Here's today's AFR column.
No pain no gain. Were all familiar with the cliché. Meet its twisted sister. Courting the pundits respect for taking tough decisions, our politicians simply make the economy worse. Call it all pain, no gain.
In the next few weeks the Federal Government will lower tariffs for cars and apparel even though simple economics says tariffs shouldnt fall further unless matched by our trading partners. Why? Because if we cut tariffs we import more — thats the point of the exercise. And to pay for those imports we export more. And to export more we will slightly cut our export prices. Bearing that small cost is fine if we're reducing high tariffs, but low tariffs impose miniscule costs, and they raise revenue that will have to be raised some other (costly) way.
The major decision makers know all this. But they explain patiently they can't stop tariff cuts because it just wouldnt look right. They're not referring to the economic merits here, but rather to what the pundits might say.
Now, pointing to the emperor's lack of attire can be hard work from Opposition. But its usually a doddle from government where your decisions control of the agenda and can be chosen to illustrate the tradeoffs being made. When, after years of economic reform the zero tariffs parcel was passed to Dr Hewson did it do Paul Keating any harm to point to the costs of going all the say? Does the Federal Government really want to find the billion odd dollars extra revenue tariff cuts generate every year?
Still this is small beer compared with the pundits' fiscal policy. It sounds so responsible to minimise debt. But debt can fund more infrastructure which improves amenity and accelerates economic development. Whats not to like about the economics or politics of that?
And the alternative? Well behold the NSW Government still shuffling towards its political grave with the contradictions behind its arbitrary minimisation of debt still ripping it apart — AAA rating and all.
All this because State Governments havent had the stomach to give their opponents a few cheap shots about rising debt though of course theyre taking them anyway! In addition to controlling the political agenda, governments should also develop independent institutions to ensure infrastructure projects are well chosen and to reassure the public of their fiscal prudence.
Thus when battling perceptions of his party's past fiscal laxity Steve Bracks as Victorian Opposition leader promised to get the Auditor General's seal of approval on government budgets. And so he did, but then retired back into debt aversion and under-investment in infrastructure which is now making life interesting for his successors.
And all this could really matter at the Federal level sometime soon. A few years ago I proposed that governments should start moving the institutions of fiscal policy towards the model offered by monetary policy. For instance the government could build some independent institution to publicly advise it on its fiscal stance, including on borrowing to invest in infrastructure and other assets (including financial assets). This would have cramped the Governments profligate style during the boom and so went nowhere.
But what if the economy turns down? Forecast budget surpluses would be at risk. Then, as the inevitable political pressure comes on, well be told - even though we've sensibly posted tens of billions of dollars in surpluses (and yes it should have been more) - that we have no choice but to prune the budget. Why? Because letting the budget bottom line suffer might be good for the economy, but it would look bad. It would offend the pundits.
Economists who want to run the economy according to the best guidance our discipline gives us will be complimented on our candour and forthrightness. But it will be patiently explained to us that doing the wrong thing economically will play better with the pundits as indeed it will — at least for a while.
Still Im hoping that some in the Government, looking at the demise of Morris Iemma and with their eyes focused on making it through the political cycle over the next 24 months might be prepared to brave a few 24 hour news cycles to talk the talk and build the institutions that can help us apply ourselves to fighting the next downturn as best we know how. Some long term futures might depend upon it.
It mighn't be all beer and skittles. But then, as they say, no pain, no gain!
Part of the problem, Nicholas, is that we are still caught in mind traps from the past. If you remember back to your time in JB's office, we were coming out of the admittedly crazy protectionist world. This made it very hard to get anything up that smacked of direct assistance. This thinking is still around.
These claims are recycled nonsense Nicholas and (I suspect) you know it.
Simple economics? My ass. There is no presumption in international trade theory that a small country such as Australia should condition tariff reductions on tariff reductions by neighbours. What you are recycling is your idiosyncratic and absurd theory that because Australia has price setting power in export markets and does not exploit this power, by setting an optimal tariff that this failure can be redressed by imposing low tariffs on imports.
Even if I was wrong in my claims (and I am not) there is no way that this is 'simple economics'. It is absolutely not 'simple economics'.
At best it is idiosyncratic economics.
It is also just wrong because what you are suggesting is that the factor substitutions that would be engendered by a tax on exports will be equivalently achieved by input shifts resulting from a tariff on imports. That's wrong in fact - restricting exports by an optimal tariff will not shift resources in the same way that a tax on imports will in an economy with more than two economic sectors - and doubly wrong because of the a priori assumption you make that monopolies governing our mineral exports are not already extracting rents. If monopoly power captures these rents then an optimal tariff on these exports is redundant anyway.
There is not a reputable international economist in Australia who would agree with your views and I wonder about your motives for expressing them. Is there a commercial interest or just a pig-headed insistence that a theory that you espouse which would have zero support from anyone who knows anything about trade is right regardless of the illogic?
The article is a harmful input (one repeated many times before) into Australian trade policy debate.
I asked one of Australia's most prominent trade theorists about your earlier attempt to rescue protectionism and before I got half way through my inquiry he said 'Don't tell me its one of these silly 'optimal tariff' arguments. But in the end it was and I felt embarrassed that I even wasted 10 minutes of his time with the inquiry.
Try another line in op-eds. Perhaps one that doesn't draw on international trade theory.
Where did Nick say anything about "optimal" tariffs? I gathered his argument was that Australia's tariffs are already lower than those of our trading partners, and indeed generally very low, so we stand to lose by cutting ours further before they at least cut theirs to match ours. I don't see any implication that there is some optimal (non-zero) tariff all trading partners should ultimately be aiming for.
Hi Harry,
Nice to see you back here - I don't know how you manage to do it but you always turn up with a few views for us whenever I mention this topic.
What do you think of Peter Dixon. Is he reputable?
NPOV,
You have the wrong end of the stick. The level of others' tariffs is largely irrelevant to the argument except in the specific way in which they were brought into the discussion. That is, there is no case for cutting tariffs below some level unilaterally because the result will bring more costs than benefits (this is regardless of others' tariff levels). The exception is that if it helps us get access to others' markets - if its part of a deal in which they cut tariffs reciprocally with us, then the costs of reducing our tariffs are lower and the benefits greater and we should go further. But if tariffs were higher, there would be a strong case for cutting unilaterally. The point is however that the level of others' tariffs does not enter directly into the question of whether there's a good case for reducing our own tariffs - what's relevant to the unilateral case is (generally) the level of one's own tariffs.
Nick...hmm...ok...so if our trading partners all had zero tariffs today, there would still be a case for us maintaing our tariffs?
Good question - clarifies the point. The answer is 'yes'.
That would seem to ignore the likelihood that our trading partners would look over this way and think "hmm, well if they still have tariffs, we might just have to introduce them here too".
Sorry, but I don't get it. I completely accept that cutting tariffs will lead to more imports, but where is the problem with that? After all, what is the point of exporting anything if it is not to buy imports. If we reduce imports we have to either miss out on those goods or have dearer local substitutes. Where's the gain? I also accept that the benefit for further cutting already very low tariffs is limited and I don't mind the idea of a tariff as a tax to pay the cost of AQIS.
Pedro, it's explained in the piece. We sell exports to pay for imports. If we cut their price to do so that generates a cost. Now tariffs also generate costs. So you have to work out which effect dominates. At high tariff rates the efficiency effect of cutting them dominates, below some point - the optimal tariff point - the cost of cutting one's export prices dominates.
NPOV, here are 3 seperate arguments about tariffs here:
- the traditional view, founded in some rigorous logic, that tariffs always cause you a net loss in income, no matter what others do. So you cut them no matter what others do.
(Personally I agree with this but unlike Harry I think our current tariffs are so small that it's not a big issue anyway).
- Nic's view, only slightly less traditional and just as logically rigorous, that if your exports are monopolies or near monopolies you can make an extra buck by keeping some tariffs, no matter what others do. So you keep them no matter what others do.
(The logic's fine, but just point us to the export monopolies, Nic).
- the "strategic" one that our tariffs cause us loss in net income but cause others even more loss. So you keep them "temporarily" as bargaining chips in agreements to make others reduce their tariffs.
(This one is beloved of trade negotiators - it gives them a reason for existing. In the real world keeping tariffs makes others more, not less, likely to keep theirs - as you point out.)
DD,
It might be better to have the debate without cutout figures like 'monopoly'.
You don't need monopoly. You just need to believe in the proposition that you're in a market where you can't expand your exports without (slightly) cutting their price. That's a completely mainstream assumption. I know of no modellers of the Australian economy who don't just make that assumption in their modelling but who don't also believe it.
The PC's modelling assumes that this parameter is 10 - ie that for each one percentage point of price reduction we get a ten percentage point expansion in sales. I'd guess it's a bit lower than that - say 6-8 and Peter Dixon (thinks it's closer to 4). But let's go with the PC's latest preference. That makes the optimal tariff 11%. The current auto tariff, which we will shortly announce unilateral intention to cut, is 10%. So it will reduce welfare by a small amount. And that's before you scrabble round trying to collect the revenue that it gives away - imposing additional costs.
Go figure.
My use of "monopoly and near monopoly" was for clarity of exposition, rather than saying "inelastic demand". Sorry for the looseness of expression.
I'm still not sure that our long run pricing power in commodities is significant - the time series econometrics can really only pick up the short run quantity responses. These are always much higher than the long run ones because we have competitors who will eventually react.
But why single out cars? It seems to me you're only making a case for a low and broad-based tariff (with consequent effects on the exchange rate), rather than one that picks out a single narrow import sector. Even if the optimal rate of the broad-based tariff was 11%, it doesn't follow that the optimal rate of a narrow based one is, because a narrow tariff will only have a muted effect on the exchange rate while causing the internal distortions of resource use that traditional theory predicts.
I think your penultimate sentence may be double counting, BTW - the conventional comparative static net welfare calculations of tariffs implicitly includes the transfer of consumer and/or producer surplus to the tariff imposer (ie the government).
DD,
It's true, it's basically impossible to estimate the long run elasticity of export demand with any accuracy - so you have to go with your best guess. Ten is a big number.
Below is an extract from the discussion on elasticities of export demand our paper.
Your point about double counting is a reasonable one, but we discussed that and concluded that the whole cost of replacing the revenue from the tariff was not accommodated in the normal modelling.
Nicholas, how do cheaper import costs make exporters reduce prices to increase exports? Won't the immediate impact be on the current account with flow on adjustments to currency values? It seems to me that your theory assumes a visible hand for our market.
Tariffs are a combination of consumption tax and rent and so the general benefit comes from the reduction in the rent and the missing tax could be made up with a different tax. Even a general tariff produces something of a rent because it benefits manufacturers focusing mainly on the local market at the expense of everyone. But a small general tariff to pay for AQIS etc seems like a good idea to me.
Yesterdays drop in the currency did more for Holden than any tariff retention could. don't know how much ford and toyota export.
Pedro,
More imports => lower exchange rate => exporting becomes more profitable => we do more of it. To do more of it, exporters reduce their prices (slightly).
The argument regarding the exchange rate is a red herring. Yes there are plenty of other things going on. Always have been. Always will be. If we have a wages boom or cut wages by 20% tariffs would also be a small part of the relative story for producers and importers. So what?
Isn't more accurate to say that the lower exchange rate makes exports cheaper to the buyers and therefore increases demand for them? How does a lower exchange rate make exports more profitable? to the extent that other imports are a factor of production of the export goos then they will be dearer surely?
Lower exchange rates make exports more profitable - certainly if you're contracting in the foreign currency. They make the domestic currency you make from each unit you sell at the price you're selling it in the domestic market greater. So happy exporters that are increasingly profitable fancy making a bit more money by selling more exports but to do so they have to cut their price a bit. So they do - and they do make more money. Bob's your uncle. If they have imported inputs, then the effect is somewhat diluted. But only diluted (so the effect remains in diluted form) - not extinguished. The only way the effect will be extinguished is if it's 100% imported content, which raises the question of why we're exporting it - and what value we get from it if we do.