Trade and Labour Regulations: The Twin Evils

In the early 1950’s development economists Raul Prebisch and Hans Singer came up with an economic strategy for developing countries, which they called ‘import substitution industrialisation (ISI).’ They were successful in persuading the governments of several developing countries that adopting the strategy would make their nations more prosperous. Some followed the strategy with almost religious zeal. High tariff walls formed a key element of the scheme and the substantial number and variety of tariffs still retained by developing countries is largely a hangover from this fervour. However, these so-called ‘safeguards’, as they are now almost affectionately called, are by no means the solution to the problem of poverty. Rather, they impose significant costs on a majority of the country’s people and reduce trade with potential trading partners.

Due to the small markets in most developing countries, domestic producers are faced with a dilemma under ISI protectionist policies. Either the number of firms producing a given good must be very small, or the size of individual plants must be well below the size required for minimum efficiency. If the number of firms is small, the absence of competition will result in low-quality high-cost production. On the other hand, if the number of firms is large, they produce in small quantities, restricting their ability to exploit economies of scale. Countries that adopt the alternative of open, liberalised trade regimes, allow their low-cost producers to expand their outputs well beyond what is demanded in their domestic markets, which in turn creates opportunities for them to sell part of their production in foreign markets.

Recent trade statistics for Africa show that the continent’s trade with the rest of the world has been declining. UNCTAD notes that Africa’s share in world exports fell from about 6 per cent in 1980 to 2 per cent in 2002, and its share of world imports from about 4.6 per cent in 1980 to 2.1 per cent in 2002. The substantial decrease in trade can be attributed almost entirely to the trade policies applied by many African governments. South Africa is not among them. The apartheid government erected formidable trade barriers, which since 1994 have been steadily whittled away, increasing the ability of local firms to trade with foreigners. While SA consumers have benefited considerably from reductions in tariffs, there have been negative consequences for previously protected firms and their employees. Such firms either have to improve their efficiency to remain competitive or the entrepreneurs and workers have to deploy their capital and labour in alternative enterprises, which is a difficult and painful process.

Many African countries have hidden behind myriad protectionist barriers for decades, justifying their actions with infant industry arguments. But the question that is never answered is: when will these infant industries ever grow up? Inefficient industries hiding behind protectionist barriers consume resources that could be more efficiently utilised elsewhere and consumers suffer because they have to pay high prices for locally produced products and are denied access to lower-priced imported goods. Import-substituting policies have therefore imposed substantial costs on African consumers and greatly reduced the well-being of the continent’s citizens. It has long since been recognised that import substitution is a failed strategy. The dismal economic performance of the Latin American countries as compared to the success of the South East Asia countries bears testimony to the wisdom of following more outward-orientated trade policies.

When governments adopt protectionist strategies they cannot avoid making arbitrary decisions about which industries to protect, inevitably based on inadequate knowledge, especially about future economic events. This ‘cherry-picking’ as it is commonly called, often has very costly consequences for citizens. A more open trade regime results in greater reliance on the market, increased domestic competition, and greater overall efficiency.

Trade barriers are, of course, not limited to developing countries. Developed countries such as E.U. members have persistently prevented access to their markets for commodities in which African countries have a comparative advantage. A World Bank study estimated that European Union trade regulations are costing African exporters approximately US$400 million in exports of cereals, dried fruits and nuts each year.

Trade liberalisation by both industrialised and developing countries is needed to reduce poverty in poor countries. The World Bank estimates that the gains from eliminating all barriers to merchandise trade range from US$250 billion to US$680 billion per year. As mentioned earlier, everyone gains as a consumer, but that is little comfort to firms and workers currently unemployed in industries such as clothing and textiles, which have to compete with Chinese producers. Can the South African government protect them? Not if it wishes to see increases in exports to China of the products in which SA does have a comparative advantage, such as the commodities for which the Chinese economy has a ravenous appetite.

What can the government then do for workers that lose their jobs in industries that are-out-competed on our domestic market by lower-cost foreign producers? Those individuals that have lost their jobs have been knocking on the wrong government department’s door. They should be focusing their attention on the Ministry of Labour. If labour laws became more flexible, moving from unemployment to employment and from one job to another would be much easier. Couple this with a more open free trade regime, which makes foreign investors feel welcome, and unemployment would be substantially reduced. Many employers are not hiring workers because the costs of compliance with the labour laws have become excessive. In a labour surplus economy like South Africa’s, workers should be allowed to move freely on their own negotiated terms without unnecessary official interference. As in free trading markets, free labour markets tend to produce the greatest good for the greatest number, and that is surely what most South Africans want.

Author: Jasson Urbach is an economic researcher at the Free Market Foundation. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the members of the Free Market Foundation.