Export subsidies as a diversification tool: a trap for Kazakhstan

Introduction


The Government of Kazakhstan is trying to end the oil curse through subsidizing exports, opening another can of worms.


Explaining the Dutch Disease

Many countries suffer from the Dutch disease. When export prices rise, revenues strengthen the national currency price. This drives up dollar labor costs in the country, decreasing its attractiveness to foreign investors and diverting resources away from non-exporting sectors.

The term “Dutch disease” dates back to the 1960s, when the Netherlands began to exploit natural gas deposits in the North Sea. The Dutch guilder appreciated; non-oil exports became less competitive. Any change, causing a large inflow of foreign currency, such as rising natural resource prices, large foreign direct investment, and many others, can cause the Dutch disease. Since extracting natural resources does not create value added, it is particularly beneficial to diversify into non-extraction industries.

Abrupt declines in foreign currency inflows are also dangerous. When export prices fall, central banks often devalue or allow depreciation of the national currency, as Kazakhstan had done. This accelerates inflation. Diversifying exports can mitigate fluctuations in foreign currency inflows, since the correlation between the prices of various categories of products is negative or nearly zero.


Subsidizing exports for diversification

Various government programs include export stimulation and diversification measures. Strategy “Kazakhstan 2050” includes at least doubling the export of processed goods by 2050, compared to 2015, and boosting it to 30 billion dollars per year. At least 10 multinationals will enter the processing industry to export goods abroad, according to President Nazarbayev’s Program “Nation’s Plan - 100 Steps of Realization of Five Institutional Reforms”, reports Kazinform.

The Government has been undertaking many export support measures. For example, the government-owned Bank of Reconstruction of Kazakhstan lent 35 billion KZT 2015, and 15 billion KZT in 2016, at an annual interest rate of 0.15%, for a term of 20 years, to be paid semiannually, reports Kazinform. In comparison, the annual market interest rate on business loans in tenge by Kazakh banks in 2015 ranged between 13.8% and 18.1%, reports the National Bank. The difference is a subsidy of the loan to exporters.

Export subsidies are inefficient. Prices of exported goods increase domestically by the amount of the subsidy, since producers do not sell the good at Home otherwise. Kazakhstan, a small country, cannot affect world prices. Domestic production increases and new jobs are created, but the cost of producing the exported goods exceeds the revenue, earned on exporting it (not including the subsidy). Also, Kazakhstan’s trading partners may set countervailing duties that would make it more expensive to sell goods abroad. Subsidizing loans for export is also inefficient, since the market interest rate reflects the risk of lending to exporters.

Examples and alternatives: the Latin American experience

Instead of subsidizing exports, Kazakhstan should continue deregulation, trade liberalization, and maintain exchange rate stability. Kazakhstan can draw upon the example of Latin America in its policies.

A study of export subsidies and the share of manufactured exports in 8 Latin American countries was conducted. The countries studied were: Argentina, Brazil, Chile, Columbia, Costa Rica, Mexico, Peru and Venezuela. The ratios of manufactured goods were examined for three periods: 1970-74, 1975-79, and the 1980s. When the exact figures for subsidies were not available, the United States countervailing duties were used as proxies for the subsidy.

The study showed that export subsidies generally do more harm than good. Only Mexico and Brazil were successful in diversifying exports, even though all countries, except Chile (which did not subsidize exports), relied heavily on export subsidies. In Argentina, export subsidies encouraged rent seeking and corruption. The subsidies stimulated exports through specific ports, from specific regions and through particular ports.

Mexico diversified exports by liberalizing trade. The ratio of manufactured exports to total exports had decreased from 37.1% in 1970-74 to 17.7% in the 1980s, in spite of export subsidies. However, the figures for the 1980s hide an increase in the ratio. From 1981 to 1985, the ratio rose from 10% to 27%, and increased even further afterwards. During that period, Mexico decreased the maximum tariff rate from 100% to 20%. Decreasing tariffs makes inputs cheaper and encorages specializing in internationally competitive goods. Early in 1985, Mexico also signed an agreement with the United States, eliminating export subsidies (having averaged 12% between 1980 and 1984) for certain goods, based on an injury test that the United States International Trade Commission conducted. Thus, Mexico was able to achieve a manufacturing export boom, while eliminating export subsidies.

Brazil was the only country in the sample that achieved export diversification, while subsidizing exports extensively. The ratio of manufactured exports to total exports increased from 18.2% in 1970-74 to 39.9% in the 1980s. However, the country also liberalized imports then. Also, the Brazilian real was the most stable of the currencies in the sample between 1965 and the early 1970s. Finally, Brazil was open to foreign direct investment, reports Julio Nogues, of the World Bank.

Conclusion

By relying on export subsidies to overcome the Dutch disease, Kazakhstan may be bargaining one trouble for another. At best, diversification could be cheaper without subsidies. At worst, the subsidies may increase rent seeking and corruption.

References

Kazinform. In Kazakhstan, 85 billion tenge is being allocated to support domestic producers. http://inform.kz/rus/article/2777515. 2015.

Kazinform. Nation’s Plan - 100 Steps on realization of Nazarbayev’s Five Institutional Reforms. http://www.inform.kz/kaz/article/2777943. 2015.

The National Bank of the Republic of Kazakhstan. Interest rates of banks on extended loans (by maturity and type of currency). http://nationalbank.kz/?docid=214&switch=english. 2017.

Nazarbayev, N. Kazakhstan 2050: Our power. Address of the President of the RK N. Nazarbayev to the People of Kazakhstan. https://strategy2050.kz/ru/page/message_text20142/. 2015.

Nogues, J. Latin America’s experience with export subsidies. http://documents.worldbank.org/curated/en/574271468758762222/pdf/multi0page.pdf. 1989.

Taxing “parasites” in Belarus

Introduction

Allegedly fighting tax evasion, the Belarussian Government is compelling people to work, like in the Soviet Union, though the relevant legislation is full of loopholes. The new tax parallels other inefficient quasi-socialist policies in the country.

The “tax on parasites”

On February 17, 2,000 people in various Belarussian cities protested a tax on those not full-time employed, as well as on people working abroad, known as “the tax on parasites.” The law had been passed on April 2, 2015. Those, officially working less than 183 days per year, must pay $250 dollars to compensate for foregone taxes. An exception is made for the officially unemployed, who perform community service tasks for $10 per month, so most do not register.The alleged purpose of the tax was to increase collections from the self-employed. Critics, however, argue that the Government forces people to work, like in the Soviet Union.

On March 9, President Lukashenka announced that the decree will not be cancelled, but those, who had not paid the tax for this year, will not be penalized until next year. Furthermore, those who had paid already, may receive a refund after finding an official job.

Effects of the tax

The tax did not increase government revenues. About 470,000 people should have paid, but less than 10% did, so only $6 million was collected, reports Andrei Machovsky, of Reuters.

Economists recognize various motives for tax evasion. Tax compliance depends on the probability of getting caught and the penalties that the non-payer may incur. Also, some taxpayers may rationalize evasion, viewing the tax as unfair or not trusting the government to spend their money.

There are many incentives for evading taxes in Belarus. Many entrepreneurs do not register their businesses, to avoid inspections, reports Yevgeniy Kirillov, of Zautra.by. If the husband in the family owns a firm, he can “hire” his wife and “provide” her a nominal minimum wage, though she may not really work, reports Elena Daneiko, of Thinktanks.by.

The penalty for evading the “tax on parasites” is insignificant. A caught non-payer faces an administrative liability of a fine of 2-4 basic units (42-46 new Belarussian roubles, or $22.58-$24.70), or compulsory labor of up to 15 days, reports Olga Yerokhina, of the Komsomolskaya Pravda newspaper. The fine is only 5.82-6.38% of the official average wage of 720.70 Belarussian roubles ($387.47), as of January 2017, according to the National Statistical Committee of the Republic of Belarus, so it does not stop evaders. Yet increasing the penalty would only anger many taxpayers, who view the tax as unfair.

The Belarussian “tax on parasites” is inequitable. The lower the income, the higher the portion of the “tax on parasites” to be paid, making the tax regressive. Payers have to pay a fixed portion, regardless of income, but the tax is not lump-sum: whether the person must pay, depends on the payer’s behavior. The tax distorts the taxpayers’ behavior, increasing labor supply and lowering wages: to avoid paying the tax, part-time workers must work more, while individual entrepreneurs, facing the tax, are discouraged from hiring new workers.


Proposed alternatives: excluding non-payers from welfare

To discourage tax evasion among the self-employed, some have proposed to exclude evaders from extensive welfare benefits. For example, Lithuania mandates most citizens to pay 9% of the minimum wage to buy a health insurance card. However, the Belarussian Constitution guarantees free treatment, so this measure is not feasible without an amendment. The Government may also exclude tax evaders from discounts on utility services. Nevertheless, in the long run, government subsidies on utility services will be abolished, so the Government will need new measures to exclude non-payers from receiving the benefits, reports Tut.by. By 2020, Belarusian utility bills will be triple the 2015 level, with users bearing the entire costs of utility services, reports Belarus Digest.

The welfare benefits themselves are inequitable. Since the rich consume more electricity and other utilities than the poor, they benefit more from the subsidies. Excluding tax evaders, many of whom are poor, would exacerbate the inequality.

The welfare benefits are also inefficient. Belarussian enterprises pay for the difference between the market price of electricity and the price that individuals pay for utilities. This difference is passed on to consumers of goods that enterprises produce, so they pay more than would have, if utilities were not subsidized. The World Bank estimates that Belarus spends about 2% of GDP on heating alone, about half of the country’s expenditures on health care and one-third of expenditures on education, reports Tatyana Manenok, then of Belarussians and Market, a weekly business newspaper.

Like any in-kind benefits, the Belarussian utility subsidies are more expensive than cash benefits for the same amount would be. If an individual consumed less than the Government paid for, his or her increase in purchasing power could be achieved with lower government expenditures. Rather excluding non-payers from these benefits, the Government should eliminate them, and substitute cash benefits, oriented towards those who really need them.


Conclusion

Both the Belarussian “tax on parasites” and the proposed measures of excluding non-payers from Belarussian welfare benefits are partial methods of plugging the holes in the country’s economy. Belarus needs a more radical optimization of its welfare system.


References

Alachnovich, A. Are housing utilities about to become market-based? Belarus Digest. http://belarusdigest.com/story/are-housing-utilities-about-become-market-based-23204. 2015.

Daneiko, E. How did the “parasite tax” affect Belarus? https://thinktanks.by/publication/2016/11/08/chto-prines-belarusi-nalog-na-tuneyadstvo.html. 2016.

Makhovsky, A. Thousands of Belarussians take to the streets to protest “parasite law.” Reuters. http://www.reuters.com/article/us-belarus-protests-idUSKBN15W1Y0.

Manenok, T. Having played too much with utility fees. Belarussians and Market. http://belmarket.by/ru/285/65/23125. 2014.

Tut.by. To leave parasites without free medicine and utility privileges. Experts on alternatives to Directive # 3. https://finance.tut.by/news540975.html. 2017.

Yerokhina, O. Non-payers of the “Tax on parasites” will be forced to sweep the streets. http://www.kp.by/daily/26363.5/3245005/. 2015.

Zautra.by. The calm before the storm: a rebellion of parasites may occur in Belarus. http://zautra.by/art.php?sn_nid=22861. 2016.