Log Export Ban in Ukraine: A Case for Presidential Veto

On April 9, Ukrainian Parliament has passed the law #1362, which bans log export

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On April 9, Ukrainian Parliament has passed the law #1362, which bans log export.  The debate about the desirability of the law can only be decided based on first principles and international experience with LEB. Illegal deforestation and undeveloped domestic processing industry are not unique to Ukraine.

They are present in many developing countries, especially in tropical areas. LEB is, perhaps, the most extreme and distortive tool to decrease demand for log and protect domestic processing industry. There are many alternative, less distortive, measures that can be undertaken to encourage investment in domestic processing industry and curb illegal harvest, – writes Timofiy Mylovanov, assistant professor at the University of Pittsburgh, in his column for VoxUkraine.

On April 9, Ukrainian Parliament has passed the law #1362, which bans log export. The purpose of the law is to prevent illegal deforestation, minimize corruption in the industry, and encourage development of the domestic wood processing industry.

The law is polarizing. For some “lovely-borderline-violent” Facebook battles, please see here, here, here, here, and here. Opponents of the law accuse the supporters of incompetence and lack of understanding of basic economics. Supporters of the law, in turn, accuse opponents of lack of knowledge of institutional details of the industry. For a more measured discussion in the media please see here and here.

The conflict is about the likely impact of the law. The basic economics is simple. Log export ban (LEB) will decrease foreign demand for logs. The price on the domestic market will decrease. Domestic wood processing industry will become more profitable. Profitability will attract investment in the industry. So, there are losers (log producing enterprises and foreign buyers) and winners (domestic wood processing industry). Absent additional considerations, the standard accepted economic thinking is that LEB distorts the price and leads to inefficiencies. Losses outweigh gains.

There are several standard qualifications to this simple argument. First, the unrestricted market price might fail to capture negative environmental effects of deforestation. In this case, LEB can improve efficiency by making deforestation less profitable. Second, illegal deforestation might be more difficult to control if illegally produced logs can be moved out of the country. Thus, LEB can have a direct effect on decreasing illegal deforestation. Third, export traders can unfairly benefit from some price distortions and uneven rules of the game (e.g., low railroad tariffs for export of logs). Fourth, export might allow for tax evasion (e.g., a foreign buyer can pay a share to foreign off-shore accounts of officials authorizing sale). If these distortions are substantive, LEB can be justified. Finally, the domestic wood processing industry might need to be protected at the initial stages until it develops and becomes competitive (infant industry argument). See Resosudarmo and Yusuf (2006) for a review of the economic pro and con arguments for LEB.

These arguments are theoretical in their nature. Neither the supporters nor the opponents of the law have conducted proper empirical analysis. Furthermore, any such analysis will be of dubious validity given the systemic changes occurring in Ukraine. (A VoxUkraine article has remarked on a particularly inadequate use of data in justification for the law submitted to the parliament).

So, the debate about the desirability of the law can only be decided based on first principles and international experience with LEB.

Illegal deforestation and undeveloped domestic processing industry are not unique to Ukraine. They are present in many developing countries, especially in tropical areas. The most well studied countries are Indonesia and Costa Rica. Both countries have adopted LEB.

There is no strong evidence that LEB is beneficial. Quite to the contrary. A study by Kishor, Mani and Constantino (2001) has estimated that removal of LEB in Costa Rica could bring expected welfare benefits of 0.1% of GDP. However, LEB did decrease deforestation. Gaduh and Roesad (2004) argue that LEB in Indonesia has created an inefficient domestic producing industry, generating welfare losses. It had little impact on deforestation. Dudley (2004) also studies Indonesia and warns about unanticipated consequences of LEB. In particular, he offers scenarios under which LEB increases deforestation due to excess demand from domestic industry. Lindsey (1989) finds substantive welfare losses due to Indonesian LEB.

Interestingly, IMF and World Bank have asked for repeal of LEB in Indonesia, Costa Rica, and Ghana. Historically, World Bank has advocated against LEB and high log export taxes. (See Goodland and Daly (1996) for a list of arguments why LEB might be defensible.)

LEB is, perhaps, the most extreme and distortive tool to decrease demand for log and protect domestic processing industry. There are multiple alternatives, including the above mentioned export tax, subsidies for domestic industry, measures that improve domestic business environment, or introducing Reduced Impact Logging (RIL) practices to maintain healthier harvest methods and increased productivity of logging (see for example de Blas and Perez (2007) for the analysis of RIL and forest reform in Cameroon)[1].

Conclusions

The empirical studies for other countries find no conclusive evidence that LEB succeeds in encouraging development of healthy domestic processing industries. The overall welfare effects of LEB tend to be negative. LEB might or might not curb the overall amount of harvest.

There are many alternative, less distortive, measures that can be undertaken to encourage investment in domestic processing industry and curb illegal harvest. Of course, they might not be feasible in the current Ukrainian circumstances. If this is so, adoption of LEB signals to the domestic and international markets continuing weakness of institutions in Ukraine. This decreases attractiveness of conducting business in Ukraine, further jeopardizing economic recovery and development.

There are several other important considerations related to LEB. First, there is a risk of capture of legislation by the domestic industry. Once an inefficient industry comes to rely on LEB for survival, the Ukrainian parliament might find it difficult to rescind the ban in the future.

Second, LEB and other similar measures underscore that the Ukrainian parliament finds it acceptable to intervene in functioning of the markets based on empirically dubious rationale. The parliament substitutes the market by deciding how resources should be allocated. In doing so, the parliament teaches the businesses and the industry that they should compete through lobbying in the parliament, financial and informational, rather than through innovation and efficiency improvement in the market place.

The markets in Ukraine do not function properly. The job of the parliament and the government is to provide for the rules that foster market development. It is not the legislator’s job to substitute for the markets by directly regulating allocation of resources. Until those who are in power accept this basic axiom, the new Ukraine will continue to spin the wheels.

Notes

[1] In 2009, Russia has increased log export tax from 6,9% to 80%. See Turner, Buongiorno, Katz, and Zhu (2008) and   Solberg, Moiseyev, Kallio, and Toppinen (2010) for the analysis of the effect of this policy. The first group of authors estimates that “Russian export revenues would be US $3.4 billion (23%) lower as growth in processed exports would fail to offset reduced roundwood export revenue”. The second group states that ”Our results show that the tariffs decrease harvest and roundwood prices in Russia, but improve the speed of development in the Russian sawnwood and pulp industry. The results also suggest that policies which improve the investment climate in Russia are more vital than the tariffs for the Russian forest industry to develop favourably.” Russia has also experimented with providing preferential treatment to Chinese companies harvesting wood in Russia, under the conditions that they will develop wood processing manufacturing. So far, the results have been mixed.

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