Trade Liberalisation, Productivity, and Protection: The Case of an Open Developing Economy

Abstract

<p>Over the past three decades, trade liberalisation has become a major part of countries’ development strategies. Since trade liberalisation remains a highly debated issue in the literature, this dissertation is strongly driven by several theoretical debates that raise a significant question of whether trade liberalisation impacts are positive for developing economies. As trade liberalisation induces competition because of the domestic economy opening to world markets, domestic industries, especially from least developed and/or developing countries that produce low-value goods can be adversely affected. This type of vulnerability to external shocks in developing countries provides support to the argument that domestic industries are not prepared sufficiently to absorb trade liberalisation-induced shocks. The current study takes an opportunity to delve into this issue in the context of an open developing economy from South Asia. The study investigates Nepal’s rapid trade reforms that intensified in the early 1990s and studies the trade-productivity nexus using four-digit manufacturing industry data. The study sets up three major objectives that include – i) investigating the impact of trade liberalisation on manufacturing productivity; ii) determining the preconditions of trade liberalisation to ensure domestic industries are prepared enough to enter the global market; and iii) investigating an appropriate endogenous protection strategy that remains non-anti-trade in nature.</p> <p>The foundation for the conduct of empirical investigations in the study is built upon a large number of reviews and discussions presenting several theoretical perspectives and empirical evidences. The ‘review and discussion’ chapter is focused on capabilities of domestic industries from developing countries to withstand globalisation shocks. The chapter concludes that as long as inequality prevails at the industry level in terms of resource availability and use between developed and developing countries, the degree of liberalisation shocks may be felt higher in industries from the latter group of countries. The policy advice from the chapter for open developing countries like Nepal is that while they agree to pursue with bilateral/regional/multilateral/global trade agreements, they must have their domestic industrial strategies in place to protect their vulnerable industries, and they also need to ensure that their own development policy options are not compromised.</p> <p>The first empirical chapter investigates if trade liberalisation helps improve industry productivity in Nepal. The study utilisesstandard methodology in literature to estimate industry production function. The trade-productivity link is then examined using both the conditional mean approach that is common in the literature and the distributional approach that employs the quantile regression technique. The result shows that trade liberalisation impacts are industry-specific and dependent on industry characteristics and productivity distribution. While the link between trade policy and industry productivity is positive, the benefits of productivity improvement accrue only to large industries due to scale of efficiency. Only the highly efficient industries appear to derive productivity gains from trade liberalisation. Methodologically, the results indicate that a trade-productivity study should examine distributional variations as well as conditional mean variations to capture all relevant industry productivity responses to trade policy changes. The results inform policymakers that, while trade liberalisation is generally productivity-enhancing, they should not lose sight of the fact that there are vulnerable industries that will be adversely impacted in the short term, especially for those in least developed countries wanting to liberalise their economies.</p> <p>The second empirical chapter investigates the level of technical efficiency of Nepalese manufacturing industries and estimates the impacts of trade liberalisation and scale-effect on the industries. This empirical assessment provides an insight into the within-industry capability to withstand external shocks. The study utilises industry panel data and analyses the relationship using the stochastic frontier analysis. The technical efficiency estimates show that the manufacturing sector of Nepal is highly inefficient. Technical progress is observed initially, however after 1996/97, technical regress dominates each period. Efficiency, on average is gauged around 22.5%, whereas inefficiency is estimated as high as 173%. The scale of operation, as expected, appears highly significant in explaining industry efficiency; whereas trade liberalisation, though it carries the expected sign, does not. The ‘scale effect’ that advocates industry size also represents the embodied-technology effect that comes with imported inputs. The results show that technology contained in imported intermediate inputs is an important source of efficiency improvement for the Nepalese manufacturing sector. For Nepal, the technology-diffusion channel of liberalisation may have been working better relatively in helping the country to realise increasing economic benefits via industry efficiency improvements. For industries to thrive in an intensely competitive global environment, the path of efficiency improvement is, therefore, the foremost endogenous protection strategy that Nepal needs to focus on. In other words, efficiency improvement of domestic industries seems to be an important precondition of trade liberalisation for least developed/developing countries like Nepal. </p> <p>The third empirical chapter, inspired by the first two chapters, examines the protection pattern in Nepal following the theory of endogenous protection. While most studies stick to the common modelling strategy proposed in the endogenous protection literature, this study provides new insights on the model’s appropriateness considering the industry environment of Nepal. The study adopts two modelling strategies. The first strategy that follows the literature helps to examine how endogenous protection theories written for developed countries would work for a developing country. The second strategy, that is built upon a developing country scenario based on industry welfare need, reveals why same modelling strategy cannot be used everywhere as long as there is a gap in the industry environment between developed and developing countries. The study investigates the endogenous protection issue via the industry welfare viewpoint and finds import penetration to be a weak choice in the endogenous protection modelling for a developing country like Nepal. That is, there is no reason for treating import penetration endogenously. Unlike other studies in the literature, this study introduces industry efficiency in the endogenous protection framework and shows new evidence that protection significantly contributes to industry efficiency improvement. Statistically, under the existing industry circumstances for the year 2011/12, a 1% increase in the number of non-tariff measures (NTMs) applied to a product raises industry efficiency by 0.042%. With the objective of elucidating the long-running debate on the choice between trade liberalisation and protection for a developing country, the study also examines and compares the effects between trade liberalisation and NTMs on industry efficiency improvement. It is evident that NTMs contribute significantly than tariffs reductions in improving industry efficiency in Nepal. The result shows that endogenous protection for manufacturing industries is, on average, much needed at the current level of industry efficiency. However, this result does not negate the importance of trade liberalisation to improve industry efficiency in Nepal.</p> <p>Overall, this research study identifies a marked heterogeneity in industry responses to a common liberalisation shock, investigates industry efficiency level and finds importembodied technology a significant determinant of industry efficiency, and provides evidence that endogenous protection is indispensable at the current level of efficiency for Nepal. To note, all study results are based on manufacturing data of government registered four-digit industries during the study period. In future studies, given the availability of sufficiently disaggregate data (i.e., at the establishment level) and for both formal and informal sectors, the study can be extended to demonstrate more robust information from the perspective of the primary production unit.</p>