Tag: import substitution policy
The Russian Food Embargo: Five Years Later
In this brief, we report the results of a quantitative assessment of the consequences of counter-sanctions introduced by the Russian government in 2014 – Russian food embargo. We consider several affected commodity groups: meat, fish, dairy products, fruit and vegetables. Applying a partial equilibrium analysis to the data from several sources, including Rosstat, Euromonitor, UN Comtrade, industry reviews etc. as of 2018, we obtain that consumers’ total loss amounts to 445 bn Rub, or 3000 Rub per year for each Russian citizen. This is equivalent to a 4.8% increase in food expenditure for those who are close to the poverty line. Out of this amount, 84% is distributed towards producer gains, 3% to importers, while the deadweight loss amounts to 13%. Based on industry dynamics, we identify industries where import substitution policies led to positive developments, industries where these policies failed and group of industries where partial success of import substitution was very costly for consumers.
The full text of the underlying paper is forthcoming in the Journal of the New Economic Association in October 2019.
In August 2014, in response to sectoral sanctions against Russia, the national government issued resolution No. 778, which prohibited import of processed and raw agricultural products from the United States, the EU, Ukraine and a number of other countries (Norway, Canada, Australia, etc.). The goal was to limit market access for countries, which supported sectoral sanctions. The other rhetoric of the counter-sanctions was to support domestic producers via trade restrictions, or by other words – import substitution.
This brief provides an update of welfare analysis of counter-sanctions based on partial equilibrium model of domestic market. The initial estimations based on 2016 data can be found in another FREE Policy Brief here. This time we compare the consumption, outputs and prices of the counter sanctioned goods as of 2018 relative to 2013. The estimated consumer surplus changes, producer gains and prices are reported in Table 1.
Table 1. Welfare effects of counter-sanctions in 2018 relative to 2013.
Data sources: Rosstat, Euromonitor, UN COMTRADE
* Negative losses correspond to gains
** Negative gains correspond to losses
Green color was used to mark the commodity groups with a noticeable consumption growth in 2013-2018 and red color those with consumption decrease.
Effect on production
From the point of view of price dynamics, on the one hand, and consumption and output, on the other, the studied products can be divided into three groups.
The first group which we call “Success of import substitution” includes goods for which real prices (in 2013 level) increased by 2016 but afterwards, the growing domestic production ensured that by 2018 prices fell below the level of 2013 with a corresponding increase in consumption. This group includes tomatoes, pork, poultry and, with some reservation, beef. For beef, growing domestic production pushed prices down after 2016, but the level of consumption and prices have not yet reached the pre-sanction level.
For the second group, import substitution has not resulted in a price decrease, we call this group “Failure of import substitution”. For products in this group, the initial increase in prices by 2016 was not reverted afterwards. Their consumption decreased significantly compared to 2013, and domestic production either continued to fall after 2016, or its growth turned out to be fragile. This group includes apples, cheese, fish, as well as condensed milk and processed meat.
We call the third group “Very expensive import substitution”. It includes fromage, sour milk, milk and (to a lesser extent) butter. This group is characterized by increase in consumption and output in the period 2016–2018, but real prices over this period still remain very high.
Effect on consumers
By comparing the losses and gains of consumers in different categories of goods due to changes in real prices and real consumption, our analysis provides the following monetary equivalents. For all considered counter-sanctioned product groups, with the exception of poultry, pork and tomatoes, consumer losses are around 520 billion rubles per year (in 2013 prices). In three product groups (poultry, pork, tomatoes), in which there was a decrease in prices and a significant increase in consumption, the consumer gains are equivalent to 75 billion rubles per year. Thus, the total negative effect from counter-sanctions for the consumers amounted to 445 billion rubles a year, or about 3000 rubles for a person per year.
Given the cost of the minimum food basket, defined in Russia as 50% of the subsistence level, the impact of counter-sanctions on the budgets of Russian consumers can be estimated as follows. 3000 rubles account for approximately 4.8% of the annual cost of the minimum food basket. The minimum food basket is a set of food products necessary to maintain human health and ensure its vital functions that is established by law. In other words, one can say that 3000 rubles a year are equivalent to a 4.8% increase in food expenditure for those who are close to the poverty line.
Consumer surplus losses were significantly redistributed in favor of domestic production, totaling 374 billion, or 2500 rubles per year per person. Another 56 billion rubles (or 390 rubles per person) correspond to the deadweight loss, i.e., reflect the inefficiency increase of the Russian economy, and 16 billion rubles (110 rubles per person) is the equivalent of redistribution in favor of foreign producers, who get access to Russian market with higher priced products than before counter-sanctions.
Effect on foreign partners
As a result of the selective embargo, the geography of Russian imports of the affected goods has changed. Traditional suppliers of these goods, primarily from Europe, were replaced by suppliers from other countries due to trade diversion. Given the changes in the composition of importers after the imposition of sanctions, we single out countries that have lost and countries that have gained access to the Russian market. We use the change in trade volumes from the respective countries as indicators of growth and decrease in share of these importers in the Russian market. Below we consider in detail the three groups of goods with the largest gains for importers in 2018 compared with 2013: cheese, apples, butter.
Cheese imports decreased significantly after the imposition of counter-sanctions, in 2018 accounting for only 42% of their dollar value in 2013. The total gain of importers due to the growth of domestic prices in 2013-2018 amounted to 17.3 billion rubles (Table 1) and was distributed among following importing countries: Belarus (78%), Argentina (6%), Switzerland (4%), Uruguay (3%), Chile (3%), other countries (6%). Countries that lost their shares of the Russian cheese market included Ukraine, Holland, Germany, Finland, Poland, Lithuania, France, Denmark, Italy and Estonia. As mentioned earlier, domestic production and Belarusian imports were not able to fully compensate for imports from countries on the counter-sanctions list, and in 2016-2018 cheese consumption in Russia decreased significantly.
Apple imports after the initial drop in 2016 partially recovered in 2018, amounting to 66% of their dollar volume in 2013. The total gain of importers in 2018 compared to 2013 amounted to 15.0 billion rubles (Table 1); it was distributed between Serbia (22%), Moldova (19%), China (13%), Turkey (10%), Iran (10%), Azerbaijan (7%), South Africa (4%), Chile (3%), Brazil (3%) and other countries (9%). Poland suffered the most from the ban on apple imports; it accounted for about 80% of all losses. Other losers from counter-sanctions include Italy, Belgium and France. The reorientation of trade flows did not completely replace Polish imports, so apple consumption in 2016-2018 was significantly lower than in 2013.
Imports of butter in 2018 was also below the level of 2013 (67% of dollar value). The gain of importers in 2018 compared to 2013 amounted to 11.2 billion rubles and was distributed among the following trading partners: Belarus (90%), Kazakhstan (4%), Kyrgyzstan (3%) and other countries (3%). Among the countries bearing most of the negative burden of the diversion of trade, one should mention Finland and Australia.
Conclusions
Five year after counter-sanctions were put in place Russian consumers continue paying for them out of their pockets. While few industries have demonstrated a positive effect of import substitution policies, most are not effective enough to revert the price dynamics.
References
- Kuznetsova, Polina; and Natalya Volchkova, 2019. “How Much Do Counter-Sanctions Cost: Welfare Analysis”, Journal of New Economic Association, N3(43), pp 173-183. (in Russian)
The Economics of Russian Import Substitution
This policy brief discusses the economic mechanisms triggered by import substitution policies, associated losses and conditions that ensure positive economic effects. Numerical estimations of potential effects of Russian import substitution policies indicate a decline in GDP, decrease in output of unprotected sectors and consumers’ welfare losses. We conclude with a discussion of the role imports play in economic efficiency.
Import substitution: pro and contra
Two years after joining the WTO, in the new political reality, Russia began implementing a series of import substitution policies. Supported sectors range from agriculture and production of metal products, to computer equipment and special purpose vehicles. The potential economic effects of these policies are of substantial interest and importance both for researchers, policymakers and the general public. However, they have not yet been quantitatively assessed. This policy brief summarizes the results of a study of these effects conducted at CEFIR in 2016 (Volchkova and Turdyeva, 2016).
Import substitution can be implemented by a range of instruments aimed at creating preferential conditions for domestic producers of imported goods compared to foreign competitors. Barriers to trade are the most common and easily available policy tools. Trade barriers lead to price increase on domestic market relative to the world price of the good.
Domestic manufacturers in the protected industry enjoy higher prices on domestic market, thereby securing higher revenues at the same costs. The protected sector also is able to put into operation those capacities that were generating losses in the absence of protective measures. However, if the economy works at full employment in absence of import substitution, then in order to increase production in the protected sectors, factors should be reallocated there from the other sectors. As a result of the import-substituting policy, producers in unprotected sectors will decrease the scale of production, and some will exit the industry. That is, producers that were efficient enough before import substitution policies will be forced out by those that cannot compete at international prices. From the point of view of welfare economics, this maneuver is accompanied by a loss of economic efficiency.
Economic literature discusses several cases when import substitution can be justified, such as a presence of positive external effects from protected sectors to the economy; learning-by-doing effects in protected sectors; and an infant industry argument. All of these cases imply market failures in the absence of government intervention, leading to lower than socially optimal output of the sector in question. Then, government interventions aiming to increase output – such as import substitution – might bring additional welfare improvement to the economy. If any of these effects do take place then the gain brought by protected sectors may compensate for the loss by the unprotected. To validate any of these cases one needs to perform a thorough and independent analysis of the economy based on very detailed information.
Estimates of static and dynamic effects of import substitution
In order to illustrate the potential effects of import substitution policies in the current Russian situation, we use a static CGE model of the Russian Federation constructed at CEFIR.
Based on publicly available documents (Russian Government’s Decrees №2744-Р 29.12.2015 and № 2781-р 31.12.2015), we identify the sectors that are targeted by the import substitution policy: agriculture and four manufacturing sectors (metal production; machinery and equipment; cars; sea crafts, airplanes and spaceships).
To model the effects of import substitution, we calculate an ad valorem tariff equivalent, which ensures a 10% decline of the volume of import in each of five industries. In order to simulate proposed policy measures, we conduct six experiments: increase in import tariffs in each of five industries individually, and a comprehensive policy change with an increase in all five tariffs simultaneously.
If import substitution policy is implemented not by trade policy instruments but only through producer support measures then it will be accompanied only by changes in relative prices for producers while consumer prices will not be affected and will be determined solely by international prices. In this case, our estimates will represent an upper bound of possible consumers’ losses. Since the distortion of relative prices for producers do not depend on a particular instrument chosen to implement import substitution policy then the consequences for other sectors and for efficiency of the overall production will be the same under trade or domestic policy interventions.
Table 1 shows the results of our calculations. Columns (1) – (5) present the estimates of the effects of the import-substitution measures in the relevant sectors. Column (6) reports the results of the comprehensive policy reform.
Table 1. Consequences of the decline in imports by 10% in the protected sector (s).
| Agriculture | Metals | Machinery, and equipment | Cars | Sea crafts, airplanes and space ships | Tariff change in all industries | |
| (1) | (2) | (3) | (4) | (5) | (6) | |
| Ad valorem tariff equivalent, % | 2.9 | 3.9 | 6.1 | 6.7 | 5.6 | |
| Change in | ||||||
| CPI, % | 0.04 | 0.09 | 0.39 | 0.3 | 0.3 | 1.0 |
| Protected sectors’ output, % | 0.7 | 2.5 | 9.8 | 10.3 | 8.3 | 3.8 |
| All other production, % | -0.2 | -0.4 | -0.5 | -0.2 | -0.5 | -2.3 |
| GDP, % | -0.002 | -0.011 | -0.023 | -0.005 | -0.018 | -0.049 |
| Welfare, % | -0.015 | -0.020 | -0.074 | -0.041 | -0.080 | -0.215 |
Source: Authors’ own estimation.
Our results illustrate the anticipated effect of import substitution policy in economy with full employment. The protected industries increase their output at the expense of other industries. An increase in economic inefficiency is reflected by a fall in GDP.
In order to capture dynamic effects of the proposed import substitution policy, we simulate an import tariff increase in a Solow-type growth model calibrated for the Russian economy. The proposed policies result in a deeper economic decline in 2016 than in the baseline scenario (-0.76% in the baseline scenario and -0.79% in the import substitution scenario), followed by somewhat faster growth in subsequent years due to a lower base. The aftermath of the import substitution policy is still visible in 2020: GDP growth in 2020 relative to 2015 in the baseline equals 2.4365%, while the import restriction in all targeted industries will reduce economic growth in a five-year term by 0.007 percentage points, to 2.4295%. The numbers correspond to the expected reduction in economic efficiency as a result of the import substitution measures.
While numbers in terms of GDP do not look particularly large, the annual losses in GDP in nominal figures correspond to $650 million in value added, which is roughly equivalent to 30,000 jobs lost in Russia due to import substitution. Besides, effect on growth adds to 5,000 more jobs lost over 5 years.
As we mentioned above these losses might potentially be justified by the positive external effect from an increased output of the protected industries on the rest of economy. To ensure this, the selection of industries for protection should have been done through independent expertise based on a thorough analysis of sectoral interaction over time. However, the way the economic policy is formulated in modern Russia, with heavy influence of lobbying groups and very little contribution from independent economic research, we can hardly expect that the industries targeted for import substitution satisfy the objective criteria of positive external effects.
Imports as drivers of competitiveness
Classical trade theory shows that imports are a major cause of gains from trade integration. Modern trade theory complements the classical mechanism by selection effects among heterogeneous firms when only the most productive firms are able to sell in foreign markets (Melitz , 2003).
Keeping in mind that a substantial part of manufacturing trade flows consists of intermediate products that are used as inputs in subsequent production (in the case of Russia, the share of intermediates in imports is more than 60%) then the above reasoning implies that the competitiveness of domestic production is determined, among other things, by the availability of cheap imports.
Numerous empirical studies for many countries confirmed that industries with a higher share of imported intermediate goods are more productive than industries with a lower share (Feenstra, Markusen, and Zeile, 1992). Recent studies, analyzing data at the level of individual firms (Bernard at al., 2012; Castro, Fernandes, and Farolec, 2015; Feng, Li, and Swenson, 2016), confirm that the effect takes place at firm level: firms importing more intermediate goods have higher productivity than firms importing less, other things being equal, which suggests that imports of intermediate goods is an important source for the growth of firms’ competitiveness.
A study conducted for Russian firms showed that labor productivity in Russian companies which import intermediate goods is 20% higher compared to similar firms not importing intermediates (Volchkova, 2016).
On this basis, we have every reason to believe that import is one of the sources of economic competitiveness that enhances effectiveness of the economy. Thus import substitution policies in the absence of objective information and a profound selection procedure for protected sectors, are harmful to the economy. In an open economy, the effect of the firms’ selection and the availability of cheap imports ensure growth of sectoral productivity, but productivity declines in “protected” sectors. That is, while our estimates above assess the direct negative impact on Russian economic output and welfare from inefficient reallocation of factors of production, the implementation of import substitution policies also puts the Russian economy in a disadvantaged position relative to more liberal economies on the international markets due to forgone competitiveness. This creates additional obstacles for Russia on its way to export diversification and sustainable growth.
References
- Feenstra, Robert C, James R Markusen, and William Zeile. 1992. “Accounting for Growth with New Inputs: Theory and Evidence.” The American Economic Review 82 (2). American Economic Association: 415–21. http://www.jstor.org/stable/2117437.
- Feng, Ling, Zhiyuan Li, and Deborah L. Swenson. 2016. “The Connection between Imported Intermediate Inputs and Exports: Evidence from Chinese Firms.” Journal of International Economics 101: 86–101. doi:10.1016/j.jinteco.2016.03.004.
- Melitz, Marc J. 2003. “The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity.” Econometrica 71 (6). Blackwell Publishing Ltd: 1695–1725. doi:10.1111/1468-0262.004
- Pierola Castro, Martha D., Ana Margarida Fernandes, and Thomas Farolec. 2015. “The Role of Imports for Exporter Performance in Peru.”
- Volchkova, Natalya A. 2016. “Prospects of the export diversification:” Dutch Disease “or the failures of economic policy?” in “Seven lean years: the Russian economy on the verge of structural changes: the round table materials” / ed. Rogov. -Moscow: Foundation “Liberal Mission” (in Russian)
- Volchkova, Natalya A., and Natalia A. Turdyeva 2016, “Microeconomics of Russian import substitution”, Journal of New Economic Association, forthcoming (in Russian)