Policy Pulse - 19 June 2019 - George Anjaparidze
Last week, Pristina hosted foreign dignitaries in celebration of 20 years since the departure of troops of former Serbian President Milocevic. It was also an occasion to showcase Kosovo’s progress in recent years across a number of critical areas. According to the World Bank 2019 Doing Business report, Kosovo was ranked as the 44th easiest place to do business, scoring higher than the Eastern European regional average. Life expectancy has risen from 69.2 in 2007 to 71.9 years in 2017. Despite these successes, there have also been misguided policy interventions. In particular, the decision in November 2018 to impose a 100% tariff on goods originating from Serbia is particularly damaging to Kosovo’s economy.
As a result of these tariffs, we forecast a significant reduction in the purchasing power of Kosovo consumers. Our impact analysis (How harmful are trade tariffs to Kosovo consumers?) estimates a reduction in purchasing power by 6.4% due to 33% higher import costs on goods impacted by tariffs (mid-range estimate). The chart above presents a sensitivity analysis on the range of cost impacts on goods covered by these tariffs. The chart also offers a breakdown on drivers behind the higher import costs. The analysis is top down in nature and assesses the expected future short-to-medium term impacts.
Domestic production in Kosovo is not well suited to offer effective substitutes for imports impacted by tariffs. Our analysis (Kosovo status quo has a high cost) highlights the lack of competitiveness of domestic production. This is consistent with the findings of a bottom-up assessment produced by the GAP Institute, which concludes that domestic production has not seen an increase in activity since the introduction of tariff measures.
The GAP institute uses Kosovo Customs commodity level and country of origin data to assess impacts. Perhaps the most surprising finding of the GAP Institute report is that 12% of exports from Serbia continue to be imported by Kosovo despite the 100% tariff. This points to the difficulty of finding effective import substitutes from other trading partners. While Veritas Global does not have access to this data, we find the GAP Institute assessment is a useful preliminary retroactive review of impacts. Once new data becomes available, we expect results will converge with our mid-range estimate of impacts.
Annex: Further details on sensitivity analysis on import costs from tariff measures
Logistics and weak transit system
On average, global logistics costs make up about 13% of the value of trade. Although, landlocked economies and those with less developed transit infrastructure have much higher costs, which can be as high as 25%. For purposes of being conservative, this assessment uses the global average of 13% as the basis of the estimate for logistics costs for imports into Kosovo. To estimate the impact of having to substitute imports for tariff impacted goods from more distant markets, the high-range estimate assumes a doubling in logistics cost for these goods. Meaning that an additional 13% in cost will be incurred. Sensitivity analysis is used to present a mid-range scenario whereby logistics cost will add 8.7% to import costs and low-range scenario of 6.5%. We consider this range to be appropriate, given the research findings from the World Bank on transport economics in landlocked countries.
Rent-seeking due to lower competition
The product markets for imported goods into Kosovo are best characterized as monopolistic competition. On average, the "monopolistic component" is likely to be significantly higher in Kosovo compared to economies that are well integrated into global trade. This is due to higher transaction costs, smaller market size and higher operational barriers. Therefore, in the short-to-medium term, the goods markets covered by tariffs will result in increase in rent-seeking behavior from existing supplies (non-tariff impacted suppliers). Evidence from rapid market exit (due to liquidation) in the US airline industry shows that following disorderly market exit an increase in fares of 12% was observed. The impact on fares was found to be persistent over time. For purposes of being conservative, this impact is estimated based on the share of the value of imports impacted by the tariffs rather than all products in impacted product markets. For the high-range estimate an additional 12% in cost is modelled. 8% and 6% is used for the mid and low-range estimates respectively.
Search and switching costs
In the context of the tariffs imposed by Kosovo, search costs are the costs incurred by importers in identifying an alternative market from which to source products impacted by the tariffs (for example staff time, travel expenses, relationship building etc.). Switching costs are the costs incurred by importers from changing suppliers (for example the need to make new currency conversions, open new accounts, draft new and close existing contracts etc.). It may not always be practical to distinguish between search and switching costs. Empirical research from Loughborough University highlights the need to look at search and switching costs together. Additional search and switching costs may also be incurred by consumers in the process of familiarizing themselves with substitute products.
Empirical evidence on search and switching costs suggest a significant range. For the high-range estimates this assessment uses findings on search and switching costs in the US auto insurance industry, where these costs are estimated at about 18%. Sensitivity analysis is used to present a mid-range estimate of 12% and low-range estimate of 9%. The unplanned and immediate effect with which the tariffs were introduced suggests that the range presented in the sensitivity analysis is appropriate. It is important to note that search and switching costs will dissipate over time as new trading relationships are established.
Delay and disruption
Delay and disruption costs will arise given the unplanned and immediate nature in which Kosovo introduced the tariffs. These are likely to arise as importers look for substitutes and establish new supply routes for products from other import markets. Empirical evidence on the impact of delay and disruption costs suggests a wide range. For example, an assessment of the Niigata-Chuetsu earthquake quantifies economic loss resulting from lower intra and interregional trade due to seismic transport network disruption in the range from 20-40%. Given the high variability and context specific factors, a conservative approach has been taken for estimating the short-run delay and disruption costs. For the high-range estimate an additional 6.5% in cost is modelled. 4.3% and 3.3% is used for the mid and low-range estimates respectively. It is important to note that delay and disruption costs are likely to be more immediate in nature and will dissipate over time.
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