Mahoshada

“Free trade agreements may eliminate tariffs and quotas, but as a falling tide exposes a rocky reef, these barriers recede to reveal other obstacles to trade.” Timothy Skud

In a previous article it was argued that the South Asia Free Trade Agreement (SAFTA) that has recently been negotiated and is now to be implemented, is unlikely to lead to any substantial increase in regional trade. There are two reasons why trade barriers will not be reduced to any appreciable degree: the first is the very extensive “sensitive lists” used to exclude goods from the planned reductions in import duties. These sensitive lists can be expected to exclude 90 percent or more of the goods being traded by most SAFTA member countries. The second reason is that even for the relatively few goods that will be subject to custom duty reductions, relatively cumbersome and restrictive rules of origin will need to be met before they will be eligible for preferential trade treatment.

If the combined effect of long sensitive lists and restrictive rules of origin means that trade barriers will not be effectively reduced – then there will be very little or no increased trade as a result. It is simple common sense.

However, even if the SAFTA were to be substantially strengthened to greatly expand its coverage so that custom duties for the goods actually produced and traded among South Asian countries, we should recognize that there will still be very high barriers to trade. As the quote cited above suggests, as counties reduce customs duties, eliminating import tariffs as the most visible trade barrier, the importance of other significant barriers to trade that have largely remained out of sight become much more readily visible.

If you were to ask any business person with experience in exporting goods to other countries within the region, What are the biggest problems in being able to compete in the markets of these other countries? The answer would almost certainly include the high costs associated with overcoming the bureaucratic hurdles that stand in the way of moving goods from one country to another. These hurdles include, for example, slow, inefficient and often corrupt customs services that have few incentives to expedite trade; inconsistent and often arbitrary regulatory requirements setting standards that products must meet before they can enter the local markets; and very weak infrastructure supporting the movement of goods into and out of countries in the region.

Trade Facilitation
So, even if the SAFTA were to lead to a rapid reduction in most custom duties and other taxes on trade by countries within the region, there would still be major barriers that would need to be overcome before much greater trade would result. Economists and policy makers refer to the process of removing these and other “non-tariff barriers” to trade, or NTBs, as trade facilitation. And as experience around the world has been making very clear in recent years, these other barriers tend to be a much greater problem than many analysts had previously understood.

One useful way to think about the process of exporting a good from Sri Lanka to another country is as a chain of linked transactions that must take place. The first transaction usually entails getting the order for the good from a buyer in the other country. The next round of transactions for the local producer might well entail acquiring the necessary inputs either from the local markets or from overseas suppliers. Only then does the process of manufacturing the good take place. Following that, the producer must move his or her goods to the port and meet any requirements set by customs, the Treasury or the Central Bank – which typically includes a great deal of paperwork. Only then, once the good has been loaded on a ship for transportation to the importing country, do the transactions here cease to be a factor. It is when the good arrives in the importing country that the next rounds of hurdles have to be overcome, including the time and difficulties in moving through customs; demonstrating that the good being imported meets local standards for health, safety and other consumer protection requirements; physically moving the good through the port of entry and then to the final buyer. Finally, the last critical transaction that must be undertaken is the payment to the producer of the good here in Sri Lanka.

At each stage of the process of manufacturing and exporting a good, for each transaction involved, there are costs incurred – in addition to any explicit taxes and charges, such as customs duties. We should not forget that, as the old expression goes, time is money. Even if the process of moving goods across borders takes place without making any formal (or informal) payments, if it takes an inordinate amount of time, this is as good as a imposing and additional tax that must be paid. Why? Because the producer has either borrowed the money or has tied up his or her own funds to meet the costs of production and shipment. And every additional day between the time or production and the time of receiving payment, costs the producer more.

It is worth keeping in mind that in the end it is the consumer that ends up bearing any extra costs associated with the time it takes to move goods from producers to the market. Like the costs of labour and raw materials, these transactions costs are built into the price.

Trade facilitation is essentially an attempt by countries to minimize the transactions costs that are incurred at every step of the process of moving goods from producers to the final consumers – including the costs associated with moving goods across countries’ borders. It would not be possible, nor would it be desirable, to completely eliminate all of the transactions costs incurred through trade. For example, no one would argue that ensuring that health and safety standards are adequately met. But these checks can be carried out quickly and with minimal costs or they can be done in ways that lead to high costs. The choice is usually up to governments and their officials.

How High Are The Costs?
It is very easy to be complacent about the costs associated with trade. After all, this is a developing country and systems are not as efficient as in the developed world. Modest delays seem a normal part of life and hardly seem as though they would lead to huge cost increases. But the reality is that these costs do quickly add up and can be quite high.

To get an idea of how high these costs may be, several years ago an economist estimated the costs due to regulations and inefficiency in moving goods through the port in Malaysia. It should be stressed that this is only a relatively small part of the chain of transactions that a good entering international trade would go through. This analysis suggested that these additional costs were on the order of 30 percent of the value of the goods being shipped. In other words, port regulations and inefficiency were equivalent to an additional 30 percent customs duty being levied on all imports. And the closer one looks at the way things actually work in cross border trade (or don’t work), the easier it is to believe that the unnecessary additional costs being imposed are very large indeed. And as already mentioned, it is the consumer that inevitably ends up paying these extra costs.

Trade Facilitation in SAFTA
The SAFTA offers the South Asia region an opportunity to begin to address the high costs of non-tariff barriers to trade. But it has to be recognized that this is neither a simple nor short term exercise. In comparison, it is relatively straightforward for countries to negotiate a schedule of tariff rate reductions and agree to trade related parameters such as the rules of origin. Once these things have been agreed, the negotiating process is finished.

In contrast, the goal of improving trade facilitation by minimizing transaction costs is very much a moving target. New issues arise continuously that must be addressed. New technologies are introduced that raise the potential to reduce transaction costs even further. So, unlike negotiating the reduction of customs duties, work on improving trade facilitation is, or ought to be, ongoing.

It is also important to recognize that addressing trade facilitation issues will involve a wide range of different institutions and the laws and regulations that they are charges with implementing. This is a far more complex challenge than simply cutting tariffs. For this reason, to be successful in reducing these trade related transactions costs, the private sector would have to be heavily involved in any process of designing reforms and monitoring results. The reality is that very few bureaucrats have any substantial understanding of the way business is actually carried out. They certainly do not seem to have much appreciation of the costs associated with delays.

The fact that the SAFTA has been negotiated and formally launched on schedule is a reflection of the considerable political will to reduce trade barriers amongst countries in the region. If this political will is maintained, it can provide the impetus needed to greatly strengthen the terms in the agreement as well as provide a basis for countries to significantly reduce trade related transactions costs. It is true that most of the changes needed to improve the trade facilitation environment will have to be done by the countries themselves – what economists call “behind the border” reforms. This process need not directly involve other countries or be part of any trade agreement. However, this will almost certainly be politically easier to manage and sustain if it reflects a collective commitment on the part of the countries in the region.