Protectionism and the EIC

All government economic policies, especially protectionist measures, have unintended consequences. Sadly the demands of a few pressure groups easily outweigh the greater good

Protectionist policies are very popular all over the world. Governments are quite fond of anything that favours their citizens over the citizens of another country. It would initially appear to be a political no brainer. Why bother to pursue a policy that appears to harm the locals and help foreigners? Annoying voters in a democracy could mean the end of political power. It could result in social unrest and eventual overthrow for dictators. Instead, it is far easier to pass protectionist restrictions on trade that will only result in unhappy trading partners and interminable litigation within the World Trade Organization. But there is a problem. Protectionist policies while seemingly benign always have unintended consequences, which, over time, backfire and harm those whom they are supposed to favour.
A recent example has to do with the Chinese attempt to protect their production of rare earth elements. The misnamed rare earth elements include 17 elements that are essential for many high-tech devices. Through a concerted policy the Chinese were able to dominate the world supply by driving the price down and their competitors out of business. They now control over 97% of the world supply.

With almost a monopoly on this commodity, the Chinese tried to drive the price up. In September 2010 they halted shipments to Japan, the principal buyer. They also created an internal monopoly. The largest producer, Baotou Iron & Steel Group, took over or bought out smaller mines in the area and the government went on a campaign to close down the many illegal operations.

Initially these methods worked. The price of rare earths sky-rocketed and the local Chinese industry reaped record profits. But the protectionist measures that manipulated prices backfired. Rare earths are critically important for some products like fluorescent lighting and military radars, but these products use minimal amounts. About one-fifth of the demand came from low-end applications like magnets. As the price of rare earths increased, manufacturers of everything from white goods to cars switched to use cheaper iron magnets in their electronics. The result was that prices slid by 30% since July 2011. Besides driving the price down, the Chinese restrictions increased smuggling, which deprived the government of revenues.

Even worse than substitution, the Chinese restrictions forced customers to find alternative sources. Since the rare earths were a necessity in certain military application, the US passed laws to subsidise production outside of China. While in Japan, large corporations like Toyota have financed exploration in other countries, which will rob the Chinese of their monopoly.

China is not the only advocate of protectionist measures. Although often easy to institute, once in existence they are very difficult to reform as India recently illustrated.

India’s retail sector is highly fragmented; made up of tens of millions of mom-and-pop shops and powerful middlemen traders who link farmers to consumers. The inefficiency of this system result in what the Times of India called a “criminal waste of food” that occurs due to the lack of integrated storage. The inefficiencies increase the final price and deprive farmers of the potential value of their produce.

Recently India’s Congress party attempted to open up the $450 billion retail sector to hyper-efficient western marketers like the American company, Wal-Mart, the British firm, Tesco and ubiquitous Swedish furniture firm IKEA.  The law stopped short of giving the foreigners unrestricted access, but required them to partner with local firms like Pantaloon, Shoppers Stop, Koutons and Trent. The reform lasted a mere nine days. The political uproar created by local and opposition politicians forced the government to withdraw the programme. The result is that the Indian consumer is deprived of less expensive higher quality food and the local partners and shareholders were hit with losses of up to 10%.

The irony is that the protectionist policies in India are nothing new. It is just that the shoe is on the other foot. Three hundred years ago the protectionist policies were those of the United Kingdom trying to protect local weavers from a cheaper and better product—cotton textiles imported from India by the East India Company.

The East India Company started to import cotton because they could not get access to the spice trade which was monopolised by the Dutch. So they searched for an alternative—Indian cotton. But the cotton soon drove British silk and wool weavers out of business and they successfully petitioned Parliament for restrictions. The final restrictions only allowed the importation of cotton thread. But this restriction not only increased smuggling, it also encouraged entrepreneurs to create cheaper ways to use the thread. The result was the industrial revolution that put the weavers out of work for good.

All government economic policies, especially protectionist measures, have unintended consequences. Sadly the demands of a few pressure groups easily outweigh the greater good.

(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages. Mr Gamble can be contacted at mailto:[email protected] or mailto:[email protected])




5 years ago

read $ 60 billion instead of $ 6 in comments of Dr Alok Sharma. Please note 20% of total retail business of india is 100 billion dollars and 10 % margin on it is 10 billion dollars. No 51% fdi in multi brand retail will harm other nations by $ 5 billion a year.Yesterday india allowed 100% fdi in single brand retail. But india is engaged in reverse protectionism of 450 billion dollar as imports each year forgetting indigenous cheaper substitutes . So india is not adopting protetionism but it is involved in fatal liberalization.

Dr Alok Sharma

5 years ago

India is a country showing reverse protectionism that is it is protecting the businesses and jobs of rich foreigners and harming its own. We are too liberal for bullion imports of about $60 a year sending Rs 312,000 crore about 5 % of GDP to rich bullion exporters. Banning which can result in safer investment of the said amount in Indian real estate, bonds, FDS creating indigenous business helping our poorest nation of the world. We are importing oil, coal, nuclear, solar and allied capital goods worth $ 150 or Rs 780,000 crore 10% of GDP each year from other richest nation and are not using indigenous free infinite solar, coal and hydro increasing cost of energy in this energy starved and inflation prone poorest nation. We are eating costly almonds and fruits and throwing our own cheap food. Only god can save this country with wise policy makers and wiser public. Come on yaar use cheaper indigenous stuffs in place of costly imported things to help mother India.

L&T Prudence Fund: Would it be a prudent choice?

To succeed in investing, investors must be conscious of their risk profile and choose carefully, while making risky equity investments, or putting money in relatively secure debt instruments. Though this would be a less risky time to enter the market, one should see how the balanced scheme of L&T performs before investing

L&T Mutual Fund recently filed an offer document with the Securities and Exchange Board of India (SEBI) for launching an open-ended balance scheme—L&T Prudence Fund. The fund would invest in both equity and debt securities, with a higher weightage to equities. The scheme would be available in two plans—Moderate Plan and Aggressive Plan. The Moderate Plan would invest in large-cap equities defined as those companies which have market capitalization more than that of lowest constituent of S&P CNX Nifty index, or highest constituent of CNX Mid-cap index (whichever is lower). On the other hand, the Aggressive Plan would invest in a diversified portfolio of equity stocks, with medium- to long-term potential. For both the schemes 60%-75% of the assets would be invested in equities while the remaining would be invested in debt, money market instruments & government securities.

How have other balanced funds performed in the last one-year, three-year and five-year periods ending 3 January 2012? Out of the 20 balanced funds that we analysed, just seven of them were able to out-perform the benchmark (Crisil Balance Fund index) on all the periods. And five of them underperformed the benchmark in all periods. Half of these schemes underperformed their benchmark for the one-year period. In the three year period, majority of the funds outperformed the benchmark whereas in the five-year period, 11 of them have underperformed the benchmark.

If we compare the returns to the movement of the Sensex, the funds have performed the best when the index has given the maximum returns. In the three-year period the Sensex returned 17% and 14 of the 20 schemes outperformed their benchmarks. The same can be said for all equity mutual funds— they performed well when the market has done well. The actual test comes when the market is flat or in a bearish mood.

How have the L&T funds performed in the same period? In the five-year period, three out of the four equity funds of L&T have underperformed their respective benchmark. L&T Growth Fund and L&T Midcap Fund have outperformed the benchmark in both the one-year and three-year period.

Funds ranked as per one-year performance.
Figures in red have under-performed the benchmark

To succeed in investing, investors must be conscious of their risk profile and choose carefully, while making risky equity investments, or putting money in relatively secure debt instruments. However, most investors find it hard to decide what the ideal asset allocation should be, and they are, therefore, often led to balanced fund schemes of mutual funds that are supposed to provide a blend of capital appreciation and income generation. Such funds cater to investors who are looking for a mix of income, capital appreciation and safety. The fund managers take a call on the allocation and realign the portfolio depending on their market expectations. For instance, if equity outperforms, the fund manager will book profits in stocks and put these gains into debt instruments to maintain the asset allocation. But as we can see, taking a call is not as easy as it seems. Only a few fund managers are equipped for the job. Though this would be a less risky time to enter the market, one should see how the balanced scheme of L&T performs before investing.


Shrinking trade surplus may help China in yuan dispute

China’s trade surplus may narrow to an eight-year low in 2012 as slowing external demand undermines exports, a shift that may help the nation rebuff overseas criticism for maintaining an undervalued exchange rate.

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