Tariff rationalization is an imperative to boost exports
Javed Hassan
One of the critical challenges the PTI government faced upon coming into power in August 2018 was an unsustainable trade and current account deficit, which was also rapidly eroding Pakistan’s foreign exchange reserves. The country potentially faced the unimaginable prospect of defaulting on its foreign debt obligations. This external account crisis was tackled by rapidly reducing the trade deficit, primarily through the curtailing of imports. However, despite a more than 30 percent depreciation in the exchange rate parity value of the Rupee, exports remain a challenge. Pakistan’s export growth was almost flat in FY19, and in the first six months of FY20 increased by only 3.15% to $11.5 billion from the $11.2 billion for the same period in the previous year. Currency depreciation has not provided sufficient impetus to export growth to the level required to significantly expand Pakistan’s share in global trade flows.
Data from the World Bank shows that those countries that have undertaken tariff rationalization and trade liberalization have achieved much faster export growth than those that have been reluctant to open up their economies. In the last decade, the 20 fastest export-growth economies have reduced their import tariffs. The two fastest-growing, namely Vietnam and Bangladesh, have reduced tariffs by 72 percent and 51 percent respectively.
Pakistan has in the same period moved in the opposite direction with average tariffs increasing by 11 percent as well as the imposition of various regulatory duties. It is ironic that policymakers have until recently chosen to ignore evidence of data for exports from 2001 onwards, which clearly demonstrates that export growth is strongly correlated to tariff liberalization.
Exports grew by 173 percent from the US $ 9.2 billion in 2001 to $ 25.1 billion in 2014, in the same period when the applied weighted mean tariff in Pakistan was reduced from 20.62 percent to 8.92 percent. However, from 2014 to 2017, the tariff liberalization was reversed by gradually increasing the applied tariff to 10.09 percent, as exports declined by 19 percent to $ 20.4 billion.
Currently, Pakistan maintains the third-highest average weighted tariff among the 68 countries having more than $20 billion annual exports. Direct import tariffs constitute 13 percent of the total tax revenues in Pakistan compared with export-driven economies, e.g. Malaysia (1.6 percent), Turkey (2 percent), Indonesia (2.5 percent), South Korea (3.9 percent), Thailand (4.3 percent) and China (4.6 percent). The total customs revenue collection in Pakistan at the import stage is over 40 percent of the total tax revenues.
One of the main drivers for the increased import tariffs has been the failure of governments to generate direct taxes in order to fill in fiscal gaps. They have instead increasingly relied on import tariffs as a revenue tool since it was easier to implement than imposing direct taxes. As the cost of inputs and intermediate goods increases with increasing import tariffs on imported raw materials, intermediate goods and machinery, large swathes of the Pakistani manufacturing sector became uncompetitive both domestically and internationally.
The inefficiencies of the manufacturing sector have meant that Pakistani companies have not only lost out in competitiveness to regional and international competitors for global market share but have also in many instances lost share in the domestic market. In effect, the tariff regime had instituted an anti-export bias such that manufacturers have had to primarily focus on only products where they have protected domestic markets rather than trying to compete internationally or enter global value chains.
The burden of the protection has been borne by domestic consumers since domestic prices for protected items are maintained above international market prices for goods that often fail to match up to international standards of quality. Multiple duty slabs, high tariffs, concessionary SROs and regulatory duties keep the tariff structure complex, and prone to misuse through smuggling, under-invoicing and misdeclaration of quantity and quality of goods.
If Pakistan desires to enter the global value chain of products and services, it has to ensure that it gives its industry a fair chance to improve competitiveness by rationalizing the tariff structure that not only eliminates many of the existing duties but also makes those that exist transparent and predictable.
Such a tariff regime will boost domestic value additive manufacturers and attract efficiency-seeking foreign direct investment in the manufacturing sector. Reducing the burden of excessive protection will also help lessen the distortions in the domestic price structure and improve consumer welfare.
The domestic industry may be provided ‘strategic protection’ against the foreign competition during the infancy phase keeping in view the cost of doing business in Pakistan, but these need to be time-bound and phased out so as to incentivize global competitiveness. Incentives for protecting infant industries should not be such that they make them dependent on tariffs indefinitely. Finally, the tariff structure needs to be simplified by reducing exemptions and concessions.
A cascading tariff structure may also be retained, but again only for a time-bound period. While tariffs on inputs should be lower than the tariff on the finished product, the differential should be minimized to incentivize local manufacturers to improve their quality.
The Ministry of Commerce & Textile and The National Tariff Commission have been addressing the above issues constructively, and it is hoped that they will devise a policy that effectively moves the tariff regime away from being an instrument of revenue generation to that of being an effective tool for export-oriented trade policy. Trade liberalization will also unambiguously benefit Pakistani consumers since product prices fall and consumer choice increases, as well as encourage efficiency-seeking inward foreign investments and stimulate the diffusion of new technology.