PRINCIPAL MACRO-MICRO ECONOMIC REZULTS OF PROTECTIONIZM

ZVIAD BESHKENADZE

The present external trade policy of Georgia has a liberal nature, which brings great problems to local production. True, free trade can cause much use to the country provided process of trade liberalisation develops in a phased way by means of moderately reasonable protectionism.

It is noteworthy that developed foreign countries have passed phases to the complete liberalisation of trade. Reduction of trade tariffs and other barriers of limited trade have developed gradually even within the frames of economic blocs so that to avoid negative effect on economies of countries incorporated in it. Post-Soviet countries with successful reforms transited to open economy by means of gradually relaxed limitations and control on the processes as well as performed protectionism with the purpose of protecting domestic market.
In Georgia trade liberalisation process developed in phases as a result of which almost each local branch turned out to be unprotected. With newly-privatised or state national enterprises failing to provide competitive production and with a whole number of entrepreneurial branches working with half load or being completely stopped, the simultaneous liberalisation of external trade had a shocking effect on them. As I. Meskhia says: “Crisis in national economy and non-protection of local production has made a great blow on the leading branches of real sector… Non-protection of national economy has greatly damaged light industry and agriculture. During the Soviet period different republics (among them Georgia) specialised in the production of particular products. Despite the fact that this specialisation was more “artificial” than “natural”, still it existed, but this advantage did not exist in international scales. After the disintegration of the Soviet Union, tradition ties between enterprises were broken and traditional sales markets were lost. This made most local enterprises dependent on domestic markets where it became difficult to sell production due to low domestic demand. At the same time, after the global liberalisation of trade, low-competitive local enterprises have not only penetrated into foreign markets, but have also failed to provoke competition to cheap import surplus in local markets. Enterprises have gradually stopped functioning in the country, which resulted in the growth of unemployment level, decrease of population’s real incomes, domestic demand and gradual deterioration of its structure. Gradual and collateral reduction of overall demand and general delivery “fed” each other. All this was reflected in the sharp decrease of production, in significant changes in the structure of industrial forces and in the de-industrialisation of the country, etc.
Nowadays, development and restoration of country’s economy is impossible without protective measures of the state. According to G. Miurdal, western economist, developing countries will not be able to effectively develop industrial forces without protective measures. Kh. Shroeder, German economist, goes even further saying that “penetration of CIS countries into the world market is impossible without trade benefits, protective measures and wide-scale technical assistance”. As far as we know, new industrial countries (South Korea and others) consecutively resorted to import-replacing and export-oriented policy that first of all encompassed protective measures along with many other economic ones aimed at protecting local enterprises.
Protectionism is indispensable for the encouragement of certain branches and economy on the whole. Temporary protection from foreign competition is necessary for the restoration and strengthening of competitiveness of newly-privatised and state-owned enterprises. Protectionism will be abolished when the branches reach a particular level of development, when priorities are established in the country, when the country wins comparative advantages in the production of particular products.
Presently, national market is congested with imported goods. Local demands are satisfied mainly through import. The narrow domestic market becomes less capacious for local enterprises. Low domestic demand is a main factor impeding the development of national enterprises. Protectionism is the only way for the expansion of domestic market and local demands.
Protectionism of domestic market can be performed by means of customs tariffs as well as non-tariff methods (import quota, technical standards, sanitary norms, etc.). Protective measures increase import price thus mitigating its competitiveness and encouraging local production.
A question arises: which local branches should be protected? Selection of the branches is rather difficult, but we think that branches with good chances of development in the given stage or branches with unloaded production facilities (branches whose production facilities do not require great financial resources) as well as branches with sufficient domestic demands in case of protection, should be protected in the first place. Nowadays, solvent demands in Georgia are mainly aimed at essential commodities, such as foodstuffs, clothes, shoes, different kinds of household goods, etc. Thus, we think that agricultural branches and processing industry as well as particular branches of light and food industry should be protected in the present stage.
What results can protectionism – limitation of import of particular goods on the macro and micro stage- lead to? Let us first consider main economic results of protectionism by means of a simple model of supply and demand of certain branches on the micro level.
As shown in picture (1), local demands (OQ) are satisfied (it is so in reality) in free trade conditions – import contains Q1Q1 and local production contains Q1. Let us imagine there are trade limitations (f.e. tariff – T) that brought import to zero. Let us first imagine the way commodity consumption will change. Establishment of tariff will increase price from P1 to P2, followed by reduction of consumption from Q1 to Q2. However, if we take into consideration the fact that price elasticity of essential commodities is low (demand curve on the downward bias), we should suppose that consumption will be insignificantly replaced with Q2Q1. As for supply, we mean that the mentioned commodity could be produced within he country, i.e. there are appropriate unloaded production facilities. (Thus, supply curve is quite elastic). Production at low (P1) price is unprofitable, but price growth (from P1 to P2) will provide stimulus and will finally increase the production volume of protected branches (OQ1 and OQ2).
Consumer savings were D+C+A before the tariff, but this reduced after the tariff and D was left; entrepreneur’s savings increased after the tariff and became B+C (was added by C or losses of consumers). The total economic loss (loss of economic welfare) represents A area (i.e. general savings were reduced by A). Thus, tariff reduces the general economic welfare of a country whereas free trade increases it.
This consideration is justified if we consider this issue from macroeconomic point of view – in case of one particular branch (production) and at the same time, in case a country has relative advantage in producing particular production. If we consider this issue in the case of our country from macroeconomic viewpoint, if we consider branches in complex, the result will be a different one. With most branches of the country being competitive, with cheap import having completely or partly stopped most of local branches, free trade does not only promote the growth of consumer savings and general economic welfare but, on the contrary, leads to mass unemployment, reduction of population, total savings and deterioration of general economic welfare.
Thus, the main economic result of the tariff is on micro level: growth of local production volume (from Q1 to Q2), growth of entrepreneurial savings, decrease of import (from Q1 to Q1) and negative effects such as price increase from (P1 to P2), reduction of consumption (from Q1 to Q2), reduction of consumer and total savings.
Let us now consider possible economic results of protectionism on macro level by means of common supply curve.
Exact determination of the location of common supply curve is rather difficult. In our opinion, it has rather a downward form as a lasting economic crisis and a long-term stoppage of industry has caused moral and physical deterioration of capital assets. Therefore, free production facilities are not so great in economy on the whole.
Some think that stimulating fiscal policy (main stress is made on the reduction of tax rates) is necessary for averting crisis and stimulating economy. According to one group, such policy will increase demand as well as production volume and employment as a result of multiplication effect (Keinz’s approach). According to the second group, this will tell on production stimulus, i.e. this will cause shift of one supply curve and therefore, growth of production volume and employment (neoclassic approach – economic theory of supply and Laffer’s conception). Many Georgian economists are sceptical towards “supply-oriented theory”. Pursuance of supplysider policy in Georgia is a complete nonsense according to this very theory; as recently-made research reveal, Laffer’s famous conception in transition economy countries “works ineffectively”.
As for Keinz’s approach, we think that though tax cuts will increase common demand, there will be solvent demand not for local production, but rather for import production in the conditions of unprotected domestic market and non-competitive enterprises. Thus, import volume will increase resulting in the deterioration of tax balance, which will certainly effect currency reserves. The Central Bank will have to perform devaluation of national currency, which will increase price level in the country, i.e. cause inflation rather than growth of production volume. (There will be similar result in stimulating money and credit policy).
By means of protective measures we can “liberate” solvent demand and direct it at local production. Let us consider this process by means of AD-AS model (picture 2). As mentioned above, we consider that one supply curve has downward form (picture 2 AS). Yet by means of protectionism we will, on the one hand, be able to single out comparative horizontal site (KM site, i.e. branches with unloaded production facilities protected by us) and, on the other hand, increase one demand in this site (from AD1 to AD2, i.e. shift solvent demand from import to local production). This will result in the significant growth of production volume (from Q1 to Q2) along with slight growth of prices (from P1 to P2). If we encourage economy, this might shift to “automatic regime” of growth of one demand and one supply – one demand stimulus might increase incomes and profits of branches and encourage them for the growth of supply while supply might generate its demand (Sey’s law). The government should promote this by means of reasonable macroeconomic policy and expanded protective measures in accordance with domestic demand growth and change of its structure.
As a result of protectionism, import volume will decrease in the country, which will lead to reduction of tax balance deficit and increase of country’s currency reserves. In case of fixed currency rate, the government will have to purchase foreign currency and sell local one; this is increase of money supply in economy that should give it additional stimulus. Import reduction should also provide additional stimulus to common demand.
It is interesting how import limitation would effect budget revenues. True, tax revenues of country’s budget are, mainly, derived from import taxation (VAT, customs, excise, etc), but reduction of import should by no means reduce budget revenues. Instead this should grow them. Given the fact that protectionism is followed by the functioning of local branches and growth of employment, tax revenues from taxation of local residents should increase appropriately (VAT, profit, social, income tax, etc). They should exceed losses of import taxation.
Protectionism has negative consequences, too. This is first of all reflected in the growth of prices on production of protected branches. We have mentioned that in the first stage protectionism should encompass production of essentials. Yet, the greater part of consumer goods basket belongs to this very production. Thus, prices increased as a result of protectionism will reduce population’s real incomes (which is an anti-stimulus for the growth of consumer demand) and social welfare.
Protection of some branches can have a negative effect on the situation in other branches. For instance, if we protect agricultural branches (as a result of which prices on this production will grow), this will decrease competitiveness of its processing industry (f.e. food-canning industry) as agricultural production means raw materials for this industry.
Very often protection of one branch requires protection of other branches related to it. We will not achieve a desirable effect if of two branches producing interchangeable production we protect only one branch, as demand becomes elastic after establishment of tariff on protected branches (as price on it increases while the price on replaceable goods remains unchanged). Picture 1 shows shift of D to D1.
Of contrary arguments on protectionism, argument of limited competition is of greater interest. In its turn, this makes for market monopolisation. At the same time, if protectionism is used for a lengthy period, this might endanger the development of protected branches. Though, we should mention that if protectionism is followed by concentration of production and expansion of enterprises, this might be a positive rather than a negative effect as this makes it possible for enterprises to realise scale effect and increase production competitiveness.
Micro and macro consequences of protectionism are comparatively wider. We should mention that in Georgian reality the issue is well-studied requiring complex approach and deep scientific analysis.
We are far from the opinion that only protectionism can contribute to the development of local branches, growth of production volume and encouragement of economy. With this purpose it will be necessary to perform complex measures – support of branches by means of low-interest, long-term credits, tax preferences, direct subsidies, etc. as well as pursuance of reasonable macroeconomic, external economic and other policies, etc.
As for practical aspects of domestic market protection, nowadays the opinion that after membership in the WTO the country will not be able to protect domestic market is dominating. True, the right of Georgia to protect local branches by means of customs tariffs becomes limited, but with the same rules and norms of the WTO the country has the right to protect the market from dumping, subsidised, low-grade or falsified import while the domestic market is expanded with such goods. According to the same WTO laws, member-countries have the right to protect domestic market if the quantity of imported goods will or might damage local production. Damage arising after import in Georgia is great for local branches though no one has ever tried to protect them. A whole number of benefits is envisaged for developing and transition market economies that require usage. Though there can be no talk about protection with economic (customs) borders being uncontrolled and with most import production being smuggled.