Can trade policy reforms improve resilience to economic shocks?

The COVID-19 crisis has renewed the interest among economists in firms’ ability to adjust to economic shocks. Given the growing connectivity between firms through global value chains, trade policy is likely an important – yet under-studied - determinant of this resilience.  A relatively large body of literature has analyzed different types of firm-level characteristics that determine the extent of adjustment to such shocks (Gupta, 2020; Hyun et al., 2020; Ding et al., 2021) and shown that global value chains remain resilient to various shocks (Miroudot, 2020). Despite yielding important findings on firms’ resilience to shocks, these studies may provide limited guidance to policymakers as many factors that are not directly affected by policies can explain the variations in these characteristics across firms. Faced with a sudden change in the demand for their goods, exporting firms must optimally change their inputs and/or input sources. To the extent that import measures change the relative costs of such adjustments, they could have a prominent impact on the resilience of firms to shocks.  

In a recent World Bank Working Paper, we test whether a country's trade policy, both non-tariff measures (NTMs) and tariffs, makes such adjustments harder for firms that rely on imported inputs. The analysis focuses on the impact of exchange rate shocks on Indonesia’s exports to Japan, its largest regional trading partner (after China). A key innovation of this paper is the extensive coverage of NTMs, which represent increasingly important but still under-researched trade policy instruments. This is done by matching a novel hand-collected database on NTMs from different regulatory agencies in Indonesia for 2014-2018 at a highly disaggregated product level with data on the universe of Indonesian exporters.   

In response to a depreciation of the yuan, which makes Chinese exports more competitive, the findings show that firms that face NTMs on their inputs see a much larger drop in their export values compared to firms that do not face any NTMs . That is not the case for import tariffs on inputs, which do not affect the export response to the shock. This difference is consistent with NTMs increasing the uncertainty and/or the fixed cost per shipment of new import varieties, which raise the cost of switching intermediate inputs. That is not the case for import tariffs, which raises the cost of the imported inputs proportionately to their value but do not normally increase the uncertainty on the timing of input availability. The magnitude of this effect depends on the type of NTM and firms’ characteristics, such as their participation in global value chains, size, and product quality.  

Bundling all NTMs together, however provides little detail for policy consideration. A key distinction here is between NTMs that clearly address possible negative externalities of trade, such as measures protecting consumers' health by establishing permissible maximum residues of harmful substances in food and those which do not. Hence, the paper also looks at the impact on exporters' response to shocks of the most prevalent NTMs that do not clearly address a negative externality and/or unnecessarily increase costs in the way they are applied . We identify four such measures and estimate their effects individually. These measures include Import Approval Requirements (IAR), Pre-Shipment Inspections (PSI, Laporan Surveyor), mandatory certification with Indonesian product standards or Standard Nasional Indonesia (SNI), and Port of Entry Restrictions (PER). Importantly for our purpose, all of these measures entail an increase in uncertainty around the import procedures. 

The results suggest significant negative impacts of each of these NTMs on exporters' responses, thus identifying possible opportunities for welfare-enhancing reforms (Figure 1A). These effects are driven by firms participating in global value chains---exporting firms that rely on imported inputs in their production processes. Additionally, firms that import inputs less frequently are small and produce high-quality goods suffer more from the presence of NTMs following a yuan depreciation. These findings are consistent with the intuition that NTMs make it harder to adjust inputs for less flexible firms.  

In 2021, Indonesian government undertook several reforms to address some of these NTMs, but some still need much attention. Indonesia abolished over 20 regulations related to pre-shipment inspections (Figure 1B), and the share of products for which PSI applies reduced. Additionally the government implemented an integrated risk-based approach where the Ministry of Trade can grant ease of business licensing to reputable exporters and importers in collaboration with customs. The share of products subject to SNI also declined, though the procedure still needs to be improved. On the other hand, while the government simplified and unified the technical regulations related to import approvals by reducing them by over 50% after a decade-long upward trend, import approvals remain stringent, affecting even more products. Similarly, more products have been subject to the port of entry restrictions, and challenges remain in having adequate quality infrastructure and human resources at ports. While these are being addressed, there is the need to review for which products this measure is still needed. 

Figure 1A: Percentage differences in elasticity of exports to exchange rate depreciations: Firms with mean level of NTM exposure vis-a-vis without		Figure 1B: Number of active pre-shipment inspections regulations 2008-2021

Source: Cali, M., Ghose, D., Montfaucon, A. F., Ruta, M. Trade Policy and Exporters’ Resilience: Evidence from Indonesia. World Bank Policy Research working paper
Note: Fig 1A: * p < 0.1, ** p < 0.05, *** p < 0.01. Fig 1B: MoT = Ministry of Trade; MoMAF = Ministry of Marine Affairs and Fisheries

Continued targeted reforms that eliminate these burdensome, costly, and unpredictable NTMs will not only boost firms’ competitiveness in Indonesia as documented in other related research (Cali and Montfaucon, 2021), but will also complement reforms undertaken in the Omnibus Law and boost investment in Indonesia.  

Research referenced: 

• Trade Policy and Exporters’ Resilience: Evidence from Indonesia 
• Non-Tariff Measures, Import Competition, and Exports 
• Corporate immunity to the covid-19 pandemic 
• R & D and firm resilience during bad times 
• The role of global connectedness and market power in crises: Firm-level evidence from the covid-19 pandemic 
• Reshaping the policy debate on the implications of COVID-19 for global supply chains