Feb 25, 2014

Export promotion subsidies and incentives - Justified?

The question regarding benefit accruing out of providing export incentives/subsidies to firms involved in exports has been debated since Bhagwati's time and earlier. The idea of providing such subsidies and incentives have come under strong criticism from economists such as Arvind Panagaria in the past. You can read a working paper by him in the world bank series on the topic, here. (year Y2K)
Arvind goes about demolishing all the arguments related to export subsidies and incentives in the paper. Talking about the argument of export products and market diversification related subsidies (the mainstay of our incentive schemes under India's foreign trade policy), Arvind has this to say:

I have not come across any quantitative study which does a proper analysis to show that export subsidies, in general, and export-credit subsidies and export-credit insurance, in particular, are a part of the least-cost package for achieving a certain level of export expansion or diversification. Most authors, who are enthusiastic about these subsidies, go only so far as to argue that when combined with other export-friendly policies, these subsidies can be an effective means of export expansion. This is a rather weak claim since any failures can be blamed on the absence of complementary policies while successes may be the result of other sound policies. Moreover, even when export expansion is helped by the subsidies, as is likely if one believes in supply response, it is necessary to know what their cost is.
The above holds true about incentives and subsidies given in any repackaged form. India's foreign trade policy is providing such subsidies in the name of offsetting infrastructural inefficiencies, increasing market presence (Focus market schemes) or to boost employment in small scale sector (Focus product schemes), promoting agricultural exports(VKGUY) and so on. Apart from these, various other schemes are run by different export promotion councils, under Ministry of Commerce, in the name of Market Access Initiatives and Market Development Assistance. Also, interest subvention schemes are run by the banks under RBI mandate. The amount spent on these schemes adds up to around Rs 3000 crore (USD 500 million approx). Source here.

One of the major reasons why there are not many quantitative studies in this area (across the world) is the difficulty in isolating the effect of the export subsidies on export performance. One interesting classic study in this area was conducted by Julio Nogues in 1989 titled "Latin America's experience with export subsidies" which surveyed the Latin American countries. Nogues study indicates the poor returns out of export promotion schemes. Among the countries, the effect in Brazil and Mexico has been somewhat positive, but Brazil's advantage was countervailed by the US, significantly increasing the cost when compared with Mexico. Even for Mexico, there remains a question mark on the absolute returns of such schemes. In case of Argentina, these schemes lead to rent seeking behavior, bribery and corruption. Nogues doesn't deny the effect of such schemes outright, but cautiously adds the effects of supporting enablers such as infrastructure and policy regimes.

It is in this light that a recent study conducted by the World Bank in Tunisia, titled "Are the benefits of export support durable" gathers importance. The study can be accessed here. The study is interesting because it tries to isolate the effect of export assistance given, under a program named FAMEX in Tunisia, to different sized firms over a period of time. FAMEX grants were used mostly to co-finance the cost of technical assistance and marketing services provided by local and foreign experts. Five types of activities were financed: (i) market prospection, (ii) promotion, (iii) product development, (iv) firm development, and (v) foreign subsidiary creation.

The study finds that relative to the control group (which was not given the FAMEX treatement), the experiment group showed statistically significant improvement in export performance. However, this advantage was lost over a period of four years and firms in the control group caught up. There was also an effect of the size of the firms in question. The medium sized firms retained better performance over period of time, over smaller and larger firms. The spillover effect (from treated firms to the control group firms) was shown to be non-existent. In the words of the paper:

...the paper considers also the longer-term impact.....beneficiaries initially see faster export growth and greater diversification across destination markets and products. However, three years after the intervention, the growth rates and the export levels of beneficiaries are not significantly different from those of non-beneficiary firms. Exports of beneficiaries do remain more diversified, but the diversification does not translate into lower volatility of exports. The authors also did not find evidence that the program produced spillover benefits for non-beneficiary firms. However, the results on the longer-term impact of export promotion must be interpreted cautiously because the later years of the sample period saw a collapse in world trade, which may not have affected all firms equally....

The above study raises interesting conjectures. In my experience, I have observed that most of the export promotion schemes run in India are actually benefiting the existing, established exporting firms and not the new, breakaway firms that are looking to grow in international trade. I also occasionally come across small exporters who have narrated experiences where financial incentives are factored in costing and help them undercut competition, thus helping them at international markets. Such cases need to be studied closely to find out the exact category of exporters (and the product groups). This is the job of export promotion councils. Unfortunately, the multiple export promotion councils in India have ended up as lobby groups of leading exporters. DGFT, the apex govt. body for trade policy making and promotion, has now started a program under a scheme called 'Niryat Bandhu' to train/enlighten new firms about these schemes, and handhold them during their initial breakaway period. Niryat Bandhu scheme sounds a lot like the FAMEX, if executed well.

That leads us to the half a billion dollar question, literally. Is the spending for such schemes, as they exist today in India, justified? I hope the makers of the next five year trade policy, which plans to roll out after elections, are pondering over this point.