‘Luxury’ products ban in Pakistan will encourage rent seeking inefficiency
https://arab.news/mg3n7
The government has banned the import of so called ‘luxury’ products, which among other things includes cars, cellular phones, home appliances and cosmetics. The stated aim of the measure is to reduce by USD 6bn the burgeoning trade imbalance that is likely to touch USD 45bn in the current fiscal year, and correspondingly reduce the current account deficit (CAD) that is expected to expand to USD 16bn in FY22. With liquid foreign exchange reserves of only USD 10bn, of which less than USD 5bn is available for meeting external obligations, Pakistan potentially faces a balance of payments (BOP) crisis. It is therefore not unreasonable for the government to institute measures that curb foreign exchange outflows.
However, the government is once again relying on import substitution measures whose effectiveness in delivering the stated objective is questionable. For example, the ban on cars is likely to shift the imports from completely built units (CBUs) to the parts required to build complete vehicles by local assemblers, namely completely knocked down kits (CKDs). The substitution effect will effectively imply that the use of foreign exchange will divert from cars to parts, with a negligible net impact on the trade balance.
The limited positive impact of protectionist tariffs/restrictions on the trade balance can be shown by observing the net result of imposing import duties on mobile phones in 2021. According to Gonzalo Varela, Senior Economist at the World Bank, the import value of mobiles did decline from USD 124mn per month in FY21 to USD 27mn in FY22. However, imports of components (CKDs) necessary for assembling mobile phones increased from USD 52.8mn to USD 147mn per month. He states that “on average, imports of mobiles and CKD mobiles reached USD 177mn in FY21 and USD 174mn in FY22 – virtually no change in dollars spent on imports”. In other words, the net impact on trade balance has been minimal.
Perversely, the banning of the 38 ‘luxury’ products creates an anti-export bias. Import restrictions enable firms to charge a higher price by selling in the domestic market due to the decrease in competition. Not only does it make the domestic market more lucrative than competitive foreign markets, but also results in artificially high prices for consumers of products that often fail to match up to international quality standards. Thus, overall welfare is harmed while an uncompetitive environment is encouraged, which in turn results in stagnating productivity growth across the industrial sector.
In the short-term, the government should address BOP concerns by lessening aggregate demand through fiscal austerity and tightening monetary policy. However, in order to mitigate the BOP constraint that dampens sustainable growth, Pakistan has to generate resources through improved savings levels, and by broadening the tax base.
Javed Hassan
Effectively a ban on end-user products such as mobile phones and cars provides domestic incumbent manufacturers market power to become price setters and be able to extract rent with little regard for international prices of comparable products. So, what is being presented as a means of addressing the BOP crisis, and self-reliance, will not only fail in the stated objectives, but provide rents to a small group of domestic manufacturers producing lesser quality substitutes for banned imports.
Heckscher-Ohlin (H-O) theory, one of the standard models for international free trade developed by Nobel laureate Bertil Ohlin and Eli Heckscher, predicts that for countries whose exports are predominantly labour intensive, restricting imports negatively impacts wages, thus exacerbating inequality even further. This plays out in Pakistan through the frequent use of import bans and imposition of tariffs, which sends a signal to potential and existing businesses that profits are more likely to remain high in non-tradable sectors in future. This in turn undermines growth of the tradable sector, thus perpetuating the external imbalances as well as dampening real wage growth.
The trade restrictions also serve to detract from underlying causes of recurring BOP crises - the savings-investment imbalance and inadequate productivity growth. Consequently, growth in Pakistan has been primarily financed through external borrowings. Although that has not been the intended purpose of the several bailout programs agreed with the International Monetary Fund (IMF), they have nevertheless served to enable multilateral agencies, friendly countries, and international credit markets to fund growth that is largely consumption-driven without the necessary structural change required for improving productivity and overall productive capacity.
In the short-term, the government should address BOP concerns by lessening aggregate demand through fiscal austerity and tightening monetary policy. However, in order to fundamentally mitigate the BOP constraint that dampens sustainable growth, Pakistan has to generate resources through improved savings levels, and by broadening the tax base increase the tax-to-GDP ratio. It is also important to rationalise the tariff regime such that it promotes competition and productivity improvement, which will help Pakistan integrate into the global economy. A reformed tariff regime should look to boost domestic value additive manufacturers as well as attract efficiency-seeking foreign direct investment in the manufacturing sector.
Finally, the government should seek to lessen distortions in the domestic price structure and improve consumer welfare by eliminating trade barriers rather than moving in the opposite direction.
- Javed Hassan is an investment banker who has worked in London, Hong Kong, and Karachi. He tweets as @javedhassan. The views expressed in this article are author’s own and do not necessarily reflect the editorial policy of Arab News.
