Price of Replacing Georgian Imports with Local Production

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Olga Łabendowicz

After a recent TV address of Georgian Prime Minister Irakli Garibashvili, it became known that the state’s efforts in 2014 and the coming years will be focused on the implementation of an import replacement policy. According to the prime minister: “It is a shame when imports account for 80% of the net export structure.” A special matter of concern is the import of agricultural produce, especially during the winter period when production in Georgia in this regard is very low. The aim of this article is to show that the state policy of replacing imports with local production is more likely to impede economic growth than to promote it and, as a result, the welfare of the population will worsen rather than improve.

The Georgian government is claimed to be looking into the demand on those imports that must be replaced with local production in the future. The finance minister’s opinion about the devaluation of the national currency exchange rate is indirectly linked to this issue. Finance Minister Nodar Khaduri assumes that the devaluation of the Georgian lari against foreign currency might even prove beneficial. By saying that, he means that goods will become expensive for importers, thereby creating a favorable competitive environment for local production. Actually, subsidies in the agricultural sector, discussions about a draft law on agriculture insurance, and the budget for 2014, all indicate that the Georgian government intends to replace, as a first stage, the import of agricultural products with local produce and also to encourage the development of food processing, which accounts for an insignificant share in the structure of imports. However, the attempt to decrease imports in such a way will only lead to a slowdown of economic growth.

That the level of the economy in Georgia is very low does not require much corroboration; this is even clear from the net export structure. However, this does not mean that changing the net export structure will automatically improve the level of economic development. No one doubts that both the prime minister and other public officials want to improve the situation. They have huge authority and, consequently, power. They also believe that by using that power it is possible to influence various economic indicators and thus accelerate economic growth. In reality, however, their political decisions bring about negative economic results that outweigh the positive results obtained through the government’s efforts. In reality, it is very easy to slow down economic development, whereas it is impossible to speed it up.

Do I oppose the replacement of imports and the development of local production? Quite the contrary. The key indicator of economic growth is the amount of goods and services produced by a society. The greater the amount by which exports and local production increase, the more the living conditions of the population improve. One does not require any special education in economics to understand this basic rule. A question thus naturally arises: What is wrong with the state promoting the replacement of imports with local production through influencing the net export indicator? The issue is much more complicated than it seems. The answer requires us to establish and analyze the cause and effect relation between the economic processes correctly.

The economy is created by people undertaking mutually beneficial transactions. Every citizen participates in one way or another in the formation of the economy. The number of private initiatives, their frequency, and the benefit derived from these transactions determine the size of the economy. The number of private initiatives increases when (within a business-friendly environment) citizens manage to generate such projects that create goods and services that are marketable on international markets. This entirely depends on the knowledge, skills and qualifications of the people.

The net export structure is something which provides the information that, at a given stage of development, the citizens of the country decide to buy those goods and services that are most advantageous for them given their family budgets. The specifics of demand shape the structure of supply. All entrepreneurs try to meet the demands of their clients and offers them goods at a price and quality that the customers seek. Nevertheless, the increase in wealth has nothing to do with the amount of imports. The increase of wealth depends entirely on how society handles the limited resources available to it.

A high share of imports indicates that local production is uncompetitive at this stage. An entrepreneur who spends capital to carry out imports could have used that capital for generating local production. However, given the type of demand from customers on the market, importing is more advantageous for the entrepreneur. During imports, foreign currency is exchanged for products. The supplier of foreign currency is a customer. Consequently, customers manage to save that amount of foreign currency needed to finance current imports. The amount of goods and services created inside the country are sources of accumulating foreign currency.

People will be able to better satisfy their needs not with the replacement of imports with local production, but with the wealth created inside the country being increased. These two categories cannot be equalized as imports may be replaced with local production so that the wealth remains unchanged or may even decrease. Consequently, in terms of cause and effect, the increase in wealth has nothing to do with the amount of imports. The increase of wealth entirely depends on how society handles the limited resources available to it.

Naturally, the increase in wealth causes changes in the net export structure. In particular, customers purchase more local products than imported ones and, as a result, the share of imports gradually decreases. Thus the cause is the increase in wealth, whilst the effect is the net export structure, not vice versa. Consequently, replacing imports with local production does not mean that the wealth of people will increase. A rational use of limited resources depends on who handles those resources.

Some people can use this or that resource better than others. The central issue here is to give the right to handle this or that resource only to those who can best manage them and create greater wealth by using the least resources. The free market mechanism deals with this issue perfectly well. The efficient redistribution of resources is possible only within a society based on private property. Today, this issue is no longer debated – even the most radical critics of free market agree with this opinion.

How efficiently a person uses resources depends on their knowledge, skills, qualifications and ability. Education is the most expensive resource, the insufficiency of which results in the insufficient growth of wealth. Thus, if the state thinks that the economy is not growing at a desired level, it must seek the problem in the level of education of society, not in the net export structure. This is the reality at our current stage of development and it is impossible to speed up progress. This is the natural tempo for the development of society and any generous intentions or motives to accelerate matters will actually only slow down economic development.

The state itself does not create anything, but it participates in the redistribution of public wealth. Part of the wealth becomes public property through taxes, which is used by that group of people who win political elections. As a result, public servants acquire the right – and a huge amount of power – to dispose of public resources. This power encourages people to interfere in the free market mechanism; they sincerely believe that they can accelerate progress and better ensure social welfare.

When free trade is restricted, the state of consumers will deteriorate whereas that of producers will improve. However, overall economic welfare deteriorates because the losses to consumers are higher than the benefits to producers. Lord Acton’s famous expression that power corrupts is not really connected to the fact that public servants use public resources to meet private interests. The amount of money embezzled for meeting private interests comprises an insignificant share of the Gross Domestic Product and does not influence the process of creating wealth in any significant way. Quite the opposite. The most dangerous public servants are those who use their power with sincere intentions to alter the structure of transactions occurring among people. The structure of transactions changes when the economic decisions of powerful politicians artificially create an environment that differs from that existing before the intervention. Politicians think that the welfare of people will increase to a greater extent if they interfere. The replacement of imports with local production is one example of such an intervention. The state can, of course, change the structure of net exports. However, the attempt to decrease imports in such a way will only lead to a slowdown of economic growth. The state can employ numerous instruments towards this end. Let’s discuss several of them.

Depreciation of the lari exchange rate

The current state of the foreign currency market is largely conditioned by capital outflow. However, a decrease in the rate of refinancing and an increase in the amount of lari has contributed to this process. The nominal economic growth observed in November and December 2013 was a form of short-term euphoria and inflation awaits us ahead. The depreciation of the lari increases the price of imports because importers need larger amounts of lari to purchase foreign currency and carry out imports. This situation creates favourable grounds for local production to develop because it becomes possible to replace imports, which have become expensive.

This factor will also contribute to the increase of exports because the same amount of lari is worth a lesser amount of foreign currency and, consequently, products taken out of country are cheaper. Consequently, the depreciation of the lari affects the structure of net imports. Exports will increase and imports will be partially replaced by local production. More interestingly, will the wealth created increase and how will the welfare of the population change? As a result of the depreciation of the lari, one segment of society reaps benefits at the expense of another. Those who suffer are importers; citizens who have loans denominated in foreign currency, but their income in the national currency; citizens who have savings in the national currency; and the entire society which has to pay more because of increased product prices. Those who benefit are entrepreneurs that have replaced the importers with exporters.

In total, the damage exceeds the benefits because to meet the same amount of demand people need higher incomes. However, the growth of incomes is less likely to be achieved because those who are most damaged are those who managed to create the wealth, whereas the beneficiaries are those who did not participate in this process as much. The resources are thus shifted from a competitive to an uncompetitive society; which puts an end to the illusory attempt to create wealth quickly.

Restriction of imports

The restriction of imports is one of the ways to stimulate local production. Import takes place when the price of a local product exceeds the international price of the same product. By means of imports, the prices of products will decrease until they drop to the international price of those products. As a result, the welfare of consumers will increase whilst the level of local production decreases. In other words, the state of producers will deteriorate while that of consumers will improve. All in all, free trade increases the living standards of the nation because the benefits to consumers exceed the losses of the producers. And vice versa, when free trade is restricted, the state of consumers will deteriorate whereas that of producers will improve. However, overall economic welfare deteriorates because the losses to consumers are higher than the benefits to producers. Thus, the net export structure can be changed within a short time span, but it will come at the cost of worsened economic welfare.

Subsidizing

The aim of subsidies is to assist certain businesses at the expense of those citizens who have succeeded in developing their businesses. Subsidies run counter to the philosophy of business development because part of the income viewed as a source of investment for innovative business projects gets distributed among those citizens who cannot create such business projects. This slows down economic activity and, with it, the speed of economic growth. While it is possible to replace some imports with local production through subsidies, the benefits from such a move will be much lower than those lost opportunities that would have better contributed to economic growth.

Social investments at the expense of what?

The source of social investments is social savings. Saving occurs when tax (and customs) revenues exceed social costs within a given space of time (creating a budget surplus). In this case, there must be a substantiated vision that social savings, which have been transformed into investments, are more advantageous than private savings, which are also viewed as a source of creating new business projects.

There was no budget surplus over the period of the last four years. Nor did the annual average rate of economic growth allow for the planning of a surplus budget. Hence, no social savings have been created. In such a case, the source of investment is not social savings, but other planned social projects which are no longer being implemented or/and domestic and foreign debt. We, the taxpayers, want to know which projects have had their financing rejected; what the benefits of those projects would have been; and by how much the benefits of the investment exceed the benefits of those rejected projects. To put it simply, this requires a cost-benefit analysis which, despite my best efforts, I have failed to secure. No previous Georgian government ever undertook such an analysis and it is extremely unfortunate that the new government is following that defective tradition.

Akaki Tsomaia
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