“Many people want the government to protect the consumer. A much more urgent problem is to protect the consumer from the government.” – Milton Friedman
Typically, “saving foreign exchange” is the reason given by developing countries for implementing protectionist trade measures including a ban on select import of goods. The argument goes something like this: foreign producers of a product are offering Pakistani consumers a more attractive price or better quality product than they can get from Pakistani producers of the same product. This can occur for any number of reasons.
For example, foreign producers may be more efficient than the Pakistani producers. Otherwise, foreign producers may receive subsidies in its home country, thereby allowing it to charge lower prices to Pakistani consumers.
The fact is that the particular reason will make no difference with respect to the arguments presented here. The main argument used to defend protectionism is that the less expensive or higher quality foreign products are “costing the leakage of foreign reserves.” In other words, if more of these products were produced domestically and fewer were imported, then more people would need to be employed in the Pakistan Industries manufacturing the product allowing the country to save valuable sources of foreign exchange.
Hence, if Pakistan. imposed a ban on imported products, Pakistani would drastically purchase fewer products from foreign firms. Conceptually, more of the product would be produced in Pakistan, fewer would be imported, and more foreign exchange could be saved by such a ban of select items.
Winners and losers from protectionism
The typical argument for protectionism is accurate in that it identifies those Pakistani interests that gain from the protectionist policies, but it does so while ignoring those who lose. In particular, it ignores those whose jobs are put in peril from trade barriers. Here is how the winners and losers from protectionism break down :
Economically, as opposed to politically, there is only one winner from protectionism and ban on imports – the domestic industry being protected from competition. Because of reduced competition, the Pakistani or domestic industry will produce and sell more. For instance this shall benefit Pakistani automobile and mobile industry as the ban targets finished cars or mobiles but not their component parts. With a captive Pakistani consumer who has limited options to purchase consumer options, they are likely to generate higher profit margins and shall enjoy the ability to set higher prices. Another example is how Pakistani pet food manufacturers will benefit from the ban being imposed as imports previously had met up to 75-90% of the total demand for such products in urban areas of Pakistan. Furthermore, limited supply of pet food is likely to result in higher prices of both previously stocked imports as well as local pet food.
The Ministry of Commerce has projected that the imports of Pakistan would now only grow to $77 billion by the end of June as a result of the measures taken by the government. The projected saving from banning the import of 38 products therefore is estimated at $600 million or around 5% of the annual bill. It is also noteworthy that a ban on certain goods such as cigarette imports is likely to result in massive savings of foreign exchange as up to 20% of the local market currently consists of cigarettes sold which are smuggled by illegal mechanisms. Therefore, in the grand scheme of things, the saving of foreign exchange by banning the list of 40 import products is at best limited. Finally, such marginal gains are also likely to be wiped out resulting from further depreciation of the PKR on the open market against the dollar in the coming weeks.
The Pakistani Consumer
Protectionist measures are a tax on all those who purchase a product manufactured by the protected industry. This includes those who purchase the protected product for direct consumption purposes and those who use the protected product as an input into other production processes. It is necessary to note this tax is paid not necessarily through higher prices but from inferior quality of domestic products or limited choice of products available to consume or poor quality goods. For instance, there has been an exponential surge seen in spending money on both local as well as imported cosmetics and personal products. However, there are many reported facts about high loads of lead, mercury, copper, and other hazardous and cancerous elements in local Pakistani cosmetic brands according to a local scientific study. Consumers are therefore at the mercy of limited quality regulation by the government of local cosmetic manufacturers and are forced to consume a substandard product compared to imports irrespective of the price difference.
Since the government announced it shall also ban salon items, shampoos, and personal care products, we have been hearing about its harm to service providing industries such as beauty parlor’s, for which such products form an important input. The fact of the matter is that protectionism drives up the cost of production for industries that use the protected products. As such, it leads to a reduction in the supply of those products, which, in turn, means fewer people are employed in those industries.
The fact is that there are many industries and employment opportunities that exist because we, as consumers, purchase imported products. For example, while unions typically support protectionist trade policies, you will never see the longshoreman’s union endorsing them. These are among the many categories of workers who take a hit when trade falters, regardless of reason, including increased protectionism. Other industries that would be harmed because of protectionism include many parts of the financial industry, retail industries of all kinds, shipping, and other forms of transport.
With a captive market for many domestic producers, they have little incentive to produce higher quality products produced at a lower cost by innovating when they can merely generate supernormal profits by meeting the demand of local consumers. This is likely to be the case for furniture and electrical appliance producers.
Ultimately, the performance of an economy and society cannot be made better off, on net, through ban of trade imports. Such policies can only result in an expansion of the protected sectors of the economy at the expense of depressing others. Any foreign exchange savings resulting from the protected sectors will furthermore be more than offset by losses in other areas.
The arguments against protectionism and in favor of free trade were put forth by Adam Smith in his 1776 masterpiece, The Wealth of Nations. At the time, he found the arguments for free trade to be so obvious that he thought they were hardly worth stating. As Smith concluded, In every country it always is and must be the interest of the great body of the people to buy whatever they want of those who sell it cheapest.
The proposition is so very manifest that it seems ridiculous to take any pains to prove it; nor could it ever have been called in question, had not the interested sophistry of merchants and manufacturers confounded the common-sense of mankind. Unfortunately, there is just as much sophistry from merchants and manufacturers (not to mention politicians) today than there was when Smith penned these words.