Protectionism or Free Trade?

A while ago I came across a news story about imported potatoes. With the decision of Cabinet of Ministers, the tariffs on potatoes are doubled, from the previous rate of 15% to 30%[1]. This might not be a binding decision, because as Minister of Agriculture, Inam Karimov himself mentioned, Azerbaijan’s potato production is two times more than its consumption[2]. Considering this statistic, how does the new law fit in? and overall, what is going on with protectionism in Azerbaijan?

Firstly, if we really produce almost twice the amount of potatoes than we consume then naturally the price of the good should be reasonably low in local markets. And if the foreign farmers were still able to offer cheaper goods despite 15% tariffs + costs associated with transportation while we had surplus supply, then clearly, foreigners have a wide advantage over us in potato production. We are not good at producing potatoes and these extra tariffs will not change it for the better. Keeping in mind that this good is a vital product for majority of low income families, the law itself and the absurd explanations by the officials makes no sense to me. It is either they have not thought of the law as a whole or there is another bureaucratic reason behind. At this point you may argue that a considerable amount of people gets their livings from harvesting this crop, but then if we have colossal surplus production, where are these goods supposed to go? Only option is to other countries (assuming Azerbaijani household will not double their potato consumption in a matter of months). Yet as far as common sense goes, higher import tariffs do not boost exports in any way. As a matter of fact, they tend to do the opposite as trade restrictions are usually mutual. Thus, that argument also seems invalid. It almost feels like we are back to Mercantilism with gold/silver being replaced by potatoes.

I am not going to dedicate this post to potatoes, but nevertheless, it underlines a critical approach towards free trade in Azerbaijan that has reigned for years.

Free trade is a widely discussed topic in economics today. It is accepted that if country A and B focus on producing different products and then trade, both of them will be better off. Nobody denies the fruits of free trade, yet countries usually take protective measures for a number of reasons, particularly:

A. Protecting Local Infant Industries: when a certain industry is being newly developed most of the time it needs some sort of support to safeguard it from competition of other countries which have already developed that particular industry. It is understandable that under the conditions of free trade, the infant industry could not compete with developed “players” in the market who have achieved specialization and economies of scale far earlier.

B. Decrease Import Dependency/Combat Balance of Payment Deficit: importing too much from abroad means that the money is going to flow out of the country, which is an undesirable situation from the point of view of national economy. Governments usually hope to constrain the imports by using tariffs and other trade barriers.

C.  Protect Critical Industries: developed countries usually protect their agricultural industries so that they can support their nation with food if the international trade fails to provide enough resources for a certain reason. This allows the country to be more independent in its decision making process.

D.  Prevent Unfair Competition: more advanced states tend to have higher environmental, safety and labor standards than developing countries, which makes cost of production more expensive for them. In order to compensate for that “cost gap”, protectionism is a widely used tool against “unfair trade”.

E.  Collecting budget revenues: tariffs are a source of revenue for the state budget. However, in 2017 the total revenues from customs duties equaled 706.9 million AZN in Azerbaijan, which is only 4.3% of total budget revenues[3]. Thus, it can be argued that tariffs on certain products can easily be decreased without putting much pressure on the state budget. For that reason, I will be ignoring this motive for the rest of the paper.

Considering these motives in mind, where does Azerbaijan’s protectionist policies fit in? Certainly (D) prevent unfair competition is not the reason. If anything, we can be a source of unfair competition for Europe and other developed countries, considering low standards for labor/safety, as well as an exchange rate regime that is de facto controlled by the government. You may argue that regional countries such as Turkey, Russia and Iran experienced large depreciation of national currencies this year and it will be unfair for Azerbaijani producers (which I agree), but as you will see below, we are restricting goods not only from these countries, but also goods coming from other countries with much more stable currency, such as Euro or US dollars. This leaves us with the other three motives. In order to analyze the topic further, let’s look at these motives on two product groups: agricultural products and manufactured goods.

  1. Agricultural products: majority of agricultural goods in Azerbaijan are subject to tariffs, which is usually 15% or a specific amount per unit. Of the three remaining reasons for protectionist measures, (A) – protecting local industries can not be true in this case, as agriculture is definitely not an infant industry in Azerbaijan. I am not arguing that this sector is developed, but it is not a new sector either. Thus, the reason behind agricultural tariffs are a mixture of two motives. Firstly, as motive (C) – protecting strategic industries mentions, it is not wise to abandon agriculture altogether (despite being a low income sector for the economy) due to food security. Additionally, the tariffs may have been imposed in order to shrink foreign deficit in accordance with motive (B) – decrease import dependency. Such short sighted policies, on the other hand, completely miss the point of international trade, which is specialization and economies of scale. Perhaps the reason behind our stagnating non-oil economy is the fact that these sectors lack motivation to improve themselves. It is easier for a large company to lobby for protectionist measures rather than actually improving itself to withstand foreign competition.
  1. Manufactured goods: vehicles and their parts, electronics, pharmaceuticals etc. are the product categories that Azerbaijan imports the most with almost no export. Most of these products are also subject to tariffs either at 15% or a specific amount. We can confidently say that they are not a strategic good, so the reason (C) – protecting strategic industries is out right away. How about motive (A) – protecting infant industries? Well, Azerbaijan does not produce electronics or majority of pharmaceutical goods, but it does produce cars (at least tries to). First Nakhchivan Automobile Factory (NAZ) and now Azermash is producing cars designed for domestic and CIS markets. Yet do these import tariffs really protect the infant industry? I can ensure you that this is not the case, as NAZ was reported to produce only 21 cars during first six months of 2017[4]. People do not stop buying far superior foreign cars and switch to NAZ because of tariffs. The protective measures also are not going to help to achieve motive (B) decrease import dependency as well because once again, people do not have a real alternative. There are no local telephones, laptops, cameras, televisions, game consoles on the market, so what is the point of higher tariffs on these products? Which infant industry are they supposed to protect? Which alternative local products are they going to make more competitive? The answer is none. Maybe these tariffs are levied for the purpose of diminishing imports? Even in that case, they are ineffective because telephones, laptops etc. are now an essential part of every day life for majority of people in our country. I would argue that they have somewhat of a more inelastic demand nowadays, which effectively undermines the motive (B).

Conclusion

I believe that well-regulated free trade can increase welfare of the people to a great extent. The real question is, how do we define “well-regulated”? Certainly, imposing tariffs on goods that have no local alternative for the mere purpose of raising revenues for the state budget cannot be considered as a good regulation. This is exactly what is happening in Azerbaijan when it comes to goods such as electronics, vehicles and other manufactured goods which usually do not have a domestic substitute. I agree that trade barriers may be needed in Agriculture in some cases from the food security point of view, but they also undermine the incentives towards more efficient and specialized production. Perhaps it is time for Azerbaijan to change its policy on international trade. It would not be an easy process as a lot of people, particularly those working on agriculture may face the risk of losing their jobs, but those losses can be offset by temporarily redistributing income from “winners” of free trade to “losers”, as well as educating population in real vocational schools for allowing them to specialize in a certain trait. In my opinion, rather than giving export subsidies, creating state owned manufacturing companies and imposing trade restrictions, this long and tough process of trade liberalization is the only way to successfully improve the non-oil sector of Azerbaijan.

Footnotes

[1] https://www.cabmin.gov.az/page/doc/3008

[2] https://az.trend.az/azerbaijan/society/2950593.html

[3] http://www.maliyye.gov.az/node/966

[4] http://marja.az/news/10348

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