LCRs versus tariffs: The see-saw of trade barriers?

You may have not noticed it, but the use of local content requirements (LCRs) has gone up for years. They are used by developed as well as developing countries. LCRs aim to promote the use of local inputs. They also serve the purpose of fostering domestic industries. BRICS and many other emerging countries are frequent users of LCRs, together with the US.

However, LCRs can be highly damaging for the economy. While LCRs might have the perceived benefit of creating industry activity and local employment, these gains or often generated in the short-term. LCRs are most likely to have a damaging economic impact that is wider in the long run. This harmful impact therefore evolves over time, which eventually outweighs any specific short run gain they can create.

ECIPE’s new study with undersigned contribution estimates the damaging impacts of LCRs for BRICS countries. Our team has translated their negative effects into so-called ad valorem equivalents (AVE). This is a methodological concept that allows one to readily compare the adverse impact of any non-tariff barrier (NTB) such as an LCR with a tariff. Our study has taken LCRs in the heavy vehicle sector as a case in point.

The results are presented in the figure below. They show that Brazil and Russia apply the most distortive LCRs for heavy vehicles. The two countries have an estimated increase of their import price of 15.6 and 11.1 percent respectively. China and South Africa both show low AVEs of 4.5 and 3.3 percent respectively. India’s LCRs are least harmful as it shows an AVE estimate of 2.2 percent.

 

Source: ECIPE calculations, based on ECIPE LCR BRICS database; WITS/UNCTAD TRAINS

Are services really not helping the economy?

Bullocks! That is the conclusion that came to me when I participated in the roundtable conference on services and economic development in Tokyo last month. This conference was organized by the Asian Development Bank Institute (ADBI) and discussed with experts the positive role of services in the world economy.

It’s high time for this discussion. In recent years there has been a slight backlash against services as a contributing factor to the economy, particularly for developing countries. One reason for this set-back against services stems from a recent article by Dani Rodrik in which he drives the point that many developing countries are de-industrializing faster than before and therefore moving into services too quickly.

This premature de-industrialization, he argues, prevents them from using the manufacturing sector as a tool for rapid economic growth. According to Rodrik, in large part this is due to globalization and trade itself because globalization has produced changes in relative prices in advanced countries. This can have serious negative consequences for developing countries’ growth potential because, in the future, they would be much less able to capitalize on manufacturing exports.

There are, however, a couple of remarks that in my view must be made here.

First, these conclusions are most probably based on aggregate figures between countries’ services and manufacturing activities, which in great part mask the fact that many manufacturing sectors have already become “servicified” to a high degree. This means that a lot of gains by manufacturing firms are earned though services, not manufacturing. For instance, is Zara a garment manufacturer nowadays or just a retailer? Most probably it comes close to the latter. Such servicification is not yet picked up and properly classified in aggregate figures – and this is true also for developing countries.

Second, there are surely economic meaningful sectors in a country’s services economy. The old way to look at services is that they don’t show a great economic role as they are not receptive to productivity improvements. That assertion seems to be out of date. Even though productivity for services is hard to measure, European micro-level data suggest that productivity varies hugely across services, and therefore their contribution to the overall economy is also varied. (see figure below). This should also be the case for non-developed economies.

Source: Data taken from Van der Marel, Kren and Iootty (2015) "Services in the European Union: What Kinds of Regulatory Policies Enhance Productivity?", World Bank Policy Research Working Paper No. 7919, World Bank, Washington DC.

Productivity, Manufacturing and Trade

A very interesting piece by Robert Lawrence on manufacturing productivity and trade. Three very interesting conclusions come out: 

(a) that not trade is the major contributor to a decline in the share of manufacturing employment, but faster productivity; 

(b) that therefore productivity growth is in large part the factor that has contributed to losses of manufacturing jobs (together with our habit to not consume more goods but more services when we get richer); and 

(c) that there seems to be a trade-off in recent times between the share of manufacturing employment and productivity growth: more of the one is less of the latter -- or reverse. 

For economists dealing with this topic, the first two conclusions are not entirely new. In fact, this is how I have learned it from my textbook economics. The latter is new to me and very interesting. 

The last conclusions also raises some questions. For instance, is the historical leveling off of economic growth we have seen in the past (i.e. previous wave of globalization) related to this fact? Can new technologies in other sectors such as services we currently seeing reduce this trade-off? 

Some questions to think about.