The import regime and the challenge of export diversification

Yet this relief is a double-edged sword, because it means that Bangladesh's export basket is becoming less, rather than more, diversified. Export diversification continues to remain a challenge.

Bangladesh experienced double digit export growth over the past 15 years. Yet this superior performance masks the fact that the surge was limited to one product group -- readymade garments -- aided not least by the MFA regime. With over two million jobs and 76 per cent of export earnings from the RMG sector, too much of the nation's fortune is riding on this one sector. Export concentration in readymade garments makes the economy, jobs and income, extremely vulnerable to external shocks arising from changes in global demand for RMG. The government's focus on export diversification as a cornerstone of its export policy for several years now is no doubt appropriate. The problem lies in its implementation.

Export concentration: Export concentration is not a new phenomenon for Bangladesh. For many decades prior to the emergence of RMG exports, jute and jute goods dominated the export sector making up 70 percent of exports in 1981. With development practitioners advising the need to diversify exports, developing non-traditional exports became the dominant mantra of export policy. Non-traditional exports implied a shift into manufactures. This shift materialised for the Bangladesh economy thanks largely due to an external event -- the multi-fiber arrangement of 1974 -- that offered a lifeline for the emergence and rapid expansion of the RMG industry. Meanwhile, policy errors domestically and the emergence of jute substitutes globally soon led to a rapid decline in the export of jute and jute goods. The pendulum swung to the other extreme.

By 1990, RMG exports had overtaken Bangladesh's traditional exports and, by the close of the 1990s, export concentration emerged afresh, with RMG exports reaching a share of 77 percent. While Bangladesh's export growth for the last decade and a half could be characterised as robust, a sudden decline in demand for Bangladeshi RMG would send shock waves throughout the economy. Such a prospect can be avoided through the creation of a diversified export basket. But that is easier said than done.

The export diversification challenge: The absence of MFA quotas, and the consequent competitiveness pressures on the RMG sector, means export diversification takes on new importance for Bangladesh, a country that needs superior export performance in the medium -- to longer term for sustained high growth and the reduction of poverty. While global market access issues are no doubt important, Bangladeshi exporters face enormous challenges domestically that often undermine their competitive advantage. These challenges -- or constraints -- are often policy induced, or the result of institutional or infrastructural weaknesses. To foster diversification, the traditional strategy seems to have been to focus on promoting those exports that have current or future potential, often with the help of cash subsidies or other incentives.

This kind of strategy is often subject to abuse and is seldom found to produce the desired results. There is little empirical evidence around the globe that such a strategy works. Export diversification is not necessarily about promoting one category of exports or the other (picking winners), but rather of creating a conducive business and policy environment in which producers of current and potential exports can maintain their competitive edge in the international marketplace.

Can a cumbersome import regime be the problem? While Bangladesh's overall exports consistently show robust growth, and new export products are coming on stream, there is not enough momentum to result in a diversified export basket. The share of exports other than garments shows no sign of increasing. The trend towards diversification is hitting road blocks somewhere. What might be these road blocks? We know about the infrastructure problems (power, ports, other logistics), corrupt bureaucracy, and so on. But few identify the import regime as a stumbling block to export diversification. Exports -- particularly of manufactures -- involve processing of imported inputs which have to be made available in adequate quantities, on time, and at world prices. Why at world prices? Because the duty paid on inputs adds to production costs and undermines the competitiveness of exports. This was clearly understood by Korean policymakers who engineered Korea's export boom of the 1970s. Their job was to ensure that exporters were able to trade at world prices. Accordingly, they designed policies that allowed exporters to import all inputs and sell all exports at world prices.

By contrast, in Bangladesh, with relatively high tariffs, most intermediate inputs and raw materials have to be imported on upfront payment of duties. It was extremely good policy foresight that kept the RMG sector outside this--more in line with the Korean export policy framework described above. With all its flaws, such a scheme still delivers export growth in an otherwise protective regime that would favour import substitution with its inherent anti-export bias. The RMG sector, for example, operates within a “free trade” enclave in that all imported inputs come in under a bonded system duty free. Had this not been the case, RMG exports would not have reached the heights they have given the economy's import regime which is riddled with complex tariffs and other import restrictions.

A few other selected exports, such as leather products, also enjoy the facility of bonded imports. For the rest of exports and potential exports, getting world-priced imported inputs is a challenge. The option available to them is to seek duty reimbursements (drawbacks) from the Duty Exemption and Drawback Office (DEDO). To say the least, DEDO is dysfunctional. Because of the procedures involved, the earliest an exporter can get reimbursed on duties paid is on average six months to one year from the point of time duty was paid at the port of entry. Thanks to reported malfeasance in the drawback system, reimbursement is hardly ever 100 per cent.

An example of this dilemma is the electric cable export business. Bangladesh is exporting electric cables in small but growing amounts. The industry has to import inputs such as copper rods, aluminium foils, steel tape, cable paper, which are all subject to duties of 17 percent to 29 percent. Duties paid on these inputs at the time of import will only be reimbursed after actual export of cables following which the exporter may apply for duty reimbursements(DEDO).

New exporters cannot compete in the world market if they have to pay the existing rates of duty on imported inputs and expect to get drawbacks only after they have actually exported the goods and fully satisfied DEDO. Such drawbacks seldom reach exporters before six months to a year at the earliest. Without being able to import inputs at world prices, they are at a disadvantage vis-à-vis their competitors. Export diversification suffers, as a result. In contrast, the export basket in EPZs is more diversified. Only 48 percent of FY05 exports of $1.5 billion from EPZ were readymade garments, with electronic goods, agro-processed goods, leather products, ceramics and home textiles, making up the rest. The EPZ's free trade regime made export diversification possible.

In all fairness, the current tariff structure does not make the job of DEDO any easier. Bangladesh has one of the five highest average tariffs among developing countries. And the structure is made complex by the application of quasi- or para-tariffs, such as supplementary duties and infrastructure development surcharges, each with a different base for computation. An import duty neutralisation scheme becomes easier to manage and involves lower transaction costs if the tariff structure is simpler and tariffs are low. Lower input tariffs also reduce the pressure for seeking tariff exemptions and -- by facilitating a more efficient duty-rebate system -- will help move the net incentives for different exported products towards a more neutral range. Finally, lower input tariffs, and therefore lower drawback and other rebates, reduce the incentives for negotiation between exporters or their agents and Customs officials and, therefore reduce the incentives for corrupt practices such as over-invoiced or misclassified export shipments

Finally, policies that promote import substitution through protection of domestic industries create an anti-export bias. Protection helps raise profitability of import substitutes while exports must be sold at world prices (essentially, zero protection).

An import duty is therefore akin to a tax on exports because it raises relative incentives in favour of the import substitute. Although Bangladesh has managed to insulate the RMG sector from the effects of protectionist policies through the bonded-warehouse and EPZ schemes, the World Bank's analysis (Export Competitiveness and Growth, 2004) shows that further trade reforms are needed to provide comparable stimulus to other industries with the potential to diversify the country's exports.

To be sure, considerable progress has been made since the early 1990s in liberalising the import regime. Tariffs have been scaled back and rationalised. Gone are most of the import bans and quantitative restrictions, and the exchange rate regime is technically on a floating system. Measures already taken have had the effect of reducing overall anti-export bias of the import regime compared to what it was before 1990. Yet, in a world of razor edge competition, an import regime that raises import costs even slightly above world prices undermines export competitiveness.

What can be done? Here is a short list of what can and should be done to create momentum towards export diversification. First, all is not lost with jute -- a natural golden fiber. In the past five years, exports of jute yarn and twine have doubled and industry insiders see a resurgence of external demand. Renewed attention to the sector with indisputable comparative advantage -- the jute industry -- is therefore warranted, not to devise policy intervention but to remove existing policy distortions. For starters, current policies need to be harmonised to treat public and private jute mills at par in matters of credit access and other facilities. Second, for new exports and potential exports, the duty neutralisation scheme has to be made fully effective. DEDO needs to be completely overhauled -- modernised, automated, and made fully-service-oriented. Third, further simplify, rationalise and reduce import tariffs bringing greater uniformity and transparency to the tariff structure -- thus making drawbacks easier to handle. Fourth, gradually re-orient customs administration, leaning more towards trade facilitation and less on revenue mobilisation; in the process, shifting the burden of revenue on domestic taxes. Last but not least, continue to invest in and modernise trade logistics and infrastructure -- ports (land and sea), roads, and railways.

A smoothly functioning import regime with minimum transaction costs is the sine qua non of export competitiveness. Streamline Bangladesh's import regime and give export diversification a chance.

Dr. Devarajanm, a Sri Lankan national, is the World Bank's Chief Economist for South Asia Region. Dr. Sattar is a Senior Economist of the World Bank.