requirements of rents. 18. SEZ is being used here in a generic sense to cover any one of a the industry. In other cases, such as the case of standardized variety of similar regimes, including industrial-free zones, EPZs, traditional manufactured products, the distance to other maquiladoras, investment promotion zones, foreign trade zones, free potential markets and the availability of raw materials and zones, and wide-area SEZs. 19. The discussion here is drawn from World Bank (2009a). inputs may have a larger weight in the location decision. 20. Export subsidies are a lower-cost alternative to governments hav- ing to buy up the excess production. 21. Innovation is defined as new ways to solve problems by com- Notes bining technology (an improvement in product, process, marketing, or organization) with transformational entrepreneurship (typically 1. See Bown (2010). Petitions to apply trade remedy laws increase involving commercialization of technologies via formal firms but also during recessions. According to the World Bank’s Global Antidumping including value generation by informal, nonprofit, and governmental Database, the number of trade remedy investigations increased after entities). Innovation ranges from incremental new-to-the-firm adop- mid-2008, only declining in the final quarter of 2009. 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Washington, DC: World Bank. 2009. “Industrial Development Report 2009: Breaking In and Mov- World Bank. 2003. “From Goats to Coats: Institutional Reform in Mongo- ing Up: New Industrial Challenges for the Bottom Billion and the lia’s Cashmere Sector.� World Bank, Washington, DC. Module 3 Policy Options for Competitiveness and Case Studies This module of the Toolkit provides a discussion of broad policy areas and options for consideration in addressing the specific constraints identified through the Diagnostic exercise. It also includes case studies of good practice show- ing policies that were effective in addressing specific trade competitiveness constraints across a wide range of coun- tries. However, given the highly context-specific and endogenous nature of policy development (particularly in the area of competitiveness), and the critical need to take into account political economy considerations when crafting policy, it does not provide prescriptive advice on specific policies that should be adopted. Market Access trade negotiations is slow, countries could pursue bilateral and regional trade strategies for preferential access in major Market access issues often appear to be beyond a country’s markets. Scope also exists to reduce tariffs among develop- policy purview and control. This need not be so. After the ing countries, such as the G-77 and China, under the aus- Diagnostics is conducted, and if market access comes pices of Global System of Trade Preferences (GSTP). across as one of the serious hurdles to export competitive- ness, it will be clear whether the problem pertains to the trade policy of other countries or to domestic capacity Monitor and Seek Disciplines against Trade Remedy constraints. Policies can address both sets of issues at least Measures, and Simplify Rules of Origin over the medium term. With the reduction in tariffs and elimination of quotas, countries often take recourse to trade remedy measures Develop and Implement a Trade Negotiations Strategy such as antidumping and antisubsidy petitions to stem the Countries need to pursue tariff reductions at the WTO in flow of imports. Such trends should be monitored and both agricultural and nonagricultural (that is, NAMA) fought vigorously if they affect market access or may do so negotiations. The reduction in MFN tariffs is particularly in the future. These measures could be taken up in negoti- important for exporters that are hurt by preferential tariffs ations on WTO rules to reduce the impact of trade remedy enjoyed by competitors that export similar products. Con- measures with protectionist intent. LDCs could push for a versely, LDCs that stand to lose their margins of tariff prefer- moratorium of such actions against their exports. Empha- ence because of fall in MFN tariffs will need to negotiate to sis must be put to issues like harmonizing the rules of ori- benefit from aid-for-trade measures and interim trade- gin so that beneficiaries are not burdened with different related assistance for export diversification. Until the time criteria in different preferential schemes. Poor countries tariffs are eliminated, they should also pursue duty-free- make greater utilization of preferences when rules on quota-free access for all their exports. In cases in which exist- cumulation and value added requirements are relaxed. In ing GSP schemes exclude exports of interest to them, such as BTAs/RTAs, lax regional cumulation requirements could textiles and clothing, countries should lobby for their inclu- encourage countries to form more integrated supply chains sion in the major markets. Because progress on multilateral within their regions. 163 164 Module 3: Policy Options for Competitiveness and Case Studies Enhance Domestic Capacity to Monitor and Upgrade Trade and Investment Policy Quality and Standards of Exports In an increasingly integrated world, an open trade policy The underutilization of trade preferences and existing can improve countries’ export competitiveness mainly by market access opportunities indicates that much of reducing the cost of imports and increasing the variety of export competitiveness is blunted by poor domestic imports. Policies that restrict access to foreign sources of capacity. Foreign markets have legitimate concerns about intermediate goods and services can deny firms access to the safety and the SPS status of goods entering their bor- the goods and services they need to compete internation- ders. To avoid rejections, exporting countries need to ally, and these policies are more likely to produce firm meet the required minimum of such standards in a cost- closures and job losses. Experience has shown that poli- effective manner. Countries need effective legal and cies that protect domestic production from foreign com- regulatory frameworks to comply with SPS standards set petition with the goal of protecting jobs and avoiding by international agencies like the Food and Agricultural trade-related structural adjustment are often counter- Organization and the World Health Organization. productive, temporarily saving jobs in vulnerable sectors Although the WTO permits countries to set their own often at the expense of higher paying jobs in competitive SPS standards, they must instill confidence in importing sectors of the economy. Delaying inevitable adjustment countries by focusing, among others, on biosecurity, almost invariably translates into greater long-term hard- storage, and disinfection of pests and diseases. Especially ship than would be the case if policies of market open- for agricultural exports, this requires public-private ness were pursued. partnerships to establish mechanisms for information Although an open trade policy is an essential compo- sharing and support to organized exporting groups, nent of sustainable economic growth, complementary including the establishment of laboratories and policies also are needed to realize full benefits. Other policy microbiology testing facilities for residues of drugs and choices that matter include adequate institutions and rule pesticides. of law, which are crucial for property rights and for lower- Box 3.1 gives an example of the role of bilateral trade ing transaction costs; sound regulatory framework and agreements in facilitating market access for exporters. appropriate labor market, macroeconomic and investment Box 3.1. Case Example of Good Policy Practice—Securing Market Access through a South-South Bilateral Trade Agreement Frustrated with the slow progress in securing market access through the regional South Asian Free Trade Agreement (SAFTA), Sri Lanka and India signed a BTA, which became operational in March 2000. India committed to give duty-free access, within three years, to all Sri Lankan exports, except tea, textiles, and other items listed in the negative list. Given India’s much larger size, it agreed to include in its negative list only 419 tariff lines at the HS six-digit level. Sri Lanka maintained a larger negative list of 1,180 tariff lines primarily to shield its agricultural sector from Indian competition. The BTA spurred trade flows between the countries in the early years. Indian exports to Sri Lanka increased from US$539 million in 1998 to more than US$1 billion in 2003. The share of Sri Lankan imports from India reached 25 percent in 2008 from about 8 percent in 2000. The share of Sri Lankan exports to India also picked up from about 1 percent in 2000 to 9 percent in 2005. It has since declined to less than 5 percent in 2009. Although India’s exports were diversified, Sri Lanka’s were concentrated in a few commodities such as copper and vegetable oil, which also attracted Indian investors to route developing country imports via Sri Lanka to take advantage of the tariff preference. Generally considered a successful BTA, experiences with implementing the India–Sri Lanka Bilateral Trade Agreement highlight specific issues that are relevant to other pairs of developing countries seeking similar trade agreements. First, the rules of origin need to be negotiated carefully and then implemented well. Because the main export surge from Sri Lanka to India was in products for which the rules of origin were not enforced, the resulting trade disputes led to the introduction of TRQs, with India limiting preferences to imports up to a certain quantity only. This led to a decline in Sri Lankan exports during 2006–09. Second, mutual Module 3 recognition of standards is crucial to reduce NTBs. Exporters suffer when SPS standards are not mutually recognized and shipments are subject to random harassment and lengthy approvals from the partner country. One of Sri Lanka’s major export interests, tea, not only was subject to a TRQ but also could enter India only through two designated ports, leading to low utilization of preferences. Third, the trade agreement should be comprehensive and set milestones. Both India and Sri Lanka saw their FDI inflows increase into each other’s territories. This increase was not only to take advantage of tariff preferences but also a response to signals issued by the signing of a legal agreement that increased business confidence. This success has led the two countries to negotiate an expansion of the current goods-only agreement to cover trade in services and cross-border investment under a Comprehensive Economic Partnership Agreement. This agreement will require the management of domestic opposition and the political economy, as well as a higher threshold of regulatory preparation and changes. Sources: Jayasekera 2004; Weerakoon 2010. Trade and Investment Policy 165 policies that facilitate the allocation of resources to increas- may be appropriate, depending on the constraints iden- ingly productive employment; and adequate social safety tified. nets and adjustment assistance. Box 3.2 provides some case study examples of good pol- The table below provides some broad guidelines as icy practice in addressing anti-export biases in the trade to the types of trade and investment policy levers that policy environment. Policy areas and main issues Remedies/Project components Import barriers • Cut import tariffs to reduce tariff dispersion, escalation, and effective rate of protection • Reduce gap between MFN and preferential tariffs • Analyze revenue impact of tariff reductions • Make tariffs publicly available Export duties • Eliminate export duties and quantitative restrictions • If duties used for tax revenues, consider alternative fiscal revenues Nontariff measures • Identify NTMs implemented by all government agencies • Encourage dialogue among agencies to avoid duplicate and redundant regulations • Streamline related procedures in terms of time and cost • Improve information on NTMs for private sector • Firm survey on NTMs faced by importers and exporters • Set up a public-private NTM review committee • Discuss less trade distorting alternatives • Use a Regulatory Impact Assessment • Facilitate customs procedures by connecting all government agencies to Single Window • Make NTMs publicly available • Study impact of state-trading enterprises, if any Exchange rate and • Study the appropriateness of the current exchange rate regime FDI policy • Liberalize access to key input sectors and/or promote foreign participation in joint ventures • Identify restrictions like licensing requirements and other regulatory requirements that create an unlevel playing field between domestic and foreign investors Source: Authors. Note: FDI = foreign direct investment; MFN = Most Favored Nation; NTM = nontariff measure. Box 3.2. Case Examples of Good Policy Practice—Trade and Investment Policy Chile: Unilateral Liberalization, FTAs, and an Agribusiness Export Boom In the past two decades, Chile has become a major export success, particularly beyond its traditional minerals sectors, encompassing the agricultural and agriprocessing sector, including salmon, wine, and horticulture and, more recently, pork, poultry, and dairy. In addition to supply-side initiatives, Chile’s trade policy played a key role in stimulating the growth of agricultural exports, through a combination of low tariffs, the removal of NTBs, and the strategic use of FTAs. Unilateral liberalization of tariffs has played an important role in Chile’s agricultural export success. Average tariff rates stood around 20 percent at the end of the 1980s, but they were cut virtually in half within five years, and in half again within another five years. Uniform MFN tariffs now stand at 6 percent, with the effective tariff rate around 2 percent because of the many preferential trade agreements into which Chile has entered. Preferential trade agreements have significantly expanded producers’ Module 3 market access to new markets for agricultural products, for example, pork in the Republic of Korea and Japan. These agreements have been critical in removing regulatory NTBs in Chile’s agricultural sector (and in parallel improving export market access), as most of the trade agreements have included strict implementation and monitoring procedures, for example, related to SPS arrangements. In addition to improving market access potential, the reforms had two important impacts on agribusiness producers and exporters in Chile. First, they improved their access to competitively priced inputs, most important, capital equipment, but also other key agricultural and nonagricultural inputs. This particularly catalyzed investment and growth in the processing sector. Second, they triggered supply chain consolidation and vertical integration in the agribusiness sector, linked in part to a significant increase in FDI, resulting in larger and more competitive exporters. (continued on next page) 166 Module 3: Policy Options for Competitiveness and Case Studies Box 3.2. (continued) Between 1990 and 2006, annual agricultural exports grew from US$2 billion to US$9 billion, an average growth rate of almost 10 percent per year. In addition, Chile has successfully diversified its destination markets for agricultural exports—in the four years to 2005, for example, 30 percent of agricultural exports went to North America, 25 percent to Europe, 26 percent to Asia, and 18 percent to Latin America. Perhaps more important has been Chile’s success in adding value to primary agricultural production—processed food products have risen to be the most important subsector in manufacturing, accounting for 30 percent of all manufacturing output (ahead of even nonferrous metals and chemicals, traditionally important sectors in the country). Sources: OECD 2008; Ffrench-Davis 2010. Mexico: Streamlining NTMs The Mexican government embarked on an ambitious reform agenda to streamline its NTMs as part of a broader competitiveness agenda in the aftermath of the financial crises that hit Mexico in the 1980s and 1990s. Then NAFTA provided a strong political anchor to a reform process by making reversion to protectionism politically impossible. The process was institutionalized through the creation of a regulatory-improvement agency. The Economic Deregulation Unit (UDE), created as early as 1989, was placed under the Secretariat of Trade’s authority, but given, by presidential decree, a broader authority than the Secretariat. It was then transformed into a formal federal agency, COFEMER, in 2000. The regulatory reform process was top-down and driven by a small group of 15 to 20 technocrats. These were a mixture of economists and lawyers, many of them trained abroad. The number of licenses, permits, and other information requirements in the commerce and transport sector, for instance, was cut from about a thousand in 1995 to fewer than 400 in 2000, and UDE reviewed more than 500 regulatory proposals between 1995 and 2000. In total, about 90 percent of Mexico’s regulatory framework was affected by the process. Sources: Salas 2005; IFC 2008b. Module 3 Domestic Policies and Institutions: Business Environment and Governance 167 Domestic Policies and Institutions: Business The design of regulation determines the efficiency of Environment and Governance economic and social outcomes. Good practice is not lim- ited to rich countries or countries in which comprehensive Once areas for improvements are identified and priori- regulatory reform has taken place. Previous country expe- ties are clearly defined, government authorities need to riences have shown that not all reforms need to be done at undertake a series of reforms to tackle the aspects of the the same time and that setting priorities is the initial step business environment and governance that most con- for successful reforms. Partial reforms may lead to a virtu- strain competitiveness of exporters. Successful countries ous circle in which the success of one reform emboldens often combine high levels of human capital in the public policy makers to pursue further reforms. Simplification is administration, and the use of modern technology to the most common objective in regulatory reforms. Simpli- minimize the regulatory burden on businesses and ensure fication involves not only a business process change but greater transparency. Furthermore, in cases in which pri- also cultural change in how regulators view those they reg- vate markets are functioning, competition serves as a ulate, and how those who are regulated perceive the value substitute for regulation. By combining simple regula- and effectiveness of the regulatory processes. Simplifica- tion with good definition and protection of property tion does not mean compromising core standards with rights, they achieve what many others strive to do—that respect to health, safety, the environment, or labor. Simpli- is, having government regulators serve as enablers of fication means reducing or eliminating elements of a competitiveness and economic growth. Aside from how process to reduce complexity and inefficiency. It also much and what they regulate, good practice countries involves limiting the potential of any reintroduction of share common elements in how they regulate. For exam- cumbersome or unnecessary requirements or steps. Sim- ple, countries with the least time to register a business, plification does not absolutely require that regulators make such as Canada, have single registration forms accessible radical changes to its processes; rather, it can be achieved over the Internet. Countries that take the least time to through a more gradual and incremental approach. enforce a collateral agreement, Germany, Thailand, and Box 3.3 provides some case study examples of good pol- the United States, for example, allow out-of-court icy practice in addressing business environment reforms. enforcement (IFC 2006). Box 3.3. Case Examples of Good Policy Practice—Domestic Policies and Institutions Serbia: Business Registration Reform For decades, starting a business in Serbia was time-consuming and burdened with unnecessary bureaucratic hurdles—the rules inherited from its Communist past were not business friendly. Some of the biggest problems included the following: the $5,000 minimum capital requirement for starting a limited liability company, the necessary inspections before a company could start operating, and the commercial courts checking every document. Sixteen commercial courts were in charge of registering enterprises, and 131 municipalities dealt with registering entrepreneurs. The practice was so inconsistent that even judges in the same court required different documents. Countless reports identified the need to reform the system. By 2001–02 a decision was taken to undertake reform. The reform had two elements. The first was a radical change of the laws, and the second was making the new system work in practice by establishing a new registry. Using the Irish system as a model, the system was centralized and accessible via the Internet, leading to far greater legal certainty. Another very important change was the five-day deadline to register a company. If no decision is made in five days, the applicant is free to begin operations (that is, silence is consent). For the company law, too, rather than amend the old law, a new one more suitable for a market economy was created. The new company law reduced the minimum capital requirement for limited liability companies (90 percent of all companies in Serbia) from $5,000 (equivalent to around €4,500 at the time) to €500 and eased requirements for establishing companies by making the rules more flexible. Module 3 The effects of the reform were felt almost immediately. The time necessary for starting a business was reduced from 51 days in 2004 to 18 in 2005. The new system was a radical change, with a focus on customer service and user friendliness. And the forms for registration are being continually improved to reduce the time to complete them. After the decentralized and inconsistent practices of the commercial courts, the new system is centralized, with Internet access to all registration data. To unify practices, only one person—the registrar—has final authority and the power to interpret the relevant laws. This increases legal certainty and uniformity across the board. During its first year, the Serbian Business Registry Agency registered almost 11,000 new companies, 70 percent more than in 2004, shrinking the informal sector. In two years, the number of registered businesses more than doubled. Source: World Bank 2008 (http://www.doingbusiness.org/reforms/case-studies/2007/starting-a-business-in-serbia). (continued on next page) 168 Module 3: Policy Options for Competitiveness and Case Studies Box 3.3. (continued) Arab Republic of Egypt: Tax Reform With 37 percent of Egypt’s workforce in the informal sector, the government realized reform was the way to broaden its tax base and increase revenues. Tax rates were high, the process of making payments was cumbersome, and tax evasion was the norm. In July 2004, a new cabinet took office with a mandate to reform. One of its goals was to increase employment through investment. To do so, a high priority was placed on amending the tax law, customs law, and customs tariffs and on enacting competition and antitrust laws. Making Egyptian tax law closer to international practice would increase Egypt’s competitiveness and its attractiveness as a destination for foreign investment. The boldest reform was to simplify tax law so that every business faces the same tax burden—with no exemptions, tax holidays, or special treatments for large or foreign businesses. Taxation administration also improved. Self-assessment replaced administrative assessment, which was essential for the tax reform. There is also less room for interpretation, reducing the possibility of negotiating taxes. The results were an immediate increase in taxpayer submissions by almost 50 percent, an increase in corporate tax revenues from £E22 billion in fiscal year 2004 to £E39 billion in fiscal year 2005, despite the fall in corporate tax rates (from a variable rate between 32 percent and 40 percent to a flat rate of 20 percent), and an overall increase in tax revenue from 7 percent to 9 percent of GDP. Source: World Bank 2008 (http://www.doingbusiness.org/reforms/case-studies/2007/adding-a-million-taxpayers-in-egypt). Australia: Competition Policy Australia’s competition-oriented reforms happened in three waves, first through increased exposure to international markets in the early 1990s; followed by the development and implementation of the National Competition Policy (NCP) in the mid-1990s, and with regular updates in the late 1990s and onward. Comprehensive reforms coordinated across all levels of government aimed to (1) reform all legislation that restricted competition; (2) implement a culture of “continuous improvement� in regulatory quality; (3) implement competitive neutrality for all public businesses; and (4) provide third-party access to significant infrastructure facilities. The NCP was implemented through an incentive scheme in which the national government financially rewarded (or penalized) achievements of negotiated milestones. A system of “competition payments,� defined as the state’s share of additional revenue arising from the NCP, was introduced. Federal to state governments made payments that implemented specific reforms, while pecuniary penalties were imposed on slow reformers, in the form of reduced or delayed budget transfers from the central government. Although a majority of reform goals in competition policy were met on time in the 10-year period, in some cases, pecuniary penalties for slow reformers exist. For instance, Western Australia’s uncompleted plans for water systems led to a 5 percent suspension penalty of its 2005–06 competition payments. When reform goals were finally met in 2007, suspended payments were then disbursed. Similarly, Queensland’s failure to address anticompetitive restrictions in liquor licensing resulted in a 5 percent permanent deduction penalty of the state’s 2003–04 competition payments. The Australian experience is considered to be one of the most successful examples in recent years. The NCP helped make Australia one of the top-performing OECD economies and has enhanced economic flexibility and adaptability to change, showing the quickest recovery from the global crisis among OECD countries. The reforms have reduced barriers to entry and exit and improved competition, estimated to have increased GDP by 2.5 percent (not including dynamic effects). Source: World Bank 2011b. Module 3 Access to Finance 169 Access to Finance Policy areas and main issues Remedies/Project components General access to • Improving the regulatory framework and competition in the banking system finance issues • Facilitating the development of early stage financing, including “business angel� networks • Improving credit information systems (e.g., credit bureaus) • Establishing or improving the operation of a credit guarantee program • Capacity building to improve bank knowledge and capability in dealing with SMEs or the export sector Trade finance • Establishing a focused trade finance institution • Strengthening the capacity of existing institutions (e.g., export credit guarantee agency) • Expanding access to existing services offered through government-owned development banks by enabling them to be distributed through existing commercial banks • Providing backing for an export credit insurance product • Developing markets for factoring and forfeiting products Source: Authors. Note: SME = small and medium enterprises. Box 3.4 provides some case study examples of good policy practice to facilitate access to finance for exporters. Box 3.4. Case Examples of Good Policy Practice—Access to Finance Singapore: Financing SME Growth and Internationalization With a small population and an extremely limited geographic base, growth for Singaporean firms depends on competitiveness in export markets. In line with Singapore’s development strategy of broad global engagement, the government has made strong efforts to facilitate the expansion of domestic SMEs into international markets, including through overseas investment. These efforts include, among others, financing, tax incentives, and grants. Among the key programs are the Growth Financing Programme and the Internationalization Finance Scheme. The Growth Financing Programme, run by the Singapore Economic Development Board (EDB) makes long-term equity investments in early stage SMEs that are seen to have the potential to become globally competitive. Companies that have successfully completed product development and can show some initial “customer traction� can apply for equity financing for overseas market expansion through the program, with the potential that every S$2 raised by the growth company from third-party investors will be matched by S$1 from EDB, subject to a maximum of S$1,000,000 (and with a minimum third-party investment of S$500,000). The Internationalization Finance Scheme, run by International Enterprise (IE) Singapore, facilitates financing for fixed investments abroad or confirmed overseas projects, including loans, guarantees, and asset-based financing (e.g., leasing). The amount of financing available under the scheme recently was raised from S$15 million to S$50 million. To attract private financing, the government of Singapore assumes 80 percent of the risk of financing. The program is open to Singapore-based firms with less than S$300 million in turnover. The program has been effective in facilitating outward expansion by Singaporean SMEs. According to a government survey of SMEs in 2009, 69 percent had established overseas ventures. Data from the 2010 Start-up Enterprise Survey shows that 25 percent of Singaporean start-ups now have overseas revenue. Sources: http://www.iesingapore.com (accessed November 9, 2011); www.edb.gov.sg (accessed November 9, 2011). Note: S$1 = US$0.784 as of September 21, 2011. Vietnam: Securing Lending Module 3 In Vietnam, accessing credit continues to be a binding constraint for entrepreneurs and the burgeoning sector of smaller businesses in Vietnam. Donor reports estimate 20 to 40 percent of households and small firms do not have access to formal financing channels. IFC responded to a request from the government of Vietnam to streamline the country’s secured transactions laws and registry. This effort resulted in a three-point improvement on the relevant Doing Business indicator, putting the Vietnamese legal framework on par with the OECD average. Vietnam’s “getting credit� ranking in the Doing Business 2008 report improved from 80 to 48 among 145 countries. As a result of the law, any asset could legally be used as collateral, creditors would be better able to assess the risk profile of their lending portfolios, and all conflicting legislation was repealed. Source: IFC 2008a. (continued on next page) 170 Module 3: Policy Options for Competitiveness and Case Studies Box 3.4. (continued) Mexico: NAFIN Productive-Chain Reverse-Factoring Services for SMEs Following Mexico’s major internationalization in the 1990s, mainly induced through NAFTA, many large companies became highly successful exporters. Yet the large SME sector still struggled with traditional barriers to growth and export participation, most important, access to finance, linked to their lack (or perceived lack) of creditworthiness. In response to this, and partly as a strategic commercial move in its own right, Nacional Financiera (NAFIN), a state-owned development bank with 32 branch offices nationwide, developed a so-called productive chains program in 2001 to link large creditworthy buyer firms with small risky firms unable to access formal finance. The NAFIN factoring program operates an electronic platform that provides factoring services online. The website has a dedicated page for each big buyer, and small suppliers are grouped into chains with those big buyers with whom they have business relationships. The suppliers and NAFIN sign an agreement allowing the electronic sale and transfer of receivables. Once a supplier delivers goods and its invoice to the buyer, the buyer posts a negotiable document equal to the amount that will be factored on its NAFIN webpage. In general, this is equal to 100 percent of the value of the receivable. The supplier will then be able to access its buyer’s NAFIN webpage and see all factors that are willing to finance this particular receivable along with their quotes for interest rates. Picking the one it deems has the most favorable terms, the supplier clicks on the name of the factor, and the amount of the negotiable document less interest is transferred to the supplier’s bank account. When the invoice is due, the buyer pays the factor directly. The efficiency of the electronic platform means that small suppliers typically have money within one business day. A few features make the NAFIN factoring program unique, namely, the following: • The use of the electronic platform and the Internet reduces costs and improves efficiency for all parties involved: sellers, buyers, and factors. More than 98 percent of all services related to the factoring are provided electronically, all transactions can be completed within three hours, and money is credited to the supplier’s account by the close of business the same day. This provides immediate liquidity to suppliers. • The use of reverse factoring transfers the credit risk of the small suppliers to highly creditworthy buyers and enables NAFIN to offer factoring without requiring collateral to SMEs, which often lack a credit history or access to other forms of formal financing. In addition, there is no service fee, and the maximum interest rate charged is about 8 percentage points below commercial banks’ lending rates. • The competitive, instant, online, multifactor structure nurtures competition among factors and allows small suppliers to pick the factor with the most favorable terms. Most factors refinance their factoring activities with NAFIN, earning the difference between the rate they charge the suppliers and the rate NAFIN pays. Two important steps taken by the Mexican government enabled NAFIN to undertake its successful factoring program. First, in May 2000, the government implemented reforms to legislation pertaining to e-commerce that gave electronic messages the same legal validity as written documents. Passage of the Law of Conservation of Electronic Documents established requirements for conservation of the content of electronic messages regarding contracts, agreements, and accords. The Electronic Signature Law permits substituting electronic signatures for written signatures and allows the receiver of a digital document to verify the identity of the sender. Modifications to the Federation Fiscal Code included amendments necessary to complete electronic transactions, including factoring. Second, favorable taxation treatment helps keep factoring costs low for SMEs and gives them incentives to participate in the factoring program. All interest charges that small suppliers pay to their factors are tax deductible. The factoring program managed to secure the participation of 190 big buyers (accounting for 45 percent of the output in the private sector) and more than 70,000 SME suppliers. Twenty domestic banks and finance companies act as the factors. Since the program’s inception in September 2001, NAFIN extended more than US$9 billion in financing to SMEs in its first few years of operation. The program also contributed to a dramatic turnaround in NAFIN’s own finances from a deficit of US$429 million in 2000 to a surplus of US$13 million in December 2003. With the efficiency of its Internet platform, NAFIN’s market share of factoring grew from 2 percent in 2001 to 60 percent in 2004. It is able to provide the cheapest form of financing available for small suppliers in Mexico. An example for other countries as well, NAFIN has entered into an agreement with a development bank in Republica Bolivariana de Venezuela to develop a similar product. NAFIN’s model is also being considered for replication in other Latin American countries such as Argentina, Chile, Costa Rica, El Salvador, and Nicaragua. Source: World Bank 2006. Ghana: Farmers Use of Warehouse Receipts to Finance Exports Since 1989, the NGO TechnoServe has worked closely with the Department of Co-operatives and the Agricultural Development Bank in Ghana in encouraging small-scale farmers to form cooperatives and use warehouse receipts to store their crops for sale in Module 3 the lean season. The bank provides loans against the members’ grain, at 75 to 80 percent of current market price, and the grain is stored in cooperatively owned warehouses. The scheme is concentrated in the Brong-Ahafo “maize triangle� of Ghana—the major area of agricultural surplus, where annual price fluctuations are high. From 1992 to 1996, farmers participating in the scheme in this region were able to increase their profits on grain sales by an average of 94 percent per year. Source: UNESCAP 2003. (continued on next page) Access to Finance 171 Box 3.4. (continued) Philippines: Credit Guarantee for Indirect Exporters—the Asparagus Case An association of small farmers in South Cotabato, Philippines, with landholdings ranging from three to five hectares wanted to enter into a contract to grow asparagus for Dole Philippines Inc. The farmers were beneficiaries of the government’s Agrarian Reform Program that distributed rice and corn farm lands. Dole identified the area as suitable for planting asparagus and offered the farmers a contract growing scheme whereby Dole would provide the farming technology and inputs such as asparagus seedlings. Dole planned to export fresh asparagus to Japan. Under the growing agreement, pricing was subject to a floor price with an escalation should the export market price increase. This was a start-up project and the first commercial-scale production of asparagus in the country. No commercial banks would lend to the farmers association. The farmers’ only assets were their small agricultural lands titles that were not yet perfected. A government bank, the Development Bank of the Philippines (DBP), was willing to finance the project under its Window 3 Program, which charged less-than-commercial rates for developmental projects. The bank determined that the asparagus production was developmental as it involved a new agricultural industry, agrarian reform beneficiaries, and foreign exchange earnings. DBP, however, needed a guarantee for the loan. The guarantee was provided by the Guarantee Fund for Small and Medium-Scale Enterprises (GFSME), a quasi-government agency (now the Small Business Corporation, a government-owned financial institution). The GFSME provided an 80 percent guarantee, and Dole Philippines issued a commercial guarantee for 10 percent, for a total of a 90 percent guarantee on the PHP 30 million loan to the farmers from DBP. Beginning with 90 hectares first planted with asparagus on a commercial scale, more than 3,000 hectares of asparagus have since been planted in South Cotabato and other provinces. Foreign exchange earnings from the export of asparagus mainly to Japan and Europe have made asparagus a major cash crop in the country. Income and employment effects on the local economies have been substantial. Source: ITC 2009. Indonesia: Export Credit Guarantees in Times of Crisis When financial institutions do not have confidence in the stability of the importer’s country or in the standing of the financial institution issuing the L/C, confirmed letters of credit become difficult and expensive—sometimes impossible—to obtain. During the Asian crisis (1998), Indonesian banks had difficulty getting foreign counterparties to confirm the L/Cs they issued on behalf of Indonesian importers because of doubt over the stability of the entire Indonesian financial system. Without confirmed L/Cs, Indonesian importers could not import raw materials needed for their own export production. Both national and bilateral support in terms of export credit guarantees played an important role in freeing up the market. Indonesia’s Central Bank deposited US$1 billion in 12 foreign banks to guarantee export L/Cs issued from Indonesian banks. They also provided a short-term hedging facility for exporters to provide additional liquidity. Some relatively stable Indonesian banks also made deposits in foreign banks and used those deposits as cash collateral for their L/Cs. Finally, Japan Export Import Bank (JBIC) provided financing via the Bank of Indonesia to guarantee L/Cs issued by domestic Indonesian banks. Strict qualification requirements restricted its take-up in the market initially, but this improved later. Sources: ITC 2009; Chauffour and Farole 2010. Module 3 172 Module 3: Policy Options for Competitiveness and Case Studies Labor Markets, Skills, and Firm-Level Technical Efficiency Policy areas and main issues Remedies/Project components Labor markets • Improvements in labor market regulation—for example, hiring and firing practices, shift protection from and skills employment to social policy (e.g., unemployment insurance) • Linking regular minimum wage increases with productivity • Training and skills development initiatives, including the following: addressing skills mismatches; pre-employment skills training initiatives; and active labor market training programs to reintegrate the unemployed and disadvantaged back into the workforce • Ensuring greater portability of education and training credentials • Focusing vocational training programs to meet the needs of the private sector • Decentralizing provision of vocational training and facilitating greater private provision • Improving enforcement of labor standards Firm-level • Programs to support public-private initiatives for training and vocational education technical • Encourage high-quality business education efficiency • Establish a regulatory environment which makes entry easy and which allows quality to determine success • Entrepreneurship development training Box 3.5 includes brief case studies highlighting good petitiveness through improving labor skills, productivity, practice policies and initiatives designed to improve com- and technical efficiency. Box 3.5. Case Examples of Good Policy Practice—Training, Skills Development, and Technical Efficiency Malaysia: The Penang Skills Development Centre (PSDC) The PSDC is the first skills industry-led training center to be set up in Malaysia. It was conceptualized in 1989 out of urgency that, for Penang to continue to attract FDIs, its human capital must be trained to keep pace with changes in technology. Although the initiative, land, and some financial support came from the state and federal governments, with initial support from some of the US electronics MNCs in the state, the leading role in the center was the private industry. Not only did they provide the initial trainers and equipment, but also were responsible for designing the training programs to meet their needs. PSDC now has 140 members and operates as a nonprofit society. Its mission is to pool resources among the Free Industrial Zones and Industrial Estates in Penang to provide up-to-date training and education programs in support of operational requirements, as well as to keep abreast of technological progress. The center operates on a full cost basis, and companies that send employees to the center pay for the training. To ensure that the training provided meets the needs of industry, the programs were continually upgraded and adapted to evolving skill needs. The PSDC now caters to the firms in the free industrial zones and industrial parks in Penang, which as of late 2007, had a total of 1,277 factories employing approximately 220,000 workers. The center has trained more than 150,000 participants through more than 7,000 courses, pioneered local industry development initiatives, assisted in the input and formulation of national policies pertaining to human capital development, and contributed directly to the Malaysian workforce transformation initiatives. More recently, the PSDC has set up a new Shared Services Center to house Malaysia’s largest Electromagnetic Compatibility Lab, which will provide training programs to fast-track the work readiness of university graduates. The program will be conducted in partnership with member companies to bridge the competency gap of Malaysian graduates and needs of the industry. Initially, the PSDC was unique, but its model has since been adopted throughout the country; currently, 11 of 13 states in Malaysia now have skills development centers. Sources: Penang Skills Development Centre 2010; InvestPenang 2010. Honduras: Instituto Politécnico Centroamericano (IPC) Module 3 IPC is a nongovernmental, nonprofit, vocational training institute that was founded in 2005. An assessment of Honduras vocational training system had concluded that the system was broken: instructors were incapable of teaching and 95 percent of equipment was stolen, broken, or irrelevant. Based on these findings, IPC was established to design courses for current and future workers in all sectors of the economy, including in manufacturing and textiles and clothing. The institute’s objective is to provide workers with relevant skills demanded by industry. Its curricula are hence strongly influenced by input from employers. IPC strives to offer the best technical equipment, curricula, and test instructors in the region. For example, a majority of the 12 instructors are brought from North America, Europe, and Latin America. In the spring of 2009, IPC had 270 full-time students, and some 1,400 workers were upgrading their skills in courses lasting between 2 and 18 weeks. A majority of the graduates join the maquila companies: for example, Gildan, a large Canadian apparel company, hires 60 students from IPC every year. (continued on next page) Labor Markets, Skills, and Firm-Level Technical Efficiency 173 Box 3.5. (continued) Ninety percent of students come from families earning less than US$300/month and the fee for a year of full-time training is US$1,500. The expenses are partly covered by companies, charitable organizations, and governments: a US NGO covers transportation and a daily meal; a Swiss company that supplies chemicals to the textiles industry donated a chemistry lab; a French company provided design equipment; and an Italian company donated sewing equipment. Roughly 95 percent of the students receive a corporate scholarship that covers 75 percent of the fee. In return, they commit to work for the sponsor for two to four years. Foreign multinationals are carrying most of the expenses, whereas Honduran companies have been less willing to invest in training and retraining—a pattern that is common in many developing countries. Source: IPC 2009. Mexico: Comprehensive Training to Support Skills Development and Modernization for SMEs Despite its successful internationalization, Mexico’s large SME sector still struggles with traditional barriers to growth and export participation. One such barrier is skills development, including at the managerial level. One program that has proven effective to address this challenge was the Integral Quality and Modernization Program (Programa de Calidad Integral y Modernización, known by its acronym CIMO), established in 1988 by the Mexican Secretariat of Labor. Set up initially to provide subsidized training, CIMO evolved when it became apparent that lack of training was only one of many factors contributing to low productivity among smaller enterprises. All states and the federal district of Mexico have at least one CIMO unit, each staffed by three or four promoters and housed in business associations that contribute office and support infrastructure. Promoters organize workshops on training and technical assistance services, identify potential local and regional training suppliers and consulting agents, both public and private, and actively seek out SMEs to deliver assistance on a cost-sharing, time-limited basis. They work with interested companies to conduct an initial diagnostic evaluation as the basis for organizing training programs and other consulting and technical assistance. The government does not deliver the training; instead, its role is to identify the most qualified local public and private training providers. To reduce unit training costs, providers usually deliver the training on a group or association basis. This strategy is deliberate: One of the program’s objectives is to promote the development of regional training markets able to serve the needs of local enterprises. The CIMO program also targets industrial clusters and works with large firms and their SME suppliers to organize and deliver cluster-specific training programs. By 2000, CIMO was providing an integrated package of training and industrial extension services to more than 80,000 SMEs each year and training upto 200,000 employees. Private sector interest has grown, and in 2004, more than 300 business associations participated in CIMO, up from 72 in 1988. Several rigorous evaluations have found CIMO to be a cost-effective way of assisting SMEs. Although CIMO firms tended to have lower preprogram performance than a comparison group with similar attributes, their postprogram outcome indicators tended to show improvements in key areas, such as labor productivity, capacity utilization, product quality, wages, and employment. Source: World Bank 2010b. India: Improving Quality and Technical Efficiency in Software Firms by Adopting Standards The leading Indian firms have moved up the value chain in software services, developing organizational and managerial capabilities that enable them to offer more comprehensive services than merely low-cost programming. One sign of maturity is that the industry increasingly procures fixed-price contracts, rather than the time-and-materials contracts of earlier years. With the greater risk of fixed-price contracts comes flexibility in organizing work, greater management control, and an opportunity to earn higher returns as efficiency improves. Revenue per worker is increased, indicating a move up the value chain—from an average of $9,000 in fiscal 1995–96 to $20,500 in 2000/01—but revenues are still lower than what they are in product-based companies. To build client value, companies have expanded their capacity to service a wider range of software-development tasks, as well as to move into new services, such as product design and information services outsourcing. Software development includes analysis and specification of requirements, software design, writing and testing of software, and delivery and installation. Indian companies are trying to move beyond only writing and testing, which require the least skill and account for only a small portion of the overall project costs, to higher skill levels that require deeper business knowledge of the industry for which software solutions are being developed. In their quest to climb the value chain, India’s software firms ensured product quality and reliability by adopting internationally recognized standardized work processes. Because most Indian software firms are export-oriented and serve clients around the world, meeting globally acceptable frameworks and standards has been critical to validating their credentials to new clients, who often demand that vendors adopt ISO and Capability Maturity Matrix (CMM) standards. An increasing number of firms have met international certification requirements for key quality standards. For many, this was an exercise in brand building, but the processes Module 3 and procedures put in place left their hallmark on the quality of software products and services. Firms seek certification from various sources, beginning with quality management practices that meet ISO 9000 standards to ensure consistent and orderly execution of orders. The next stage focuses on software engineering and certification under the People CMM framework of the Software Engineering Institute (SEI) at increasing levels of process maturity. Another stage focuses on aligning internal practices with the CMM, which is a framework to guide attracting, motivating, and retaining a talented technical staff. The Six Sigma methodology ensures end-to-end quality across all company operations and focuses on improved customer satisfaction by reducing defects, with a target of virtually defect-free processes and products. As of December 2003, India had 65 companies at SEI CMM Maturity Level 5. In October 2002, the SEI of Carnegie Mellon University published a list of high-maturity organizations as part of its Survey of High-Maturity Organizations and High Maturity Workshop research. The full set of 146 high-maturity organizations includes 72 Level 4 organizations and 74 Level 5 organizations. Of the 87 high-maturity organizations assessed outside the United States, 77 are in India. Source: Guasch et al. 2007. 174 Module 3: Policy Options for Competitiveness and Case Studies Intermediate Inputs and Backbone Services Policy areas and main issues Remedies/Project components Inputs and • Institutional reform and capacity building in utilities regulators backbone • Liberalization of utilities markets services • Land market reforms—development of a land registry, extension of land use rights periods for FDI, surety of title • Establishment of industrial parks/SEZs • Introduction of PPP legislation/frameworks • Trade policy reform (reducing tariffs/NTBs) • Establishing trade credit lines/other access to finance initiatives • Establishing/reforming duty-drawback regimes; establishing manufacturing under bond programs Source: Authors. Note: FDI = foreign direct investment; NTBs = nontariff barriers; PPP = purchasing power parity; SEZ = special economic zone. Box 3.6 provides some case study examples of good policy practice in improving access to competitive inputs. Box 3.6. Case Examples of Good Policy Practice—Intermediate Inputs and Backbone Services Kenya: Air Services Liberalization Promotes Goods and Services Exports Like most countries, Kenya air transport market was highly regulated during the 1970s and 1980s. In East Africa, the breakup of the former regional airline, the East African Airways Corporation, in 1977, led to the emergence of national carriers, which were subsequently highly protected, with implications on the availability, quality, and price of air transport services. Liberalization of Kenya’s air transport sector began in the late 1990s with regional agreements through the Common Market for Eastern and Southern Africa (COMESA) and the East African Community, followed by the establishment of the Kenya Civil Aviation Authority as an autonomous regulator in 2004. But what really catalyzed the development of the sector in Kenya actually preceded these regulatory reforms—the privatization of the national carrier, Kenya Airways, in 2006. This led to KLM taking the largest stake in the carrier and bringing in international management expertise. The result was that Kenya Airways has become one of the leading airlines in Africa. Critically, this has facilitated the development of two major sectors of the Kenyan economy. First, the tourism sector benefited significantly from access to a wider range of domestic and international air services, and the sector has become one of the most important employment and foreign exchange earning sectors in the country. Second, the rapid expansion of air freight capacity in Kenya—both through Kenya Airways and the opening up of the market to other airlines, especially dedicated cargo freighters—has facilitated the massive growth in horticultural exports (particularly cut flowers and vegetables) that is a well-documented Kenyan success story. Fiji: Duty Suspension Scheme Fiji’s duty suspension scheme is managed by a private sector organization—The Exporters Club—on behalf of Fiji Islands Revenue and Customs Authority. Members must be in the business of importing materials for transformation into products for export. The Exporters Club assesses the qualifications of applicants, recommends a list of materials to be imported and subsequently used in the production of exports, calculates advance credits and entitlement proportion (EP) ratios, and advises Customs when all requirements are met. The exporter receives credits for every dollar of exports achieved under the system. It can use these credits to import approved materials duty free. The credit is based on the EP, that is, the proportion of imported goods required to produce one unit of the export product. As long as the company operates within its EP ratio, it can continue to import approved goods duty free. The EP is calculated when companies enter the scheme, using the company’s import and export history and an audited set of accounts. For the first export operation, companies can be provided with advance credits that would enable them to import for two months using the credits. Specially developed software has been created for Customs as an attachment to the Automated System for Customs Data (ASYCUDA) system. The software enables the Exporters Club to manage the day-to-day operations of the program and Customs to Module 3 audit arrangements with individual members. Members have access to their own data but cannot access the details of other members. The Exporters Club is a nonprofit organization owned by eight peak industry groups involved in promoting exports. A board manages the club, representing owners and the Customs Authority. The club monitors the performance of each club member through a computerized system that calculates the amount of credits earned and automatically reduces these credits when products are imported. To cover the costs of operation, the club charges an application and assessment fee, an annual subscription fee, and an activity fee. Source: World Bank 2009c. Trade Facilitation and Logistics 175 Trade Facilitation and Logistics Policy areas and main issues Remedies/Project components Regulations of transport and logistics • Introduce professional standards and certification for logistics services providers services/quality and reliability of • Introduce standard performance contracts for transport and logistics services transport and logistics services/ • Encourage development of large, long-haul trucking fleets business practices • Create incentives to upgrade transport fleet • Allow increased scale of logistics service providers (mergers and acquisitions) • Encourage integration of logistics services for trade and distribution • Allow introduction of new technologies for tracking and security • Introduce modern supply chain management techniques • Support for national logistics council and other mechanisms for self-regulation Customs modernization • Reform and automate customs procedures • Improve border facilities • Introduce risk management programs to expedite clearance, including reduced inspections and authorized economic operators • Improve trade security (e.g., scanners, secure supply chains) • Integrate activities of border management agencies • Introduce a single point of entry for information used in clearing cargo • Accept scanned copies for supporting document and e-signatures • Automate and simplify procedures for SPS and for standards certification Related procedures and trade • Develop public information platforms for sharing trade and logistics data facilitation initiatives • Introduce e-government services and e-signatures to facilitate government approvals • Strengthen capacity of authorities regulating trade and logistics • Improve collection of key statistical information and performance indicators • Develop capacity to analyze indicators and monitor results of policies and investments Transit regime/air and sea connectivity • Plan and manage multimodal freight corridors and liberalization of services • Develop urban and line-haul transport interface (e.g., urban truck terminals) • Liberalization/deregulation of air services policies (e.g., introducing fifth freedom or other bilateral freedoms) Public infrastructure • Increase private sector participation to provide and maintain public infrastructure • Introduce commercial management in port and airport operations • Construct new transport links • Upgrade existing transport links • Plan and manage multicountry freight corridors • Establish dryports and inland clearance facilities • Develop logistics hubs (e.g., free zones, distribution centers) • Improve telecommunications services to support logistics Source: World Bank 2010d. Box 3.7 provides some case study examples of good policy practice in trade facilitation and logistics. Box 3.7. Case Examples of Good Policy Practice—Trade Facilitation and Logistics Cambodia: Risk Management Cambodian importers of raw materials for garment manufacture and subsequent export “are subjected to as many as 64 documentary inspections, physical goods inspections . . . [and] a requirement for over 70 signatures and 12 separate payments . . . . [and] exporters who are exporting ready-made garments . . . have to fulfil as many as 90 documentary inspections, possibly 100 signatures and 17 different formal payments, in addition to informal payments they have to make in order to get the thing done.� (Sovicheat 2006, 1). The Royal Government of Cambodia has since introduced a comprehensive risk management approach to border management. Module 3 The approach has consolidated and rationalized the requirements of government agencies involved in the inspection and clearance of goods at the border through the following: • Raising the level of understanding of all stakeholders—particularly the implementing agencies involved in inspection and audit— of the principles of risk management, compliance management, and information management, and assisting them in the achievement of a strategic approach to risk management and compliance management. • Providing a framework for risk management whereby the inspection of import and export consignments is focused on high-risk shipments and maintains a balance between facilitation and control. • Developing an understanding of specific risks Source: World Bank 2011a. (continued on next page) 176 Module 3: Policy Options for Competitiveness and Case Studies Box 3.7. (continued) Cameroon: Customs Integrity Initiative Within the Cameroonian context, customs is perceived as one of the institutions with the most important problems of transparency. A new program financed by the World Bank and introduced in 2006 was designed to strengthen the chain of command by holding each link accountable—with the assistance of activity, performance, control, and risk indicators—to improve understanding of activities on the ground, to provide an effective decision-making tool, and to reduce corruption in customs. Cameroon Customs had already carried out steps to strengthen accountability. They included the regular publication of revenue collection data, increased contacts with the business community, automation through the use of ASYCUDA software, and reduced information asymmetry through the use of individual performance indicators. The head of Customs still wanted to initiate a second wave of reforms to change the behaviors of frontline officials and to reduce corruption and increase performance. Accordingly, she commissioned the development of an integrity action plan with a specific focus on human resources policies through a monitoring and incentive framework. A pilot was set up and performance contracts for the two largest customs stations were designed. In early February 2010—following a dialogue among frontline officers and senior management—individual and team performance contracts with measurable indicators were signed. Each inspector’s performance was to be assessed through eight indicators: four related to trade facilitation and four related to the customs clearance process and fines. For each indicator, a maximum or minimum value was set based on median monthly values in the three preceding years. An inspector achieved his or her contract if he or she improved performance by 15 percent on all indicators after the six-month pilot period. For inspectors below 100 percent contract performance, a system was established that began with warnings and interviews and failure to meet performance goals can lead to the inspector’s transfer to another customs station. For the best performing inspectors, a limited financial bonus was granted, along with nonfinancial recognition. Frontline officers, as well as middle management, supported the initiative because they wanted their performance to be assessed on the basis of objective criteria. Early results show that performance contracts have led to decreased clearance times and reduced poor practices, with revenues maintained at the same level as before. Moreover, the contracts have contributed to increased information flow from inspectors to the Head of Customs. Source: World Bank 2011a. Trans-Kalahari Corridor: Document Standardization and Simplification The Trans-Kalahari Corridor (TKC), the road route between Gauteng province (South Africa) and Walvis Bay (Namibia) via Botswana was opened in 1998, replacing the traditional longer route through western South Africa. Despite major road rehabilitation in 1999, traffic reached only 15 percent of the expected capacity. The major obstacles occurred at the border crossings. This led the TKC Corridor Management Group to seek a partnership with the customs administrations of Botswana, Namibia, and South Africa. This partnership resulted in agreements (October 2000) to extend the operating hours of customs at the Namibia–Botswana border from 22 to 24 hours to enable loading and unloading in Windhoek and crossing the border in the same day. In August 2003, the TKC started a pilot phase to replace all existing transport documents with a single administrative document (SAD). To complement this effort, South African Customs developed a website with details on the SAD process. Border processing times were cut by more than half, from an average time of 45 minutes to 10–20 minutes. According to the US Agency for International Development (USAID) estimates, reduced border delays created savings of $2.6 million per year along the corridor. As a result, the route became economical, and traffic flows increased. Operators were moving about 620,000 tons annually along the TKC, about 65 percent of expected capacity, until the Botswanan government increased road user charges in February 2004. In some cases, road charges were multiplied by a factor of 10. The customs problem had been settled; but following this unilateral decision affecting the transport sector, traffic decreased significantly. Source: World Bank 2004. Northern Corridor Stakeholders Consultation Forum: Trade Facilitation Committees Since 1999, officials dealing with transport, transit, and private operators along the Northern Corridor (including Ministry of Transport, Ministry of Trade, customs agencies, exporters, and importers associations, and so on) have been regularly meeting twice a year to discuss transit issues. This private-public sector alliance has produced the following positive developments: • Elimination of charges on imports routed through the port of Mombasa (by Kenya Bureau of Standards and the Kenya Plant Health Inspectorate Service) • Development of a one-stop processing center • Reduction of the number of required stamps to go through Mombasa port (from 21 to 11) Module 3 As a result of this forum, national transit and trade facilitation committees are being established in the region. Private sector participation has been extended to include insurance clearing agents, bank associations, the shippers’ council, and the like. Public- private partnerships to tackle trade and transport facilitation are also being established in West Africa. Source: World Bank 2004. Trade and Investment Promotion 177 Trade and Investment Promotion Policy areas and main issues Remedies/Project components Export promotion agencies • Consolidating agencies dealing with export promotion • Institutional reform and capacity building of an export promotion agency • Increasing private sector participation • Developing targeted export promotion strategy • Realigning focus—for example, support versus promotion; new versus existing exporters • Improving service delivery through outsourcing—for example, market research and training Investment promotion agencies • Institutional reform and capacity building • Increasing private sector participation • Developing targeted investment promotion strategy • Development/implementation of anchor investor strategy • Improving aftercare services • Developing/improving online presence • Development of a land bank portal Source: Authors. Box 3.8 provides some case study examples of good policy practice for export and investment promotion. Box 3.8. Case Examples of Good Policy Practice—Export and Investment Promotion Tunisia: Targeted Export Support Through a Matching Grant Program Tunisia’s export sector is highly focused on natural resources–based industries and strongly oriented toward Europe. Although the bulk of its exports are dominated by large (state-owned or formerly state-owned) concerns, diversification of the export base relies largely on SMEs, with relatively limited experience and knowledge of foreign markets. As one program to promote the internationalization of Tunisian SMEs, the Tunisian Export Market Access Fund (FAMEX) was established in April 2000; following its success, FAMEX II was launched in 2005. The creation of FAMEX marked an important shift of focus for export promotion in Tunisia, away from a trade-promotion organization model led by the government to a public-private sector participatory approach. Acknowledging that firms, not countries, compete, the Tunisian government emphasized individual exporters and their associations. FAMEX helped individual firms implement a systematic strategy to enter, sustain, and expand export markets. The $10 million fund was set up by Centre de Promotion des Exportations de la Tunisie (CEPEX; Tunisia’s export promotion agency) with World Bank assistance. It was privately managed by international and local experts. FAMEX encouraged firms, especially SMEs, to enter export markets by temporarily covering up to 50 percent of the cost of consultant services (up to US$100,000 per firm) and providing technical assistance. Services were offered by local consultants and international experts in response to demand from private firms. A key factor in the delivery of the program was the process by which exporters were selected to participate. Although the program was designed for SMEs, a minimum size threshold was established (around US$140,000 turnover for manufacturing firms and US$70,000 for services firms). To qualify for the grant, firms were required to prepare an export development plan, within which they would identify specific projects for which they requested grant support. Applicants had to define whether the projects were being linked to new export entry or to new product or market entry (for existing exporters). They were required to show that serious consideration was given to the feasibility of the proposed projects. Plans were reviewed by a panel including senior experts from FAMEX management, and the process included detailed interviews; successful applicants had to sign a letter of intent to bind them to activities in the plan. In the five years that it existed, FAMEX I helped 700 firms become exporters, export new products and services, or enter new markets. Estimates indicate that each $1 of FAMEX assistance generated more than $20 of additional exports. A recent survey indicates that 60 percent of the firms that benefited from FAMEX assistance are now willing to pay, or are already paying, full market price for export services (FAMEX 2008). A small export consulting industry has also been created as a result of the Module 3 program. FAMEX thus served as a catalyst to develop business-to-business markets. A more recent detailed evaluation of the FAMEX II program found clearly that participants in the FAMEX program achieved substantially higher export growth than nonparticipants. Sources: Nassif 2010; Gourdan 2011. Costa Rica: Coordinating Investment Promotion to Attract Intel Costa Rica took advantage of a close-knit government and business community to organize a flexible, unified effort to attract Intel to establish a US$300 million semiconductor plant under the country’s free zone program in 1996. A team was assembled (continued on next page) 178 Module 3: Policy Options for Competitiveness and Case Studies Box 3.8. (continued) that included high-level representatives of all relevant government ministries and private sector stakeholders, with close involvement of the president. Key to this was the role of the Costa Rica Investment Promotion Agency (CINDE). As a nonprofit, autonomous organization, CINDE maintained close ties with the government and the private sector and was able to act not only as an effective coordinator of the approach to Intel but also as a credible mediator between Intel and the government. Box figure 3.8.1 gives a perspective of the cross-agency coordination involved in the Intel investment promotion effort in Costa Rica. Intel was impressed by the degree of commitment by the President. He hosted members of the site selection team on several occasions and visited Intel’s plant in Chandler, Arizona. INTEL Ministry for Environment & Intel’s first contact with Costa Rica was a Energy Presentation made by the Director of CINDE’s New I.C.E. (Costa York office Rican Electric Utility company) assured action from each government CINDE (Investment Promotion Direct Involvement of the Presidency Ministry for Agency) THE PRESIDENCY Public Works & Transport • Director of Investment Promotion Ministry for (responsible for Free Zones) body Ministry of Foreign Trade • Investment Officer – Human Finance Resources and Education • Investment Officer – Real Estate, Construction, and Permits Ministry of • Director – New York office Science & Technology As the process continued, the President After the preliminary Ministry of assigned the Minister of presentation, CINDE Foreign Tade to Costa Rica took over and Education assigned three full-time coordinate all interactions with the specialists to attend to Costa Rican government Intel’s requests –Intel was given top and questions. priority. Technical In the initial stages, Institute of The minister held weekly CINDE coordinated meetings with the government Costa Rica President and CINDE to involvement. discuss progress Sources: Authors, based on Spar (1998); figure reprinted from Spar 1998, 29. Chile: ProChile Export Promotion In the past two decades, Chile has become a major export success, particularly beyond its traditional minerals sectors, encompassing the agricultural and agriprocessing sector, including salmon, wine, and horticulture. ProChile, Chile’s export promotion agency, is widely acknowledged as having played a critical role in facilitating the country’s export-oriented growth over this period, with its specific focus on the SME export sector (it focuses mainly on firms with a turnover range between US$50,000 and US$7.5 million). Two important components of its success—its sectorally oriented structure and approach, and its program to identify and support promising exporters—are summarized below. Module 3 ProChile has four operating divisions: a Sectoral Division (about 40 staff) manages the delivery of export promotion products and services to each exporting sector; an International Division (about 160 staff; 140 of which are based outside the country) manages the operation of the trade offices abroad; a Marketing Division (about 30 staff) manages all marketing activities, including trade missions; and an Information and Technology Division (about 15 staff) manages systems for providing information to clients, including websites and training modules. Key to the operations of ProChile is the targeting of priority sectors—the Sectoral Division is organized into seven separate business units, one for each key sector. Linked to this, ProChile maintains close financial and working relationships with the main industry associations representing these sectors. Asoex, the industry association representing 85 percent of Chile’s fruit exporters, exemplifies the relationship between ProChile and sector organizations. Asoex has an annual export promotion budget of about US$5 million, of which $2 million comes from ProChile’s cofinancing fund. With assistance from (continued on next page) Trade and Investment Promotion 179 Box 3.8. (continued) ProChile, Asoex was able to set up an office in the United States, opening new opportunities for export of previously unknown Chilean fruits. Wines of Chile, an international marketing association representing 90 percent of all wine exporters, has an annual export promotion budget of about US$6 million of which $2 million comes from ProChile. With this assistance, Wines of Chile set up a European office in the United Kingdom in early 2000. To improve the export skills of smaller existing exporters and to encourage new SME exporters, ProChile developed the Internalization Plan in 2001. One component, Interpac, is designed for SMEs in the agricultural sector; the other, Interpyme, is designed for SMEs in industrial sectors. These programs provide Chilean companies with systematic training in exporting issues faced by SMEs. They include training modules on production capabilities, market research, logistics, marketing plans, banking, international law, searching for partners, and the export process. Interpyme and Interpac are operated by a team of private sector consultants hired by ProChile and participants are provided with individual one-on-one counseling as part of the program. Participants complete one module at a time, and when they have completed the full program, they become eligible for ProChile cofinancing programs, provided that they have promising export plans. These programs take about one year to complete. ProChile covers up to 90 percent of the cost, provided that participants have an exportable product for which there is international demand and that they use labor-intensive production methods. The results have been impressive. Since the early 1990s, the number of exporters in Chile has doubled. Diversification of sectors, products, and markets has been dramatic, with the number of new products doubling, the number of markets growing by more than 50 percent, and the relative concentration of the mining sector reducing significantly. Between 1996 and 2006, Chile’s nontraditional exports (which account for 90 percent of SME exports from Chile) increased from US$6 billion to US$15 billion, an annual growth of 10 percent. Several impact evaluation studies have shown that ProChile has had a positive and significant impact on export participation, new product introduction, and firm-level technological and management improvements. Source: Derived from Nathan Associates (2004). Costa Rica: Linking Local Firms to FDI—the Provee Program Until the mid-1990s, Costa Rica’s economy was highly concentrated in the natural resources sector (mainly traditional agriculture). With the attraction of FDI, and of Intel in particular, in the 1990s, its export and economic structure changed dramatically. Recognizing that sustainability of growth would require the development of more innovative and value adding domestic firms, the country’s government embarked on a program designed to develop enhanced linkages between local SMEs and MNC foreign investors. The aim was to support the growth of local SMEs and promote technology transfer to facilitate upgrading. The Supplier Development Project for High-Technology Multinational Companies, a program inspired by Singapore’s Local Industry Upgrading Program, was established in late 1999. Its aim was to enhance domestic value added in high-technology MNC production and improve domestic SME competitiveness. This project had three key components: a Pilot Procurement Program, a Comprehensive Information System, and Costa Rica Provee (a domestic supplier development office). From 2003 on, Costa Rica Provee operated out of the Foreign Trade Corporation of Costa Rica (PROCOMER), but in 2005 it became one more management unit of PROCOMER. This latter organization includes Costa Rica Provee in its strategic plan, as a key component of value added for domestic exports. Costa Rica Provee engages in detecting the needs of MNCs, identifying business opportunities, and recommending registered suppliers who meet the production, technical, and quality specifications and characteristics required by the business at hand. The work of Provee with domestic suppliers focuses on ensuring their strategic role as MNC suppliers. For local suppliers, benefits include the following: • Participation in a supplier network highly qualified by these foreign companies • Reliance on a team made up of professionals from different fields including chemistry, electronics, materials, marketing, and business management • No investment requirement • Permanent project follow-up by Costa Rica Provee’s staff that ensures fulfillment of transnationals’ requirements Specific support provided by Provee includes technical support and diagnosis. Technical support focuses on analyzing goods to be offered to MNCs. This task is undertaken by Provee’s staff, made up of professionals with relevant experience in business development and majoring in engineering, industrial chemistry, and business management. Diagnosis applies evaluation tools aimed at ensuring long-term business relationships, including comprehensive diagnosis in finance, production, marketing, business management, and environmental and quality systems, among others. The mission consists of facilitating business deals between MNCs and domestic suppliers, thus contributing to enhance value added from Costa Rican industries as well as the country’s global competitiveness. More than 258 domestic suppliers have profited from the direct operation of Costa Rica Provee as well as from access to transnational companies (TNCs). This has led to improved supply of goods and services, technological specialization of suppliers’ production processes, and increased social benefit resulting from additional daily business. Currently, more than 186 TNCs Module 3 cooperate with PROCOMER and Costa Rica Provee. Source: Spar 1998. Czech Republic: Pilot Supplier Development Program CzechInvest (CI, the investment promotion agency of the Czech Republic) learned from surveying investors that multinationals considered the local supplier network to be a key determinant in their investment decisions, in fact, second only to labor availability. Yet multinational investors operating in the Czech Republic imported 90 to 95 percent of their components to meet their production requirements, driven by world-class standards and global competition. CI’s top management perceived a two-sided opportunity: address investors’ supply demand and a willingness to source locally by strengthening the capabilities of Czech (continued on next page) 180 Module 3: Policy Options for Competitiveness and Case Studies Box 3.8. (continued) suppliers. From CI’s perspective, a robust, competitive Czech supplier base for key prominent sectors was a way to “embed� FDI into the economy and channel its benefits, helping to both retain and attract investors while supporting domestic suppliers. With these objectives in mind, CI launched the Pilot Supplier Development Program (also called the Twinning Programme) in the electronics sector, the Czech Republic’s fastest growing and second-largest FDI sector after automotive. The program’s orientation was demand driven and practical; its overall objective was to equip participating suppliers with the information and skills to meet investors’ requirements and win more and higher value-added contracts. The program consisted of three elements: • Collection and distribution of information regarding the products and capabilities of potential Czech component suppliers to enable foreign manufacturers to shortlist and contact potential suppliers. The profiles of potential suppliers are available through CI’s website. Approximately 1,000 firms were listed in 2001. • Matchmaking, including three elements: (1) “Meet the Buyer� events between foreign investors and potential Czech suppliers. The sessions focus on identifying the type of components and services that foreign investors are considering subcontracting. (2) Seminars and exhibitions organized with and for Czech suppliers and foreign affiliates. (3) Taking forward concrete proposals to potential foreign investors, indicating potential suppliers in the Czech Republic. • Upgrading of selected Czech suppliers: Suppliers are selected according to predefined criteria in high-technology industries, such as electronics, or for selected engineering firms supplying to a wide range of industries. The selected firms produce an upgrading plan, tailored to their individual capacities and requirements. The upgrading process usually includes consultancy and training support in such areas as the utilization of technology, general management operations, quality control, and organizational change. In the case of the electronics sector pilot, CI identified 45 companies as potential candidates to expand their businesses and supply foreign manufacturers based in the Czech Republic. These companies outlined the areas of support they needed and then were provided training by Czech and international experts in the first phase of the program. After seven months, the companies were reevaluated. The 20 suppliers that were found to have shown the most improvement in their performance were invited to participate in the program’s second phase of individually tailored assistance. CI’s researchers determined all but four of the initial 45 company participants demonstrated marked improvement in their capabilities. CI’s evaluation of the electronics sector pilot program 18 months after it ended in July 2002 showed promising results. Fifteen suppliers had landed new, renewable contracts, amounting to more than US$46 million for the period 2000–03. Participating suppliers especially valued improvements in their strategic management, management of customer relationships, and communications. The experience suggested that government assistance could help an important segment of Czech firms compete for contracts that otherwise might be won by new foreign suppliers or sourced abroad. On the basis of these results, CI subsequently rolled out Twinning II, extending the scheme to the aeronautics, automotive, pharmaceutical, and engineering sectors. Source: Potter 2001. Module 3 Standards and Certification 181 Standards and Certification component of government industrial policy in high- income and middle-income countries alike (for example, Although the policy prescriptions in any one country will South Africa and the United Kingdom). be context dependent, certain broad policy issues should be considered with regard to the standards environment. These issues are outlined below. Government May Need to Assist Firms when Lead Firms Do Not Promoting Awareness of Standards In cases in which lead firms do not upgrade their supply It is incumbent on each government or supporting agency chains, a key challenge for policy makers is to ensure that a to ensure that the producers in their lead and emerging system of incentives is introduced to enhance both the sectors are aware of the nature and changing portfolio of demand for appropriate standards by firms wishing to par- standards. The producers also should be aware of the conse- ticipate gainfully in global value chains and the capacity of quences of achieving or not achieving these standards as local providers to supply support for local firms seeking to well as the steps required to achieve them when this is a fea- achieve accreditation. Support for the business services sible and sensible objective. Are governments aware sector is a key component of this agenda. In some cases, whether their economies possess the certification bodies this may be provided by the relevant industry association. and capabilities required to gainfully meet global standards In other cases, specialized providers may address the needs requirements? To what extent do their standards align with of many industries, such as those offering to assist firms to global standards, and does this matter? introduce ISO 9000 and ISO 14000 standards. Ensure that Standards Do Not Rule Out Local Suppliers Assisting Small-Scale Producers In some sectors, lead firms specify standards that have the Special problems arise for small firms, because achieving unintended consequence of ruling out local suppliers. standards accreditation may be a relatively costly process This is, for example, a common case in Africa’s mining (the costs tend to be fixed, irrespective of scale, and thus sector, in which the mine-commissioning firms often adversely affect small producers). One way to reduce these specify the use of standards for items such as electrical fit- scale economies can be achieved by banding together a tings and piping that are used in their home market but group of small producers to share the costs of certification, not in the local market. For instance, in Tanzania, this has both in its initial and then annual recertification stages. But led to the exclusion of existing suppliers utilizing UK this will only diminish the disadvantage confronting small rather than Australian specifications. Particularly in large producers, not remove it. A strategic decision will have to infrastructure and mining contracts (in which both have be made about whether small producers have a place in considerable potential for local linkages), governments standards-intensive global value chains or whether a subsi- need to be aware of the need for lead contractors to utilize dized scheme should be established to sustain their partici- those standards that are in use in the domestic economy. pation. This will require a country- and sector-specific set of judgments, balancing off distributional concerns and the upgrading benefits of standards against their fiscal and Role of Lead Firms in Promoting Standards economic cost. In many sectors, lead firms in global value chains are the key drivers of standards. There are, however, two contrasting Targeting Low-Income Markets outcomes of the standards imposed in corporate-driven value chains. The first is reflected in the contributions made Individual producers, or countries, may actively segment Module 3 to metal- and plastics-working suppliers by global auto markets, depending on standards requirements. Some assemblers. Driven by the imperatives of lean production, firms—perhaps small-scale producers—and some pro- auto assemblers have made it their business to upgrade duction lines may be dedicated to the low-income mar- their suppliers’ performance through the systematic use of kets, whereas others develop the standards’ capabilities to standards, setting a moving target of standards that suppli- participate in high-income markets. This agenda is appro- ers need to meet. Attracting these firms to upgrade their priate for firms and their industry associations as well as for supply chains (which also feed into other value chains and governments engaged in industrial policy designed to max- hence have spread effects) has been a core and successful imize the gains from participating in the global economy. 182 Module 3: Policy Options for Competitiveness and Case Studies Harmonizing Standards and Developing Countries pervasive and reliable infrastructure. In these and other cases, Participation in Standards-Setting Bodies low-income country governments need to participate actively in setting standards in those international fora that Many developing country firms are confronted with a bewil- are relevant to local producers. Particularly for small dering variety of standards that their producers have to meet economies, this process may be best undertaken through col- and at considerable cost. This is perhaps most evident with laborative specialization and collective action. regard to labor standards, but it is not unique to labor Box 3.9 provides case study examples of good practice standards. At the same time, some of the technical industry in developing standards programs that support export standards that are set reflect the operating conditions in high- competitiveness. income economies—predominantly temperate climates with Box 3.9. Case Examples of Good Policy Practice—Standards and Certification Peru: Quality Standards Promote Asparagus Exports Realizing that it was in the best interest of the country, the leaders of Peru’s asparagus industry and government specialists worked together to bring Peruvian agricultural standards in line with international norms. Both the industry and Peru have greatly benefited as a result. Over the past decade, Peru has quickly risen to become one of the world’s largest exporters of asparagus. This is particularly true for fresh green asparagus and, to a lesser extent, for fresh white asparagus and canned asparagus. In 2002, export revenue for all forms and presentations reached $187 million, representing nearly 25 percent of the value of Peru’s agricultural exports. Peru is able to produce quality asparagus year-round; however, in certain seasons, high air and sea transportation costs prevent it from matching prices with inexpensive asparagus from Mexico. Nonetheless, the Peruvians have continued to increase exports and gain market share during their main season by growing asparagus of consistently higher quality that can be internationally certified with respect to good agricultural practices, good manufacturing practices, and HACCP. In 1997, Spanish health authorities asserted that two cases of botulism had been caused by consumption of canned Peruvian asparagus. Despite assurances from the Peruvian government and companies, press coverage of the botulism scare left an unfavorable impression among consumers in European markets, causing sales to slump in Peru’s leading market. The incident motivated the industry and government to take action by reinforcing the fact that one careless (usually artisanal) exporter could disrupt markets. Beginning in 1998, officials of the Peruvian Commission for Export Promotion (PROMPEX) convinced the asparagus industry to implement the Codex code of practice on food hygiene. PROMPEX specialists worked with industry leaders and production managers to ensure proper implementation. The industry soon saw improved production and processing methods, as well as better product quality and safety. In 2001, national fresh asparagus norms were published. They provided a quality and performance baseline for the industry that allowed many firms and farms to generate the skills and experience needed to be certified under stringent international standards. Many large exporters have reached the level at which they can now be certified under the even stricter Eurepgap protocol. Looking ahead, the Peruvian asparagus industry should be well positioned to adjust to new or more stringent requirements from its trade partners on the basis of continued strong leadership and public- private cooperation. Source: World Bank 2005. Spain: Using Standards to Develop a Quality Export Brand: The Consorcio del Jamón Serrano In 1990, the producers and exporters of air-dried cured ham in Spain formed the Consorcio del Jamón Serrano Español to harmonize standards and create a quality brand. The Consorcio’s seal, which is given only to hams that meet its standards, guarantees the high quality of the certified product. Under EU regulation, the “Serrano ham� denomination is protected as a Traditional Specialty Guaranteed (TSG). The TSG standard for Serrano ham specifies the method of processing the meat, although it does not refer to a specific processing area or to the origin of the raw material. Cured ham cannot be sold in the European Union with the words “Serrano ham� on the label unless it is duly certified as meeting the TSG standard for the product. In addition to meeting the TSG requirements, the Consorcio also imposes its own standards, which in certain aspects are more demanding than the TSG standards. For a ham to earn the Consorcio seal of quality, it must— • be “Serrano� ham (meeting TSG requirements), produced by a certified company • use only Spanish raw material (Spanish pigs slaughtered in Spain) • be processed exclusively in Spain • be cured a minimum of nine months Module 3 • have a fat covering of at least 1 centimeter (to ensure the ham’s texture and aroma) • have shrunk 34 percent in relation to the weight of the original fresh ham • pass an individual sensorial inspection (piece by piece) • be produced by a company that has passed the quality inspections that the Consorcio constantly carries out The inspections performed by the Consorcio are certified according to the Spanish national standards. The Consorcio strives to ensure that hygienic, temperature, and humidity conditions established in the TSG standard, as well as the boning, slicing, and packaging procedures, are respected during the different stages of the process. In addition, each piece of ham is subjected to visual ~ inspection. A ham that meets all the standards will have a fire seal on the skin with the Consorcio del Jamón Serrano Espan ol logo and will also have a numbered control label. Consumers who purchase the certified products pay a premium price in exchange for the quality assurance that the certification provides. Source: Guasch et al. 2007. Special Customs Regimes and SEZs 183 Special Customs Regimes and SEZs Policy areas and main issues Remedies/Project components Duty drawback and MUB • Improving efficiency of reimbursement • Reducing documentation or other administrative requirements EPZs/SEZs • Reform of legal and regulatory framework • Addressing institutional design of zones authority • Infrastructure implementation or upgrades • Shifting from traditional EPZ to SEZ models • Establishing or improving “one-stop shop� services Source: Authors. Note: EPZ = export-process zone; MUB = manufacturing under bond; SEZ = special economic zone. Box 3.10 provides some case study examples of good practice in developing special customs regimes and SEZs. Box 3.10. Case Examples of Good Policy Practice—Special Customs Regimes and SEZs Zambia: Duty-Drawback Regime The refund of duty drawback works more efficiently in Zambia. To guarantee duty-drawback refunds, the Customs and Excise Division of Zambia has created a ring-fenced fund at the central bank. All import duties paid are deposited into that fund. The fund is then used to pay duty drawbacks within a period of six weeks, following claims. The remaining balance, after all pending drawback payments have been made, is then remitted on a monthly basis to the Treasury. A similar system is used for refunding value added tax. Source: UNCTAD 2006. Ghana’s Tema Free Zone: The MPIP, A New Approach for Integrating Local Firms with FDI As part of the relaunch of the Tema zone following the departure of the initial private developer, Business Focus of Malaysia, the Ghana Free Zones Board (GFZB) decided to commit part of the enclave to nonexport companies. The GFZB denominated about 70 hectares of Tema as Multipurpose Industrial Park (MPIP), with the support of the World Bank for the development of on-site infrastructure. The MPIP is designed to support the development of small-scale domestic industries and to create linkages with major exporters. Although companies within the MPIP will not have access to a special fiscal and customs regime, the plan for the industrial park is to facilitate competitiveness by establishing critical common infrastructure and cluster-based business support services. These services might include, for example, common packaging and labeling facilities, kiln drying, warehousing, and so on. The creation of the MPIP represents an innovative shift in the enclave model in Ghana, becoming that of a hybrid EPZ, which combines free zone and non-free-zone investors in the same location. It should offer a substantial opportunity for local firms to become better integrated into the supply networks of exporters in Tema. Source: Authors. Module 3 184 Module 3: Policy Options for Competitiveness and Case Studies Industry Coordination and Sector Support Policy areas and main issues Remedies/Project components Clusters and industry bodies • Ensuring cluster and sector targets in line with comparative advantage • Facilitating public-private dialogue • Provision of key public and coordinating infrastructure • Facilitating the building of networks among cluster participants Subsidies and incentives to sectors and exporters • Aligning incentives with comparative advantage Source: Authors. Box 3.11 provides some case study examples of good practices for industry coordination and sector support. Box 3.11. Case Examples of Good Policy Practice—Industry Coordination and Sector Support Italy: The Role of Trade Associations in Supporting SME Export Clusters In Italy, the main trade associations representing small firms identify cooperation opportunities, suggest ways in which firms can link complementary skills, create contacts among potential partner firms, motivate firms to cooperate, and mediate critical phases in the establishment of a network. In Bologna, one of the three major trade associations, the CAN (Confederazione Nazionale Artiglianato) has about 17,000 member firms, 41 local offices, and 500 employees. The CAN prepares 22,000 pay packets monthly for 5,000 firms. It keeps financial records for 10,000 firms, prepares income tax declarations for most of its members, and organizes 80 training courses a year on subjects ranging from management and business administration to computing and foreign languages. In the 1950s, the CAN established a large assessment and guarantee consortium in Bologna, which now has 7,500 member firms and guarantees some US$12 million in loans. So far, it has promoted 41 other consortia dealing with production and joint buying and selling, which now have 8,000 member firms and 42 industrial parks, in which 1,030 small firms are located. Sources: OECD 2001; Word Bank 2010b. Chile: Growth of the Salmon Cluster Chile has become a major export success beyond its traditional minerals sectors, most notably in the agricultural sector. Within this sector, the growth of the salmon industry exemplifies the success of Chile’s cluster approach to developing export industries. Very early on in the development of the cluster, many stakeholders formed collaborative associations that worked together to solve upstream and downstream challenges. The Chilean Farming Association (SalmonChile) for instance was the main group that represented producers and suppliers of the cluster. Other groups contributed to the development of the cluster, such as Instituto Technologico del Salmon, which was the technological arm of the association. Ship-owners, and Maritime Services, the Association of Diving Companies, and the Association of Veterinary Laboratories were other important associations that significantly supported the development of the industry. Together these associations launched initiatives to address issues and constraints faced by the sector, including the following: • The development of a pioneer quality seal to face stringent quality market requirements • The launching of a phytoplankton vigilance program • The monitoring of a series of environment, market, and regulation variables • The establishment of geographic and good management practices tools • The development of a labor-competency certification system for various subsectors of the salmon cluster by SalmonChile • The implementation of a “Clean Production Agreement� for the salmon industry and a Vigilance and Management Model that serves the principal producers and suppliers in the industry, both coordinated by SalmonChile and INTESAL The government of Chile, through its public sector institutions, has played a significant role as a catalyst and facilitator in the development of the cluster. Working with respective associations, it actively sought to promote joint actions and to build trust among cluster participants. The government sought to enforce regulations related to coastal zones and to mitigate environmental Module 3 impacts from projects. More recently, the government sought to promote research and development (R&D) among associations, particularly among producer-supply relations. Some of the initiatives include creation of an innovation and knowledge platform to coordinate public and private efforts on areas, such as fish health, genetics, animal feeding, environment, clean production, development of new technology and production management, and certification. Chile’s salmon industry grew from US$538 million in 1997, to US$2.2 billion in 2006, more than a threefold increase in 10 years. The sector now contributes 4 percent of total exports and more than 56 percent of total fisheries exports, and employs more than 53,000 persons (directly and indirectly). Source: Ramsawak 2010. (continued on next page) Industry Coordination and Sector Support 185 Box 3.11. (continued) Malaysia: Evolving Incentives Like most developing countries, Malaysia has used a system of incentives to attract investments. The structure of incentives, however, has been revised continuously to meet the evolving national development objectives. By linking the incentives and the provision of specialized infrastructure facilities to skills development and technology upgrading, Malaysia was able to take advantage of the global changes to improve Malaysia’s competitive position. The evolution of the system of incentives in Malaysia reflects a shift from general investment promotion to a focus on high-technology sectors and industrial clusters. The Pioneer Industries Ordinance (PIO) was introduced in 1958 to provide incentives and tariff protection for the development of manufacturing industries. These firms enjoyed tariff protection and tax relief of two to five years depending on the level of investment. By the late 1960s, the need to shelter import substituting industries was overtaken by the need to export. Toward this end, the Malaysian government passed the Investment Incentive Act (IIA) in 1968 to encourage employment creation, dispersal of industries, and investment of capital-intensive projects. The incentives provided under the IIA (the Pioneer Status, Labor Utilization Relief, and locational incentives offer tax relief for 2–10 years, and the Investment Tax Credit offers tax credits ranging from 25 to 40 percent of capital expenditure) were oriented to attract more labor-intensive and export-oriented industries compared with those of the import substituting industries-oriented PIO. In addition, to enhance the role of the manufacturing sector in the economy, several new policies and programs were introduced. The most notable was the Free Trade Zone Act of 1971 to allow for the formation of Free Trade Zones (FTZs). The main objective was to attract export-oriented MNCs to invest in Malaysia. Industries operating inside the FTZs would enjoy better (and subsidized) infrastructure, expedited customs formalities, and duty-free imports of raw materials, components, and machinery. This approach to promote export manufacturing was timely and successful in attracting the first major wave of export-oriented electronics manufacturing, concentrated initially in components, to Malaysia. To supplement the FTZ program as well as to promote dispersal of industries to the less developed regions of the country, in 1973, Malaysia introduced the Licensed Manufacturing Warehouse program, which extended similar treatment to individual factories set up outside the FTZs. In 1985, the industrialization process took on a more cohesive program with the announcement of an Industrial Master Plan (IMP), which identified three policy instruments for increasing technology capability, namely, research manpower; institutional arrangements, such as industrial parks; and incentives for R&D. Twelve priority sector development plans were announced as part of a comprehensive strategy to lift Malaysia’s industrial base. To further give the boost to the IMP, the Promotion of Investment Act (PIA) of 1986 was legislated to replace the IIA. Under the PIA, the Labor Utilization Relief incentive was abolished and the Pioneer Status incentives were modified. Promoted industries and projects would enjoy tax relief up to five years regardless of the size of the capital investment. In addition, an amendment to the Income Tax Act of 1967 provides tax incentives for training, R&D, and reinvestments, and complements the PIA. Other instruments including the exemption of import duty on raw materials, tariff protection for selected industries, and financial and credit assistance were used to promote industrial development. These incentives, along with other moves to create a more liberal investment environment, are the impetus behind the recovery of the Malaysian economy in the late 1980s and the rapid uptake of manufacturing investments. The Second Industrial Master Plan, 1996–2005 (IMP2), extended its approach beyond export manufacturing operations toward more locally integrated clusters to encourage the growth of supporting industries, including the services sector. The IMP2 emphasized deepening integration of manufacturing operations along the value chain, including investments in R&D and design capability; development of integrated supporting industries; enhancement of industrial linkages through packaging, distribution, and marketing activities; and increased productivity and competitiveness. Since the early 1990s, the investment incentives were increasingly tied to technological deepening, exports, and domestic sourcing of inputs. Beyond these incentives, R&D and training incentives were also introduced. In 1991, a broad reform of Malaysia’s investment policy regime was carried out by phasing out tax incentives for exports and reducing the scope of the Pioneer Status. With these changes, ordinary Pioneer Status would qualify for only 60 percent exemption (instead of the previous full exemption), and the period would be for only three to six years (instead of 10 years). Full tax exemptions, however, were granted to investments in specific high-technology and strategic sectors. Furthermore, the Malaysian Investment Development Authority announced that it would screen applications for Pioneer Status more rigorously using four broad criteria: value added of 30 to 50 percent, local content levels of 20 to 50 percent, depth of technology, and linkage effects. Source: Summarized from a background paper prepared for UNCTAD by Lim and Ong (2002). Module 3 186 Module 3: Policy Options for Competitiveness and Case Studies Innovation tively few firms that continuously export. A reduced num- ber of firms persistently sell to international markets, how- Policies to support innovation are diverse. First, developing ever, which accounts for the majority of the export value. countries still have huge unrealized benefits as they catch Therefore, policies that aim to develop a broader base of up to the frontier. Developing countries should prioritize innovative exporting firms may need to create mechanisms diffusion, technological learning, and adaptation of exist- to foster entrance, intensity, and permanence in interna- ing technologies. All developing countries have more to tional markets. gain in terms of growth and improved living standards Finally, policies to facilitate integration of firms into from the adoption of existing global technologies than global production networks can play a critical role in from riskier and costlier invention and commercialization facilitating low-level innovation in low-income coun- of new technologies. Second, policies should promote tries. Indeed, trade in tasks could provide a lifeline for appropriate technological learning by grassroots entrepre- countries yet to industrialize because it simplifies getting neurs. These entrepreneurs typically include farmers, arti- started. Starting to export by undertaking a single task is sans, and subsistence entrepreneurs who may have little or far less daunting than breaking into the global market for no formal education and who devise new solutions at the an entire product. In some manufacturing activities, a individual or collective level largely through improvisation production process that eventually generates a finished and experimentation. product can be decomposed into a series of steps or Third, policies should support the incremental adapta- tasks. Each task is distinct. It may (1) require distinct tion of existing technologies across the range of informal skills, (2) use labor and capital in different proportions, and formal micro and small enterprises in developing (3) require distinct inputs, and (4) have distinct conse- countries. These enterprises are often in traditional clusters quences for the local environment (UNIDO 2009). And and typically are characterized by limited deployment of no evidence indicates that task-based production is less capital and by low technical and managerial capabilities. technologically sophisticated than production of final Their main challenge is usually not commercializing new products. Instead of needing to acquire the entire range technologies but rather upgrading quality and productivity of skills necessary to produce a product all at once, man- by reverse engineering existing technologies. Any policy to ufacturing can start with specialization in tasks most incentivize innovation as a driver of trade competitiveness suited to the skills available. that is designed for broad-based development should take Box 3.12 provides some case study examples of good into account that exports usually are concentrated in rela- practices in innovation. Box 3.12. Case Examples of Good Policy Practice—Innovation Malaysia: National and Regional Incentives for Innovation Malaysia is a model of an economy that, over a period of two decades, achieved dramatic export-oriented growth along with structural change from a reliance on natural resources toward manufacturing and services. The government of Malaysia, at both a national and a regional level, has played a significant role in supporting export-entry as well as firm-level innovation and upgrading, through a series of industrial policy programs. Among these are a number of financing and incentive schemes designed to support investment in innovation. At the national level, the Ministry of Industry and Trade (MITI) operates a Commercialization of Research and Development Fund, which provides partial grants of 50 to 70 percent of R&D expenditures related to innovation. Activities covered through the grants include market research, product design and development, standard and regulatory compliance, intellectual property concerns, and demonstration costs. In addition, the Technology Acquisition Fund provides grants of up to 70 percent to purchase technology licenses and patent rights. Specifically in the Penang region, a number of financing schemes are available to support innovation, some of which are Module 3 targeted specifically to support the SME sector. Three of these include the following: • The Industrial Technical Assistance Fund (ITAF) was set up in 1990 to prompt SMEs to upgrade their technical capabilities in areas such as product development, design, quality, and productivity enhancement. Assistance is given in the form of grants, with 50 percent of the project costs borne by the government and the remainder by the applicant. • The Modernization & Automation 2 Scheme (MAS) is a soft loan scheme aimed at promoting the use of modern technology processes by Malaysian-owned SMEs. The scheme assists SMEs in the acquisition of new machinery and equipment. Loan amounts are up to RM 1 million and up to 75 percent of the machinery or equipment purchased, with an interest rate of 4 percent per year and loan periods of 5–10 years. (continued on next page) References 187 Box 3.12. (continued) • The Normal Loan Scheme offers project loans, leasing, and share financing. The scheme offers lease financing of machinery and equipment for a minimum amount of RM 100,000, at 5 percent interest and for a maximum period of five years. With regard to share financing, the scheme offers to take up equity in companies for amounts ranging from RM 100,000 to RM 5 million, with an interest rate of 5 percent and a maximum period of five years. Rapid growth in Malaysia’s high-end manufacturing activities (especially electronics) has contributed to the country now having one of the most sophisticated export mixes in the world. More recently, patenting activity outside of Malaysia by Malaysian residents also increased. Between 1995 and 2008, US patents issued to residents of Malaysia rose 20-fold, from an average of less than 10 per year to nearly 200. Sources: World Bank 2010c; UNCTAD 2011. Ireland: Leveraging European Union Assistance to Support Innovation and Growth As a relatively peripheral European economy, with a small population, an agricultural history, and a long-term problem of persistently high unemployment, the dramatic growth and structural change achieved by Ireland stands as a useful lesson for developing countries. Government policy stimulates innovation through research, education, and industry-specific measures. Resources of about €2 billion were applied for this purpose in the period 2001–06 under measures agreed with the European Commission in the Ireland National Plan. Through the agency Enterprise Ireland, three types of programs are available to encourage the acquisition of technology: • Grants: Enterprise Ireland has a number of grant schemes, which are designed to encourage and support research, development, and innovation by firms. They support projects, the acquisition of equipment, and various kinds of cooperation with third-level educational institutions. These include: (1) the RTI Competitive Grant Scheme, which supports commercially focused, industry-led projects in product and process development (expenditure is greater than €95,000); a grant of between 25 and 45 percent of eligible expenditure is available, depending on company size and its location in Ireland, up to a maximum of €440,000. The aim of this scheme is to increase the level of high-quality R&D in businesses in Ireland, with a focus on improving competitiveness; (2) The Research and Development Capability Initiative, which covers additional resources, such as R&D staff, equipment, and so on; it also provides a grant of between 25 and 45 percent of eligible expenditure is available; (3) Innovation Partnerships, which support collaboration on applied research projects, with commercial application, between industry and third-level colleges; (4) a Basic Research Grant Scheme for third-level institutions; and (5) Regional Business Incubation Space, which aims to strengthen regional innovation infrastructure by facilitating the provision of incubation and commercial R&D space for the establishment of high potential start-ups. • Equity schemes: Enterprise Ireland also invests in some of its client companies, where it is satisfied that such investment is justified. Equity may be in the form of ordinary shares. Loans can be provided in the form of redeemable preference shares. • Venture capital: With the support of the European Commission, Enterprise Ireland established a seed and venture capital initiative under the operational program for industrial development, 1994–99. The aim was to develop a venture capital market to fill an existing gap in equity for SMEs. Fifteen partnership funds were created between Enterprise Ireland and the private sector, offering not only funding for these companies but also badly needed skills to accelerate their growth. From 2000 to 2007, Enterprise Ireland supported 430 high-performance start-ups, 40 percent of which were specifically R&D projects. This investment yielded sales of €638 million and exports of €344 million, and generated employment for 5,500 people. More broadly, business expenditure on R&D quadrupled between 1995 and 2008; similarly, spending by higher education institutions on R&D doubled over this period to reach EU average levels. Sources: UNCTAD 2005; Department of Enterprise, Trade and Employment (Republic of Ireland) 2009. References InvestPenang 2010. http://www.investpenang.gov.my. IFC (International Finance Corporation). 2008b. “Regulatory Transfor- Chauffour, J. P., and T. Farole. 2010. “Trade Finance in Crisis: Market mation in Mexico, 1988–2000.� World Bank, Washington, DC. Adjustment or Market Failure.� In Effective Crisis Response and Open- IPC (Instituto Politécnico Centroamericano). 2009. IPC Company ness: Implications for the Trading System, eds. Simon J. Evenett, Brochure. San Pedro Sula, Honduras: IPC. Bernard M. Hoekman, and Olivier Cattaneo, 119–142. Washington, ITC (International Trade Commission). 2009. How to Access Trade DC: World Bank and CEPR. Module 3 Finance: A Guide for Exporting SMEs. Geneva: International Trade Department of Enterprise, Trade and Employment (Republic of Ireland). Commission. 2009. Science, Technology & Innovation: Delivering the Smart Economy. Jayasekera, Douglas. 2004. “Bilateral and Regional Free Trade Agreements: Dublin: Department of Enterprise, Trade and Employment. Dublin: Case Study of Sri Lanka.� Background Paper, UNDP Asia Trade Initia- Department of Enterprise, Trade and Employment. tive, Hanoi. Ffrench-Davis, R. 2010. Economic Reforms in Chile: From Dictatorship to Lim, P. L., and C. I. Ong. 2002. “Malaysian Case Study of the Use and Democracy. Second edition. Ann Arbar: University of Michigan Press. Impact of Performance Requirements.� Paper prepared for UNCTAD, Guasch, J. L., J. L. Racine, I. Sanchez, and M. Diop. 2007. Quality Systems Geneva. and Standards for a Competitive Edge. Washington, DC: World Bank. Nassif, C. 2010. “Promoting New Exports: Experience from Industry Case IFC (International Finance Corporation). 2006. 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Border Management Modernization, eds. Gerard Penang Skills Development Centre. 2010. http://www.psdc.org.my. McLinden, Enrique Fanta, David Widdowson, and Tom Doyle. Potter, J. 2001. Embedding Foreign Direct investment. Paris: OECD. Washington, DC: The World Bank. Ramsawak, R. 2010. Cluster Best Practices: Lessons from the Field. World Bank. 2011b. “The Russian Federation: Export Diversification Trinidad: Arthur Lok Jack Graduate School of Business, University of through Competition and Innovation—A Policy Agenda.� World the West Indies. Bank, Washington, DC. Salas, Fernando. 2005. “Institution Building: Lessons from Mexico, Public Word Bank. 2010b. Innovation Policy: A Guide for Developing Countries. Policy for the Private Sector.� Washington, DC, World Bank. Washington, DC: World Bank. Sovicheat, Penn. 2006. Cambodia Ministry of Commerce, speaking at the World Bank. 2010c. Malaysia Economic Monitor: Growth through Innova- Consultative Meeting on Trade Facilitation and Regional Integration, tion. Washington, DC: World Bank. Bangkok, August 17–18. World Bank. 2010d. Trade and Transport Facilitation Assessment: A Practi- Spar, D. L. 1998. “Attracting High Technology Investment: Intel’s Costa cal Toolkit. Washington, DC: World Bank. Rica Plant.� FIAS Occasional Paper 11, World Bank, Washington, DC. World Bank. 2009c. Duty and Tax Relief Suspension Schemes: Improving UNCTAD (United Nations Conference on Trade and Development). Export Competitiveness, A Reference and Learning Toolkit. Washington, 2006. Blue Book for Ghana. Geneva: UNCTAD and Japan Bank for DC: International Trade Department, World Bank. International Cooperation. World Bank. 2008. Doing Business. www.doingbusiness.org. UNCTAD (United Nations Conference on Trade and Development). World Bank. 2006. “Expanding Access to Finance: Good Practices and 2005. 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Module 3 Appendix A: Summary of Recent Papers on Determinants of Trade Competitiveness This toolkit refers to an extensive body of literature related it provides insight on policy prescriptions that aim to to trade competitiveness. This appendix presents a more achieve export diversification by pointing out several drivers detailed summary of four recent papers—two of which of diversification (for example, infrastructure, education, were commissioned as background to this project—that and governance). explore determinants of different dimensions of export The authors employ the Theil index to examine how performance and thus are closely related to the general concentration (diversification) has evolved over time on objective of this toolkit. The first, Carrère, Strauss-Kahn, 134 countries. They take advantage on the decomposability and Cadot (2011), identifies several drivers of export diver- property of this index to identify changes in diversification sification as a base to prescribe policy recommendations within groups (the intensive margin of trade) and between in developing countries. The second, Hallaert, Cavazos, groups (the extensive margin of trade). They define two and Kang (2011), identifies and quantifies the severity of groups to be analyzed: group one includes active export binding constraints to trade expansion in developing lines for a country-year pair, and group zero includes inac- countries in general and in some categories of countries— tive export lines (that is, export lines for which there are no landlocked countries (LLCs), small and vulnerable exports). Results confirm previous findings of a U-shaped economies (SVEs), and commodity exporters—in particu- relationship between export concentration and income lar. Finally, in the two papers commissioned for this report, and, most important, indicate that most of the concentra- Seker (2011) investigates the possible reasons that prevent ‚ tion in levels occurs at the intensive margin (in goods that convergence of countries in export performance, and are long-standing exports) whereas changes in concentra- Cusolito (2010) sheds light on the relationship between tion occur at the extensive margin (see figure A.1). export competitiveness and the extensive and intensive Next, the authors take account of the main variables margins of international trade. used in the literature and propose a quantitative assessment of the main determinants of export diversification. Specifi- cally, they regress the overall Theil index, the within-groups Olivier Cadot, Céline Carrère, and Vanessa Theil, the between-groups Theil, and the number of Strauss-Kahn. 2011. “Trade Diversification: exported products on 10 variables using a panel database Drivers and Impacts.� World Bank, including 87 countries during 1990–2004. Country and Washington, DC. year fixed effects control for unobservable characteristics in This paper proposes a quantitative assessment of the main all regressions. Table B.1 reports the results. determinants of export diversification. The authors address Results confirm the U-shaped tendency of income on the issue of how export diversification is measured and dis- export diversification. Once controlling for gross domestic cuss the stylized facts about export diversification across product (GDP) per capita, the results show that infrastruc- time and countries. Then, the authors identify the potential ture appears to be an important driver of diversification: A determinants of export diversification. Finally, they tackle 10 percent increase in the infrastructure index decreases the relationship between export trade diversification, the Theil index by about 0.7 percent. Remoteness also has growth, and employment. This work is important because the expected sign: The more remote the country, the lower 189 190 Trade Competitiveness Diagnostic Toolkit Figure A.1. Contributions of within- and between-Groups to Overall Concentration, All Countries 6 Total Theil 5 Between 4 3 Within 2 0 10000 20000 30000 40000 GDP per capita, PPP (constant 2005 international $) Source: Authors. Table A.1. Diversification Drivers in a Panel Data Set, 1990–2004, 87 Countries In (Theil) ln ( Theil_within) In (Theil_between) In (Nber) Coef. Std. Err Coef. Std. Err Coef. Std. Err Coef. Std. Err In (per capita G-DP) –0.505 0.09*** –0.193 0.13* –1.054 0.32*** 1.055 0.38*** In (per capita G-DP) – squared 0.040 0.01*** 0.009 0.01 0.054 0.02** –0.106 0.02*** In (Infrastructure) –0.072 0.03*** –0.122 0.04*** –0.303 0.08*** 0.119 0.07* In (Remoteness) 1.092 0.46** –0.439 0.50 3.753 2.14* –3.533 1.51** Trade liberalization –0.009 0.01 0.017 0.02 0.031 0.05 0.108 0.06* Pref. Market Access –0.179 0.04*** –0.244 0.05*** –1.031 0.21*** 0.316 0.11*** FDI (% GDP) 0.001 0.00** 0.001 0.00* 0.002 0.00 0.000 0.00 In (Years of Schooling) –0.114 0.06* 0.017 0.07 –0.625 0.26** 0.619 0.21*** ICRG –0.047 0.04* 0.086 0.04** –0.584 0.14*** 0.416 0.12*** Policy Score –0.002 0.00* 0.002 0.00 –0.003 0.00 0.019 0.00*** In (population) –0.187 0.07*** 0.041 0.08 –0.642 0.27** 1.582 0.27*** Country fixed effects yes yes yes yes Year fixed effects yes yes yes yes Observations 1195 1257 1257 1257 Ajusted R-squared 0.97 0.92 0.98 0.95 Source: Cadot, Carrère, and Strauss-Kahn (2011). Note: Robust standard errors in italics. *Significantly different from zero at 10 percent ;**significant at 5 percent ;***significant at 1 percent. its export diversification (that is, the higher its Theil) that they produce in high volumes. They also find a signifi- essentially in terms of the extensive margin and number of cant impact of education on export diversification. A 10 products. The analysis thus confirms that high distance to percent increase in the years of schooling reduces the Theil importers increases the export fixed cost and consequently index by 1.1 percent and increases the numbers of drastically reduces export diversification. Preferential mar- exported products by 6.2 percent. Similarly, the quality of ket access is clearly an important factor of diversification at institution appears clearly significant with a positive both margins. In contrast, net inflows of foreign direct impact on diversification. Finally, as expected, the larger investment (FDI; in percent of GDP) seems to concentrate the population, the more diversified the economy. exports value on some products and thereby increases con- As noted by the authors, these results should be seen centration at the intensive margin. This result could be with caution. The regressions are informative of the factors expected as multinationals specialize in specific products that have a significant impact on diversification and of the Appendix A: Summary of Recent Papers on Determinants of Trade Competitiveness 191 sign of this impact once controlled for others factors. It is columns 3–6. Controlling for country and year effects, the difficult, however, to rank these factors and clearly isolate a results suggest that middle-income countries that under- single impact because of potential multicolinearity issues took trade liberalization reforms have a significantly more existing between these variables. diversified structure of exports along the intensive margin. Next, the authors single out the role of trade liberalization By contrast, low-income countries diversify mostly along as a driver of diversification. To do so, they combine the Theil the extensive margin. index of export concentration computed at the HS six-digit Overall, this work suggests that poor countries have, level for 1988–2006 with the trade liberalization date on average, undiversified exports. As they grow, they of Wacziarg and Welch (2008). The sample used includes diversify, and then reconcentrate at high-income levels. 100 countries, 62 middle-income and 38 low-income coun- The extensive margin (new products) dominates the tries over 1988–2006, with respectively 68 percent and 49 per- action in terms of diversification, but the intensive margin cent of country-year observations occurring in liberalized (higher volumes) dominates the action in terms of export regimes. The authors run fixed-effects regressions of the growth. Thus, if governments ultimately are interested in Theil index on a binary liberalization indicator defined by the export (and employment) growth, then the intensive mar- dates of liberalization (equal to one when liberalized) to gin appears to be a better bet. Because of enormous assess the within-country effect of trade liberalization on the churning, many of today’s new products are tomorrow’s diversification of exports. Specifically, they use a difference- failed products. in-difference approach given by the following: Theilit = li + dt + fLIBit + eit (A.1) Jean-Jacques Hallaert, Ricardo Cavazos where Theilit is the Theil index of country i exports in Cepeda, and Gimin Kang. 2011. “Estimating year t, LIBit a dummy equals to one if t is greater than the the Constraints to Developing Countries Trade.� Organisation for Economic year of liberalization (defined by Wacziarg and Welsh, Co-operation and Development, Paris 2008) and zero otherwise. li and dt are respectively coun- try and year fixed effects. The sample is not restricted to This paper adds to the literature by identifying and quanti- countries that underwent reforms. Results are reported in fying the severity of binding constraints to trade expansion table A.2. as well as by assessing the role of complementary policies The regression shows a highly significant within- in affecting trade reforms impact on economic growth. country difference in export diversification between a lib- Although the authors acknowledge that constraints to eralized and a nonliberalized regime (reported in table A.2, trade expansion are largely country specific, they empiri- column 1), with a coefficient twice as high for middle- than cally test the role of these constraints in a cross-country for low-income countries. They also regress equation A.1 exercise that is used as a benchmark against the specific using the Theil index’s decomposition (within groups ver- needs of three country groupings: LLCs, SVEs, and com- sus between groups). Results are reported in table A.2, modity exporters. This analysis is complemented by two Table A.2. Fixed-Effects Regressions of Diversification Index on Liberalization Status Theil Theil-within Theil-between Liberalization (LIB) –0.190* –0.075 –0.100* (2.0) (0.8) (2.8) LIB - Middle Income –0.241* –0.271* 0.067 (2.0) (2.0) (0.5) LIB - Low Income –0.138* 0.053 –0.209* (1.6) (0.5) (2.0) Number of Obs. 1794 1394 1394 Number of countries 100 100 100 Period 1988–2006 1990–2004 1990–2004 Country fixed effects Yes Yes Yes Year fixed effects Yes Yes Yes R2 within 0.39 0.39 0.28 0.29 0.75 0.75 Source: Jean-Jacques Hallaert, Ricardo Cavazos Cepeda, and Gimin Kang (2011). Note: Standard errors in parentheses; heteroskedasticity consistent and adjusted for country clustering. * significant at the 10 percent level. 192 Trade Competitiveness Diagnostic Toolkit case studies (Azerbaijan and Uganda) that illustrate not appears to be the main constraint to trade expansion; this only the mechanisms highlighted by the econometric work is less related to availability than to reliability. (4) Air trans- but also the importance of some variables the econometric port, labor force, labor productivity, and rule of law are work could not capture because of data limitations. important factors affecting exports but not imports, The empirical work to determine the impact of the vari- whereas investment, access to domestic credit, and mis- ables identified as the binding constraints on trade and, management of the real effective exchange rate appear to subsequently, the impact of trade on growth is composed of remarkably affect imports but not exports. (5) The results two stages.1 They employ a two-stage least squares estima- confirm the importance of complementary and compati- tor (2SLS) in which the first stage quantifies the magnitude ble policies (education, governance, business environment, and direction of the direct effect of the binding constraints and macroeconomic stability) that are important for trade on trade indicators (exports, imports, and openness),2 and expansion and economic growth because they affect fac- the second stage quantifies the magnitude and direction of tors having a large impact on trade performance, such as the composite effect of the binding constraints on the econ- investment, labor productivity, and labor participation. omy’s growth rate through their effect on trade indicators. How do the binding constraints differ from these gen- The first stage is then given by the following: eral results for the various country groupings? The authors shed light on this question by looking at three different Trade = Wî + tGDPi, t–1 + ei,t (A.2) country groups (LLCs, SVEs, and commodity exporters) where Trade is defined as above; W is a vector of exogenous to identify the most binding constraints for each group. variables in the model that determine the country’s level of The highlights of the main results follow. trade, including those related to the binding constraints and a constant; GDP represents initial GDPi, t–1; t is a Landlocked Countries parameter to be estimated; ei,t represents the regression error term; and î is also a parameter to be estimated. The LLCs face particular constraints that significantly dimin- second stage regression is given by the following: ish their trade integration. The openness ratio is reduced by 5 percent, just for the fact of being a landlocked coun- ΔGDP = α 0 + α1GDPt ,0 + α2$ Tradeit try. Electricity is the main problem followed by tax rates, + α 3Investment + X β + ωi,t (A.3) access to finance, and transportation. The growth effect of where DGDP is the change in real GDP, GDPt,0 represents trade appears to be slightly larger in LLCs than in the $ initial GDP, Tradeit is the predicted value of the trade indi- benchmark scenario: An increase of 10 percent in the cator in stage one (exports, imports, or openness), Invest- openness ratio will determine an increase of growth rate of ment is the amount of investment in the country as a share 1.6 percent (compared with 0.8 percent/1.1 percent of the of GDP (investment is part of this equation because it is a unrestricted sample). This result is valid both for imports key determinant of growth and because literature has and for exports. shown that it is an important channel of the impact of Poor domestic policies are one of the factors responsible trade on growth), X is a vector of other variables affecting for the low trade performance of LLCs. Restrictive trade GDP growth, wi,t represents the regression error term, and policies (measured by customs tariff) seem to have a the ak and b are parameters to be estimated. greater impact on trade performance of LLCs than in other This model is estimated on a database of 65 countries countries. A 10 percent appreciation of the real effective that are recipients of Official Development Assistance exchange rate would lead to a drop of about 1 percent of (ODA) covering the period from 1981 to 2009. These coun- export, import, and openness ratios. Access to credit tries account for 57 percent of the aid for trade disbursed instead appears not to be a significant constraint to trade since the inception of the Aid for Trade initiative (2005–08) expansion in LLCs. and 55 percent of 2008 aid-for-trade commitments. Results for the whole sample of countries are reported in table A.3. Small and Vulnerable Countries The results for the unrestricted sample show five main findings: (1) In line with economic literature, both imports The authors define SVEs as countries whose share in global and exports boost economic growth, but the constraints to market does not exceed 0.12 percent and whose population exports differ from the constraints to imports. (2) Despite does not exceed 15 million. According to these criteria, and recent trade liberalization, a cut in import tariffs can still given the available data, 36 ODA-eligible countries are boost exports and imports performance, but the impact is defined as SVEs. In these countries, the size of the state small compared with other constraints. (3) Electricity limits the diversification opportunities of production. Appendix A: Summary of Recent Papers on Determinants of Trade Competitiveness 193 Table A.3. Results for the Unrestricted Sample (1) (2) Openness Exports Imports Openness Exports Imports Loggdp1 –0.287*** –0.413*** –0.192** –0.277*** –0.401*** –0.183** (0.0906) (0.106) (0.0814) (0.0852) (0.0997) (0.0766) l_air_trans_carr_dep 0.101*** 0.195*** 0.039 0.119*** 0.203*** 0.067* (0.0388) (0.0574) (0.0343) (0.0425) (0.0598) (0.0367) I_roadkm2 0.097*** 0.082** 0.111*** 0.074** 0.064 0.083*** (0.0280) (0.0405) (0.0238) (0.0295) (0.0392) (0.0266) l_electric_power_losses –0.185*** –0.240** –0.170*** –0.214*** –0.288*** –0.174*** _p_out (0.0666) (0.0984) (0.0546) (0.0644) (0.0945) (0.0546) l_dom_credit 0.176** 0.004 0.290*** 0.171* 0.011 0.271*** (0.0866) (0.117) (0.0733) (0.0907) (0.121) (0.0758) Simple_average3_mfn –0.013** –0.014** –0.011** –0.012* –0.013* –0.010* (0.00561) (0.00670) (0.00506) (0.00602) (0.00703) (0.00549) I_gfcf1 0.423* 0.218 0.507** 0.480* 0.257 0.582** (0.254) (0.294) (0.228) (0.273) (0.313) (0.242) l_property_rights 0.229 0.496** 0.159 0.127 0.458** –0.015 (0.167) (0.219) (0.149) (0.156) (0.202) (0.139) l_l_force 0.138** 0.263*** 0.055 0.154** 0.290*** 0.057 (0.0674) (0.0857) (0.0594) (0.0770) (0.0916) (0.0700) l_productivitity_per 0.122* 0.309*** –0.027 0.110 0.287*** –0.026 _worker (0.0736) (0.0942) (0.0664) (0.0681) (0.0869) (0.0625) l_reer –0.678* –0.696 –0.572** –0.557* –0.580 –0.450 (0.367) (0.440) (0.332) (0.319) (0.395) (0.284) l_government_spending –1.570*** –1.840*** –1.404*** –1.737*** –2.016*** –1.553*** (0.510) (0.571) (0.479) (0.608) (0.682) (0.562) Landlocked –0.501*** –0.709*** –0.359*** –0.633*** –0.852*** –0.470** (0.126) (0 179) (0.113) (0.196) (0.247) (0.183) Island 0.005 0.019 –0.033 –0.004 0.033 –0.053 (0.137) (0.163) (0.129) (0.137) (0.161) (0.132) SVE 0.264 0.246 0.274 (0.185) (0.218) (0.166) Commodity exporters –0.069 –0.040 –0.193*** (0.0889) (0.130) (0.0730) Constant –2.972 –3.994 –4.095 –3.438 –4.582 –4.393 (3.778) (4.230) (3.493) (3.427) (3.861) (3.157) Observations R–squared 175 176 176 175 176 176 0.454 0.411 0.503 0.462 0.416 0.520 Trade variable in 0.081 0.054 0.102 0.111 0.074 0.07 growth estimate (0.0885) (0.0607) (0.127) (0.0801) (0.0580) (0.077) Source: Jean-Jacques Hallaert, Ricardo Cavazos Cepeda, and Gimin Kang (2011). Note: Robust standard errors in parentheses, ***p < 0.01, **p < 0.05, *p < 0.1. This would result, other things being equal, in a larger index for non-SVEs (0.145) or LDCs (0.127). Further- import-to-GDP ratio. More in detail, SVEs are character- more, the small size of their labor force is an important ized by a physical isolation, geographic distance from the statistical constraint: A 10 percent increase in the labor main markets, high transport and transit costs, minimal or force would increase the openness ratio by more than no export product diversification, dependency on few 3 percent of GDP. export markets, low competitiveness, difficulties in attract- In SVEs, the relevance of the electricity problem appears ing FDI, and susceptibility to natural disasters. larger than any other group. Transportation issues seem to SVEs are open to trade by necessity. Export concentra- be more severe than for the average country but less than tion reduces significantly their openness: the Herfindahl for LLCs. According to the estimations, quality of road Index (HS four digits, SVEs export concentration, infrastructure largely affects trade openness in SVEs: A 2000–07) equals 0.176, which is much higher than the 10 percent increase in paved roads would augment 194 Trade Competitiveness Diagnostic Toolkit openness by 3 to 5 percent of GDP. Similarly, a 10 percent have a significant impact mainly for imports (although increase in road density would increase openness by about it had remarkable significance for both importers and 2 percent of GDP. Finally, the impact of roads on the whole exporters, in the case of SVEs and LLCs). This may be due economic growth would be substantial: A 10 percent to the specificities of the investment in commodity coun- increase in the quality of roads should increase the eco- tries and to the impact of a Dutch disease. nomic expansion by more than 0.4 percent, mainly Interestingly, in the case of commodity exporters, prop- through trade. erty rights are a significant statistical variable. Specifically, Electricity is the main constraint for SVEs’ exporters. property rights are highly significant (and negative) for The problem is associated, in particular, with the reliability imports and basically insignificant for exports. A 10 per- of electricity. Telecommunication infrastructure, given the cent increase in the property right variable will determine remoteness, landlockedness, and insularity of most of these an increase of between 2.3 percent and 2.5 percent of GDP countries, also represents a major issue of constraints: of the openness ratio for the unrestricted sample but will Increasing the number of fixed telephone lines per 100 cause a reduction of 1.2 percent of GDP in the commodity inhabitants would increase the trade openness ratio by exporter group. 0.2 percent. Supportive macroeconomic policies are essential for the sustainability of trade reforms. Although the impact of the Murat Seker. 2010. “Trade Policies, ‚ mismanagement of the exchange rate appears more limited Investment Climate, and Exports across in the case of SVEs, the impact of government spending Countries.� World Bank Policy Research Working Paper No. 5654, World Bank, remains absolutely significant, much more than for the Washington, DC. unrestricted sample. Estimation results show that focusing on tariff reforms would not affect SVEs significantly. The This study investigates the possible reasons that countries biggest impact would be given by the complementary poli- fail to converge in export performance. The study’s data set cies, in particular, by addressing the export concentration comprises countries with various income levels and from issues. Access to credit is also a major impacting factor: A different regions of the world to shows how trade policies, 10 percent increase in credit to the private sector would trade facilitation, and investment climate (IC) variables increase all trade ratios by 3 to 4 percent of GDP. affect export performance. To accomplish this goal, the author uses two indexes to measure the restrictiveness of tariff policies. The first is the Commodity Exporters Trade Tariff Restrictiveness Index (TTRI), which shows the The commodity exporters group is defined by countries restrictiveness of domestic trade policies on imports. for which raw materials account for more than 45 percent The second is the Market Access Trade Tariff Restrictive- of goods exports. The impact of trade on the whole eco- ness Index (MATTRI), which shows the ease of foreign nomic growth appears to be smaller in magnitude than for market access of the country. Unlike simple or weighted any other country group: A 10 percent increase of open- average tariff rates, these indexes are well grounded in ness ratio would increase the economic growth to between trade theory and provide sound aggregate measures of 0.09 percent and 0.17 percent. In short, it seems that their trade restrictiveness. high export concentration makes them more vulnerable to The author focuses on six indicators, each representing world commodity prices. a different aspect of the IC. These indicators are regula- The tariff regime appears to be a more important con- tory quality, trade facilitation, entry regulations, access to straint for commodity exporters than for other country finance, infrastructure, and property rights. Although a groups: A 10 percent cut in tariffs would augment the number of studies analyze how some of these indicators export-to-GDP ratio by 0.2 to 0.6 percent and the import- affect export performance, none have looked at the interac- to-GDP ratio by 0.2 to 0.3 percent. Electricity also appears tion of these indicators with the restrictiveness of foreign to be a major constraint (more in terms of availability market access. rather than in terms of reliability): A 10 percent increase in Regulatory quality—obtained from Worldwide Gover- electricity consumption is associated with an increase of nance Indicators (WGI)–captures the capability that a 4 percent of the export-to-GDP ratio and of 1.6 percent of government has to carry out sound policies that facilitate the openness ratio. private sector development. It fluctuates between -2.5 and Complementary policies to boost investment have a pos- 2.5 (high scores correspond to better outcomes). Access to itive impact on trade openness for commodity exporters. finance measures financial development. It corresponds According to the results, an increase in investment would to the log of money divided by quasi-money (M2) to Appendix A: Summary of Recent Papers on Determinants of Trade Competitiveness 195 GDP collected by World Bank’s World Development Indi- The results of estimating this equation are presented in cators. The entry regulations measure is an index that tells table A.4. GDP is a strong correlate of high export per- how many procedures are needed to start a business. formance, which is a common finding in gravity models. Trade facilitation is measured by a country’s customs effi- Conversely, large and remote countries export less. A 10 ciency. Time to export is counted as the log of the number percent increase in the remoteness of the country decreases of days needed to export a good. Infrastructure represents export sales by 4 to 5 percentage points. Past export growth the quality of overall infrastructure (for example, trans- also contributes significantly to the current export per- port, telephone, and energy). It varies between one and formance. Lastly, the trade restrictiveness index, which seven, where one corresponds to very low rating. Finally, measures the stringency of domestic trade policies on property rights is an index obtained from Heritage Foun- imports, negatively affects exports. This index shows that dation’s Economic Freedom database and ranges from there is complementarity between importing and export- one to seven as well. ing activities, which could be caused by exporters’ extensive The data set covers three years of observations between usage of imported intermediate goods. 2005 and 2007 for 137 countries. It is not balanced because The author uses the MATTRI as a proxy for foreign some variables have missing observations for some of the market access. Table A.4 shows that difficulties in market countries. The data include countries from six regions of access significantly decrease export performance. In four of the world and five income groups. The primary estimation the six specifications, its coefficient is negative and signifi- method is pooled ordinary least squares (OLS) method. cant. A 10 percent increase in market access leads to a 2 to The estimation equation is presented as follows: 8 percentage point increase in exports. Among the IC indi- cators, the significant indictors are in accordance with the log(Exportit) = b0 + b1 log(GDPit–1) + b2 log(Areai) empirical findings in the literature. Better regulatory qual- +b3 log(remotei) ity, quality of infrastructure, and protection of property +b4 log(ExpGrowth)it–1,t–2 rights lead to higher export sales, whereas inefficiencies in + b5 log(TTRIit–1) trade facilities decrease exports. The interaction terms + b6 log(MATTRIit–1) + b7Indicatorsit–1 between market access and IC indicators are significant + b8 log(MATTRIit–1)*Indicatorit–1 with the expected signs in all specifications. This shows + b9d2006 + b10d2007 + eit. (A.4) that improvements in IC would make larger contributions Table A.4. Estimation Results with Pooled OLS Method Regulations Finance Entry Time to Export Infrastructure Property RealGDP(PPP) 0.989 1.006 1.064 0.976 0.978 0.994 (0.031)*** (0.045)*** (0.034)*** (0.032)*** (0.030)*** (0.034)*** Log(Area) –0.082 –0.081 –0.129 –0.060 –0.079 –0.091 (0.035)** (0.043)* (0.043)*** (0.037) (0.040)** (0.041)** Remoteness –0.384 –0.470 –0.422 –0.474 –0.504 –0.533 (0.155)** (0.188)** (0.182)** (0.157)*** (0.163)*** (0.175)*** Export Growtht,t–1 0.094 0.094 0.077 0.101 0.134 0.121 (0.046)** (0.060) (0.049) (0.047)** (0.048)*** (0.047)** log(TTRI) –0.265 –0.498 –0.458 –0.432 –0.397 –0.411 (0.094)*** (0.111)*** (0.109)*** (0.085)*** (0.084)*** (0.096)*** log(MATTRI) –0.185 –0.805 0.202 0.269 –0.526 –0.536 (0.046)*** (0.318)** (0.131) (0.257) (0.170)*** (0.167)*** log(MATTRI)*Indicator 0.124 0.173 –0.037 –0.141 0.299 0.058 (0.055)** (0.089)* (0.011)*** (0.077)* (0.117)** (0.025)** Indicator 0.281 –0.028 0.004 –0.345 0.599 0.114 (0.076)*** (0.139) (0.021) (0.134)** (0.195)*** (0.039)*** Constant 3.493 4.357 2.915 5.761 4.321 4.457 (1.612)** (1.959)** (1.843) (1.671)*** (1.591)*** (1.833)** Observations 205 175 204 203 193 189 R2 0.953 0.933 0.944 0.952 0.954 0.954 Source: Seker (2010). Note: Robust standard errors clustered by country are in parentheses. All regressions control for year fixed effects. ***p < 0.01, **p < 0.05, *p < 0.1. 196 Trade Competitiveness Diagnostic Toolkit to increasing export performance of countries with low labor market regulations, and business environment on both foreign market access relative to those with high foreign the extensive and intensive margins of international trade. It market access. Firms in a country with low foreign market identifies constraints that prevent countries from increasing access have to be more competitive and efficient in export trade along these margins. Variations in the intensive margin markets to be able to compete with those firms in more capture changes in the value of already exported and open countries. Hence, the marginal contribution of imported goods. By contrast, variations in the extensive mar- improvements in IC to export sales will be relatively greater gin account for changes in the number of exported and in countries with low foreign market access. imported products. Using the estimation results reported in this table, the The author uses a version of the standards gravity equa- author computes the total impact of one standard devia- tion that controls for selection, firm heterogeneity, remote- tion change in IC indicator on growth rates of export sales. ness, and endogeneity. The methodology has two steps. In To show how countries with different levels of foreign mar- the first step, a probit model is estimated where the ket access benefit from this improvement, the author com- dependent variable, Yij, is a dummy that takes value one if pares 25th and 75th percentiles of a foreign market access country i exports to country j. In the second step, the stan- restrictiveness index, which corresponds to 2 and 5.5 per- dard gravity equation is estimated, controlling for selec- cent tariff rates, respectively. The difference between tion, remoteness, and firm heterogeneity. Specifically, the growth rates of export sales generated by the change in model is as follows: each IC indicator for the two values of the foreign market Xij = β1 + β2LPIi + β3(MKT Accessi) + β4(ICTi) access index are given in table A.5. The table shows that a + β5(Institutional Indexi) + β6(Labor mkt inst.i) country in the 75th percentile of market access index dis- + β7(Knowledge economy indexi) tribution benefits from a one standard deviation improve- + β8(Av. Tariffsi) + β9(GDPi) + β10(GDPj) ment of regulatory quality by 10 percentage points more + β11(Remotenessi) + β12(Distanceij) than a country in the 25th percentile of the distribution. + β13Zij + β14(Heterogeneityi) + Ij + µij, (A.5) The impacts of the other IC indicators are of similar mag- nitude. This finding shows that IC improvements are important in reducing the barriers to trade and leading to Yij = 1[α1 + α2LPI + α3(MKT Accessi) + α4(ICTi) the convergence of export performance of countries. + α5(Institutional Indexi) + α6(Labor mkt inst.i) After controlling the effects of size, remoteness, and past + α7(Knowledge economy indexi) export growth performance of countries, this analysis indi- + α8(Av. Tariffsi) + α9(GDPi) + α10(GDPj) cates that restrictions in foreign market access and domes- + α11(Remotenessi) + α12(Distanceij) + α13Zij tic tariff policies reduce export performance. Another + α14Entry Costsi + Ij + vij > 0], (A.6) important result is that improvements in the IC indicators where vij˜ N(0,1) and (µij, vij) is independent of X with (regulatory quality, trade facilitation, entry regulations, zero mean. access to finance, infrastructure, and property rights) not The variables are as follows: only increase export volumes but also reduce the distor- tions caused by restrictive foreign market access. • Xij is the volume of exports from country i to country j • LPIi is the logistic performance index of country i Ana Paula Cusolito. 2010. “Export • MKT Accessi is a variable related to the difficulties to Competitiveness and the Intensive and the have access to foreign markets Extensive Margins of Trade.� World Bank, • ICTi is the information and communications technol- Washington, DC. ogy index of country i This note studies the impact of export competitiveness deter- • Institutional Indexi is an index related to the quality of minants, such as market access, institutional environment, institutions in country i Table A.5. Impacts of Improvements in Investment Climate Indicators on Exports (in Percentage Points) Indicator Regulations Finance Entry Time to Export Infrastructure Property Total Impact 10.1 9.9 12.4 7.9 10 9.6 Source: Cusolito (2010). Note: Improvements in IC indicators indicate an increase for regulations, finance, infrastructure, and property indicators, and indicate a decrease in entry time and time to export. Table A.6. Impact of Export Competitiveness Determinants on the Extensive and Intensive Margins of Trade Extensive margin I II III IV V VI VII VIII IX Competitiveness 0.0018792*** index [0.0002393]*** Starting a business 0.004545 0.0044718 0.0048344 0.0092452 0.0029094 0.0051268 0.0022697 0.0997738 0.0009022 [0.0000705]*** [0.0000627]*** [0.0000503]*** [0.0001409]*** [0.0001069]*** [0.000068]*** [0.0000554]*** [0.001161]*** [0.0000305]*** Logistic performance 0.0031626 0.0009409 index [0.0003799]*** [0.0001568]*** Input costs index –0.0007365 –0.0002196 [0.0000105]*** [7.93e–06]*** Institutional index 0.0477447 0.0018187 [0.0007383]*** [0.0001293]*** Labor market 0.0170846 0.0048798 institutions index [0.0005755]*** [0.0001332]*** Innovation index 0.0022063 0.0008842 [0.0000996]*** [0.0000541]*** Trade restrictions 0.003139 0.0010258 [0.0000615]** [0.0000384]** Market access –0.0934245 –0.0008957 [0.0027671]*** [0.0000349]*** Intensive margin I II III IV V VI VII VIII IX Competitiveness 671273.8 index [786408.4] Logistic performance 19174.39 33200.4 index [1811.708]*** [9638.709]*** Input costs index 31259.08 –1007.211 [120344.9] [2213.621] Institutional index 18320.78 –12206.62 [1447.257]*** [18334] Labor market 2580.366 18302.31 institutions index [2640.032] [49116.03] Innovation index –1649529 5869.807 [682173.6]*** [8924.48] Trade restrictions –1030.634 4291.595 [180.3156]*** [10346.13] Market access 3737039 –3282.468 [1.29e+07] [9049.59] Num. of obs. 511567 590253 512682 246361 246361 512682 512682 512682 511567 Source: Cusolito (2010). 197 Note: ***p < 0.01, **p < 0.05, *p < 0.1. 198 Trade Competitiveness Diagnostic Toolkit • Labor mkt inst.i is an index related to the rigidities in The quality of the institutional environment is another labor regulations important factor that affects trade. A 1 percent change in • Knowledge economy indexi is an index related to the regulatory and rule of law quality increases the probability intensity of the R&D activity in country i of trade by 0.0018 percent. No evidence indicates, however, • Av. Tariffsi is the mean of the tariffs imposed by country i that institutional quality affects the volume of exports. • GDP refers to gross domestic product Innovation has a positive and significant impact on • Remotenessi is a measure of how far country i is from trade. This is the result that innovation increases total fac- the rest of the world tor productivity, reduces production costs, and allows • Distanceij refers to the distance between country i and firms to cover the fixed cost of exporting. A change of one country j unit in the innovation index increases the probability of • Zij is a vector of variables that includes dummies cap- exporting by 0.088 percent. No evidence indicates, how- turing the landlocked condition of country i, the exis- ever, that innovation affects the intensive margin. tence of a common border between country i and j, a Tariffs and other trade policy barriers to trade limit the common language between country i and j, a colonial access to foreign markets and reduce the probability that relationship between country i and j, and a common two countries engage in trade. By contrast, expanded colonizer between country i and j policy-induced export opportunities can have a positive • Entry Costs is a measure of the number of procedures a effect on firm performance, which in turn affect trade. In country has to complete to operate legally in the markets the estimation, a 1 percent change in the uniform tariff of trading partners increases the probability that two coun- The data are at the Industry level (SITC revision 3 three- tries engage in trade by 0.0009 percent. digit classification) from the World Integrated Trade Solu- In sum, the signs of the coefficients for trade logistics, tion (WITS) database. Data on competitiveness come institutions, innovation, and market access are according mainly from the World Bank. The TTRI and the MATTRI to the theory. The signs of the coefficients for starting a are used to measure trade policy barriers. The author con- business, labor market rigidities, and tariffs are different structs an index of export competitiveness by applying from those expected. Unfortunately, the author cannot principal component analysis (PCA) to the main determi- rationalize these findings. nants of export competitiveness: TTRI, MATTRI, LPI, ICT, KEI, II, and LMR. The new indicator is defined as the pre- dicted value of the first component. Higher values indicate Notes better performances. Table A.6 shows the result of estimat- 1. The motive for using a two-stage procedure is the presence of an ing these equations.3 endogenously determined variable in the growth regression, the level of trade. Previous literature has shown the reverse causality between trade The estimated coefficient is positive for the extensive levels and GDP growth. and intensive margins. It is statistically significant at the 2. The reason behind the idea of splitting the impact of binding con- first one, however. A 1 percent change in the Export Com- straints on openness into impact on exports and impact on imports hinges on the political-economic developments of the Aid for Trade ini- petitiveness Index increases the probability of exporting by tiative. In the Hong Kong, China, declaration (WTO, 2005), the stated 0.018 percent. To analyze how different determinants of objective of the initiative was actually to “expand trade.� The role of export competitiveness affect the intensive and the exten- imports, however, in explaining growth and in trade policy analyses is sive margins of exports, columns II–VII report results largely underestimated and not well understood. Part of the difficulty in explaining the role of imports in growth probably comes from limited using the determinants of competitiveness separately. The data availability. Theory suggests that imports may foster growth by more last column displays the estimation outcome when we efficiently reallocating resources, ameliorating domestic manufacturing include all the variables. by lowering the cost of inputs and of capital goods, allowing better access to foreign technologies, and so on. Most of these gains are dynamic; for The Logistic Performance Index is statistically signifi- instance, imports increase productivity, which is a major determinant of cant and positive to explain both the probability that two economic growth and in per capita income. The impact of imports on countries engage in trade and the value of their trade rela- economic expansion is not limited, then, to the technology embedded into imports but also arises from competition from cheaper imports. tion. A change of one unit in the index increases the proba- 3. To satisfy the exclusion restriction, the author introduces the num- bility of trade by 0.09 percent. The same variation raises ber of legal procedures needed to start a business (SB) as an explanatory the volume of exports by US$33,200. variable in the first step. TRADE AND DEVELOPMENT SERIES In recent years, the agenda to support trade growth has moved beyond trade policy to embrace a wider set of “behind the border� issues, focused on establishing an environment conducive to the emergence of �rms that are competitive in both export and domestic markets. In this context, the World Bank has developed this Trade Competitiveness Diagnostic Toolkit (TCD). The TCD facilitates a systematic assessment of a country’s position, performance, and capabilities in export markets. It combines quantitative analysis— including comparisons with peers—with qualitative techniques, including in-country interviews with key stakeholders across trade value chains. The TCD includes two components: 1. Trade Outcome Analysis: An assessment of historical trade performance covering export composition and growth, product and market diversi�cation, and quality and sustainability. 2. Competitiveness Diagnostics: An analytical framework to assess a broad set of factors that a ect trade performance, organized around three themes: 1) the incentive framework for trade; 2) factor inputs, productivity, and trade costs; and 3) proactive policies to support trade. The toolkit will be of particular interest to economists at development banks and donor agencies, government practitioners involved in analyzing trade performance, and academics and researchers in the area of trade and development economics. About our Program The World Bank’s International Trade Department produces and disseminates policy-oriented knowledge products and forges partnerships on trade to advance an inclusive trade agenda for developing countries and to enhance developing countries’ trade competitiveness in global markets. Learn more about the World Bank’s trade portfolio at: www.worldbank.org/trade. ISBN 978-0-8213-8937-9 SKU 18937