I have written a lot about how counter-productive our trade policy tends to be. In summary, we seem to have a penchant for using prohibitive measures on imports, such as tariffs and bans, as a means for spurring domestic production.
The policy makers who promote this policy argue that such measures shift demand from imported goods to domestic manufacturers which create jobs locally and all that. As I have argued many times before, the policy typically doesn’t work out that way.
First, import prohibitive measures result in higher prices for both imported products and domestic substitutes. Which means consumers suffer a welfare loss from such policies. I have also previously argued that, at least for agriculture, import prohibitive policies don’t necessarily result in welfare gains for farmers. They may be producers, but they are also consumers of the very same products.
Therefore, the welfare gains depend on their net production. If they produce less than they actually consume, then they are losing from such policies. Given that the vast majority of our farmers are subsistence farmers, then that may not be too far-fetched. But what about the large producers? What impacts do such policies have on larger producers? To answer that, we need to understand the difference between productivity and profits.
First, productivity; every economic activity requires the combination of some inputs to produce outputs through some processes over certain periods. As a farmer, for instance, land is combined with seeds, fertilizer, labour, and some other stuff to grow crops during one farming season. Or as a tomato paste manufacturer, you combine tomato concentrate, packaging, labour, electricity, and others to produce tomato paste.
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Productivity measures how much output you produce from a given level of inputs, and productivity growth in essence measures how much more output you are getting from the same inputs. As a rice farmer for instance, if you were able to increase your harvest from 0.5 tonnes per hectare to 0.7 tonnes per hectare, then we can say your productivity has gone up. Or if your factory used to churn out 10,000 tins of tomato paste per month, but with the same resources you are able to churn out 12,000 tons, then your productivity has gone up. Its important to note that productivity growth does not mean just producing more but producing more with the same resources.
Profit, on the other hand, is simply the difference between revenues and costs regardless of what happens with productivity. For instance, consider a case where your rice farm has a yield of 0.5 tonnes per hectare but due to some reason, the price you received for rice doubled with your costs remaining relatively fixed. Your profits would go up even though your farm productivity hasn’t changed. In fact, if the price of rice goes up enough, your profits could be higher even if your yields drop to 0.4 tonnes per hectare.
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The important takeaway is that profit growth does not necessarily mean productivity growth. Economists tend to care a lot more about productivity growth because that usually implies more economic activity or at least more efficiency. Profit growth is complicated because you could have higher profits with less economic activity. Profits could simply imply a transfer of value from one party to another without any increase in economic activity. In short, increasing profits do not represent increasing economic activity.
So, back to the main question of what impact policies that prohibit imports have on domestic producers.
First, import restrictions almost always increase profits for domestic manufacturers; although, as we have learned, increased profits do not mean much, and in this case, is simply just a transfer of value from consumers to producers. Do such policies increase productivity of domestic firms? The answer in most, but not all cases, is No. Think about it from a practical standpoint. Improving productivity requires effort. What incentive is there for businesses to put in effort to increase productivity if higher profits are already guaranteed?
Consider the fortunes in the domestic palm oil sector for instance. Between 2015 and 2016, the devaluation of the naira combined with a de facto barrier on imported palm oil imposed by the CBN banning the use of foreign exchange for palm, boosted the fortunes of domestic palm oil producers. Domestic producers like Okomu oil and Presco increased their profits by 100 percent and 80 percent respectively. What happened to their productivity? Well Nigeria’s overall output remained stable at about 970,000 tonnes, so it’s safe to say there was no increase in output.
Our yield per hectare remained the same too at 25,597 hg/ha. So, despite the increase in profits, there was no corresponding increase in productivity. It’s also not the case that there was no room for improvement as our yields are significantly lower than Ghana’s at 69,992 per hectare, Indonesia’s at 171,571 per hectare, and Malaysia’s at 172,601 per hectare. Did our domestic firms try to increase productivity? Presco, one of the two largest producers, actually reduced their research budget by almost 50 percent over the period. After all, why put in the effort when you have guaranteed profits?
The dynamics are not unique to the palm oil industry but replicate themselves in most other sectors where import barriers are erected. The result is typically more profits for domestic firms without any increase in productivity. If you combine that with the losses by consumers due to higher prices, then the overall result of such policies is a net loss for the economy.
If import prohibiting trade polices don’t improve productivity, then what does? Competition and innovation is the not so secret answer. Competition, forcing businesses to put in effort, and innovation rewarding businesses that figure out better ways of producing things. This does not imply that there is no room for trade policy, but the target must always be productivity growth, and competition and innovation must be at the centre of such efforts. Else, we are really just moving round in circles.
Nonso Obikili is an economist currently roaming somewhere between Nigeria and South Africa. The opinions expressed in this article are the author’s and do not reflect the views of his employers.