Response to Dr. P.B Jayasundera on why protectionism is not the answer

By R.M.B Senanayake

The Secretary to the Treasury wants a ban on imported food items that can be produced locally. He refers to the possibility of saving foreign exchange by banning imports of milk foods, sugar, etc., which can be produced locally.

We can agree that goods that can be produced locally should be produced here rather than imported. But this should not be done by Government bans or import controls or high tariffs. Any domestic product must be able to compete with the imported products.

The case for free trade was made long ago by the classical economists like David Ricardo and it is still valid. The world has by and large accepted the need for free trade when it set up the World Trade Organization. As Sri Lanka is a member of the WTO, its rules are binding on us.

Trade raises our standard of living

But why should consumers be allowed the freedom to buy a domestic or foreign product? Because it improves their standard of living while reducing their cost of living.

We tried the import substitution industrialisation under protectionist tariffs in the 1960s when the so-called ‘seeni bola’ industries were set up. Radios were imported in completely knocked down condition and sold at high prices while the import of the finished radios was subject to high tariffs or even banned.

Who benefited? The local industrialists? Who lost? The consumers. Were the people better off? Not really for the majority who are consumers had to pay higher prices and saw their welfare reduced.

Why are people not producing these goods which can be grown locally? It is because they can’t make profits by doing so. It is because the costs of production of locally-produced sugar or milk food are too high in comparison with similar imported goods. Is the answer then to ban imports and allow high cost local production alone to be available? But this reduces our welfare.

Trade and innovation

If we think about it, trade makes us better off in much the same way that innovation makes us better off. If machinery was not invented in the textile industry and weaving and spinning continued to be done by hand, we would all have been worse off than now.

If I can produce hats less expensively because I invent a machine that sews hats more efficiently than hats that can be sewn by hand, that will be good for all consumers but it will be bad only for the hat maker who makes hats by hand. He would be driven out of business by the new machine-produced hats. So do we ban the production of hats by machine? It is the same argument for allowing trade.

Adam Smith in his famous book, ‘An Inquiry into the Nature and Causes of the Wealth of Nations,’ points out that you could grow grapes and make wine in Scotland if you wanted to spend enough to do so, but Great Britain would be better off making woollen coats and trading them to the French for wine. Dr. Jayasundera seems to have forgotten this principle. Maybe he is preoccupied with the balance of payments problem.

Land, labour and capital the factors of production are all scarce in relation to demand. Land devoted to the production of sugar is not available to produce something else – say fruits. If farmers were to be engaged in producing milk, they may not be able to at the same time to engage in dairy farming on an extensive scale. If the capital available is invested in agriculture, there will be less capital to invest in industry.

Resource allocation

This is the essence of the economic problem and the resource allocation between various uses is the key problem in an economy. The free market price system provides the best allocation of resources to reflect the needs and demands of the people. The free market determination of prices can be distorted through fiscal levies like taxes, tariffs, import quotas, etc. But all these distort the allocation of resources and undermine the consumer welfare which is best secured where the free choices of the consumers are not interfered with.

Even if we can produce sugar cheaper than the imported cost, it may still not be in our interest to produce sugar say, at the expense of rice. Why? Because Ricardo proved that we should be guided by the law of comparative costs rather than absolute costs.

We should produce more of those goods where our comparative cost advantage is greater than any other good where our comparative cost advantage is less. This is the way to maximise the use of our resources vis-à-vis imports. Even if we can grow sugar, we should not grow if it means less paddy or some other good where our comparative cost advantage is more.

The Secretary to the Treasury can do better to resolve the balance of payments problem by cutting the budget deficit and eliminating wasteful and extravagant expenditure whether in local rupees or in foreign currencies. Dr. P.B J is trying to take the country to the controlled regime of the 1970s. But the open economy was able to resolve the Balance of Payments problem with the massive devaluation in 1977. He should allow the rupee to find its market determined value which will correct the long overvaluation.