Export Growth - Fuel Price Nexus in Developing Countries: Real or False Concern?.

• Author: Kpodar, Kangni

1. INTRODUCTION

   Despite progress, many developing countries still have a tight control on domestic fuel prices. This translates into a freeze in fuel pump prices for a relatively long period, or at best a low pass-through of changes in international oil prices to domestic fuel prices. The results are large fuel subsidies with adverse consequences for public finances, income distribution and the environment (see Coady et al., 2010; Clements et al., 2013 for more discussions). In countries that have considered reforming subsidies, a central concern of policy makers is the potential adverse impact of higher domestic fuel prices on the export-oriented sectors. Despite the current favorable environment of relatively low international oil price amid the COVID-19 pandemic, fuel subsidies are still prevalent, and thus the export growth-fuel prices nexus remains a relevant policy question; more so as a recovery in global demand, supply disruptions or tensions in the Middle East can send international oil prices back to the upward trajectory. Yet, there is a relatively limited empirical literature on the issue, especially using macroeconomic level data in developing countries.

   The potential impact of fuel price increases on exports is not straightforward. (1) On the one hand, higher fuel prices may hamper the competitiveness of the export sector by directly increasing input costs associated with fuel consumption, but also for other inputs whose production requires fuel (Rentschler et al., 2017). The cost of energy being an important driver of production cost in many industries, including transports, any changes to energy prices can generate significant ripple effects through the supply chain. On the other hand, to the extent that an increase in domestic fuel prices results in a reduction in fuel subsidies, this could free up fiscal space for growth-enhancing public spending that may boost productivity and hence exports. In addition, higher fuel prices may also shift resources away from less productive and energy-intensive activities, thereby improving resource allocation and minimizing market distortions which can positively affect competitiveness (Saunders and Schneider, 2000; Ellis, 2010; Whitley and van der Burg, 2015). Given that the direction of the impact is not clear cut, an empirical analysis may shed light on the net impact.

   In this paper, we study the effect of fuel price changes on export growth in a sample of 77 developing countries over the period 2000-2014, taking advantage of an original fuel price database compiled by Kpodar and Abdallah (2017). Specifically, we investigate the following questions: (i) does an increase in domestic fuel prices hamper a country's export performance? (2) (ii) are energy dependency and access to alternative sources of energy conditioning factors? (iii) does this effect vary with the temporal horizon (short versus medium term)?

   The paper tackles important gaps in the literature, including: (i) the scarce evidence on the energy prices-competitiveness link in developing countries; (ii) the lack of cross-country studies allowing to draw broad policy conclusions relevant for a large group of countries, as a complement to country-specific studies; (iii) limitations in existing studies which do not control for macroeconomic factors that also matter for export dynamics; nor investigate how the energy prices-competitiveness link may change with the temporal horizon.

   The rationale of focusing on exports is twofold. First, since domestic firms are typically subject to the same fuel prices, a natural approach is to assess how a country fares in the international trade market following an idiosyncratic shock in fuel prices. Second, policy makers are more concerned about export-oriented sectors because developing countries are often price-takers, and as a result, producers may not be able to pass on the cost increase to final consumers without the risk of losing market shares. In many developing countries, export-oriented sectors drive economic growth, bring in foreign exchanges and are potential large employers. As a result, shocks to these sectors can have large macroeconomics effects.

   The results from panel fixed-effect estimations show that domestic gasoline or diesel price increases do have a negative effect on real non-fuel export growth, in line with previous findings using industry level data (e.g. Sato and Dechezlepretre, 2015; Aldy and Pizer, 2015). Nevertheless, while this negative impact is mild or non-significant for countries with a low energy dependency ratio, it becomes statistically significant and sizeable for countries with high energy dependency ratios, arguably where energy inefficiencies are more pronounced. The adverse effect of fuel price increases on exports also declines with better access to electricity. Furthermore, investigating large fuel price shocks suggest that they do not necessarily have disproportionately large effects on export growth. Finally, to disentangle the short run dynamics from medium run ones, the local projection approach is used to estimate how shocks to fuel prices affect export growth in a dynamic setting and how persistent these shocks are. The findings confirm the adverse effect of fuel price shocks on export growth, but the impact is short-lived. It is mostly concentrated within the first two years after the shock and becomes weak and non-significant thereafter. Nevertheless, this would translate into a permanently lower level of exports, unless the medium-term efficient gains from better allocation of resources materialize.

   The paper is structured as follows. Section II discusses the theoretical channels and related literature. Section III is focused on data analysis and some stylized facts. It also lays out the empirical approach and discusses the results. Finally, Section IV concludes and draws some policy implications.

2. CHANNELS OF TRANSMISSION AND RELATED LITERATURE

   How changes in fuel prices may affect changes in exports?

   Similar to households, energy price increases affect firms through two channels: the direct and the indirect channel. The direct channel refers to the increase in energy input costs. This is the first-round impact, which is instantaneous unless energy input prices are hedged (Rentschler et al., 2017). The indirect channel refers to the increase in the production cost of intermediate inputs as energy price increases feed through the supply chains and lead to the increase in the price of other goods and services. For instance, higher fuel prices will increase transportation costs, both related to the production of inputs but also to bringing the firm's output to the market. The degree of firms' exposure hinges on the amount of energy needed to produce one unit of output and the energy intensity of its intermediate production inputs.

   In discussing the impact of fuel subsidy reforms on firms, Rentschler et al. (2017) underscore that how firms respond to the price shocks determines the net impact on competitiveness. First, the absorption occurs when margins are high, and firms can afford a temporary reduction in profit to absorb the additional production cost from fuel price increases. Second, substitution arises as firms shift to other sources of energy, but this may require a change in production technology and reliable access to those alternative energy sources. Third, firms can also improve their energy efficiency by reducing overall energy consumption while maintaining pre-subsidy removal production levels, although upgrading the production process or technology may be needed. Finally, firms can also pass-on the price shock stemming from the reform to end-users depending on the price elasticity of demand and their market power.

   The export sector in developing countries typically has a limited room to pass on the cost increase to foreign consumers either because they are price takers or competing firms on the world market are not subject to the same price shock. Further, since substitution and resource efficiency are more structural in nature and require time and investment (Rentschler et al., 2017), the only option left in the short-term is absorption. This suggests that the export sector is quite vulnerable to energy price shocks, in particular when it is dominated by small and medium enterprises (SMEs) with little margin buffers to cope with shocks, which could possibly lead to bankruptcy or exit from the market. Firms may also opt for cutting back investments which would be detrimental for their productivity and growth.

   On the other hand, an increase in fuel prices may be beneficial for medium and long run competitiveness through improved economic efficiency in situations where fuel prices are initially below their cost-recovery levels. By shifting resources away from less productive and energy-intensive activities, and reducing distortions in price signals, higher fuel prices may boost total factor productivity and promote exports (Saunders and Schneider, 2000; Ellis, 2010; Whitley and van der Burg, 2015). In addition, energy price increases may spur technological change and provide incentives to invest in more energy-efficient technology. However, the ability of firms to improve their energy efficiency hinges on the availability and affordability of modern technologies, the availability of financing and support in implementing efficiency measures (Rentschler and Bazilian, 2017; Rentschler et al, 2017).

   Several factors drive national energy policies. The first and foremost factor is the international crude oil price, which itself can react to a variety of economic and geopolitical events. For instance, demand factors (e.g. strong economic growth in major economies) and supply factors (e.g. uncertainties in crude supply when oil producers' spare capacities are low) typically lead to a rising crude oil price. Similarly, since a significant share of the worlds' crude oil takes place in the...