OPINION PIECE - PACER Plus
Monday, 07 December 2009 http://www.pacificpolicy.org/index.php?option=com_content&view=article&id=207:opinion-01&catid=60:general&Itemid=100
Putting development first - by Wesley Morgan, Communications Officer
at the Pacific Network on Globalisation (PANG).
World Bank Senior Economist for the Pacific, Dr Manjula Luthria, argues that PACER Plus could lower the economic distance between countries in the region if concerns regarding agricultural exports, labour mobility, and tariff revenue losses are adequately discussed. Here, Wesley Morgan responds, arguing that a free trade deal offers more dangers than gains for the Islands.
Putting development first
The push for a Pacific free trade agreement, to be called PACER-Plus, clearly originates from policy makers in Australia and New Zealand (and from supporters at multilateral institutions such as the World Bank and the Asian Development Bank). Both Australia and New Zealand have considerable experience negotiating free trade agreements, and stand to gain commercially from PACER-Plus. The majority of any increase in trade brought about by PACER-Plus will come in the form of an increase in their exports to the Pacific (adding further to considerable trade imbalances faced by many Pacific countries).
That Australia and New Zealand are keen to pursue a free trade agreement (FTA) means that Pacific countries are being asked to consider what they might ask for ‘in return for’ trade liberalisation. In her opinion piece (October 21, 2009), World Bank economist Dr Manjula Luthria offers a number of suggestions for what Pacific might ask for under PACER-Plus.
Clearly, this is putting the cart before the horse. Trade arrangements between the Pacific and Australia and New Zealand can, and should, be dramatically improved. But there is no need to negotiate a dangerous FTA to do so. The key question should be: ‘how can trade assist with improving development outcomes in the Pacific?,’ not ‘how can we make a FTA more palatable?’
Undermining government revenue in the Pacific
Dr Luthria quite rightly points out that PACER-Plus will leave a “significant hole” in the budgets of Pacific island countries. A report commissioned by the Pacific Islands Forum Secretariat, and completed by Washington-based consultants Nathan Associates, has found that under PACER-Plus, Pacific countries stand to lose tens of millions of dollars each year. That report found Vanuatu stands to lose around 17% of its annual government revenue, as does Tonga, while Samoa and Kiribati stand to lose around 14% of their revenue. Even bigger countries like Fiji and PNG stand to lose more than $10 million each year[1].
Dr Luthria, also quite rightly, points to a lack of solutions for this revenue loss, indicating that moving to a VAT would be difficult for many countries – especially those with large informal sectors. Dr Luthria says money delivered straight from Australian and New Zealand governments to make up the shortfall (‘time bound structural adjustment support’) is justified. Failing that, Pacific countries will simply have to ‘grin and bear it’ – at least in the short term, until the ‘benefits’ of a FTA are realised.
However, it is not at all clear that Pacific countries stand to gain much from a FTA with Australia and New Zealand – even in the longer term. Pacific countries already have duty free and quota free access to Australian and New Zealand markets for their exports, and other non tariff barriers to trade (affecting potential exports of agricultural goods for example) aren’t necessarily solved by a traditional FTA.
As for regaining lost government revenue; studies by the International Monetary Fund have found that over the past 25 years, low income countries have completely failed to recover government revenue lost from the reduction of import taxes (and that introducing VAT has little impact on meeting the shortfall)[2]. There are recent examples of this in our region – when the Asian Development Bank forced Vanuatu to lower tariffs and introduce a VAT as part of conditions for a new loan in the late 1990s for example, the country suffered massive revenue losses that it took many years to recover from.
Consumer gains from PACER-Plus?
Dr Luthria argues that reducing tariffs on imports can “significantly increase the welfare of Pacific denizens”. However, it is not clear that Pacific consumers will gain meaningful price reductions through PACER-Plus.
Experience suggests that even if tariffs are lowered, in many cases exporters and distributers (middle men) tend to increase their prices almost back to the same level after tariffs are removed, and fail to pass on the benefits to consumers.
There are recent examples of this from within our region. For example, when the Asian Development Bank forced Vanuatu to lower tariffs as part of conditions for a new loan in the late 1990s, benefits were not passed on to consumers. A report commissioned by the United Nations Development Programme on Leveraging Trade for Human Development in Vanuatu found that one of the ‘benefits of trade liberalisation – a fall in retail prices of consumer items –is not evident in Vanuatu’[3].
Any fall in the price of consumer goods as a result of a reduction in tariffs is likely to be at least partially offset by increases in consumption taxes (introduced to meet serious government revenue shortfalls).
Indeed, governments that already have these taxes have steadily raised them in recent times. Samoa for example introduced a Value Added Goods and Services Tax when it unilaterally reduced tariffs in the late 1990s. Originally levied at 10%, the VAGST has since been raised to 15%, and is likely to be raised further under PACER-Plus. Tonga, which introduced a Consumption Tax in 2005 to offset losses incurred by joining the WTO, gathered 20% less revenue than it expected to in 2008/09 and is also likely to raise its Consumption Tax again in the near future.
A further key point to remember is that Pacific countries can currently lower tariffs unilaterally at any time they like, if such a move is deemed to be of benefit to local consumers. This would avoid the dangerous, and irreversible, conditions of a FTA with Australia and New Zealand.
Finally, lowering tariffs needs to be considered against maintaining local livelihoods and jobs. If Pacific countries allow cheaper imports (often made by large corporations who enjoy bigger economies-of-scale) to flood the market, local businesses will close down as the private sector turns to imported goods. Cheaper imports may even undermine local agriculture and reduce the income of village farmers selling their produce at the local market.
Agriculture and labour - the Pacific’s ‘comparative advantage’?
Dr Luthria argues that the Pacific would do well to focus on areas that it has a ‘comparative advantage’ – namely agriculture and labour – but fails to indicate why a FTA is necessary to increase export potential in these areas.
Taking first agriculture; it is true that Pacific agricultural exports are much under-developed, especially given the prevalence of productive agricultural systems in the Pacific – for subsistence and cash-income – and climate advantages (for tropical fruits and root-crops for example).
A new regional trade agreement could open new ‘export pathways’ for agricultural exports by providing resources and expertise to meet Australian and New Zealand quarantine standards, and prioritising the assessment of Pacific produce by Australian and New Zealand quarantine agencies (at the moment, Australia is especially slow at assessing the entry of new products). As Dr Luthria points out, a hefty emphasis on ‘aid for trade’ would be required, as would a focus on improving key trading infrastructure (such as rural roads, ports, pre-shipment quarantine facilities etc.).
However, a free trade agreement with the Pacific’s biggest trading partners would remove key policy options for growing Pacific agriculture (including seasonal tariff protections, and occasional subsidies when prices for island commodities - like copra - fall through the floor), and is likely to promote a greater reliance on food imports and increased competition for local producers from foods produced in Australia and New Zealand. Over time, this will undermine the income and livelihoods of village farmers selling their produce in local markets.
Dr Luthria argues that “the other main exportable item from the Pacific is semi-skilled and unskilled labour”. However, it is not explained why PACER-Plus is necessary to improve opportunities for the export of Pacific labour.
Both Australia and New Zealand currently maintain a temporary labour mobility scheme that allows small numbers of Pacific islanders to fill labour shortages in their horticulture industries. However, demand for unskilled labour fluctuates overtime in both countries, and a binding commitment to a quota of Pacific island workers as part of PACER-Plus is unlikely. The recent downturn in the global economy and increasing unemployment in Australia and New Zealand means that labour mobility of the type sought by the Pacific countries is increasingly unlikely to be included under a new deal.
Other FTAs negotiated by Australia and New Zealand do not offer hopeful precedents for the Pacific, as negotiations have focused on market access for executives, professionals and skilled self-employed contractors who service transnational corporations and meet skills shortages. As a recent study commissioned by the Pacific Islands Forum Secretariat points out that; “[Pacific] priorities include the free movement of skilled and unskilled labour, however we believe it is unlikely that PACER-Plus negotiations will encompass free movement of unskilled labour.”[4]
If Pacific countries choose to negotiate a FTA including trade in services, in the hope of gaining labour mobility commitments, they may simply end up with what they already have. That is, they may gain a temporary labour mobility scheme designed to meet labour shortages in Australia and New Zealand (that can be suspended when unemployment rises in those countries) through onerous conditions on any Mode 4 concessions, or a side letter that deals with labour mobility. In return, the Pacific may have to liberalise a range of service markets and surrender sovereignty over key areas of national economic policy-making.
The World Bank is right to point to regional labour mobility, and improvements in agricultural exports, as key priorities for the Pacific – but clearly a free trade agreement is not the appropriate vehicle to pursue these interests.
Wesley Morgan is Communications Officer at the Pacific Network on Globalisation (PANG).
[1] Nathan Associates. 2007. Pacific Regional Trade and Economic Cooperation – Joint Baseline and Gap Analysis. Pacific Islands Forum Secretariat, November 2007.
[2] International Monetary Fund, 2005. Tax revenue and (or?) trade liberalisation. (prepared by Thomas Baunsgaard and Michael Keen). June 2005.
[3] Wagle, S. 2007. Leveraging Trade for Human Development in Vanuatu – Summary of Issues. Asia-Pacific Trade and Investment Initiative UNDP Regional Centre in Colombo.
[4] pp. viii Nathans Associates. 2007. Pacific Regional Trade and Economic Cooperation – Joint Baseline and Gap Analysis. Pacific Islands Forum Secretariat, November 2007.
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The following is the opinion piece originally posted by Dr Manjula Luthria, of the World Bank.
PiPP welcomes further comment on this topic in the spirit of promoting policy debate. The Pacific Institute of Public Policy invites opinion pieces for publication in order to stimulate thought and discussion on important policy issues in the Pacific. Views expressed are those of the authors and may not reflect opinion of PiPP.
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PACER Plus - an opinion piece by Dr Manjula Luthria (Senior Economist for the Pacific Region, World Bank)
PACER plus has the potential for lowering the economic distance between countries in the region. But only if concerns regarding agricultural exports, labour mobility, and tariff revenue losses are adequately discussed.
Along with the much larger economies of the world, the small islands of the Pacific are trying hard to cope with the effects of the global economic downturn this year. With this bleak backdrop, it is almost understandable when the idea of greater openness and trade integration through the PACER Plus Agreement does not translate into a picture of economic security in their minds. However, the reality is that even greater trade integration could translate into concrete economic benefits for them. Tariff reductions on imports from Australia and New Zealand (ANZ) – who are the main suppliers of imports into the Pacific – can significantly increase the welfare of Pacific denizens. This is primarily because it is already very expensive to get goods to the Pacific doorstep due to their small size and extreme remoteness. Adding on tariffs which result in increasing the final price of goods to Pacific consumers is akin to the islanders being shot in the foot twice, once by geographical distance and a second time through protectionist policies.
At the same time it is hard to deny that the Pacific’s hesitation to negotiate the PACER Plus agreement has some just cause. After all, tariff revenues comprise upwards of 10% of all government revenue in most islands, and their reduction will leave behind a significant hole in their budgets. There are no easy remedies for filling this revenue gap - for example, oft-heard advice to fill that hole through prudent financial management will appear pedantic. Similarly, suggestions for moving to a VAT system of tax collection are also infeasible in the presence of large informal sectors. The other commonly given advice in such situations is that this pain of adjustment is temporary and, hence either a ‘grin and bear’ approach is recommended or a call for support for temporary, time-bound structural adjustment support is justified.
This is where the stark reality of many small states facing preference erosion will need to be faced in bilateral, regional, and ultimately multilateral trade liberalization fora. For many small states this pain is permanent, because they simply do not have the size and location advantages to operationalize their comparative advantage. Recent emphasis on economic geography has also shown that efforts to push economic activity out from hubs to the periphery either through conventional policy prescriptions or through aid to build state capacity are fraught with failure. Instead, small states would do better by attempting to become economic extensions of their nearest large market. This is best achieved by reducing any economic ‘frictions’ that create economic barriers between the islands (the periphery) and the nearest hubs – be they barriers of language, transport costs, costs of telephony, or trade tariffs.
Reducing these frictions all around will also require that goods or services in which the Pacific has comparative advantage be allowed to reach neighbouring developed markets without being met with high tariff or non-tariff barriers. And there are two such items the Pacific has the potential to offer: agriculture and labour. In exporting agricultural goods the Pacific islands will face technical barriers to trade (e.g. SPS conditions) which they are almost certainly not going to be able to meet. Consequently, a hefty emphasis on trade-for-aid to build the Pacific’s capabilities to meet those stringent requirements will be needed. The attractiveness of this approach is that the abundant fertile and under-utilized land assets in the Pacific will receive a financial boost and thus set in motion the virtuous forces needed to create commercial land-leasing arrangements which are compatible with customary land ownership but currently scarce in the Pacific. Once that happens, large masses of Pacific populations that are ensconced in the informal sector may find sustainable ways to access a cash economy in which they aspire to partake. And faced with the prospect of greater openness in agricultural trade in the region, the pacific could also review some of its own tariff peaks in agriculture which are not conducive to attracting investment or to the adoption of new technical know-how in the agricultural sector.
The other main exportable item from the Pacific is semi-skilled and unskilled labour. A restriction on the movements of Pacific people constitutes a non-tariff barrier on their chief export and prevents their comparative advantage from being operationalized. This despite the fact that nearby hubs are labour starved already and likely to become even more so as their populations age and the need for labour-intensive services increases. Greater regional labour mobility for all skill types offers a chance to bring prosperity, as well as social stability and security, to the entire region.
So the Pacific might need to start thinking seriously about putting an end to shooting itself in the foot by maintaining high tariffs on imports, and ANZ might need to deliberate on a combination of aid-for-trade focus to facilitate agricultural exports out of the Pacific, significantly lowering barriers on labour mobility, and ultimately buffering any remaining revenue losses due to foregone tariff revenues. Without these ingredients the Pacific might find itself either quietly marginalized by globalization or loudly trampled upon by it. With these ingredients however, it can potentially insert itself into the globalization process as a full participant of its fruits.
Dr. Manjula Luthria, The World Bank
Senior Economist for the Pacific Region
