Resolving the balance of payments crisis

I refer to the response by Mr. Luxman Siriwardene of the Pathfinder Foundation to my article against the protectionism suggested by the Secretary to the Treasury to deal with the balance of payments crisis we are facing.

The Secretary to the Treasury was not arguing for food security or for protectionism as an antidote to dumping. But Mr. Luxman makes these two the props for his case against free trade.

I had referred to the argument about food security and pointed out that the validity of this argument depends on how serious our doomsday scenario is.

During World War II, we survived although food imports were curtailed owing to enemy action against merchant ships and mercantile shipping. Yes, if we think that all imports will cease, then there may be a case for growing our own food although it would involve a reduction in our living standards and a higher cost of living.

But even if one takes a doomsday view, yet there is no reason to assume that we cannot make the adjustment when the problem really arises rather than prepare for it beforehand by reducing our living standards now before the event takes place.

Luxman also refers to dumping. Dumping is a marketing strategy resorted to firms ha want to capture market share and having done so proceeds thereafter to raise the prices. No exporter abroad will continue to dump (sell below his cost of production) forever and go into bankruptcy.

The problem seems so big and grave because people refer to ‘countries’ as resorting to dumping. But it is not countries that engage in trade but firms and individuals. They will not court bankruptcy unless they are government-owned businesses where the state is behind the dumping. In such instances there are provisions in the World Trade Organization Rules to take action. But dumping must be proved first.

The standard technical definition of dumping is the act of charging a lower price for a good in a foreign market than one charges for the same good in a domestic market. This is often referred to as selling at less than ‘fair value’.

Under the World Trade Organization (WTO) Agreement, dumping is condemned if it causes or threatens to cause material injury to a domestic industry in the importing country. The ST did not mention dumping and I can’t think of dumping in any of the food imports we obtain – chillies, onions, milk foods, sugar, potatoes, etc. Luxman is certainly not referring to our local context but as a general argument for protectionism.

Luxman seems to think that economists like Friedman and Hayek are for protectionism. I will be grateful if he could refer to any section where Hayek or Friedman have supported protectionism. He will be hard put to find any modern economist except Paul Krugman who supports protectionism and he does so with his theory of fair trade and hence is a limited argument similar to dumping.

My basic argument was that exchange rate policy is the best way to resolve the balance of payments crisis and in fact it was the fixing of the rupee at an over-valued rate that failed to check the crisis from developing. Of course the cause for the crisis is the fiscal expansion supported by monetary accommodation of the budget deficit along with the holding down of the interest rates artificially.

Now the Central Bank has in my opinion gone overboard by using monetary policy in addition to exchange rate policy. Politics is certainly weighing in on our economic decision making.

My main point is that just as we can produce food locally at higher costs we can also build a manufacturing base behind protectionist measures as we did in the 1960s. But such measures interfere with free choice and do not produce sustainable growth. This is why the East Asian NICs earlier and China now has gone for export driven growth.

Domestic expansionary growth produces balance of payments crises after a year or two of growth. We have seen this before but seem not to learn even from our own experience. It is JR’s open economy that produced higher growth while the protectionist regime of the United Left Front in the early 1970s produced 2% growth with a plethora of controls. Do we want to go back to that regime?

Our failure to develop import substitution agriculture and industry is due to the inflationary policies pursued by our politicians supported by excessive monetary expansion by the Central Bank.  So our costs are way above those of other countries and our failure to correct the situation by allowing the Rupee to float has meant that we can only develop under protectionism. But there is a cost by way of reduced living standards a la 1970s and a higher cost of living for the poor.

It may become a lethal political cocktail.

R.M.B. Senanayake