Quadrant – October 1996

SIR: Lloyd Peasley (September 1996) points out the costs to Australian consumers from tariff protectionism. But the choice is not between tariff protectionism and no protectionism. In Australia’s case, it has to be between tariff/subsidy protectionism and exchange rate protectionism. The latter has imposed far greater costs on the Australian consumer.

Let’s say that as a result of heavy imports and poor export performance the Australian dollar falls from a value of 200 yen down to 100 yen (in fact it has fallen from around 400 yen to less than 100 yen in the years since our economic rationalists gained voice). This is equal to a 100 per cent across the board tariff on every product imported into Australia – something even the wildest tariff protectionist would not advocate.

The burden on Australian consumers is enormous. Instead of paying say $10,000 for a 2 million yen Japanese car, they end up having to pay $20,000. Worse, most of the extra $10,000 they pay ends up in Japan. With tariff protectionism most of the extra does at least stay in Australia.

The loss to the consumer does not end there. To the extent that the Australian dollar price of imported Japanese cars increases, Australian car makers can jack up their prices also. Consumers also lose out via increases in the prices of exportable goods.

This is not to say that exchange rate protectionism is necessarily worse than the alternative of tariff/subsidy protectionism. If Australia is clearly losing competitiveness vis-a-vis the rest of the world and there is little hope of recovery, then it has no choice but to adjust its currency, and the sooner the better, even if that does mean a severe welfare loss for Australian consumers via the worsening in Australia’s terms of trade.

Delay in the exchange rate adjustment – the inevitable result of the laissez faire policies of the economic rationalists – creates the worst of all possible worlds. Industries that might have survived if the exchange rate adjustment had come quickly, gradually go to the wall. As they go out of production, imports surge. The very large balance of payments deficit that results then forces a much larger exchange rate fall than would have occurred if the fall had been brought about in a planned way about much earlier. The resulting exchange rate protectionism, and the damage to terms of trade and the welfare of Australian consumers, is much larger than it needed to have been.

Exchange rate protectionism is a very blunt weapon. It provides across-the-board protectionism for all import-competing industries, including many that do not deserve protection but have been able to survive thanks to political power – many of the textile and garment industries for example. It provides subsidies for export industries that do not need them – minerals for example.

Tariff/ subsidy protectionism is far more selective and controllable. Combined with sensible industrial policies, it is in effect a tax on consumers to protect or encourage industries that have been judged vital for Australia’s future – i.e. industries which have a good chance of gaining or regaining international competitiveness, and whose existence will ease balance of payments deficits and hence the far larger imposts placed on consumers via unplanned exchange rate protectionism. Most taxes on consumers are for objectives far less worthy than that.

Almost every Asian economic success story shows a mixture of exchange rate and tariff/ subsidy protectionism. Both were severe burdens on the welfare of Asian consumers at the time. But they were handled well, and the result was the establishment of the industrial base that allows these economies to grow so vigorously and to benefit consumers so much today. Meanwhile Australia, through the naivete of its laissez-faire policies, has not only managed to destroy much of its industrial base. It has also ended up having to embrace the massive, but delayed (and therefore far less effective), exchange rate protectionism which does so much harm to the welfare of Australian consumers.

Laissez-faire makes sense if it is clear that resources used in non-competitive industries will move easily and quickly to more competitive industries. For example, if the Australian mining industry was short of both labour and capital and could easily expand both production and sales, then it would be in Australia’s interests to put its non-competitive car industry out of business and concentrate on minerals.

But this clearly is not the situation Australia faces. The loss of the car industry does little to help the minerals industry, or any other industry for that matter. It simply adds to unemployment and loss of skills. It puts other and perhaps more competitive industries (for example, the aluminium car parts industry) at risk. The trade balance worsens. The Australian dollar collapses. The resulting exchange rate protectionism helps the few other surviving industries, of course, including some that do not even deserve such help. But that same help could have been delivered to the deserving industries much earlier and at much less cost to the Australian consumer by a program of planned exchange rate adjustment and limited tariff protection.

That other favourite laissez-faire argument – that if our industries are non-competitive, that is simply because managers are lazy and need the spur of lower tariffs – shows a total misunderstanding of how industry works and of Australia’s competitive standing in the rest of the world. But that is not too surprising, given that the main sponsors of economic rationalism were bureaucrats and academics based in Canberra.