Sri Lanka warned by IMF on negative effects of import substitution

IMF      Sri Lanka’s drive towards trade restrictions and import substitution may hurt the country, as autarky has consistently failed elsewhere, an International Monetary Fund official has warned.

“It is not a matter of opinion. It is not a matter of IMF doctrine,” IMF resident Koshy Mathai told reporters in Colombo.

“It is simply a matter of fact. So I think we have to be very careful when it comes to import tariffs meant to protect a whole number of different industries.”

Import protection allows political favoured businesses to target helpless and less affluent consumers in the country without full competition from other producers in different geographical regions.

The domestic producers also arbitrage or collect the import duties that would otherwise have gone to the state, in the same manner as a smuggler or a bootlegger does as artificial unjust profits or ‘rents’.

This can lead to the build of up large inefficient monopolies especially in small countries.

Already monopolies have been built in areas related to people’s shelter that are not competitive enough to export analysts say.

Total Failure

“The increase in export and import taxes, we think will go against the direction of trade liberalization and competitiveness,” Mathai said.

“We fully agree with the goal of establishing food security for a country but at the same time import substitution as an ideology is a total failure.

“That’s been proved in country after country for the last half century.”

Sri Lanka’s food prices are also higher than the region due to self sufficiency, which critics have said is hurting the poor and may be contributing to malnutrition particularly in children of the poor, while providing rents to landowners and farmers.

Analyst say ‘self sufficiency’ and ‘import substitution’ were propagated by the so-called ‘historical school of economics’ in Germany, in an economic nationalist agenda that complemented that country’s overall aggressive nationalism at the time.

In Germany itself the Freiberg school of economics and Ordoliberalism replaced historical economics after the defeat of Hitler, leading to freedom and friendship and the so-called post-war German economic miracle (Wirtschaftswunder).

But its legacy lives on in countries like Sri Lanka.

Economic Nationalism

The person who originated protectionists policies in the West, America’s Alexander Hamilton, whose ideas were later borrowed by Germany, only advocated its use on industries and not food.

Economic historians have pointed out that ‘food security’ as an economic goal was given impetus in Germany after it was blockaded by Allied powers during World War I, itself an outcome of aggressive German nationalism.

In Sri Lanka’s 2014 budget a series of taxes were raised on imports including new ones such boats, allowing boat making businessmen to target fishermen with impunity and earn rents and pharmaceutical firms to target the sick and the old, critics say.

Export taxes were imposed on primary goods makers such as rubber and cinnamon, penalizing efficient producers who are already exporting with less than world prices.

 Mathai meanwhile warned that such policies will also ultimately hurt exports.

“It will be much more efficient – rather than from an accounting sense trying to reduce your imports in order to improve the balance of payments – much more important to promote exports in our areas of comparative advantages.

“And not provide artificial incentives for capital and labour and other factors of production to shift into import substitution when it may not be in the country’s best interests.”

Cheaper food would also raise overall living standards and reduce wage costs, helping boost export competiveness.

Economists have pointed out that higher salaries paid by profiteering import substitution businesses will also raise overall salaries and costs of production.

But workers themselves will not benefit due to higher overall price levels due to protection. (LBO)

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