Moral hazards of trade concessions

Thursday, 17 April 2014 00:00 -     - {{hitsCtrl.values.hits}}

By A Special Correspondent What are moral hazards and what is their connection to trade concessions? In economics, a moral hazard is a situation where a party will have a tendency to take risks shifting the burden of risk to others. For example, if your fully-insured car is parked under a rotten tree and damaged by a tree falling on it, the costs of such damage are not felt by you, but felt by the party which insured the car. As a child, one has no second thoughts about playing after school in the same uniform knowing that one’s mother would wash without a single objection. These everyday subconscious risk bearing and burden shifts situations routinely practiced by us have been identified by economists as ‘moral hazards’. A moral hazard arises because the individual or institution does not take the full consequences and responsibilities for its actions and therefore has a tendency to act less carefully than it otherwise would, leaving the other party to hold some responsibility for the consequences of its actions. Although these simple examples have been given to explain the concept of ‘moral hazard,’ the same ‘moral hazard’ can be seen in operation among the economic agents in a society or country. For coming home in dirty clothes, a mum may not punish her child for committing a moral hazard, but if it happens at a higher magnitude, consequences may be much larger too. Playing the role of a devil’s advocate, the writer would like to argue that the GSP+ is also a form of ‘moral hazard,’ where Sri Lankan exporters make risky bets while leaving the Government and the economic system to hold some responsibilities for their actions and consequences of such actions.     Genesis of Generalised System of Preference (GSP) (GSP+) For the benefit of the readership, it would be better to peep into the little history of GSP and the so-called GSP+ given by the EU to Sri Lanka. The developing countries were dissatisfied with the operation of the General Agreement on Tariff and Trade (GATT), governing the rules of trade in goods which was in operation since 1947. This contention resulted in promoting an institutional arrangement for international cooperation to deal with problems of world trade and development. Consequently, the United Nations Conference on Trade and Development (UNCTAD) was established in 1964. During its second meeting held in New Delhi, in 1968, all members unanimously agreed for early establishment of a mutually acceptable system of generalised, non-reciprocal and non-discriminatory preferences from the developed countries. This collective pressure had been filtered from UNCATD to the GATT forum where, in 1979, as part of the Tokyo Round of the General Agreement on Tariffs and Trade (GATT) negotiations, the so-called enabling clause was adopted in order to permit trading preferences targeted at developing and least developed countries which would otherwise violate Article I of the GATT. The enabling clause permits developed countries to give preferential treatment to poorer countries. Accordingly, the first European Community Generalised System of Preferences (EC GSP) scheme spanned an initial phase of 10 years (1971–1981) and was subsequently renewed for a second decade (1981-1991). Pending the outcome of the Uruguay Round under GATT, the 1991 scheme was extended with various amendments until 1994, when the Community made another 10-year offer. Accordingly, the second cycle of the EC GSP scheme covered the period from 1995 to 2004. Shifting its focus on more targeted and differentiated approach, the EU adopted a new GSP regulation for the period from 1 January 2002 to 31 December 2005, putting in place the third phase of the scheme by adopting Council Regulation (EC) No.2501/2001. Under this arrangement, concessions were offered to developing countries under few main categories namely, general arrangement, special incentive arrangements for the protection of labour rights, special incentive arrangements for the protection of the environment, special arrangements to combat drug production and trafficking and the last, a well-targeted scheme for LDCs – special arrangement the ‘Everything but Arms’ initiative. During this time, the notion of GSP+ was emerging and particularly referring to the special concessionary arrangements available for developing countries.     Special concessions for Sri Lanka It is noteworthy that even with this new legislation in 2001, Sri Lanka was entitled only for normal generalised preference scheme along with rest of the developing countries and competing in EU market with these countries. However, In January 2002, the Government of Sri Lanka applied for the special concessions available under Council Regulation No 2501/2001 through the special window of protection of labour rights. After back and forth examinations from the EC, the special incentive was granted to Sri Lanka towards end of year 2003. Since then, these concessions were commonly known as GSP+. Sri Lanka continued to enjoy these concessions over and above its peer developing country members with much more certainty till October 2008, when the EC announced special investigations on Sri Lanka. The full concessions continued to be enjoyed with suspense under the investigation pressures by Sri Lanka till August 2010, when the EC temporally withdrew GSP+, pushing Sri Lanka back to same old peer competitive boat of the general scheme of GSP. It is noted from the trade figures, sadly, leaving out the suspense period from 2008 till the temporary withdrawal of the GSP+ concession, Sri Lanka has shown a poor performance even from the period 2003 to 2008 in comparison with other GSP+ concession receiving countries. Graph 1 shows the export performance of countries to the EU which were enjoying GSP+ concessions along with Sri Lanka. As per graph 1, from 2003 to 2008, except Sri Lanka and Ecuador, all other major GSP+ preference receiving countries have shown a remarkable increase in exports to the EC. From 2008 to 2010, almost all counties had dipped their performance mainly due to the global economic crash which started in 2008, when Sri Lanka (Government) had to pump taxpayers’ money to compensate this part of the moral hazard through a special scheme called Export Development Reward Scheme (EDRS) from which companies bagged some handsome free money with no trace of spending on productive and sustainable purposes.     Better sans GSP+ In the meantime, other peer club members, who were in the Sri Lankan boat since 2001 till to date, as the recipients of normal/general GSP, have performed much better than the concession receiving countries such as Sri Lanka. Graph 2 shows how some of the general GSP recipient countries exports have performed in the EU since 2001. Can we expect Sri Lanka to perform with zero duty access to the EU market as the pattern depicted in the above redline (graph 2) along with the countries who enjoyed less preferences to the EU market and at the same time afford a bailout with free cash when they suffer a systematic global downturn similar to other countries, particularly those who operated in a less preferential concession scenario? The worse situation is that the GSP+ concession has resulted in Sri Lanka’s exports concentrating more and more on the European Market, while countries with no special or plus concessions have successfully reduced their exposure to the European market. According to Graph 3, except Sri Lanka, all other GSP+ countries effectively reduced their exposure to the EU market since 2001. For an example, Sri Lankan export concentration to the EU market has increased from already high level of 31% in 2001 to 40% in 2012. Countries such as India and Thailand have lowered their exposure to the EU from 10% and 9% respectively. Whatever the reasons, neither GSP+ concessions nor bailout money have resulted in bringing economically beneficial results for the Sri Lankan economy as a whole. The pertinent question to ask here is whether we are having more issues beyond our comprehension or whether other solutions would be available where we can see more responsible and strategic methods? Beyond free money for the Sri Lankan export sector, which will further promote the moral hazards? Yes.