Is New Zealand fighting a wave of protectionism?

Protectionism is a scary thing during a global downturn. A bunch of nations trying to “protect” their own interests can turn a bad situation into a worse one.

New Zealand wants to fight off what it sees as protectionism – namely subsidies for dairy farmers in Europe. However, although there is too much protectionism out there I’m not sure our argument against this set of policies is watertight.

If we think that the current shock to dairy prices is temporary, and that dairy prices will come back when the current massive increase in supply works through the system, then it makes sense for Europe to temporarily subsidise farmers in the face of a MASSIVE CREDIT CONSTRAINT.

Industries all around the world are struggling to sort out their cash flow because of a freeze up in lending. If the firms are still profitable given the expectations of future prices, then it makes sense for domestic government to prevent the industries from failing.

Do you think this type of intervention is defendable – discuss 😉

  • insider

    Well if they can do it for cars and do it for banks….

    Also Key has said he is looking at aiding certain businesses through the hard times. Will that be a subsidy in all but name?

  • “Well if they can do it for cars and do it for banks”

    You’re completely right, the argument for the car industry is exactly the same. For banks it is a little different – a failure by institutions has made the asymmetric information problem in the market light back up, which is an explicit market failure.

    “Also Key has said he is looking at aiding certain businesses through the hard times. Will that be a subsidy in all but name?”

    Indeed it is the same thing – it is strange that we can say that we will do it, but we hear about other people doing it and get wound up …

  • insider

    Isn’t the real risk not of subsidies but that short term releief measures get ‘institutionalised’ and become long term, and all the free market work done till now gets unwound in a few short months as the US and Europe look to stem the outsourcing to China and maybe do a bit of strategic damage to its growth prospects on the way.

    The big thing will be who will take a deep breath and step off the down escalator.

  • “Isn’t the real risk not of subsidies but that short term releief measures get ‘institutionalised’ and become long term”

    Definitely, very good point – and that is something we should be vigilant against.

    Also note that a temporary subsidy will hurt NZ – as it will keep the price depressed for longer (by creating extra stores of commodities). However, I think other countries have a case if their aim is to protect normally efficient industries in the face of a massive failure in credit markets.

  • What would Hayek say

    Additional point to risk of institutionalising subsidies as long term income protection.

    What is the underlying objective of the EU and is a subsidy the best use of resources to achieve it. That is, since capital is scarce, is throwing money at farmers (and any other business, union, lobby group) ging to be the best use of those scarce resources. Or would other measures be more effective at providing short term and long term relief.

    On the plus side protectionism normally benefits existing monopolies (as well as create new ones) and those sectors of the economy that are able to extract regulatory rents due to political lobbying. So it creates a short term stimulus for lobbyists and political relations people – one way to address unemployment of the socially noisey groups (if being really snarky would say journalists with limited financial skills but good spin skills).

    I’d suggest a tax on monopolies but since they can pass that straight through to the consumer, i’ll by-pass shooting myself in the foot twice. That way i might at least have some cash to invest in the monopoly and at least get some return on my wider social losses.

    Alternative uses for government expenditure could be through productivity competitions (i.e. a 22nd equivalent to prizes for powered flight and the chronometer) or a contestable tax credit fund that requires business to enter and auction for tax credits possibly set up like the UK’s spectrum auction. That way the sector that most values the tax credit and therefore most likely to provide higher returns to society (via productivity/employment/corporate tax revenue) receives the benefit. The auction would establish the price/value of the credit (or susbidy since they effectively are the same) to society without the need for political lobbying.

  • I’m not sure subsidies for the car industry are a good thing either.

    I second Insider about the risk of short term relief becoming longterm and you about the impact on price.

    If NZ still had subsidies we’d probably still have more than 60 million sheep instead of the fewer than 40 million we now have and the dairy boom which contributed so much to our economy in the last few years would have been much weaker.

  • Hi What would Hayek say,

    I would note that the only justification for these types of tariffs stems from a “temporary” shock to prices and a binding credit constraint – in such a case it would be hard for us to design a static mechanism that gives market pricing.

    However, if the subsidy had to be repaid in say, five years, that would be a different story 😉

    As a result, maybe NZ should call it “protectionism unless the subsidy is ultimately repaid” – I think that would capture the difference between temporary aid and true protectionism

  • Hi Homepaddock,

    There is definitely a risk that the subsidy gets institutionalised – and that is something we can fight. However, they have more of a case when they are talking about a short-term subsidy in the face of credit constraints – as they aren’t propping up inefficiency.

    “If NZ still had subsidies we’d probably still have more than 60 million sheep instead of the fewer than 40 million”

    That is a long term subsidy that distorts market prices – that is different to what the EU and Ireland have discussed. If it was efficient to have 60 million sheep given prices, but a short-term shock meant that the industry was not able to get credit to look after itself the government could have a role as lender of last resort – that is what a short term subsidy is.

    Of course, I don’t trust their long-term intentions either – but instead of yelling SUBSIDY and PROTECTIONISM we should be clear with our critique – as they can justify it in a way that doesn’t come off as strict protectionism.

    Again, demand that they make loans to there farmers that have to be repaid – that way they are easing the credit constraint and we still have a clean market 😉

  • Loans that have to be repaid, or other help which isn’t tied to production are certainly better (or less worse) than subsidies which incentivise producing more than the market wants.

  • “Loans that have to be repaid, or other help which isn’t tied to production are certainly better (or less worse) than subsidies which incentivise producing more than the market wants.”

    Also be mindful of the difference between the long and short run in: In the short run a glut in supply and a moderation in demand has seen prices plummet, but given credit constraints and limited ability to store said milk this price does not represent the required long-run capacity of the market. Helping to prop up an otherwise efficient industry in the case of market failure (namely the credit market) is not necessarily a bad thing – as long as it is temporary.

    Not doing so would see an undersupply of milk (given forced destocking which would reduce global capacity) when the market gets back to normal – although that would be good for us, it is not necessarily the best thing for the world.

    Fundamentally, we are comparing two equilibrium that are not first best here – so we can’t definitively say “subsidies reduce global welfare” as the credit constraint means that the “free market” solution does not give the optimal allocation of resources …

  • What would Hayek say

    Re loans that have to be repaid. I like that, IFRS would then require the EU governments (if they are using IFRS rather than cash accounting) to record the obligation and include the forgone stream of interest payments. Bit like NZ’s student loans.

    Will then be interesting to see how the bond market responds. At the end of the day it is all a cost on society/government and if your going to provide a subsidy (whether by tax incentive, cash transfer etc -) it should be transparent.

    Future reform in case of institutionalisation becomes easier because of the transparency and it also provides a political constituency (either the international bond market or the general public) to provide discipline.

    Still have a general dislike of subsides, but if it is a case of the least worst choice, then maybe. Normally the harm massively outweighs any benefits. Have to hope its not an incredibly leaky bucket. Did I say i’m still sceptical?

    If the underlying issue is farmers accessing credit markets (to provide debt funding for farming operations which would normally be provided by a bank) aren’t we talking about providing liquidity and trust support to the financial market, possibly establish a new bank rather than propping up the existing ones which are just sucking up liquidity support?

    Another alternative option – How about a government guaranteed/supported escrow account as a mechanism to support confidence in credit transations if people are worried about whether the other party will supply goods in return for payment sent?

    As said above – deeply suspicous of straight out subsidies. History shows they are too often the knee jerk policy tool and have a bad habit of being entrenched, with costs heavily outweighing any benefits.

    The UK corn laws are an example of good intentions having very bad outcomes.

  • John

    Muldoon tried to make NZ self-sufficient and what occurs to me is that we should aim to have a system to weather hard times.
    Suppose we were all Greenies by nature and were satisfied with modest green houses and suburbs where we live well but consume less, enjoyng our natural capital (such as a bush on a lawn with a bee buzzing and a spider making a web)
    If we had gardens we could eat and with sheep we could knit sweaters. Perhaps the problem is free choice which means a sector of the economy devoted to (what a greenie would call) “junk”. If our society (and economy)was like that we would have achieved sustainability and then we would be back to worrying about the weather and keeping fungus out of the potatoes?

  • Hi What would Hayek do,

    “possibly establish a new bank rather than propping up the existing ones which are just sucking up liquidity support”

    I buy your point – however, setting up a bank for a temporary credit crisis seems like a bit too much. The government can act as a lender in the face of failure in credit markets – but setting up a full institutionalised bank seems excessive.

    “As said above – deeply suspicous of straight out subsidies. History shows they are too often the knee jerk policy tool and have a bad habit of being entrenched, with costs heavily outweighing any benefits”

    Very true. However, if we are going to make an argument against what the EU is doing we have to understand what they are doing now – and in what ways it is justifiable.

    We have discovered that a loan agreement may be more efficient – and easier to reverse. That gives NZ something to suggest …

  • Hi John,

    Muldoon did try to make NZ self-sufficient – however unless he believed we had infant industries that could be efficient this made little sense (outside of fears for international trade – a more political economy view of the scenario).

    What Muldoon did do was set prices for our agricultural products where he thought they would be – however, he didn’t realise that the real price for those products was lower, and so the industries were now being subsidised by the general economy.

    “Suppose we were all Greenies by nature and were satisfied with modest green houses and suburbs where we live well but consume less, enjoyng our natural capital”

    If that was the case, then people would have placed a higher value on the things that are related to that.

    I don’t agree with the assumption “suppose we are all greenies” as ultimately, the sheer majority of people in NZ aren’t …