Jun 5, 2017

ITC HS harmonisation method for trade data analysis - a proposal

(I have used LaTeX in this post for math symbols. If you are using a mobile browser, you may consider requesting a desktop version of the page in order to view the table and formulae properly)

The International Trade Classification - Harmonised system (ITC HS) codes are used for classification purposes in international trade. All products traded internationally are represented though these codes. The codes extend upto 8 digits in India, first 6 of which are harmonised with the international system. Most of the countries are harmonised at 6 digits which implies that the product classification upto 6 digits is common. However, the next two digits are country specific and this sub classification or further bifurcation is a function of statistical and industry needs. Some countries have further two digits, taking the number of digits to 10 to help further statistical purposes. In India, it stops at 8 digits. First two digits in the classification are known as chapter number (01 to 99), the third and fourth digits make up the 'heading', the fifth and sixth digits are called 'sub headings'. The last two digits are called 'tariff headings'. A tariff heading is usually given a number ending with 00 in order to classify all 'other' products falling under the sub-heading after important ones are allotted various numbers starting with 11 and running upto theoretically 99. At times, this 'other' which ends with '00' grows big enough to warrant it's own tariff heading. I have seen tariff headings where the data under 'other' warrants a split to get granularity in data, but it has not been done. At other times, I have seen tariff headings that take up a huge bandwidth (a disproportionate share of the trade under the heading) and yet they have not been split to show further granularity. At times, it feels that the process could be automated. However, till now as I understand, the Govt. depends on various representations from industry and requests from statistical bodies for a split in the sub-headings. The requests are not always very scientific and arise out of ad-hoc needs. 

This I feel may be avoided by automating the function of splitting sub-headings of ITC HS. The proposal below suggests a method to decide if a particular tariff heading needs further bifurcation into lower levels, e.g. from 6 digits to 8 digits, or from 8 digit heading ending with 90 or 00, to further divisions and so on. 

The proposal would use the same technique used in calculating Herfindahl­ Hirschman index for market concentration in antitrust/competition law cases. The proposal doesn’t apply to cases where the new heading is needed due to environment/public interest and so on. Such headings can be considered on ad­hoc basis. The proposal utilizes the relative weight and not absolute value method. The absolute values in terms of trade in ‘X’ crore rupees might become cumbersome as the relative importance is missed out. e.g. a 20 crore exports under a particular heading under handicrafts is significant enough to have a separate heading whereas even 200 crore is negligible in the case of diamond exports. Hence a technique of harmonization that looks at relative importance with respect to parent heading might prove superior to a method of looking at absolute value. The core idea behind this proposal is to develop a system that can be programmed, thus obliviating the need of human intervention in drilling down the headings. The working is illustrated with an example below, in which a case of 6 digits HS codes at sub-heading level are being considered for further harmonization up to 8 digits.


Step 1

List down the 6 digit codes under consideration, with the total trade value of previous year and the corresponding share in their parent heading at 4 digit. Let’s take the heading 8413, under which the eight 6 digits subheadings are:

ITC HS CodeTrade ValueFractional Share in Parent 4 digits (8413)
841311A1$S1 = \frac{A1}{\sum A}$
841319A2$S2 = \frac{A2}{\sum A}$
841330A3$S3 = \frac{A3}{\sum A}$
841350A4$S4 = \frac{A4}{\sum A}$
841360A5$S5 = \frac{A5}{\sum A}$
841370A6$S6 = \frac{A6}{\sum A}$
841381A7$S7 = \frac{A7}{\sum A}$
841391A8$S8 = \frac{A8}{\sum A}$

Step 2 

$Index number =  S1^2 + S2^2 + S3^2 + … + S8^2 = \sum S^2 $

Step 3

If Index number is greater than 0.25, there is a case for further bifurcation of that subheading at 6 digit which has the highest share in trade into 8 digits. 

Step 4 

The process is repeated till all high value 6 digits are bifurcated into 8 digits. The highest possible value for the $Index Number$ is 1 (only one heading with 100% share). $Index Number$ below 0.01 indicates a highly distributed trade. $Index Number$ below 0.15 indicates an unconcentrated trade. $Index Number$ between 0.15 to 0.25 indicates moderate concentration. $Index Number$ above 0.25 indicates high concentration of trade requiring further granularity. The concentration begins somewhere at the point where the $Index Number$ reaches 0.15 and crosses the threshold once the number reaches 0.25, at which point it should be further drilled down into lower headings. 

A worked example with some numbers is given below: 

Let’s take a case where there are 16 sub­headings at 6 digit level. Now, we will consider two cases in which the six largest 6 digit headings (out of those 16) cover 90% of the trade value: 

Case 1: Six sub-headings share 15% of trade each, 5 sub-heading share 2% each, and rest 10 sub-headings share 1% each. 
Case 2: One sub-heading covers 80% while five other sub-heading cover 2% each, and the rest 10 subheadings share a minor 1% each like Case 1. 

By inspection (and common sense) we can say that the first case would be fine at 6 digits without further harmonisation, whereas the second case is apt for further bifurcation/harmonisation. 

The Index Number for these two situations makes it strikingly clear: 

Case 1: 
$Index Number = (0.15^2+0.15^2+0.15^2+0.15^2+0.15^2+0.15^2) + (10 \times 0.01^2) = 0.136 $

Case 2: 
$Index Number = 0.80^2 + (5 \times 0.02^2) + (10 \times 0.01^2) = 0.643 $

The squaring of the shares this way in the index number calculation penalises bigger shares more than the smaller ones, giving additional weight to headings with larger size. The threshold value 0.25 is based on popular usage of this threshold in antitrust/competition law cases of market monopoly. In a way, any higher share of one among many is a kind of monopoly, hence calling of use of such an index number. The above steps can be easily programmed in simple tools like excel. Any request that comes for addition of a sub­heading at 8 digit can be evaluated using this method and if deemed fit, may be taken up for harmonisation. 

Mar 29, 2017

GST effect on Foreign Trade Policy: Effect on various exemption and incentive schemes - Part 2

I had elaborated my thoughts on the topic in the Part 1 of the series. This is a continuation and part 2 of the series. As was outlined in part 1, it appears that the duty exemption schemes, specifically the popular advance authorisation scheme may get a short shrift under GST and may be made ineffective. As proposed, GST would allow only refunds on the duties suffered, unless a course correction is done before the launch and now.

I have discussed some details in the video post here:

I have also summarised my thoughts on other schemes, namely the Export promotion capital goods scheme and the export incentive schemes in the same video. I guess I got too lazy to type at some point and decided to video log it over a coffee.

To sum it up, it appears that GST has not kept the best interests of exporting community in mind at the time of rollout. However, one must also agree that GST is being rolled out with a sense of urgency and there will be kinks and knots and pockets of dissatisfaction which would get ironed out over a period of time. Probably there would be revision or rethink about the exemption schemes too. The last word is not yet out. I would most likely come up with a final part of the series then. Till then fingers crossed.

Jan 6, 2017

Undervalued currency of China and learnings for India

China maintains an undervalued currency which is one of the key reasons for trade surplus of China with most trading partners. It has also led to huge forex build up over the years. While China's undervalued currency has faced criticism from trading partners, the public policy choice of this tool for development of China is not well appreciated. China has used the currency as a policy tool to empower itself; it is just incidental that this policy has done damage to trading partners. The undervalued currency of China acts as a direct subsidy for exports. A 20% undervaluation of currency is equivalent to 20% direct subsidy support in terms of export price. Given that China has usually maintained an undervaluation of a quarter to a third of its price, Chinese exports have enjoyed this subsidy. In addition, an undervalued currency acts as a tax on imports into the country, leading to further favourable change in terms of trade. 

China has used currency as an evolutionary policy response against stifling conditions imposed upon it from WTO and other bilateral/multilateral arrangements. If one looks at China's growth decades, it can be seen that the late 70s and early 80s growth right up until mid 90s rode on the active state support to the manufacturing industries. Heavy structural change towards industrialisation was led by the state, leading to rapid increase in productivity in the manufacturing sector. During this period, China maintained heavy import restrictions, provided subsidies to industries, and incentivised investments into the manufacturing sector in the country. The strategy worked and led to creation of world beating manufacturing sector in China. The scale of industrialisation met and surpassed advanced industrialised nations within two decades. None of the above steps that China took to support its domestic industry were compatible with WTO, and therefore China didn't come onboard at the time of WTOs inception in 1995. 

While China prepared for joining WTO during late 90s, (it ultimately joined WTO in 2001) it realised that the earlier strategy of direct subsidy and import restrictions would not work. Therefore it resorted to an undervalued currency strategy which was not countervailable under existing WTO rules. The decade from late 90s onwards till very recently, China maintained an undervalued currency, thus helping its manufacturing sector weather the gradual withdrawal of direct subsidies and state support that fell foul with WTO provisions. This strategy ensured that Chinese industries continued with the state cushion while appearing to follow all WTO rules. Even today, currency policy cannot be countervailed under WTO. It was the protest by trading partners, and problem of burgeoning forex reserves that made China do a partial rethink. 

In contrast, Indian manufacturing industries were not well prepared to withstand global onslaught once the gates were opened under WTO, especially from competitors like China. Wherever Indian government provided even semi decent support, Indian manufacturing industries showed good results. For example, in auto and auto ancillaries industries Indian government had made provision for incentivising localisation, mandated joint venture requirements for direct investments in the sector, and had levied heavy import duties on fully assembled imports during the 90s. While these provisions fell foul with WTO rules later on and had to be removed, these policy steps during formative years helped our auto and engineering sector thrive. Similarly, in pharma sector, Indian patent laws allowed the industries to operate and copy generics and derivatives despite TRIPS, and today India's pharma sector has done exceedingly well. On the other hand, electronic hardware manufacturing sector in India was opened up to the world from initial days under Information Technology Agreement of WTO, and no meaningful support was provided during the early days and today we are struggling in electronics manufacturing. 

Lest I be misunderstood, the argument is not about infant industry protection or supporting protectionist policies of the yore or even to recommend currency devaluation as a potent tool for India. It is about the need for policy makers to carefully analyse the options available as policy tools whenever an industry is being subject to inorganic changes such as globalisation, treaties, change in import policies, state support introduction or withdrawal etc. To cite an example from recent times, the imposing of anti dumping duties on imported steel in order to protect the steel industry in India has bled the engineering and auto sector by raising input costs on them. It appears that policymakers did not do a good cost-benefit analysis, and therefore helping one sector is harming another. If steel sector needed to be protected, one needs to build in adequate protection for engineering sector which needs imported steel. 

Chinese policymakers were indeed smart to introduce currency devaluation while they withdrew from direct subsidies. It was a policy option they had in hand and they exercised it very well to their advantage. That's a lesson for policymakers worldwide.