May 12, 2019

The interest in free trade and related matters - a silent story from google trends

Google web-search is a rough indicator of the hotness/popularity of the topic.
Here's what you get for some of the words that this blog cares about, if you see the popularity trend in Google web searches across the world over last 15 years.

1. Free Trade

2. WTO
3. Free trade agreements

4. Tariff Barrier

5. Non Tariff Barrier

6. Trade war

7. International Trade

8. E Commerce 

Mar 24, 2019

MSMEs in cross border E Commerce – Challenges, Opportunities and Trade Facilitation Measures

MSME's and E Commerce

MSMEs currently contribute to around 40% of exports of India. E-Commerce is an area that has shown tremendous potential for growth, especially for MSMEs. It is so because MSMEs suffer from certain handicaps in traditional trade models, with regard to access and scale, that are ameliorated in an E-Commerce model. This post shall elaborate some of the challenges and opportunities that pertain specifically to MSMEs when it comes to E-Commerce trade across border before deliberating on the facilitation measures specific to MSMEs.


Data from Statista show that retail E commerce trade will grow to around 4.8 Trillion USD by 2021 – around two years from now. Around 30% of this is expected to be cross border trade through E-Commerce route. Data also shows that 82% of enterprises involved in such cross border trade are micro and small scale in size (definition of SMEs vary across countries/organisations). 


image of SMEs and E Commerce


Opportunities for MSMEs in Ecommerce

E commerce creates opportunities for MSMEs through 
a)     Easier Outreach potential 
b)    Easier Market Research
c)     Easier Reputation building
d)    Easier Marketing expenditures
e)    Development of ecosystems creating synergy

E Commerce brings a paradigm shift in terms of dealing in delivery time, warehousing concepts, customized production and social marketing. The traditional model of value chains are being broken up – for example, the evolution of shipping from bulk cargo to containers of last four decades is giving way to, what one may call, "parcelization" (there’s no such word as of now in the dictionary) where individual parcels - recall the amazon box parcel you got last time around – play the role of a unit of measure in transport cargo.   

Challenges for MSMEs in E-Commerce

The efficiency of logistics and cross border procedures are yet to catch up with the blazing speed with which E Commerce has grown. The volumes of E Commerce shipments are straining the existing logistics industry and associated business costs. 

E Commerce is also challenging border regulatory agencies and they have not evolved sufficiently fast to cater to the emergence of E Commerce. The customs operates with laws made decades ago with a priority on border controls and emphasis on duty collection over trade facilitation. 

Five types of trade costs associated for MSMEs in particular that challenge the faster growth of cross border E Commerce trade are: 

a)     Tariffs and duties
b)    Technical barrier to trade – standards that are rigged against SMEs
c)     Documentation requirements
d)    Border costs – fee/charges associated with border crossing
e)    Logistics costs – transport, insurance and warehousing costs 

The cost of delay at border clearances add up to the detriment of MSMEs, squeezing their competitiveness. 

Vulnerability of MSMEs in international trade

The vulnerabilities arise due to the fact that MSME's 

a)     Need more human resource to export per unit of revenue due to scale of operations 
b)  They Have limited access to financing and costlier financing when compared to bigger corporations with better access to credit. 
c)     MSMEs trades are usually categorized under high risk items under Risk Management Systems and are subject to greater border controls 
d)    MSMEs usually cannot afford high quality logistics operators to handle their shipment leading to sub-par performance on logistics front. 
e)    MSMEs usually export small volumes of low value added products leading to longer breakeven times for the firms. 

Trade Facilitation Measures for MSMEs in Ecommerce

Trade facilitation Measures should focus on MSME's needs if India wishes to grow in this area. The bigger multinational organisations have their in-house teams to manage supply chains and optimise the operations. Giant firms operate efficiently, optimise logistics, and involve themselves with policymakers to ensure that the border policies don't harass them. The bulk of these organisations ensure that Governments heed to their demands in the interest of earnings and employments that these firms bring to the country. That's not so when it comes to MSMEs. That's where forming associations for protecting interest of MSMEs become important. Without an association or representative body, it is difficult to hear the voices of MSMEs. 

Many countries approach the trade facilitation to SMEs through a system of de-minimis where customs duties are not levied for products with value less than a certain threshold. This encourages trade while sparing disproportionate efforts by customs in collecting what in the end adds up to a relatively small percentage of revenue. India has granted certain easier tax processing and compliances for small scale industries through the composition scheme. However, for inter state and export transactions, SMEs still don't enjoy sufficient freedom. While tax evasion is certainly an issue from revenue loss point of view, but if the revenue arm enjoys overbearing say in the area of taxation of SMEs, we may end up stifling growth. While the SMEs grow, it is better to let a small bit of revenue slip in the interest of higher employment and prosperity. This, alas, is an approach that appears lost in the din for maximisation of revenue in India. 

Also, schemes that are designed for greater ease of transaction at border, such as the Authorized Economic Operator (AEO) program - a program flowing from the Trade Facilitation Agreement of WTO -  are heavily skewed to help multinationals and bigger corporations. A rethink is required to make such programs suitable to MSMEs. 

Finally, the barriers to trade for MSMEs arising out of technical and non-technical barriers erected by various governments needs a look into. As world have negotiated away the tariffs, a common way to protect local industries is through erection of the so called Non Tariff Barriers (NTBs). The rise of NTBs in recent years has affected MSMEs badly. This has carried over to the E-commerce trade. 

To sum up, trade facilitation for MSMEs needs a paradigm shift in the way the border compliances and regulatory functions are designed. Unless addressed adequately, we may end up in a situation where the bigger organisations end up gaming the cross border E Commerce and leading to an unequal, non level playing field for SMEs.



Jan 31, 2019

Understanding beef-ban, prohibition and prostitution in India through repugnant market theory

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Bans are not always effective as we know. Gujarat's prohibition has lead to a thriving black market for liquor, whereas the ban on prostitution has held up relatively well in India with only a small steady state black market that has not grown bigger. Selling and consumption of beef on the other hand, where banned, has been effective to a large extent - to the determent of the health of cattle and leather industry - as was witnessed during recent ban on cow slaughter in Uttar Pradesh.

Bans are always blunt instruments. It is necessary for a public policymaker to study the effects from the prism of effectiveness of achieving policy objectives of a ban, over the negative externalities, and also lack of effectiveness arising due to administration issues. It is not that a stiffer punishment would automatically lead to desired outcome. To cite an extreme example, rape in India attracts imprisonment of 7 to 10 years. Murder attracts life term or hanging. If the punishment of rape is increased to life term or hanging, as was being mooted in media for cases of child rape, it might lead to adverse result where the rapist kills the victim as the punishment doesn't increase by the additional act of murder, whereas the killing of victim may eliminate the witness!

Such analysis may be grown rigorously. An interesting recent paper tackles such questions from a game theory point of view for market of repugnant transactions. Co-written by the noble prize winning author Alvin Roth of Stanford, it tries to measure repugnancy along two dimensions of extent and intensity and tries to predict the outcome of banned activities with certain assumptions on initial conditions and progress. In the words of the paper:

This paper proposes a simple, stylized theoretical model to help understand why some transactions can be effectively eliminated by legally banning them, while others are more resistant, to the point that they may be impossible to extinguish or even suppress to low levels, so that it might be wise to consider different goals for dealing with them.

The paper takes the example of drug market to develop the analysis. However, the results generally hold good across various examples including prostitution, banned meat trade and so on. An interesting result along the way is that the existence of a market before banning plays a role in the effectiveness of the ban subsequently. In the words of the authors: 

...Before beginning the analysis, consider how policy makers could have some control over the initial states. One example would be the regulation of synthetic drugs. When a new synthetic drug becomes available, it takes time before it can be banned. The number of users it attracts before it is banned may be an important factor for the prospects of extinguishing the market. So the speed of initial regulation may be consequential, and there may be markets that could be successfully prevented only by prompt action, and not when they have become well established...

I quote some of the analysis and results below: 


...if the market is insufficiently repugnant in extent or intensity, even substantial legal penalties “on the books” may be insufficient to deter participation if those penalties cannot gain enough social support to be reliably enforced. Note also that if the feasible punishment is not too large, and if the extent of repugnance among the population is low, then even the maximum intensity of repugnance among those who wish to ban the market may be insufficient to control the blackmarket. And as an illegal market becomes larger, it becomes more likely that those who wish to participate in it can do so without encountering those who would penalize them. Consequently, black markets that have operated successfully for a long time become increasingly hard to eliminate if the underlying social parameters and legal punishments cannot be changed.


But changing social repugnance, and even increasing legal punishments in an ef- fective way, may be difficult. Policy makers may be able to influence the extent or intensity of repugnance by education and public relations. But because legislators don’t have easy or direct access to who feels how much repugnance, this is not likely to be anywhere near as easy as passing legislation. At the very least, chang- ing widespread attitudes takes time. And increasing mandated punishments beyond what social repugnance will support can be counterproductive if it makes citizens less likely to report illegal transactions and juries less likely to convict.  So we may never be able to completely eliminate some markets, despite the fact that they cause considerable harm. Hence harm reduction should be in our portfolio of design tools for dealing with repugnant markets that we can’t extinguish despite the harm they may do.


Therein lies the lesson for a public policymaker. 

Jan 8, 2019

GVCs and the tariffs - a simple fact the free traders miss

A common argument of free trade supporters runs this way:
  1. Tariffs create barriers to movement of goods - India has high tariffs on various goods 
  2. Global Value Chains(GVCs) operate better with low barriers for movement of goods
  3. Therefore high tariffs are responsible for India's lack of integration into various GVCs
In principle the argument is correct.  For a graduate student who has completed a course on International Economics, the above argument is obvious. This belief carries over to the practising economists, and journalists who consult the economists. That's why we read a lot of criticism of the government when tariffs are raised - as they lead to breaking away from GVCs, or rather in India's case, not getting integrated into them.
A simple case where a duty of 10% is levied every time a component crosses the border in the journey through the value chain, where a value addition of 30% takes place at each step, leads to a situation where the prices build up pretty fast as can be seen in figure below. Starting with an initial value of 100, the component start showing significant difference in price by the time it crosses a dutiable border the third time, showing that a country with even a 10% duty at border becomes a drag in the value chain, and is liable to be opted out of the chain. Thus the logic holds.

image of GVC value chain tariff duty competitiveness
Effect of duty cascades with each border crossing making the duty levying participant uncompetitive in GVC

In practise the above argument is not as parsimonous. The argued tariff effect on GVC participation is exaggerated. Lest I be misunderstood, let me state here that high tariffs are always a blunt instrument to use and I am not a supporter of blanket high tariffs on goods, especially the ones that are part of GVCs.  However, the argument that tariffs at the border are sole reason for India not getting into GVCs is flawed. Here's why.

India, and most other countries, work under the principle that "Goods are exported, taxes and duties are not" when it comes to exports. One may call it by various names ranging from 'zero rating of exports' to 'duty nullification schemes', but the fact remains that policy practitioners all around the world understand this problem and devise means to counter this effect when it comes to goods that are re-exported with/without value addition. Such schemes also do NOT run counter to the Agreement on Subsidies and Countervailing Measures (ASCM) at WTO.

India has mainly three ways of handling such border crossings without penalising the imports that are meant for GVCs/re-export with/without value addition -
a) Advance authorisation scheme - a popular duty nullification scheme where duties are not collected at border with an assurance of re-export of goods with a minimum value addition of 15%
b) Duty free import authorisation scheme - same as above with a value addition of 20%
c) Dedicated duty free enclaves such as Special Economic Zones and bonded manufacturing zones such as EOUs.
I am aware of such schemes being run in many countries and there can't be any objection of these schemes at WTO. In addition, India also enters frequently into various trade agreements with partners where duty free access is provided.

I consider the non-tariff barriers (NTBs) more important than tariff measures which are countered through these schemes. In addition to NTBs, India also suffers from relatively poor infrastructure, longer distance and hence travel times, poor investment in industries, and lack of economies of scale in manufacturing sectors where GVCs are prevalent (e.g. electronics/semiconductors) and such other factors that matter more in GVCs than a simple border tax that the free trade theorists abhor.

The above needs to be kept in mind when we argue against a mere border tax effecting our chances at participating in GVCs. 


Excel workbook for the above picture is attached for reference below: