PETER LEON: BEGGAR THY NEIGHBOUR ECONOMICS ARE SELF-DEFEATING

It is now more widely accepted that import substitution policies seldom achieve the intended benefits

Writing in the wake of the Great Depression in 1937, on the eve of World War 2, distinguished Cambridge economist Joan Robinson observed that on the face of it an increase in exports relative to imports leads to more employment. The snag was that such an increase in exports in one country inevitably led to a decline in another.

Seven years after the US had enacted the Smoot-Hawley Tariff Act in 1930, increasing US import duties to a swingeing 60% and leading to a trade war that worsened the Depression, Robinson remarked that “as soon as one country succeeds in increasing its trade balance at the expense of the rest, others retaliate ... Political, strategic and sentimental considerations add fuel to the fire and the flames of economic nationalism blaze higher and higher.” Robinson dubbed this “beggar thy neighbour’’ economics.

The SA government’s Economic Reconstruction and Recovery Plan should be assessed in light of this, given its emphasis on using trade policy to expand domestic production or “localisation”.

Underlying the plan is the notion that inward industrialisation will improve the competitiveness of SA exports, generate greater investment and promote economic growth. The plan thus recommends strengthening the industrial capacity of the domestic economy through state funding, tax incentives, licensing and — importantly — import tariffs. Key to this is reducing the imports of intermediate and finished goods while developing export-competitive sectors that will (hopefully) expand the sales of locally produced goods. In other words, a demand rather than supply side solution to the country’s economic woes.

To this end the plan identifies the various sector-specific master plans prepared by the department of trade, industry & competition as key to achieving its objectives. To date such sectoral master plans have been formulated for the automobile, sugar, poultry, and retail clothing, textile, footwear & leather industries. Under these master plans “social partners” have engaged with the department to devise specific measures aimed at improving industrial capacity, prioritising export orientation and “reclaiming” domestic market space lost to imports. The poultry master plan, for example, specifically identifies different trade measures that could be mobilised to support the domestic industry, including the implementation of an entry price system.

Underlying the plan is the notion that inward industrialisation will improve the competitiveness of SA exports, generate greater investment and promote economic growth. The plan thus recommends strengthening the industrial capacity of the domestic economy through state funding, tax incentives, licensing and — importantly — import tariffs. Key to this is reducing the imports of intermediate and finished goods while developing export-competitive sectors that will (hopefully) expand the sales of locally produced goods. In other words, a demand rather than supply side solution to the country’s economic woes.

To this end the plan identifies the various sector-specific master plans prepared by the department of trade, industry & competition as key to achieving its objectives. To date such sectoral master plans have been formulated for the automobile, sugar, poultry, and retail clothing, textile, footwear & leather industries. Under these master plans “social partners” have engaged with the department to devise specific measures aimed at improving industrial capacity, prioritising export orientation and “reclaiming” domestic market space lost to imports. The poultry master plan, for example, specifically identifies different trade measures that could be mobilised to support the domestic industry, including the implementation of an entry price system.

But does import substitution in fact stimulate domestic industrialisation? And if it does, what about Robinson’s warning? By sheltering domestic industries from competition from — or reliance on — imports, how does this promote an efficient economy and product market competition? Equally, how does it prevent trade partner retaliation? Importantly, depending on their formulation and implementation, import substitution measures may well contravene SA’s international trade law obligations.

The weapons of “beggar thy neighbour” economics available in 1937 — forced exchange rate depreciation, export subsidies and quantitative import and export restrictions, not to mention unbound tariffs — are, thanks to the World Trade Organization’s General Agreement on Tariffs and Trade 1994 (Gatt 94), no longer available to WTO members, including SA. Article XI of Gatt 94, for example, prohibits quantitative restrictions on imports and exports “whether made effective through quotas, import or export licences or other measures”.

Particularly important for SA’s proposed localisation policy is the national treatment — or non-discrimination — principle described in Article III of Gatt 94. The WTO appellate body described this in “Japan — Alcoholic Beverages II” as providing equality of competitive conditions for imported products in relation to domestic products. Thus, Article III:4 of Gatt 94 provides that: “The products of the territory of any contracting party imported into the territory of any other contracting party shall be accorded treatment no less favourable than that accorded to like products of national origin in respect of all laws, regulations and requirements affecting their internal sale, offering for sale, purchase, transportation, distribution or use.”

While it is argued by some that the adoption of import substitution policies promotes domestic industrialisation, employment and the protection of local industries from disruptions to global supply chains, it is now more widely accepted that this seldom achieves such benefits. In fact, facilitating excessive protectionism through the utilisation of such policy instruments may have important adverse consequences by conferring monopoly positions on domestic producers, increasing the cost of doing business, reducing product market competition and weakening the incentives for productivity and innovation.

To the extent that the proposed implementation of the plan entails the use of provisions to restrict or discriminate against imports entering the domestic market, this may contravene one of the Gatt provisions highlighted above. While there is obviously some scope for manoeuvring within the Gatt framework to give effect to public policy interventions, these are restricted. Article XX of the Gatt provides some limited exceptions to otherwise proscribed conduct where it is intended to achieve certain listed public policy objectives. However, such exceptions apply in narrow circumstances and would not excuse the blanket imposition of import substitution measures.

In “US — Shrimp”, the WTO appellate body found that the Article XX exceptions seek a balance between permitting a member state to implement important and legitimate domestic policies while ensuring it respects the treaty rights of other member states. In this regard measures sought to be protected under specific Article XX exceptions are also subject to an assessment of whether they constitute unjustifiable or arbitrary discrimination between member states or a disguised restriction on international trade. In “EC — Seal Products” the appellate body found that this assessment primarily depends on the cause of the restriction and the rationale for its existence.

Significantly, the national treatment principle, as well as the prohibition on quantitative restrictions, are both replicated in Articles 39 and 40 of the Economic Partnership Agreement (EPA) between the EU and Southern African Development Community (Sadc) EPA states (EU-Sadc EPA). Non-compliance with these provisions could have particularly far-reaching consequences for SA’s relationship with one of its most important trade and investment partners. The EU-Sadc EPA aims, among other things, to enhance bilateral trade, deepen economic and trade relations and promote sustainable development.

Robinson, who many believe should have won the Nobel prize for economics in 1975, observed that increasing domestic employment through “home investment” — domestic demand stimulus — brings about “a net increase in employment for the world as a whole”, a point SA’s economic plan regrettably seems to have missed.

This article was first published in Business Live on Thursday, 29 April 2022. 

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