Whether you are pro- or anti-Brexit you need analysis points:

 You all know my stance on Brexit; yes, this is a supportive article, and you do need both sides of every issue, so if someone wants to forward to me (or put on the wider reading record) an article highlighting all the downsides to no-deal I will gladly read it. Here are 3 points to use in any trade-related essay: Matthew Lynn

City columnist

No deal is the best deal for Britain – and the EU too

Europe has a lot to gain from a thriving, independent Britain

EVEN CENTRALISING EUROCRATS LIKE MICHEL BARNIER SHOULD SEE A NO-DEAL EXIT AS A WIN

With only three months left, and with the Covid-19 crisis still absorbing our leaders’ energies, the chances of a trade deal as our transitional agreement with the EU comes to an end seem more remote that ever. Britain appears to have reconciled itself to leaving without any kind of arrangement. Most of the EU is slowly coming to the same conclusion. The gulf between the two sides looks too wide to be bridged. The EU wants Britain to remain within its legal and regulatory control, while the UK wants to make its own laws, and set its own standards. Both sides would prefer not to do a deal than compromise on those principles. 

SOME MUCH NEEDED COMPETITION

That is reasonable. The British have rightly concluded that the cost of tariff-free access to the EU market is too high for the rather minimal benefits. Most of the tariffs are fairly minor, and can easily be absorbed by the exchange rate, and while there would be some benefits from eliminating them, that can more than be made up for by growing new industries free from European regulations. And, in truth, if it was thinking straight, the EU should see that it too has a lot to gain from a successful no-deal Brexit. 

First, the UK would provide some much needed regulatory competition. To listen to the centralising bureaucrats in Brussels you might imagine that a close neighbour with a slightly different regulatory, legal and tax system is a threat. It would lead to “social dumping” (code for “making things a little cheaper than the person next door does”), hand power to unchecked corporations, and undermine their labour and environmental standards. But that is not true. Competition is a good thing, and that is just as true of tax and regulation as it is of anything else. A free-market neighbour would be a check on the centralising ambitions of Brussels, and a model for innovation, which is just what the EU’s economy needs. It would make it slightly harder for eurozone governments to raise taxes and impose new rules, and it would force them to think harder about which ones worked and which didn’t. 

Second, a no-deal Brexit might well turn Britain into an offshore hub, with a deregulated, low-tax model. But would that really be such a terrible outcome? Much like Hong Kong for China, or Singapore for the rest of southeast Asia, a deregulated, freewheeling UK could funnel a lot of trade and investment into the rest of Europe while not being bound by its rules. Singapore and Hong Kong have done a lot to boost their whole regional economies. The UK could play the same role for the rest of Europe. 

Finally, surely it is in everyone’s interests for the UK to be as successful as possible after it leaves the EU. The UK is one of the largest markets for the rest of Europe, so the richer we are, the more we will import, which means EU companies will be able to grow more quickly as well. At the same time, with no deal, and with regulatory divergence, it is inevitable that some companies will have to move operations to different countries to stay within the EU and preserve full access to the single market. Those countries will gain some extra jobs that wouldn’t exist if there were a trade deal. 

Sure, there is a big downside to a successful no-deal outcome: it will show that leaving the EU can work. If the UK departs without any formal arrangement, and does so at least reasonably well, then it may well encourage a few other countries to wonder if they shouldn’t follow suit. To hardcore federalists in Brussels, that may be too high a price to pay, and they will remain determined that Brexit should be as catastrophic as possible. To everyone else, though, it should be clear that leaving without a deal should be hugely beneficial. The UK will be richer. It will be a conduit for investment into the rest of the EU. And it will discipline the EU’s mania for over-regulating and over-taxing its economy. The UK should start persuading the rest of Europe that an amicable no-deal exit is the best deal for both sides – and to concentrate on making an economic success of that

Japan in a nutshell - very good context

The mixed legacy of Shinzo Abe

SHINZO ABE: HIS REIGN HOLDS LESSONS FOR A STAGNATING WORLD

The long-serving Japanese prime minister is quitting due to bad health. That spooked markets, but his programme for economic revival looks likely to live on. Is that a good thing? Simon Wilson reports

WHAT HAS HAPPENED?

Japan’s longest-serving prime minister, Shinzo Abe, in power since late 2012, announced last Friday that he would be resigning on health grounds as soon as his party could elect a successor. During a brief first spell as PM in 2006/7 Abe was seen as a conservative nationalist. In his second lengthy spell, since 2012, he has been seen as relatively pragmatic. He has provided much needed political stability, improved relations with China as well as allies in Asia (with the notable exception of South Korea), sealed important trade deals, and pursued an economic policy – “Abenomics” – aimed at restoring growth and ending deflation. His decision to step down unnerved markets, although his successor is likely to adopt a very similar policy programme.

WHAT IS “ABENOMICS”?

It was the attempt, from 2013 onwards, to revitalise Japan’s long-sluggish and deflation-prone economy with a “three arrow” strategy of ultra-loose monetary policy, fiscal stimulus and structural reforms. The most long-lasting of these was the sustained programme of “quantitative and qualitative” easing by the Bank of Japan under its Abe-appointed governor, Haruhiko Kuroda (who will remain in post after Abe’s departure). By 2018, after a five-year bond-buying spree, Japan’s central bank had become the first among G7 nations (and only the second after Switzerland) to own assets worth more than the whole of the national economy.

WHAT ABOUT THE STRUCTURAL REFORMS?

One of the most common criticisms of Abe is that he never delivered on his promises of deep-seated structural reforms. “It is true he never did the most radical things, such as tearing up protections for salaried staff,” says the Financial Times. “But he did liberalise Japan’s electricity market, open the country to Chinese tourists, cripple the agriculture lobby and sign two huge trade deals.” Labour-market reforms aimed at attracting more women into the workplace have been modestly successful. And Abe also introduced important corporate governance reforms, combined with a new stewardship code, that have made Japanese investments far more attractive to foreign and institutional investors. From 2017-19, Japan attracted more private-equity investments than any other country, and its level of M&A activities is second only to the US. 

“IN THE WAKE OF COVID-19, ABE WEIGHED IN WITH A STIMULUS PACKAGE WORTH 40% OF GDP”

DID ABENOMICS PROVE A SUCCESS?

Yes and no. Kuroda’s market-pleasing policy of ultra-low interest rates and bond-buying drove a rally in stocks and sent the yen lower, boosting exporters, and helping to keep growth in positive territory. Inflation picked up a little, meaning officials could declare that the long era of deflation was over. Corporate profits rose, and unemployment remained low, but in spite of Abe’s repeated urgings, those profits never fed through into wage inflation sufficiently strongly to drive a sustained boost to consumer spending. Inflation remained stubbornly below the central bank’s 2% target. Thus, on its own terms, Abenomics failed. Most notably, the anti-growth effects of raising the consumption tax from 5% to 10% outweighed the stimulus effect of great government spending. Yet under Abe both growth and employment improved, partly due to the weaker yen. And there has been no debt crisis, despite the persistent warnings of Abe’s critics (including the deficit hawks within his own party). 

WHAT ELSE DID HE ACHIEVE?

Abe’s efforts benefited from propitious timing, says Ben Dooley in The New York Times. In particular, China’s economy surged during his tenure, boosting its appetite for Japanese machine tools and the specialised components needed to manufacture things such as cars and high-end electronics. In addition, Chinese tourists, “eager to spend their growing wages, flooded Japan’s cities and tourist sites, splashing out on luxury goods”. By late last year, however, Japan’s economy was contracting due to slowing global trade and the brewing trade war between the US and China, which badly hit Japanese exports. With Japanese national debt at 150% of its GDP (the highest proportion of any developed economy), Abe once again turned to a rise in the consumption tax in the hope of tackling the debt and shoring up social programmes. The tax rise killed off spending, and then a vicious typhoon devastated central Japan, compounding the economic damage. By the time the Covid-19 pandemic took hold, Japan was already in recession.

SO ABE LEAVES ON A BAD NOTE?

Indeed. Japan’s GDP fell by an annualised 28% in the second quarter, and Abe’s government weighed in with a stimulus package worth an astonishing 40% of GDP, including low interest loans and cash grants. Covid aside, Abenomics will be remembered for growing the economy, creating jobs and keeping deflation at bay, says Kathy Matsui, vice-chair of Goldman Sachs Japan. The question now is will Abe’s successor be able to tackle the remaining reform agenda items and bring Japan “once and for all out of deflation”, says Matsui. For the rest of the world – a world struggling with a slide towards stagnation, deflation and ultra-low interest rates — Abenomics offers “powerful lessons”, says Robin Harding in the Financial Times.

WHAT ARE THEY?

The key lesson is that “monetary policy works”; the initial “bazooka” of massive asset purchases in 2013 was highly effective. “Bond yields fell; stockmarkets boomed; and most important, the yen fell below ¥100 to the dollar, a boon to Japanese industry.” Another is that “weak economies cannot handle tax hikes” and economic strength  is a precondition for fiscal tightening.  Abe went off course when the consumption tax rose from 5% to 8% in 2014, ultimately pushing Japan back into recession.  “If you promise stimulus, and deliver restraint, you get failure,” says Harding. “That is the story of Abenomics in brief.”

Oxbridge candidates see what you can make of this piece on MMT

 

This will challenge you, but it is a very good example of the way economists redefine concepts in order to explain the true impact of something. It also has extension material to impress examiners (and interviewers), such as Ricardian Equivalence.

It will not be easy to understand at first, but see how far you can get.

MMT's Very Odd Definition of "Savings"

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134 COMMENTS

TAGS Monetary PolicyInterventionismOther Schools of Thought

• LEA ESTO EN ESPAÑOL

07/30/2020Robert Blumen

Modern monetary theory, which is now experiencing its fifteen minutes of fame, contains a number of strange and counterintuitive propositions.1 Proponents claim that these propositions are not an economic theory, only an accounting identity. One of these is that the private sector can save only if the government runs a deficit. Within the self-consistent, tail-chasing world of MMT, these statements are true by definition. However, when MMT aphorisms are interpreted using their normal meaning in the English language, their conclusions are not only false, but foolish.

MMT defines savings as the accumulation of non–private sector assets. It must be the case that all liabilities between private sector actors net out to zero. And from that, the only way that the private sector can have a positive net credit is if something outside of it has a negative net. That something is the government (perhaps, but probably not so, as I will argue later).

The Definition of Saving

A good definition enables people to have a conversation about a topic by establishing a shared meaning. While anyone is free to define “up” to mean down and vice versa, Humpty Dumpty notwithstanding, a good definition, to avoid confusion, should be consistent with normal usage. In normal English, savings consist of what is produced and not consumed. I will show that using this definition it is possible for the private sector to save without a government deficit.

The first and simplest form of savings is saved consumption goods. Long duration goods such as homes, cars, appliances, clothing, and furniture are produced and then release their services over time. The US private sector has about $33 trillion of residential real estate, which consists of saved real estate services in the form of homes that will be used up over decades. Shorter duration consumption goods can also be saved, such as frozen food or tinned sardines, extra tubes of toothpaste, and in the days of the virus we must not underestimate the importance of saved toilet paper. Businesses also have saved inventories of consumption goods which they plan to sell in the near future.

The Role of Saved Capital Goods

The second and more important form of savings is saved capital goods. These are productive assets which, in the exact same way as saved consumer goods, have been produced but not consumed. According to the Fed, the United States has $56 trillion of saved capital goods. Some of that might be owned by governments, but even a fraction of the value held in private hands is an enormous amount. The importance of capital goods is that they are needed in order to produce consumption goods. Labor productivity depends on the amount of capital that workers have, which drives real wages. The gradual increase in our standard of living over the centuries is attributable to the quantity and quality of saved capital goods.

Even the Robinson Crusoe stranded on an island may save consumption goods such as caught and dried fish, harvested and stored coconuts and tubers. Crusoe may also save capital goods—such as a fishing rod, a net, or a ladder to harvest coconuts from trees—by creating them faster than they wear out.

Savings and Cash Balances

Another common usage of the term "savings" is cash balances. While MMT correctly points out that one person’s spending is another’s income, and therefore nets out to zero, the private sector cannot accumulate a net cash balance unless there are money flows in and out of it. In a gold monetary system, the private sector could accumulate cash through mining. But assuming for the moment that there are no cash flows between the private and government sector, and no money creation, the private sector cannot net accumulated cash. However, the private sector can increase its real cash balance through lower prices. This happens when the public preference for cash relative to goods changes in the cash direction.

The Problem with the MMT Definition of Savings

At this point we can see the main problem with MMT’s definition of savings as net government debt. Assets can be divided into two broad categories: debt and equity (equity being what you own and debt being what is owed). Every debt has two sides: the creditor, for whom it is an asset, and the debtor, for whom it is a liability. Net debt must balance to zero if you include both sides in your aggregate. Equity, being unencumbered, and having only one side, is a positive value, and can grow. An increase in one person’s equity in the form of saved capital or consumer goods does not require an offsetting debit anywhere else. To see this, consider Robinson on his ancap island, busily drying fish and storing coconuts. His gross equity increases on a daily basis without any offsetting liability anywhere in the South Pacific. MMT’s definition is incomplete, because it looks only at the debt component of assets while ignoring the equity.

Private sector net debt is always zero by definition. This truism tells us nothing interesting about the world and is only another way of stating the definition of debt. Private sector gross assets in the form of saved capital and consumer goods are the foundation of our economic well-being and are therefore quite important. Contrary to MMT, the proper object of study should be gross savings rather than net savings. Net assets in the form of external debts to foreign countries are not uninteresting for some purposes, but must be paid for out of either current or future production, which depends on the gross savings.

Now I will return to the issue of whether the private sector’s net position in the government debt market is truly an asset. Government debt could in theory be paid by selling government assets (and in some cases they have done so) but in most cases, government debt represents a claim on the taxing power of the government in question. And the tax liability is to a large extent owed by the same private sector that owns the bonds. Every increase in government debt imposes a future tax liability of the same amount on the same private sector. If we disaggregate down to the individual or household, some individuals owe more in tax than they own in government bonds, and others the opposite. While I am not a believer in Ricardian equivalence, the net positive asset position of the private sector in government bonds is offset by an equal tax liability on the aggregate level.

Many parts of MMT depend on the issuer of debt also being the monetary sovereign—the body that can create money out of nothing. It should be noted that this particular issue does not apply only to the issuer of government money. As long as the definition of the private sector excludes all governments of any level who borrow in the bond market, the same accounting identity applies. State and municipal governments could create MMT savings by borrowing. MMT might dispute my point about sovereign debt imposing a tax liability on the private sector on the grounds that the monetary sovereign can print and spend money into existence “for free” (i.e., without imposing any cost on the rest of society). I will not address that point here, but Robert Murphy has elsewhere.

Capital goods and consumer goods can be accumulated without any requirement in an accounting sense for obligations between the government and the private sector. If the government had no debt, it would enable the private sector to accumulate even more savings, because it would be freed of the tax liability.

You can define the word “savings” to mean anything you want. MMT savings defined as net government debt holdings enables the MMT tautology that the private sector cannot MMT save without the government running a deficit. However, this does not tell us anything useful. If anything, MMT saving should be discouraged, because the government drains resources from the domain of economic calculation and private property to socialism and government control. The focus should be on economic policies that enable private individuals and business firms to accumulate gross savings in order to improve our well-being.

Will we have a V-shaped recovery - optimistic view

DAVID SMITH

A strong bounce so far – but can it survive the autumn?

David Smith

Sunday August 30 2020, 12.01am, The Sunday Times

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We are entering a critical period for the economy. Tuesday marks the start of meteorological autumn, and the autumn will bring a series of challenges for the economy.

Will most children go back to school, thus freeing parents to return to the workplace? What will be the unemployment fallout of the ending of the furlough scheme, which Rishi Sunak is under growing pressure to extend? And is a government that wings it on most things prepared to wing it towards a no-deal Brexit, piling uncertainty and disruption on a fragile economy?

I shall keep that list of questions as an aide-memoire as we move through the coming weeks. In the meantime, Tuesday also marks the start of the final month of the third quarter, a three-month period that is crucial for the economy’s path out of the crisis.

Some readers got quite agitated a few months ago when I first suggested that this recession and recovery would have a “V” shape. They pointed to the lasting impact of Covid-19 on the way we live, work and spend. Indeed, to some it is strange to be talking about a recovery at all when city centres are deserted and commuter station car parks (including mine) have lots of empty spaces.

The answer is that people can still be working productively, and they are, even if they are not occupying city centre offices. However, the change in working patterns is severely damaging businesses that rely on commuters, the same way that public transport is being damaged.

The idea of the V was straightforward and logical. When the economy was in maximum lockdown, economic activity would be most severely curtailed, naturally picking up as lockdown measures were eased. It was more logical than an L — the economy drops sharply and stagnates at the lower level — or a U, a prolonged period of bumping along the bottom before a recovery.

The beginnings of a V were seen in the monthly gross domestic product (GDP) data for the second quarter. These and other data led Andy Haldane, the Bank of England’s chief economist, to declare his confidence in a V-shaped recovery. Politicians, including the chancellor, are understandably reluctant to join in with such talk, given that a rise in unemployment and further business failures look inevitable and that GDP does not mean much to most people.

So what are the prospects for this quarter? David Owen, European economist at Jefferies International, an investment bank, has been monitoring the downturn and upturn since the crisis began, with his economic activity radar.

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His latest readings show two things. One is that recovery is continuing. Electricity consumption has risen to 98% of normal levels, while traffic congestion is at 95%. Flights are increasing, albeit from a low base. Public transport is flat. Web searches of car dealerships are 14% above normal, while visits to property portals are 46% above normal, supporting the housing mini-boom story described here last week.

The evidence of a continuing recovery in these economic activity measures is enough to persuade Owen that there will be a 15%-plus rise in GDP in the current quarter, which would be good. We should take note of this. Very early on, his economic activity radar persuaded Owen that there would be a 20% fall in GDP in the second quarter, after which the Office for Budget Responsibility predicted a 35% fall, and the Bank of England a drop of 25%. The fall was 20%, so top marks to him for that prediction.

The other significant thing about these measures of economic activity is that they suggest that the UK’s recovery, which was lagging behind others, is now roughly on a par with those of Europe and America. There has been some evidence in Europe of an easing back in the pace of recovery.

There is other evidence of recovery. Barclays’ recovery tracker, which is largely based on spending trends, found that overall consumer spending in the middle of August was a hefty 10% up on a year earlier. There is more physical spending and less online spending, it suggested, and Sunak’s Eat Out to Help Out scheme has led to a significant increase in trade for restaurants, cafés and hotels. Its overall tracker is running at an impressive 98% of normal.

Domestic spending may have been boosted by the fact that many fewer people have been travelling abroad for holidays this summer, although the UK has lost the spending of foreign tourists. One interesting question is whether private versions of Eat Out to Help Out, introduced by some restaurant groups, can maintain the spending momentum.

Finally, the Office for National Statistics has its own coronavirus economic indicators. The latest of these showed that footfall at retail parks in the week beginning August 17 increased to 90% of year-ago levels, while shopping centre footfall was at just under 70% of last year’s levels.

Motor vehicle traffic was at 94% of pre-lockdown levels, while the issuance of energy performance certificates, a vital component in home buying and selling, rose to 83% of normal, adding support to evidence of a housing recovery. There has also been a sharp upturn in company formations: this month they have been running at 3,393 incorporations per working day, up from 2,612 a year ago. It could be that a lot of phoenixes are rising from the ashes.

All this bodes well for a strong growth number in the third quarter. But there is a sting in the tail of the ONS’s release: it is that 13% of the workforce is still furloughed this month, according to its survey of the business impact of the virus. Most workers (70%) are having furloughed pay topped up by employers, which suggests to me that these firms are not using the job retention scheme as a pathway to redundancies.

However, that 13% figure is significant. At face value, given that there are 28 million workers in employment (not including the self-employed), it suggests something like 3.6 million on furlough.

Those furloughed employees not finding their way back to work are one of the risks to recovery, together with the other questions I raised at the start of this piece. I don’t think this V will turn into a W, but the risks cannot be denied.

Politics and economics - discuss this with your parents

 

Sunak is bluffing: the Tories have no intention of paying back our Covid debts

The politics of reducing the gaping hole in the nation’s finances are 
toxic to the Conservatives

JULIET SAMUEL4 September 2020 • 8:00pm

Each spike on the chart tells of some catastrophe. The first one is World War One. The second, World War Two. The next big one is the 2008 financial crisis. The latest: Covid-19.

The spikes represent big rises in deficit spending. Afterwards, comes the retrenchment. Spending falls back down, but never by quite as much as it rose. Instead, tax revenues rise to plug the gap.

This time around, Rishi Sunak or his officials are supposedly hoping to make a head-start. There will be no tax “horror show”, the chancellor’s notes said as he was snapped leaving No 10, but there will be a little Halloween fright or, as he put it, a “plan to correct our public finances”. You’ve all enjoyed the performance by nice Rishi. Now get ready for scary Rishi!

Am I the only one entirely unmoved by this pantomime? The Government filled last weekend’s newspapers with chilling tales of a massive “tax raid” on corporations, capital gains, drivers and inheritance. That Covid bonanza has to be paid back sometime, tuts the Treasury. Well, yes, but Mr Sunak is just not a credible Scrooge. In truth, the Tories have no real intention of repairing the public finances this side of an election and unless bond markets turn nasty, they will get away with it.

The biggest reason is that Boris Johnson doesn’t believe in raising taxes. Every instinct in him rebels against the idea. Nor does it make any political sense. It would be economic madness to raise them now, before the Covid recession is over, and electoral madness to raise them later, when the next election creeps onto the horizon. As we saw in last year’s election, the Prime Minister also doesn’t believe that “austerity” is politically viable, even if he were the penny-pinching sort. So there is only one course left: keep spending and rely on the Bank of England to finance it.

This doesn’t mean, however, that the deficit is going to stay quite as high as it is today. At some point, the most acute emergency support – furlough and self-employment cash – will be withdrawn, although this may not happen in October as Mr Sunak claims. We won’t stay at the top of the spike for long. But the big, fat debt hangover it leaves behind is here to stay until the economy achieves some sort of new growth miracle or a Labour government arrives to whack up income and inheritance tax.

To understand why, it’s only necessary to look at the politics of all the alternative options. The public is sick of spending restraint and, with the exception of foreign aid, voters will not forgive any major new cuts to departmental spending. There are capital projects the Government could kill, like HS2 or hospital improvements, but such spending forms the core of Mr Johnson’s “levelling up” message and without them he hasn’t got much of a story to tell.

That leaves tax rises. The Tory manifesto effectively ruled out any big increases by promising not to touch income tax, national insurance and VAT, the Treasury’s three biggest earners. That leaves corporation tax, a levy easily avoided by multinationals which only accounts for about 8 per cent of revenues. There is inheritance, a toxic zone for Tory governments and a tax that is not currently used to raise significant revenues in any OECD country. There are a host of other little taxes, like tariffs, road tax and so on, 
all far more controversial than they are lucrative. There are property and capital taxes, which sound juicy, but likewise amount to peanuts in fiscal terms.

That brings us back to the manifesto. If Mr Sunak really wanted to tackle the national debt without spending cuts or new wealth taxes, he would have to rip up that manifesto pledge. But even here the Tories would run into problems. VAT is known to be inherently regressive, hitting the poorest hardest, and the Government currently wants to encourage more spending, not less.

Yet raising income tax also poses serious problems. Despite what many would have you believe, the UK already has one of the most progressive tax systems in Europe. It may be true that we tax our top earners somewhat less than our peers. Looking at income plus national insurance rates, they pay on average 51 per cent, versus 55 per cent across nine other Western European countries examined by the Institute for Fiscal Studies. But the really big difference is lower down the income chain. In the UK, the average tax rate for median earners is 28 per cent. Across the other nine countries, the equivalent figure is 44 per cent. When people say that the UK is lightly taxed compared to our peers, they usually gloss over this point. The group we tax least compared to our peers is not the top, but the middle.

Of course, it may none the less still be possible to extract more from the richest. But it seems rather likely that the biggest fiscal fix would come from increasing taxes on the lower-middle classes. Try putting that on an election billboard.

This is why it is essentially impossible for the Tories to fill in the big, fiscal black hole they have dug. The majority they won last year – their first in 30 years – relies on a coalition of affluent suburbanites and the patriotic working class. Between them, they cover all the constituencies that would be hit by taxing property, middle incomes and spending.

Meanwhile, so long as the most extreme Covid spending is wound down by the middle of next year, it looks unlikely that markets will turn up the pressure. Quite the opposite, in fact: most economists are fretting that governments will stop spending too soon, not too late. The biggest risk, therefore, is that we run into a big inflation shock in the next two years that sends investors running for the hills. That is a risk that the Tories are clearly willing to take.

After World War Two, Britain’s national debt hit an all-time peak of 250 per cent of GDP. It was not the Conservatives who paid it down, but the combined effect of explosive GDP growth and a frenzy of massive wealth and income tax rises imposed by a Labour government. Mr Sunak might wag his finger and fiddle around at the margins, but while Boris is in charge, the big debt hole is here to stay. For the country’s sake, we’d better hope no one calls his bluff.

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Home | Wire | The Problem with Africa's Protectionism

The Problem with Africa's Protectionism

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TAGS PovertyProtectionism and Free TradeWorld History

07/17/2020Germinal G. Van

During the postcolonial period, most of the African countries which had opted for socialism as their economic system also adopted protectionism as an economic measure to favor certain politically preferred industries. Policymakers wanted to protect domestic industries from foreign competition through tariffs, subsidies, import quotas, or other restrictions or handicaps on the imports of foreign competitors. For example, today Tanzania is one of the top exporters of agricultural commodities in Africa. It mainly exports tobacco ($248.8 million), coffee ($181.6 million), and oilseeds ($230 million). Interestingly, those products are not primarily exported to other African countries. In fact, Switzerland is the main importer of Tanzanian agricultural commodities, purchasing 16.2 percent of Tanzanian agricultural production, and India is the second-largest importer of its goods. But Tanzania does not trade much with its African neighbors. As figure 1 shows, the country only trades with Kenya and South Africa, while the rest of the world is its customer. It has imposed higher tariffs and subsidies when trading with its neighbors but has loosened those same tariffs and subsidies on non-African countries. Despite the good intentions of protectionists, we find that their policies create two substantive conundrums in the economic development of a country.

Figure 1: Tanzania Major Export Destinations (2016)

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Source: Trading Economics. "Other" includes some African countries such as Rwanda and the Democratic Republic of the Congo (DRC), and Uganda, as well as the United States, many other Western countries, and Latin America.

Protectionism harms domestic markets. A healthy domestic market relies on the freedom of consumers and entrepreneurs to choose the products they buy, whether for personal consumption or as inputs in their businesses. Protectionist policies limit this ability to choose. Since African protectionist policies are often based on quotas, consumers have very limited choice as to the quantity, quality, and type of products available to them than they would without trade protectionism. Moreover, tariffs and subsidies force a consumer to pay a higher price for a domestic product. Thus, the purchasing power of the African consumer is not as high as that of Western or Asian consumers. When trade protectionist policies are implemented upon domestic products, it compels the consumer to settle for low quality and pay more for a particular product. That is one of the reasons why African consumption is not adequate. Africans are constrained to consumption of lower-quality products that they purchase at a higher price. France, for example, sells its Peugeot automobile to many French-speaking countries, although many consumers consider Peugeots to be low-quality cars. However, because trade restrictions limit access to other choices in automobiles, many Africans end up purchasing these relatively low-quality cars at relatively high prices. This further contributes to the impoverishment of Africans.  Protectionism also negatively affects the growth of new industries. In fact, the protection of an infant industry may actually end up costing a government a significant amount of money and financial resources and actually promotes inefficiencies within the new industry, which has no incentive to make efficient, intelligent long-term investments by borrowing funds or issuing common stock in domestic international capital markets.

Protectionism also creates poverty. Indeed, GDP output falls once tariffs rise because of a significant decrease in labor productivity. Income, in addition to being based on the availability of capital, depends on the productivity of labor. But growth in labor productivity requires growth in access to capital.  When firms in the import-competing sectors receive protection, resources are reallocated within the economy to relatively unproductive uses. For example, when Kwame Nkrumah was the President of Ghana in the 1960s, he imposed tariffs and subsidies on the major Ghanaian industries. However, the president of the neighboring country Ivory Coast (Côte d'Ivoire) during that same period applied free trade policies to the major industries of the Ivorian economy. As we can observe in figure 2, income per capita significantly differed between Ghana and Ivory Coast. The application of free trade policies improved the living standard of the Ivorian people while the living standard of Ghanaians stagnated. Moreover, protectionism often leads to an increase in unemployment. Countries that close themselves off to foreign competition eventually lose their edge, along with innovation, jobs, and growth. This loss of touch with current world affairs leads to unemployment, and therefore to greater poverty.

Figure 2: Impact of Trade Liberalization on Per Capita Income: Ivory Coast and Ghana, 1960–20

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Source: World Bank, author’s computation

How Free Trade Can Improve African Economies

African countries can benefit from free trade by increasing their amount of or access to economic resources. The lowering of trade barriers helps small nations obtain the economic resources they need to produce consumer goods or services. It is here that the comparative advantage theory of David Ricardo becomes more relevant than ever. Ricardo over two centuries ago, in his pathbreaking book Principles of Political Economy and Taxation (1817), argued that comparative advantage exists where local industry can produce a product or service at a lower cost compared to elsewhere. This theory elucidates why a country might produce and export something its citizens don’t seem very skilled at producing when compared directly to the citizens of another wealthier country. The citizens of each country are better off specializing in the goods that they have a comparative advantage producing, even if one country has an absolute advantage in each item.

Over time, free trade will improve the efficiency of production in African economies, because trade enables producers to fill in the gaps in their production processes. That is, entrepreneurs and business owners can make their businesses more productive the more they have access to a full, global range of products and services. The acquisition of knowledge and skills will undeniably contribute to the amelioration of labor productivity and output efficiency. Higher labor productivity and output efficiency will logically reduce unemployment and therefore reduce poverty.

Author:

Germinal G. Van

Germinal G. Van is an author, political essayist, and libertarian scholar. He was born and raised in Abidjan, Côte d’Ivoire, West Africa. He immigrated to the United States in 2010 with a student visa. He holds a bachelor’s degree in political science from the Catholic University of America and a master’s degree in political management from the George Washington University.