Bilateral Revealed Comparative Advantage (RCA)

One way to obtain an in-depth analysis would be an examination of Sri Lanka’s presence in the US market by computing the ratio of ‘Sri Lanka’s exports to US’ vis-a-vis ‘China’s exports to US’ for various sectors where tariffs have been imposed. The sectors in which the exports of Sri Lanka as a proportion of China’s exports to the US are high are indicative of the potential gains that Sri Lanka may derive due to the higher tariffs imposed on goods imported from China by the US (Table 8.A4). Articles of apparel and clothing (HS61&62), rubber and plastic articles (HS40), etc. which are already major exports to the US are few sectors where Sri Lanka enjoys a comparative advantage over China in the US market. Most of these items are in the tariff List 4A, which came into effect in the autumn of 2019.

SMART model

The extent of trade ‘diversion’ can be gauged by using the SMART model, which is hosted on the World Integrated Trade Solution (WITS) portal developed by the World Bank, UNCTAD, ITC, UNSD, and WTO. SMART model is a singlemarket partial equilibrium simulation tool, which focuses on an importing market and its exporting partners and assesses the impact of tariff change (an increase or decrease) on a set of variables (trade creation/diversion effects, net trade effect, tariff revenue variations, change in consumer surplus). Using the SMART model, a number of simulations were run (a tariff increase of 15% and 25% on Chinese imports by the US as per the Lists) to find out the trade diversion effects on third countries, including Sri Lanka.

Table 8.A5 shows the top imports by the US from Sri Lanka in 2018 (at HS six-digit level) and an increase in imports due to trade diversion caused by the US imposing a tariff increase on China. For example, the main import by the US from Sri Lanka is HS621210 (brassieres), and the US imported US$248mn worth of this in 2018. The imposition of an additional 15% tariff on the item under List 4A by the US on China would result in trade diversion from China to other competing countries in the US market, including Sri Lanka. As a result of trade diversion, Sri Lanka could potentially increase its exports of brassieres to the US by US$2 million, or almost by 1% over and above the 2018 (baseline) figure. Other countries that are likely to reap the benefits from the US-China trade conflict include Vietnam, Indonesia, Honduras, Dominican Republic, which are major suppliers of brassieres to the US market together with Sri Lanka. The apparel exports from Sri Lanka, which accounts for the largest share of exports to the US, stand to gain from the US-China trade war, as reflected by Table 8.A5.

The effect of the trade war on Sri Lanka can also be assessed from comparing pre-tariff and post-tariff export performance using data of US imports from Sri Lanka. On aggregate, Sri Lankan exports to the US (of both tariff-affected and non-tariff-affected products) fell in 2018 (US$2801 million) compared to 2017 (USS2996 million). While the export figure for 2019 (US$2868 million) was higher compared to 2018, it was still lower than in 2017, indicating limited benefit from trade diversion.

More specifically, we also matched the tariff-affected products under the four lists (Lists 1, 2, 3, and 4A; 4B was not considered as the list was suspended before its implementation) with the list of products that US imports from Sri Lanka (at a disaggregate HS six-digit product level) to find out the extent of trade diversion. Following the various tariff announcements, exports of tariff-affected products from China to the US have declined under all four lists (Figures 8.A6, 8.A8, 8.A10, 8.A12). Data from the initial round of US$50 billion in tariffs (Lists 1 and 2), which have been in place since summer 2018, show that Sri Lanka was able to take some advantage of the current price difference created by the tariffs (Figures 8.A5 and 8.A7), especially in machinery (HS84-5) but the results are mixed for the next two rounds of tariffs (Lists 3 and 4A), recording an overall fall of exports to the US. The performance of two main exports of Sri Lanka to the US (HS50-63 textiles and clothing, and HS39-40 plastics and rubber) is also mixed, indicating Sri Lanka has not significantly benefited from the trade war or ‘trade diversion’ for these two important products. For example, exports of textiles and clothing in List 3 rose by almost US$3 million over the previous year while plastics and rubber under List 3 fell by US$15 million (Figure 8.A9) despite exports from China to the US being negatively affected by the tariffs (Figure 8.A10). However, the export of both products by Sri Lanka, which is contained in List 4A, fell (Figure 8.A11). In the case of apparel, exports fell by US$11 million between October to December 2019 after 15% tariffs came into effect in September 2019.

It has been reported that exports to the US decreased in November 2019 due to the continued slowdown in sales of Victoria’s Secret, which is a large customer of Sri Lanka (Mahadiya, 2020). Consequently, other countries that are competing with Sri Lanka in the US market (e.g. Vietnam, Bangladesh, Indonesia, India, Cambodia) may have reaped some of the benefits from the US-China trade conflict (C. Cheng, 2019). In fact, there is evidence to show that Vietnam’s exports to the US have increased at a rate much higher than other exporting countries (Ha and Phuc, 2019). In 2019, US imports from Vietnam were 35% higher than in 2018, compared to 2% in the case of Sri Lanka. In fact, other countries in Asia enjoyed faster growth rates in their market share than Sri Lanka; these included: Mongolia, Myanmar, Taiwan, Pakistan, India, Thailand, Laos, South Korea, Bangladesh, Malaysia during 2018. While the trade war has led to a diversion of trade to other countries in the region and reduced US companies from China, it has not shaken China’s role as a dominant textiles and apparel supplier (Weijia et al., 2020).

Another reason why there might not have been a substantial trade diversion to Sri Lanka since the trade war began in mid-2018 can be attributed to the fact that most of the tariffs on apparel imports in the US from China (over 91%) were backloaded and only hit with tariffs in September 2019 (Wu, 2019) under the List 4A. For example, while the Combined List (1, 2, 3, 4) contains tariff lines relevant to 95% of Sri Lanka’s exports to the US, List 4A alone contains tariffs which cover 75% of exports of interest of Sri Lanka to the US including much of Sri Lanka’s textile and apparel exports (Table 8.A6).

Nevertheless, there have been reports in the media that, because of the US- China trade war, some of the US clothing importers which source their products from China are interested in coming to Sri Lanka (Wettasinghe, 2018). According to the Chairman of Sri Lanka Apparel Exporters Association (SLAEA): ‘The US- China trade war to some extent helped with orders diverted to Sri Lanka, so it was in our favour’ (Mahadiya, 2020). At the same time, there is a concern whether Sri Lanka will be able to manufacture the volume of orders currently being serviced by China since the local industry does not have the economies of scale of China or the required manpower. For example, the US currently sources approximately one-third of its apparel imports from China, while Sri Lanka supplies about 2% of the US market (ITC, 2020).

Large diversion of trade in textiles and clothing may only become visible with certain time lags. The industry in Sri Lanka is yet to fully capitalise on the benefit of the trade war despite the initial interests of buyers in the US (Y. Lawrence, personal communication, 22 June 2020). Elowever, these benefits from the trade war are likely to be dissipated by the outbreak of COVID-19. The apparel industry has been adversely affected by the COVID-19, first on the supply side, and then on the demand side as the epicentre of the outbreak shifted from China to the rest of the world, including to Sri Lanka’s main export markets in the US and EU. Sri Lanka’s US$5 billion apparel export business is expected to lose US$1.5 billion between March to June 2020 (Economynext, 2020). In order to mitigate the situation, apparel exporters are currently looking to reposition its exports to the production of personal protective equipment (PPE), which has seen a surge in worldwide demand. Apparel exporters have already received US$500 million worth export orders to supply PPE (Daily Mirror, 2020).

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