Global Trends by Martin Khor

Monday 8 August 2005

Looming threat to local industries

Blurb:   The challenges faced by Proton in Malaysia and local firms in other developing countries point to the need for new coherence between trade and industrial policies.  But before that can happen, the current WTO talks threaten to overwhelm local industries by cutting tariffs across all sectors to very low levels, even before they can compete.


The debate about the fate of Proton Saga as it faces stiffer competition from imported vehicles points to a larger question: the challenges posed by trade agreements to local industrial firms in Malaysia and throughout the developing world.

In the case of Proton, its cars are facing competition arising from the Asean trade agreement.  Import tariffs have to be brought down, and vehicles made or assembled in Asean countries will be able to enter Malaysian markets more easily. 

However, very steep reductions in import duties of manufactured products not only from Asean but all parts of the world could also be imminent.   That’s because of the negotiations going on at the World Trade Organisation on “non-agricultural market access” NAMA), which covers industrial products and a few other sub-sectors such as fisheries.

This round of WTO talks are still targeted to finish at the end of 2006.   After the completion point, implementation will begin to cut the tariffs as committed, and the full implementation will be within some years, perhaps five.

Thus, in a few years from now, Malaysia and other developing countries could be asked to brace itself to face a new flood of cheap imports.  That is good news for consumers who will enjoy more choice and cheaper prices.

But it may spell trouble for domestic firms that are unable to compete without the shield of tariffs.  Some will close or reduce sales, and retrench staff.

The workers may find it hard to be re-employed if all the other industries are also affected by tariff cuts.  

Consumers may benefit from cheaper and better-quality imports, but those who lose their jobs and can’t find other equally well-paying jobs will have no or less income with which to buy the cheaper products.

It has been argued that if a local industry cannot survive free competition, especially after years of protection, then it does not deserve to survive. 

In a more ideal world, that may be true.  The inefficient industry or firm closes, and its resources and workers transfer to more efficient industries which can compete without protection, earning higher income without protection, with gains to the economy as a whole.

In the real world, it is more likely that if protection is removed across the board (in all sub-sectors), suddenly and sharply, then many industries and firms will be hit simultaneously.

This “big bang liberalization”, as it is sometimes called, would more likely harm than benefit the whole industrial sector and the economy.

Many African and Latin American countries have been hit by this kind of “big bang liberalization” when they were asked by the International Monetary Fund and the World Bank to cut their industrial tariffs to low levels, as a condition for obtaining new loans during their debt crises. Up to now the local industries have not recovered.

Most Asian countries have escaped this kind of “forced liberalization” as they did not come under IMF-World Bank control, and they managed their own liberalization process in more appropriate ways.

At the WTO, countries have till now had the right to choose at which levels to maintain their bound tariffs (that is, the maximum tariff levels above which they commit not to exceed) in the various products, and at which rates to cut them, if at all.

This freedom of “policy space” is coming to an end.  The WTO negotiations have produced an understanding that for the first time the developing countries will have to  compulsorily cut their tariffs in all (or almost all) products.

This would be done by subjecting the tariffs to an aggressive “Swiss formula”, in which the higher tariffs will be cut by a higher percentage.

The rates of cut are expected to be drastic, but how drastic will depend on the coefficient in the formula.  The coefficient represents the maximum tariff level, after the reduction exercise is completed.   The lower the coefficient, the greater will be the reductions.

For example, the United States has proposed a coefficient of 8.   With this, an existing bound tariff of 60% will be reduced to 7%.   All bound tariffs that are now above 60% will be reduced to between 7 to 8%.   Existing tariffs between 23 to 60% will fall to between 6 to 7%; and existing tariffs between 8 to 23% will fall to 5 to 6%.

Many countries bind only some and not all their tariffs, and have till now been free to determine at what rates to set the applied (or actual) tariffs for these “unbound products.”  Usually the “unbound” tariffs are for sensitive products which are produced locally and thus require tariff protection.

Malaysia has bound 81% of its industrial product lines, and thus 19% of the products are not bound, according to the WTO’s World Trade Report 2005. 

However the developed countries are now proposing that all the unbound tariffs be now bound, and through a calculation method that would drastically reduce them to very low levels.  Thus the sensitive locally-manufactured industrial products are also targeted for steep tariff cuts.

In a draft of principles for tariff reduction adopted by WTO members in July 2004, developing countries are given some exemptions (from binding the unbound tariffs and from the full rates of tariff cuts under the formula).

But these are very small, amounting to only 5-10% of products and limited to 5-10% of the total value of the country’s imports.  The developed countries are proposing to do away with or reduce further this already small degree of “flexibility”.

If the developed countries’ proposals go through at the WTO, it may spell the end of many local industries in many developing countries.

True, the foreign industrial firms may still find it profitable to operate in developing countries.  However, there is limited foreign investment worldwide, and foreign firms can only employ a minority of the industrial workforce.

Moreover, foreign firms increasingly prefer to locate in or relocate to countries with low-cost labour, such as China and Vietnam.

Thus, industrial development has to rely mainly on local industries and firms.  And the history of the United States, Europe and Japan show that their local industries grew under high tariff protection which prevented the entry of cheaper imports that would have ruined their local firms.

It was only when their local firms became competitive did these countries lower their industrial tariffs. And these rich countries are still protecting their inefficient local sectors (textiles, agriculture) under high tariff walls. 

Now that they have reached high industrial status, the rich countries are preaching to the less advanced nations that they should bring their tariffs down to very low levels, on the argument that competition will bring about efficiency.

Their pressures on the developing countries at the WTO are well advanced.  And the local captains of industry of developing countries are hardly aware of the dangers lurking just ahead.

When the talks at the WTO resume in September, there will be only one last chance for the developing countries to get their act together, to argue the case for a more realistic schedule for tariff reduction, instead of the “big-bang liberalization” approach that can spell doom for many a local firm.

Otherwise the kind of challenge that is now facing Proton in Malaysia, and many other local firms in other developing countries, will be only the tip of a large iceberg.  The future of industrial development itself is at stake in these talks, though few economic planners, let alone political leaders, are aware of it.