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.