Protect emerging industries, not zombies

  • Nepal must focus on industries where it has comparative advantage. There is no point in protecting industries that will lose out to outside competition anyway.

Apr 23, 2019-

Prime Minister KP Sharma Oli probably took many by surprise when, earlier this month, he accused domestic sugar mill owners of artificially creating a shortage in order to inflate prices. During last Dashain & Tihar, the price of sugar exceeded Rs100 per kg. Before that, mill owners lobbied hard for protective measures, arguing that imports were killing them and that they had surplus stock. By September 2018, the Oli government obliged with an import quota of 100,000 metric tons annually.  Earlier, in April 2018, it had raised import duty on sugar from 15 percent to 30 percent. Post-import quota, the price of sugar shot up and would not come back down until the festivals were over. It now retails for Rs75 per kg. Sugar mill owners did have a point in that sugar imports surged in the fiscal year 2017-18, which according to the Office of the Auditor General totaled 274,000 metric tons, against the 71,000 metric tons imported in the prior fiscal year. But then again, if the mill owners’ warehouses were full of surplus sugar, why would the price shoot up as soon as the import quota was imposed? This was Mr Oli’s point. There are lessons for both parties—and others—in this incident.

A world of subsidies

First and foremost, Mr Oli bowed to pressure—some might argue easily—from mill owners when he decided to hastily levy the import quota.  Businesses obviously look out for their best interests. It is their job to try to lobby the government for favourable policy. It is the government’s job to separate the wheat from the chaff. Even assuming the mill owners were right in this instance to ask for governmental support, they probably did not do themselves a favour by later antagonising the prime minister. The idiom ‘to kill goose that lays the golden eggs’ comes to mind. What if Mr Oli gets rid of the import quota, just to teach the mill owners a lesson? Sugar production in India is set to exceed local demand for the second year running. In Nepal, thanks to a favourable winter, domestic sugarcane farmers are eyeing a bumper harvest this year. This likely gives mill owners the upper hand versus the farmers, but there is another variable that could complicate things for Nepali mills. Sugar is a global commodity, entrenched in subsidy and price support. India—the second largest global producer after Brazil—heavily subsidises its sugar industry. Sugar costs less down south—Rs55 per kg. Hence, the domestic mill owners’ call for protectionist measures.

In the India-versus-Nepal dynamic, sugar is just one example. A least developed nation sandwiched between two giants—India and China—Nepal runs a massive trade deficit, three-fifths of which is accounted for by India. This dependence is the primary reason why Nepal pegs its currency to the Indian rupee. The essentially open border with India reverberates through Nepal’s economy in a lot of ways. A litre of petrol costs Rs108.50 in Nepal; across the border in Raxaul, a litre commands Rs119.50. The spread is attractive enough to lure smugglers into action. In the Tarai, chicken smuggling is on the rise. On average, Indian chicken retails for Rs270 per kg. The same costs Rs330 in Nepal. Chickens are being smuggled on motorbikes and bicycles. Another example relates to textiles. The Nepal government levies 20 percent customs duty and 13 percent VAT on readymade garments. Customs duty on imported raw materials stands at 15 percent. In order to skirt this, textile smuggling is common on the southern border.

Not all roses

If the government tries to protect the domestic sugar industry by using protectionist measures, (1) there is no guarantee that cheaper sugar from India does not illegally make its way into Nepal, and (2) in the aggregate, Nepali consumers do not benefit. In general, protectionism can be a good idea if the goal is to support promising, infant industries. Countries such as Japan, South Korea and China routinely protected their emerging industries before they were able to face global competition. It was not until December 1993 that Japan ended its ban on rice imports. In Nepal, in the 2018-19 budget speech last May, Finance Minister Yuba Raj Khatiwada said that basic protection would be provided for at least a dozen materials including sugar, medicine, iron bar, wood and cement. The goal was to become self-reliant within the next two years. As relates to sugar, Nepal is not quite there yet—consuming 230,000 metric tons annually against domestic production of 180,000 metric tons, give and take. But the thing is, because sugar costs more here, Nepali households could be potentially saving Rs5 billion annually if they were able to buy Indian sugar. This is too simplistic, but in the present context helps drive the point home.

A protectionist policy is any policy that provides an unfair advantage to a domestic industry versus its international competition. It is not easy deciding what to protect and what to let go. In the weeks leading up to last month’s investment summit in Kathmandu, Nepali dairy farmers expressed their vehement opposition to foreign direct investment (FDI) in milk production and processing, claiming the country will soon be self-reliant. They lobbied hard and were rewarded. The Foreign Investment And Technology Transfer Act of 2019 includes dairy as one of the industries where FDI is prohibited. In sugar’s case, an import quota was used. We see that the government can provide subsidies to domestic industries, or tax imports. Mercantilists can also artificially lower the value of their currency in order to boost exports. The end goal in all this is to help the domestic industry; the end result may not always turn out to be what is desired.

It is too soon to conclude whether the FDI prohibition will help or hurt the dairy industry in the long run. The risk is that, without competition, the urge to innovate will disappear—let alone the need to get efficient enough to be able to export one day. In sugar, being self-reliant is one thing, but it is unrealistic to expect Nepali sugar to go toe-to-toe with its Indian counterpart in price. It is the policymakers’ job to put their heads together and decide, for instance, if the acreage used for sugarcane production could be used for other crops, preferably suitable for export. If Nepal must spoon feed its industries, let efforts be directed toward sectors that have potential, but not toward protecting potential zombies.

Pandey worked in the securities industry in the US for two decades.  He tweets at @hedgopia.

Published: 23-04-2019 08:35

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