3.1 Assessment of Trade Policy Changes on Sri Lankan Welfare

Lower trade barriers bring progressive gains in welfare in the short run, but in later

years they become regressive. The next step in the study involves running the same scenario of paratariff liberalization using the Household Impacts of Tariffs database and computable general equlibrium–Global Income Distribution Dynamics approach. We find that, in the short term, paratariff liberalization enhances welfare. The effect of price changes benefits the poor: tariff liberalization packages would be associated with gains of

TABLE 3.1 Assessment of Trade Policy Changes on Sri Lankan Welfare Ex post analysis using reduced-form methods (local labor market Ex ante short-term Ex ante medium- and long-term approaches) analysis (HIT) analysis (CGE-GIDD)

Policy experiment

Impact on wages and informality given an increase in OECD’s import demand from Sri Lanka. Reduction of tariffs and paratariffs as one shock. Gradual reduction of tariffs and paratariffs over 10 years (same as under the HIT analysis).

Macro impacts ■ With a US$100 increase in exports per worker, average income would increase by SL Rs 206 between 2002 and 2013. ■ Export shocks operate primarily through wages rather than employment (average wage increasing by about SL Rs 975 after a US$100 increase in exports per worker).

Distributional impacts

■ The largest impact of exports on wage changes is for high-skilled workers; hence, income inequality between workers increases. ■ No statistically significant impact of changes in trade on formality of workers. ■ Paratariff liberalization could confer economic gains of 1.2 percent for the poorest quintile and 0.6 percent for the richest. ■ The impacts are progressive mostly because the poor are benefiting from lower prices of goods that constitute a large share of their consumption basket. ■ Income decreases slightly for both poor and rich households, but the impacts are somewhat higher for the richer households. ■ In the medium to long term, the baseline agricultural sector declines. This process is accelerated in the case of paratariff liberalization. ■ Growth helps to alleviate poverty (0.3 percent reduction in poverty headcount ratio at a PPP of US$5.50 a day), but increases inequality. ■ By 2028, the welfare impacts are regressive. Gains are 1.1 percent for the poorest quintile and 1.9 percent for the richest as compared to the baseline. ■ The regressive impacts are driven by higher wages of skilled workers (rich households), which outweigh the gains for the poor, who mostly benefit from lower prices of goods that constitute a large share of their consumption basket. The sole impact of food prices enhances economic benefits and tilts the gains toward the poor, the poorest quintile gaining 0.7 percent and the richest declining 0.4. percent. As mentioned above, the positive effect of food prices is reversed once the employment and wage effects are taken into consideration.

In the short-term, paratariff liberalization increases economic benefits. The gains are progressive. ■ Paratariff liberalization could increase

Sri Lanka’s GDP by 0.8 and 2.0 percent by 2023 and 2028, respectively. ■ By 2028, exports could grow by 18.3 percent and imports by 9.8 percent. ■ Key sectors that gain in employment share: textiles, apparel, and other manufacturing. ■ Output and employment mostly increase in well-established urban regions.

Source: World Bank. Note: CGE-GIDD = Computable General Equilibrium–Global Income Distribution Dynamics; HIT = Household Impacts of Tariffs (database); OECD = Organisation for Economic Co-operation and Development; PPP = purchasing power parity; SL Rs = Sri Lanka rupees.