Foreign trade in Iran’s economy requires a strategy to free itself of the cycle of mundane decisions.
Economics teaches us the principle this strategy should be based on, which is promotion of competitiveness with the aim of increasing efficiency. Lifting bans and replacing them with tariff is the tool decision-makers have at their disposal to achieve this goal.
Hossein Abbasi, a lecturer in the University of Maryland’s Department of Economics, prefaced his article for the Persian daily Donya-e-Eqtesad with this note. A translation of the text follows:
Economics prefers free trade over restricted trade because it creates competition. If trade restrictions are to be imposed for whatever reason — political or economic — then tariff restrictions should be employed and not bans or quotas. Economic theories and the experiences of other countries show that the economy will become competitive, if appropriate tariffs are set and reduced gradually.
Economic theories are based on the “motivation” of people. The value of competition is based on the same argument: individuals, enterprises and companies will be motivated to continuously improve their products only if they see the risk of losing a market to more efficient producers. This can be explained using an economic model and based on the comparison of the willingness to pay the price in the conditions of quantitative restrictions or tariffs.
A large number of goods traded between countries have different quality and prices. Based on their interests and financial status, people opt for a cheaper but lower-quality product, or a more expensive product with a higher quality.
Many of the items that Iranian consumers buy have both Iranian and foreign counterparts; the foreign brand usually has a higher quality and the customer is willing to pay a higher price for it. Of course, some foreign brands are of lower quality than domestic goods, but this does not counter the principle because the basis of the argument is the competition high-quality goods create.
Ban Versus Tariff
Now imagine the government placing a ban on the import of a commodity. How will this policy affect producers’ incentives? In this case, a part of demand for foreign goods will be met through smuggling. The price of contraband includes smuggling costs that make it expensive. The markets will no longer offer foreign products and so the consumer who is willing to pay more will now shift to domestic products.
With the ban on imports, domestic producers choose one of the two options depending on market conditions. They will possibly increase their profit by imposing monopolistic prices without increasing their output. They are also likely to introduce more products to the market. Either way, customers who are willing to pay a high price will inevitably buy a product of lower quality or the domestic producer will have no incentive to increase the quality of its products. The fact that they are certain that whatever goods they produce will eventually be sold in this limited market will kill their motivation to increase the quality of their products.
Now imagine the same market with tariffs. Tariff increases the price of foreign goods but keeps them available in the market. With the increase in the price of foreign goods, similar to the previous scenario, a group of customers will switch to cheaper goods and some will keep buying foreign goods.
Unlike the previous scenario, customers will not lose their power of choice. If the domestic producer cannot supply a product that is worth the price, i.e., the price being reasonable given its quality, the customer will prefer to buy the foreign product with a higher price. Here, the producers will see the threat of losing customers and the market, which will be a strong incentive for them to increase the quality of the products commensurate with the price, either by increasing the quality or lowering the price.
The above analysis is, of course, a simplified version of the problem. The truth is that the elimination of competition will kill producers’ motivation to increase quality and reduce costs. Import bans and quantitative restrictions, including setting import ceilings or imposing strict conditions on imports, eliminate competition and take away a customer’s choice. This is while imports accompanied with tariffs give customers the power to punish the producers and strike them out of the market if they fail to supply a product worth the price.
Setting appropriate tariffs to increase competition is a specialized job; it depends on the type of goods. However, it should not be so high to hinder imports. The costs it adds to the price of goods should be lower than the cost of smuggling goods.
A look at tariff rates in the world shows that most countries engage in trading goods at a single-digit tariff rate and Iran should also move in the same direction. In addition, tariff rates should be reduced over time to bring domestic products closer to foreign high-quality goods in terms of price and quality.
Rise of Smuggling
What has happened in Iran vis-a-vis many banned goods is that large-scale smuggling becomes rampant, or import liberalization is applied temporarily. In this case, the customer has the option to choose; the resulting welfare has been higher than the time when ban on imports is in place.
Smuggling or temporary import has created corruption and uncertainty for the producer and consumer. Furthermore, the government loses the income it could earn from setting tariffs, while it also has to spend resources on fighting smuggling. At times, the government has made import conditional on provisions that end up being anti-competitive. For example, it allows domestic producers to import an item that they themselves are producing. Such a course of action not only fails to create competition, but it also increases the producer’s monopoly.
A tariff rate that imposes a higher cost on imports than on smuggling goods or setting conditions, which practically make imports impossible from official ports of entry, is synonymous with banning imports and has no effect on promoting competitiveness. Conditions like these are usually applied under the pressure of domestic producers who resort to anything to avoid competition.
We’ve heard many senior officials praise production and employment. This is while most producers complain about the government’s policies regarding production. The main idea is to blame government intervention in almost all sectors.
The right policy is to end all these interferences by increasing competition and paving the way for the growth of more efficient producers and eliminating inefficient producers. Using the import tool without quantitative restrictions and only through applying tariffs can help us reach this goal.
The Iranian government is not ready to reduce interference to increase competition in many markets for political reasons. Even if the removal of all restrictions is not possible, the government can remove all interference regarding some goods that are less sensitive and instead increase competition by applying transparent, declining import tariff rates over time. By identifying one’s strengths and weaknesses, this policy can eventually be applied to other economic sectors.
