Targeted protectionism can aid developing economies
NOV 28, 2016

There was much irony in the fact that Peru this year came to host the recent annual Asia-Pacific Economic Cooperation forum.

APEC began life as the 1970s brainchild of some anti-communist Japanese and Australian National University academics. They wanted a trade bloc that would encourage Japan to see its future in the Pacific rather than look west to communist China and the Soviet Union. But to prove the Pacific orientation they had to include Peru and some other distant Latin American nations of little global economic importance, while nearby China, now so important to the Japanese and Australian economies, was deliberately excluded.

The Latin Americans continue as members. But APEC, which has dropped any pretence of trying to be a free trade bloc, now has to include Beijing to try to give its annual talk-fests some kind of meaning and status. Even more ironically, APEC now has to pay serious attention to China’s proposed Asia-Pacific trade bloc, the Regional Comprehensive Economic Partnership, at the very moment that the U.S.-proposed Trans-Pacific Partnership, designed as an anti-China successor to APEC but with free trade teeth, begins to implode.

An even sadder irony was the sight of Peru’s recently elected president, Pedro Pablo Kuczynski, embracing strongly the free trade slogans that dominated this latest APEC meeting. I have visited Peru many times. Like other Pacific Basin nations, including Australia, its industries long enjoyed protection not just from government policies but also from being distant from the industrial centres of the United States and Europe. It had even then a large, well-educated middle class. It was developing a range of nascent manufacturing industries — textile and metal-working especially. By the rules of economic growth it should by now be on a par with mid-level European nations.

But today, many of those former manufacturing industries are not even nascent. Free trade policies have caused most to be swamped by cheap Asian imports. The economy now depends heavily on food exports and the wildly fluctuating prices of its mineral exports.

Worse, the inability to employ a rising population, many flooding into the cities seeking work, has spawned a crime wave — not quite as bad as in Brazil, Colombia (where a Japanese student was recently shot to death for trying to foil street thieves), Mexico or some other Central American nations perhaps, but bad enough. Most of my acquaintances there have been robbed at least once, some at gunpoint. Fortunately, Peru’s vigorous media try hard to prick consciences by highlighting social problems. But corruption remains rife, the police are impotent and the politicians show little concern. Peru at one stage even tried forced sterilization as a way to stop the flow of unemployables into the cities.

Hope rose with the recent election of the principled, Western-influenced Kuczynski. But to date the improvement has been slight. As in most Latin American nations, the upper classes seem to have little interest in the squalor at the bottom of their societies. Yet a society where you cannot walk safely down the streets is not a society.

There has long been a simple answer to this growing nightmare — Thai-style targeted industrial protection. Protectionism got much of its bad name from the open-slather variety that did such damage to many Latin American nations in the past — Argentina especially, which once had a living standard equal to Australia’s. The protectionist technique of trying to develop local industries simply by banning the import of foreign manufactures will leave you, as it did in Argentina, with a range of inefficient local industries clamouring for more protection to survive. But Thailand has used targeted protectionism to create a range of efficient industries able to export around the world. How?

It began with the textile industry, some 40 years ago. Japanese textile makers had competed fiercely for a share of the Thai shirt market, but the government suddenly ruled that imports were banned and shirts had to be made locally. However, it said, the import of materials needed to make the shirts would be allowed. Thailand soon had a range of Japanese-financed shirt-making factories, many with local partners. The government then began to rule that those imported materials also had to be locally produced — first the yarn, then the fabric and then finally even the cotton needed for the yarn. At each stage the Japanese investors faced a dilemma — abandon their factories or begin local production using needed technology from Japan. Most chose to continue. Eventually Thailand, with its advantage of cheaper labor and Japanese know-how, was able to produce competitively a range of textile goods for export, even to Japan.

Thailand repeated this targeted protectionist policy with its car industry, and today it has an efficient full-fledged car industry. Compare this with Malaysia, which foolishly tried to create a car industry simply by imposing high taxes or bans on the import of cars. According to a Wall Street Journal article:

“Malaysia once harboured ambitions to be the Southeast Asian regional automotive manufacturing hub. But it lost in the race to attract foreign carmakers after Thailand — now dubbed the Detroit of Asia — showered investors with generous (export) incentives.”

But Malaysia also had those export incentives, and they did not work. They worked in Thailand because its policies had already allowed it to create an efficient car industry as a base for exports. Today those policies would be banned by the anti-protectionist dogmas now rampant — dogmas ironically created in part by Malaysia’s failures.

The Thai example could be applied worldwide, even in some of the basket-case economies in Africa and the Middle East. The formula is simple. If you are a small, weak economy, first form a trade bloc with neighbours to create a market large enough to attract investors. Then begin to ban the import of low technology goods needed by that market. From then on do as Thailand did.

At each stage there will be some temporary price increases for local consumers, and the investors will complain how they are being blackmailed into local production in order to protect what they have already invested. The anti-protectionist free traders will complain even more. But the final result could be the creation of industries able to absorb unemployment, reduce crime and produce goods that can sell around the world.