Does Sophie know she is dumping on free trade?

When Jim asked me to have a drink with him I didn’t expect to be just sitting there watching him read ‘The Australian’ - and certainly not one that was a couple of days out of date. But when I looked more closely, he wasn’t actually reading. He was just scanning as though he was looking for something.

‘Ah, here it is’ he said at last. ‘What do you think of Sophie Mirabella?’

Sophie Mirabella is the federal opposition spokeswoman on innovation, industry and science. I told Jim that I thought Sophie was a clever lawyer. I said I would rather have her on my side of the argument than as an opponent.

‘What about the dumping issue?’ Jim asked.

I said that in my view she was out of order when she dumped on Julia Gillard a few months ago by comparing her to Muammar Gaddafi.

Jim replied: ‘Nah, I mean anti-dumping policy – preventing foreigners from selling goods here at prices lower than they charge in their home markets. Sophie writes here that dumping seeks to exploit Australia’s commitment to free trade and is a distortion of our domestic market’.

‘That’s crap!’ I said. ‘It is quite normal for firms to be able to sell goods in their home markets at prices that are higher than they can obtain in international markets. How could our domestic market be distorted by importing goods at the world price?’

Jim ignored my response and read on. After a minute, he said: ‘Sophie says that when Abbott comes to power she is going to provide for preliminary affirmative determinations (PADs) to “create a shift in the balance of anti-dumping investigations, requiring the foreign producer to prove its conduct hasn’t hurt the Australian industry”. What do you think of that?’

It was hard to know where to start. I could have said it seemed to me to be a peculiar legal principle to ask anyone to prove something that they are not capable of knowing. Instead, I reflected a little on the difficulty that lawyers often seem to have in coming to terms with economic issues. I said: ‘I think Sophie makes the same mistake that a lot of lawyers make when they get involved in economic issues. They see an economic practice that they can’t understand and assume that it must be unfair. In this instance, they see firms selling in export markets at a lower price than in their home markets and jump to the conclusion that they are engaged in some kind of unfair practice, such as predatory pricing. They don’t consider that the firms might be able to obtain higher prices on home market sales because of brand loyalty and other home market advantages. Her efforts to shift the balance in favour of domestic industry will just encourage the rent seekers.

Jim replied: ‘You don’t have a very high opinion of the ability of lawyers to understand economics, do you?’

When I protested to the effect that I think some lawyers have an excellent grasp of economics, he asked me to name one. The name that came to mind immediately was Richard Epstein. (Actually, that stretches the truth a little. I find that names rarely come to mind immediately. Richard Epstein’s name came to mind after just a moment’s reflection.)

Jim asked: ‘So, what does Richard Epstein say about anti-dumping policy?’ I mentioned that I had recently read a short article he wrote about the concept of fair trade that seemed relevant. I suggested that Epstein had made the point that it doesn’t make sense to view business practices in international trade as unfair that would be considered quite normal in inter-state trade within the United States. (When I just re-read Epstein’s article, ‘The “Fair” Trade Delusion’, however, I find that he didn’t quite use those words. And he seems to be implying that FTAs promote free trade – which is hard to sustain. But I am digressing - and at risk of spoiling my story!)

Jim’s line of questioning then took a surprising turn. He asked: ‘Do you think Craig Emerson would understand that the benefits of inter-state and international trade are basically the same?’

Craig Emerson, the current Minister for Trade, has a PhD in economics from a respectable university and knows quite a lot about international economics. I said I was sure that he would know that the benefits of trade between, say, Victoria and Western Australia would not be any less if Western Australia was in a different country.

Jim then said: ‘Then don’t you think you and your mates in Canberra should stop picking on Craig Emerson? How would you like to have Sophie Mirabella running trade policy? Or, perhaps even Doug Cameron, or Bob Katter?’

I responded that it must be time for me to buy Jim a drink.

On reflection, how can anyone respond to a suggestion that what seems to be a disappointment is actually a blessing compared with something worse that might happen? Even the GFC could look like a blessing compared to the aftermath of the European meltdown that the world might experience over the next few months if everything that could go wrong does go wrong. When I think about the approach that Sophie is proposing to take with anti-dumping policy, Craig does seem like a little blessing. My problem is that I thought having Craig in control of trade policy might be a huge blessing for the Australian economy, rather than just a little one.

Would a fair-minded person say that devastation of the Australian apple crop is a price worth paying for cheaper apples?

‘I don’t think any fair-minded Australian would think that the devastation of the Australian apple crop is a price worth paying for cheaper apples.’ Please discuss.

That might be a reasonable examination question for an introductory economics course. The weaker students would probably be distracted by the allusion to fairness and the images that the word ‘devastation’ brings to mind and forget all the economics they had been taught.

There are several ways the stronger students could answer. One point they could make is that a fair-minded person would be open to weighing up the economic benefits and costs of the proposed policy action. They could raise the question of how large the value added by the Australian industry might be after making appropriate adjustments to remove price distortions, such as those resulting from import barriers. A further point they could mention is that market systems have evolved because fair-minded people have been persuaded in the past that the outcomes of market competition were generally preferable to outcomes that applied when governments attempted to protect local producers from external competition. In that context the relevant issue is whether individual consumers would voluntarily pay a higher price for the Australian product in order to prevent devastation of the Australian crop.

There are other relevant considerations, but they do not alter the general point that fair-minded people would accept that the price that needs to be paid for preservation of local industries is not always a price worth paying. If that were not so, our living standards would probably not have improved since the 18th century when regional communities within all countries were all largely self-sufficient.

How does it change the way we view this issue if we are told the quoted statement was made by Craig Emerson, Australia’s Minister for Trade, in commenting on the WTO’s recent ruling against Australian quarantine restrictions preventing apple imports from New Zealand? (The quoted statement was in an article by Geoff Kitney in the Australian Financial Review of Wednesday 1 December, p 49.) The Minister was talking about the possibility that the Australian apple industry might be devastated by a plant disease rather than by price competition from New Zealand apples. Does that make a difference?

One relevant consideration is that the part of the Australian industry that is most vulnerable to import competition from New Zealand will not need to be protected from imported diseases. It will no longer exist.

A paper entitled ‘Australia’s quarantine mess’, by ANU academics Malcolm Bosworth and Greg Cutbush, suggests that the annual cost to Australian consumers of the ban on apple imports was around $250 million per annum. This represents a very large proportion of the domestic industry’s gross value of production of around $300 million and perhaps 10 times more than local growers’ profit in a normal year.

These figures suggest that even if the introduction of apple diseases from New Zealand resulted in devastation of the Australian apple crop it is highly unlikely that any associated losses would exceed the $250 million per annum cost that the ban imposes on Australian consumers. As Bosworth and Cutbush point out, however, the probability of an incursion of any of the relevant diseases is very low under normal orchard hygiene practices, and even in the unlikely event of Australia-wide infection, annual costs of coping with the problem would be in the range of $3 to $10 million per annum. Bosworth and Cutbush also note that the apple diseases present in New Zealand have not prevented it from being one of the world’s top apple exporters.

I have previously thought of Craig Emerson as one of Australia’s most economically literate politicians. It is disappointing that he has seen fit to use his considerable rhetorical skills to imply that fair-minded Australians should always be in favour of protecting domestic industries, irrespective of cost.

Are the economic rationalists in Canberra losing their marbles?

When Jim asked me whether I was an economic rationalist I thought he was just stirring. The term “economic rationalist” has been used mainly in Australia and doesn’t seem to be used much anywhere these days. I don’t think there were ever many people in Canberra who called themselves economic rationalists. Those of us advocating economically rational policies just thought of ourselves as economists doing what economists should be doing. We knew that when people referred to us as economic rationalists they were probably intending to be offensive, just as most of those who refer to classical liberals as neo-liberals are intending to be offensive. But I don’t think the label worried us much. When people referred to me as an economic rationalist I knew that I was among good company.

I admitted to Jim that people had sometimes referred to me as an economic rationalist. Jim then asked me if I thought John Smith (name changed to protect Jim) would be an economic rationalist. I don’t know that I have ever met Smith but he has the reputation of being a good economist, having held senior positions in the Treasury as well as other government departments at a time when major economic reforms were being undertaken. I told Jim that I thought that Smith could be relied on to provide good public policy advice.

Jim then seemed to change the topic of conversation. He asked: “Do you think economic considerations should be taken into account in quarantine policy?” I replied that economic considerations were obviously relevant. For example, it doesn’t make economic sense to implement policies that will raise consumer prices by a huge amount in order to protect a tiny domestic industry, even if scientific evidence suggests a high probability that diseased imports will damage this industry.

Jim said: “So, are you suggesting that quarantine decisions should all be subject to a full blown 100-page cost benefit analysis?” I acknowledged that a full-blown analysis would be too expensive to do every time and is not necessary in most cases because the answer that such a study would come up with was usually obvious. I suggested that the legislation should incorporate a national interest test and require that the economic advice used to apply that test should be made public when decisions are made.

Jim replied: “But wouldn’t that make it difficult for politicians to take account of things like impacts that are concentrated in particular electorates, their concerns that voters might attribute damage to industries from highly improbable events to their mismanagement - and other irrationality that people exhibit on risk.” I said: “So what! If you are designing public policy rules in the interests of the whole community then you want the rules to make life difficult for populist politicians who pander to such concerns”.

Jim said: “I thought you might say that. But John Smith tried to sell me a very different line when I spoke to him in Canberra recently. He said that it would be important for the analysis of quarantine matters by the advisory economist to place higher weights on extreme events and on things with concentrated impacts and to make other adjustments to account for the irrationality that people exhibit on risk.”

I was stunned. All I could say at the time was that I could now understand why Jim had asked me whether John Smith was an economic rationalist.

Jim’s story makes me wonder how many other Canberra people who once advocated economically rational policies have lost their marbles by getting too close to politicians.

Postscript:
A friend and former work colleague has responded by suggesting that it is normal for people providing economic advice within the bureaucracy to advise Ministers on the distributional effects of policy initiatives. I think my friend has missed the point.
As I understand it, John Smith is considering what rules should apply in assessing future quarantine cases. The issues involved take this outside of normal bureaucratic policy advice. There are interest groups who will see quarantine as a way to obtain protection from import competition by the back door i.e. through a non-transparent process. Ideally, the issues involved should be subject to some kind of public inquiry to assess national economic benefits and costs through a transparent process. The fact that this is not practicable in every case doesn't mean that we have to resort to normal processes for bureacratic advice to Ministers. As I understand it what is proposed is legislation that would require an assessment to be made of the relative economic costs and benefits of proposed quarantine action. John Smith seems to be proposing to muddy the waters.

Will the financial crisis lead to more protectionism?

In opening the WTO’s Public Forum for 2008, which is taking place in Geneva at the moment, Pascal Lamy, director-general or the WTO referred to newspaper headlines heralding a potential Great Depression Two. He noted that policy-makers in the United States and across the globe, are desperately seeking to avoid the series of mis-steps that accentuated the financial crisis of the 1930s. Lamy then added:

“They are all stressing that lessons from the Great Depression have been learned, and that the many policy mistakes that were associated with it will be avoided. But one of the important lessons of the Great Depression, which we must not forget, is that “protectionism” and economic isolationism do not work. They are policies of the past, which should have no place in our future” (here).

I suppose that quite a few economists who are concerned about the current financial crisis have recently revisited what Milton Friedman had to say about the origins of the great depression. My conclusion after re-reading the relevant chapter of “Capitalism and Freedom”, is that the policy mistakes that led to the great depression are unlikely to be repeated. I am less sure that the U.S. will avoid the policy mistakes that Japan made at the beginning of the 1990’s - but that is not what I want to write about at the moment.

After I had read what Friedman had to say about the origins of the great depression I then found myself reading his comments on trade liberalisation in the following chapter about international finance and trade. If Pascal Lamy has good cause to be concerned about a rise in protectionism in the current environment – as I think he has - it seems to me that the best way to defend against it would be to revive efforts toward trade liberalisation. The following comments by Friedman on approaches to trade liberalization seem to me to be particularly relevant in the light of the recent failure of international trade negotiations:

“Given that we should move to free trade, how should we do so? The method we have tried to adopt is reciprocal negotiation of tariff reductions with other countries. This seems to me a wrong procedure. In the first place, it ensures a slow pace. He moves fastest who moves alone. In the second place, it fosters an erroneous view of the basic problem. It makes it appear as if tariffs help the country imposing them but hurt other countries , as if when we reduce a tariff we give up something good and should get something in return in the form of a reduction in the tariffs imposed by other countries. In truth the situation is quite different. Our tariffs hurt us as well as other countries. We would be benefited by dispensing with our tariffs even if other countries did not. We would of course be benefited more if they reduced theirs but our benefiting does not require that they reduce theirs. Self-interests coincide and do not conflict” (Friedman, 1982: 73).

Friedman made it clear in the following paragraphs that he was using “tariff” to cover non-tariff impediments to trade as well as tariffs.

It is difficult for those who share Friedman’s views about trade liberalization not to view WTO negotiations as vaudeville. The negotiation process seems to exist to allow politicians to clown around on the world stage keeping their domestic audiences amused, while behind the scenes they continue to pander to narrow interest groups favouring high protection.

Does this mean that the WTO is worse than useless? Not necessarily. The WTO has potential value as a forum that can help member countries to resist the pressures of domestic interests seeking to retain or even increase trade barriers. It seems to me that it is not beyond hope that WTO processes could be used to help individual countries to develop trade negotiation strategies that would achieve the benefits potentially available to them through unilateral reductions in protection. If many countries can induce each other to do this simultaneously, all can also obtain the benefits flowing from reductions in trade barriers of other countries.

How this could happen? The best ideas I have seen are in a contribution to the WTO Public Forum by Bill Carmichael, former chairman of Australia’s Industries Assistance Commission (here).

Is there evidence that institutionalised transparency reduces the political power of narrow interest groups?

Recent posts by Richard Posner and Gary Becker on their blog (May 4 ) discuss US farm subsidies that apparently amount, on average, to of the order of $50,000 per farmer. Posner suggests that these subsidies are outlandish and that “their firm entrenchment in American public policy illustrates the limitations of the American democratic system”. Becker points out that the subsidies are a consequence of interest group competition that tends to favour small groups of producers (who gain substantial benefits per person) at the expense of large groups of taxpayers and consumers (whose losses are relatively small in per capita terms).

I left a couple of comments on Becker’s post, the second of which was as follows:

“... it seems to me that some political outcomes are outlandish even though they can be explained in terms of democratic politics e.g. in terms of the relative power of different pressure groups associated with differential rational ignorance and free-rider problems.
The interesting question is whether better outcomes could be achieved through institutional changes e.g. through procedures to promote greater transparency and thus reduce rational ignorance problems.”

I must confess that the question of whether transparency institutions have the capacity to reduce rational ignorance problems is something that I have thought about quite frequently over the last 35 years, having worked in such a transparency organisation for a considerable part of that time.

The latest WTO Trade Policy Review of Australia makes the following observation:

The high degree of transparency in the formulation and evaluation of Australia’s economic policies in relation to their rationale, nature, and economic effects, enhances government accountability and public debate over the merits of these policies. Hence, transparency has contributed greatly to the continued process of reform, which began in the 1980s, and in which trade liberalization, much of it unilateral, has played an important part. (WTO 2007, p. vii)

The TPRM report emphasised that the transparency function had become
institutionalised in Australia, notably through the role of the Productivity
Commission (and its predecessor organisations) as an independent review and
advisory body on microeconomic policy and regulation.

The role of the Productivity Commission and its predecessor organisations has been discussed in a recent paper by Gary Banks and Bill Carmichael, available here.

In discussing the possible relevance of the Productivity Commission as a model for other countries, Banks and Carmichael suggest that Australia’s experience demonstrates that institutionalised transparency can help promote reforms. They do not suggest, however, that institutionalised transparency is a magic wand.

“Expectations need to be tempered: transparency is unlikely to transform the policy environment overnight. Building a pro-reform constituency in government and the wider community is a gradual process. It took Australia four decades to get tariffs down and more than a decade tackling sources of underperformance in economic infrastructure services. And neither reform program is yet complete.

That said, reforms once made in Australia have tended to stick, having stronger foundations of support or acceptance within the community precisely because the basis for reform was transparent. The programs of tariff liberalisation and regulatory reform initiated under one government have generally been maintained by new governments of different political complexions”.

Banks and Carmichael conclude as follows:

“We recognise that Australia’s transparency arrangements may not suit other countries. There can be no ‘one size fits all’ approach. Arrangements in other countries must necessarily reflect their cultural and political systems, and ensure domestic ownership of national trade policy. However, finding ways of achieving the broad principles of domestic transparency in other countries’ institutional settings is an objective to which Australia’s experience lends considerable support”.